Investment and other revenue decreased by $3.3 million or 26.4% due to a decrease in the average investment yields during the period.
Included in military contract expenses are favorable development of prior years' estimates having an earnings impact of $4.6 million for the year ended December 31, 2002 and unfavorable development on prior years' estimates having an earnings impact of $2.1 million for the year ended December 31, 2001. In addition, favorable development of prior years estimates having a non-earnings impact were $16.5 million and $11.9 million for 2002 and 2001, respectively. The non-earnings impact was offset by a reduction in military contract revenues pursuant to the gain/loss risk-sharing with the government. The favorable development was a result of claims being settled for amounts less than originally estimated.
Interest Expense decreased from $15.7 million to $7.7 million, a decrease of $8.0 million or 51.4%. Interest expense related to the revolving credit facility decreased $3.7 million due to a decrease in the average balance of outstanding debt during the period and a decrease in the weighted average cost of borrowing. Our average interest rate on the revolving credit facility, excluding the amortization of deferred financing fees, our interest rate swap agreement and fees on the unused portion of the credit facility was 4.6% in 2002, compared to 8.1% in 2001. We incurred a fee of 0.5% on the unused portion of the
Our HMO and insurance subsidiaries are required by state regulatory agencies to maintain certain deposits and must also meet certain net worth and reserve requirements. The HMO and insurance subsidiaries, including the discontinued operations, had restricted assets on deposit in various states totaling $36.5 million at December 31, 2003. The HMO and insurance subsidiaries must also meet requirements to maintain minimum stockholders' equity, on a statutory basis, as well as minimum risk-based capital requirements, which are determined annually. Additionally, in conjunction with the Kaiser-Texas acquisition, TXHC entered into a letter agreement with the Texas Department of Insurance whereby TXHC agreed to maintain a net worth of $20.0 million, on a statutory basis, until certain income levels were achieved. In conjunction with the exit from the Texas HMO health care market, the Texas Department of Insurance approved a plan of withdrawal and TXHC is now required to maintain deposits of $1.5 million and net worth of at least $3.5 million. We believe we are in material compliance with our regulatory requirements.
In April 2003, the FASB issued Statement of Financial Accounting Standards No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities" ("SFAS No. 149"), which amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS No. 133. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003, except for the provisions that were cleared by the FASB in prior pronouncements. The adoption of SFAS No.149 did not have a material effect on our consolidated financial position or results of operations.
Reinsurance Recoverable. Included in the assets of discontinued operations is reinsurance recoverable, which represents the estimated amount of unpaid workers' compensation loss and LAE reserves that would be recovered from our reinsurers and, to a lesser extent, amounts billed to the reinsurers for their portion of paid losses and LAE. Reinsurance receivable for ceded paid claims is recorded in accordance with the terms of the agreements and reinsurance recoverable for unpaid losses and LAE is estimated in a manner consistent with the claim liability associated with the reinsurance policy. Any significant changes in the underlying claim liability could directly affect the amount of reinsurance recoverable. Reinsurance recoverable, including amounts related to paid and unpaid losses, are reported as assets rather than a reduction of the related liabilities. Reinsurance contracts do not relieve us from our obligations to enrollees, injured workers or policyholders. If our reinsurers were to fail to honor their obligations because of insolvency, disputed contract provisions or for other reasons, we could incur significant losses. Prior to entering into reinsurance contracts, we evaluate the financial condition of our reinsurers to minimize our exposure to significant losses from reinsurer insolvencies. In addition, we periodically monitor the financial strength of our reinsurers to determine if an allowance for uncollectible reinsurance recoverables is warranted. To date, we have never had to write-off a workers' compensation reinsurance recoverable balance and no allowance for uncollectible amounts has been established. At December 31, 2003, reinsurance recoverable for workers' compensation was $177.3 million. Any subsequent change in reinsurance recoverable established in a prior year would be reflected in that subsequent year's operating results.
STOCKHOLDERS' EQUITY: Preferred Stock, $.01 Par Value, 1,000 Shares Authorized; None Issued or Outstanding Common Stock, $.005 Par Value, 60,000 Shares Authorized; 2003 - 33,173; 2002 - 30,953 Shares Issued.................. 166 155 Treasury Stock: 2003 - 6,221; 2002 - 1,163 Common Stock Shares.. (112,737) (17,148) Additional Paid-In Capital....................................... 227,417 196,711 Deferred Compensation............................................ (22) (473) Accumulated Other Comprehensive (Loss) Gain ..................... (479) 381 Retained Earnings (Accumulated Deficit).......................... 36,419 (23,061) ------------ ------------ TOTAL STOCKHOLDERS' EQUITY........................................... 150,764 156,565 ------------ ------------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY........................... $ 1,134,121 $ 1,065,966 ============ ============
In accordance with SFAS No. 144, during the fourth quarter of 2002, the Company reclassified its workers' compensation insurance operations as discontinued operations. During the fourth quarter of 2003, the Company announced that it and its wholly-owned subsidiary, CII Financial Inc. ("CII"), entered into a Stock Purchase Agreement, which provides for the sale of all of the capital stock of California Indemnity Insurance Company ("Cal Indemnity"), a wholly-owned subsidiary of CII.
