The Company and its subsidiaries rent office space at various locations. The Company also owns three office buildings in Tarrant County, Texas with approximately 190,000 square feet.
The following selected consolidated financial data as of and for each of the five years in the period ended December 31, 1998 have been derived from the audited Consolidated Financial Statements of the Company. The following data should be read in conjunction with the Consolidated Financial Statements and the notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included herein.
(1) The health loss ratio represents benefits, claims and settlement expenses related to health insurance policies stated as a percentage of health premiums.
(2) The health expense ratio represent underwriting, acquisition and insurance expenses related to health insurance policies stated as a percentage of health premiums. Expenses relating to providing administrative services are not included.
Certain statements set forth herein or incorporated by reference herein from the Company's filings that are not historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act. Actual results may differ materially from those included in the forward-looking statements. These forward-looking statements involve risks and uncertainties including, but not limited to, the following: changes in general economic conditions, including the performance of financial markets, and interest rates; competitive, regulatory or tax changes that affect the cost of or demand for the Company's products; health care reform, ability to predict and effectively manage claims related to health care costs; reliance on key management and adequacy of claim liabilities and the ability of the Company and third party vendors to modify computer systems for the Year 2000 data conversion in a timely manner. The Credit Card segment's future results also could be adversely affected by the possibility of future economic downturns causing an increase in credit losses or changes in regulations for credit cards or credit card national banks. The Company has certain risks associated with the Educational Finance Group business. The changes in the Higher Education Act or other relevant federal or state laws, rules and regulations and the programs implemented thereunder may adversely impact the education credit market. In addition, existing legislation and future measures by the federal government may adversely affect the amount and nature of federal financial assistance available with respect to loans made through the U.S. Department of Education. Finally the level of competition currently in existence in the secondary market for loans made under the Federal Loan Programs could be reduced, resulting in fewer potential buyers of the Federal Loans and lower prices available in the secondary market for those loans. Investors are also directed to other risks and uncertainties discussed in documents filed by the Company with the Securities and Exchange Commission.
The Company's operating segments are: (i) Insurance, which includes the businesses of the Self-Employed Agency Division; the Student Insurance Division; the OKC Division; the Special Risk Division; and the National Motor Club Division; (ii) Financial Services which includes the businesses of the Credit Services Division, Educational Finance Group; and Insurdata; and (iii) Other Key Factors which includes investment income not allocated to the other segments, interest expense, general expenses relating to corporate operations, goodwill amortization, realized gains or losses on sale of investments and the AMLI operations. Net investment income is allocated