Years ended December 31, ------------------------------------- 2003 2002 2001 ----------- ----------- -----------
The following table summarizes the Company's current and restricted investments, from continuing operations, as of December 31, 2003:
Sierra Debentures - In March 2003, the Company issued $115.0 million aggregate principal amount of its 2¼% senior convertible debentures due March 15, 2023. The debentures pay interest, which is due semi- annually on March 15 and September 15 of each year. Each $1,000 principal amount of debentures is convertible, at the option of the holders, into 54.6747 shares of Sierra Health Services, Inc., common stock prior to March 15, 2023 if (i) the market price of the Company's common stock for at least 20 trading days in a period of 30 consecutive trading days ending on the last trading day of the preceding fiscal quarter exceeds 120% of the conversion price per share of the Company's common stock; (ii) the debentures are called for redemption; (iii) there is an event of default with respect to the debentures; or (iv) specified corporate transactions have occurred. The conversion rate is subject to certain adjustments. This conversion rate initially represents a conversion price of $18.29 per share. Holders of the debentures may require the Company to repurchase all or a portion of their debentures on March 15 in 2008, 2013 and 2018 or upon certain corporate events including a change in control. In either case, the Company may choose to pay the purchase price of such debentures in cash or common stock or a combination of cash and common stock. The debentures can be redeemed by the Company for cash beginning on or after March 20, 2008.
2003 2002 2001 ---------- ---------- ---------- (In thousands) Provision (Benefit) for Income Taxes: Current.......................................................... $ 2,909 $ (11,498) $ (2,763) Deferred......................................................... 41,656 33,586 9,924 ---------- ---------- ---------- Total.......................................................... $ 44,565 $ 22,088 $ 7,161 ========== ========== ==========
December 31, ------------------------- 2003 2002 ----------- ------------ (In thousands) ASSETS Cash and Cash Equivalents....................................... $ 47 $ -- Investments..................................................... 4,048 4,263 Other Assets.................................................... 115 916 Property and Equipment, Net..................................... -- 11,967 ----------- ------------ TOTAL ASSETS.................................................... 4,210 17,146 ----------- ------------ LIABILITIES Accounts Payable and Other Liabilities.......................... 2,658 9,059 Medical Claims Payable.......................................... 202 1,754 Mortgage Loan................................................... -- 14,961 ----------- ------------ TOTAL LIABILITIES............................................... 2,860 25,774 ----------- ------------ NET ASSETS (LIABILITIES) OF DISCONTINUED OPERATIONS............. $ 1,350 $ (8,628) =========== ============
During 2002, TXHC sold four of the eight real estate properties and a parcel of land. As required under the terms of the mortgage loan agreement, pre-determined minimum amounts of the mortgage note are required to be paid as each piece of real estate is sold. Accordingly, total payments of $11.3 million were made to Kaiser-Texas on the mortgage loan. Since the principal payments resulted in a reduction of future interest, future accrued interest was reduced and a gain, net of tax, of $1.9 million was recorded.
In conjunction with the decision to sell the workers' compensation operations at the end of 2002, CII recorded valuation adjustments of $17.3 million, $11.3 million after tax, to reduce this business to its estimated net realizable value upon disposition. The valuation adjustments included the write down of accounts receivable, fixed assets and certain other assets of $4.0 million and additional loss reserves of $8.3 million for the 2002 accident year and $5.0 million for prior accident years.
In the second quarter of 2003, CII recorded $4.0 million, $2.6 million after tax, in additional valuation adjustments. On November 25, 2003, the Company announced that it had reached an agreement to sell Cal Indemnity and its subsidiaries. Cal Indemnity is a wholly-owned subsidiary of CII and is CII's only significant asset. As part of the purchase agreement, Cal Indemnity and its subsidiaries have stopped voluntarily issuing new or renewal policies except in Nevada. The buyer intends to place Cal Indemnity and its subsidiaries in run-off. An independent third party claims administrator has been engaged to administer the claims when the transaction is consummated. The transaction was initially valued at $79.5 million, consisting of $15.5 million payable at closing and a contingent payment of $64.0 million, which will be payable in 2010. The cash payable at closing is subject to certain adjustments and the contingent payment can be increased or decreased based upon favorable or adverse loss and allocated loss
Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value ---------- ---------- ---------- ---------- Available-for-Sale Investments: (In thousands) Classified as Current: U.S. Government and its Agencies................................ $ 95,419 $ 440 $ 1,430 $ 94,429 Municipal Obligations........................................... 123,439 702 414 123,727 Corporate Bonds................................................. 3,688 60 -- 3,748 ---------- ---------- ---------- ---------- Total Current...................................................... 222,546 1,202 1,844 221,904 ---------- ---------- ---------- ---------- Classified as Restricted: U.S. Government and its Agencies................................ 12,888 264 7 13,145 Municipal Obligations........................................... 4,240 212 1 4,451 Other........................................................... 533 -- -- 533 ---------- ---------- ---------- ---------- Total Debt Securities.............................................. 17,661 476 8 18,129 Preferred Stock................................................. 75 -- -- 75 ---------- ---------- ---------- ---------- Total Restricted................................................... 17,736 476 8 18,204 ---------- ---------- ---------- ---------- Total Available-for-Sale.................................. $ 240,282 $ 1,678 $ 1,852 $ 240,108 ========== ========== ========== ==========
The transaction was accounted for as a restructuring of debt; therefore, all subsequent cash payments, including interest, related to the debentures were reductions of the carrying amount of the debentures and no additional interest expense was recognized.
Intercompany Notes Receivable/Payable. In connection with the exchange offer for the subordinated debentures, CII has promissory notes payable to Sierra aggregating $17.0 million and bearing interest at 9.5% under which principal and interest are due on demand.
Litigation and Legal Matters. The Company is subject to various claims and other litigation in the ordinary course of business. Such litigation includes, but is not limited to, claims of medical malpractice, claims for coverage or payment for medical services rendered to HMO members and claims by providers for payment for medical services rendered to HMO and other members. Some litigation may also include claims for punitive damages that are not covered by insurance. Also included in such litigation are claims for workers' compensation and claims by providers for payment for medical services rendered to injured workers. These actions are in various stages of litigation and some may ultimately be brought to trial. With respect to certain pending actions, the Company maintains commercial insurance coverage with varying deductibles for which the Company maintains reserves for its self-insured portion based upon its current assessment of such litigation. Due to recent unfavorable changes in the commercial insurance market, the Company has, for certain risks, purchased coverage with higher deductibles and lower limits of coverage. In the opinion of management, based on information presently available, the amount or range of any potential loss cannot be reasonably estimated but the ultimate resolution of these pending legal proceedings should not have a material adverse effect on our financial condition.
While the SERP is an unfunded plan, the Company is informally funding the plan through life insurance contracts on certain Company employees. The life insurance contracts had cash surrender values of $14.7 million, $11.7 million and $10.3 million at December 31, 2003, 2002 and 2001, respectively.
The fair value of the look-back option implicit in each offering of the Purchase Plans is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions used for grants in 2003, 2002 and 2001, respectively: dividend yield of 0% for all years; expected volatility of 64%, 56% and 85%; risk-free interest rates of 0.93%, 1.48% and 4.36%; and expected lives of six months for all years.
SMHS completed the fifth year of a five-year contract in May 2003 and is in the first year of a contract extension. In August 2002, the DoD requested proposals for managed care services under the Next Generation TRICARE ("T-Nex") contract. The Company submitted its proposal in January 2003 for the T-Nex North Region contract, which includes Region 1, as well as Michigan, Ohio, Kentucky, Indiana, Illinois, Wisconsin, Virginia and North Carolina. However, in August 2003, the DoD awarded the T-Nex North Region contract to a competitor and the General Accounting Office denied the Company's protest of the award in December 2003. The new contractor is scheduled to be operational in Region 1 on September 1, 2004 and the new contract will supersede the remainder of the Company's current TRICARE Region 1 contract. After the new contractor is operational on September 1, 2004, SMHS will commence a six-month phase-out of operations at prices previously negotiated with the DoD. SMHS does not meet the definition of discontinued operations since the Company does not have plans to dispose of the operations before the phase-out is complete.
On January 1, 2002, the Company adopted Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS No. 142"). SFAS No. 142 requires, among other things, the discontinuance of goodwill amortization. In addition, the pronouncement includes provisions for the reclassification of certain existing recognized intangibles as goodwill, reassessment of the useful lives of existing recognized intangibles, reclassification of certain intangibles out of previously reported goodwill and the identification of reporting units for purposes of assessing potential future impairments of goodwill. SFAS No. 142 also required the Company to complete a transitional goodwill impairment test six months from the date of adoption and at least annually thereafter. The net amortized goodwill balance at December 31, 2003, is $14.8 million. The Company has determined that the recorded goodwill is not impaired under the guidelines of the pronouncement.
Income from Continuing Operations............. $ 15,481 $ 523 $ 16,004 Loss from Discontinued Operations............. (11,995) -- (11,995) ------------- -------------- ------------- Net Income................................. $ 3,486 $ 523 $ 4,009 ============= ============== =============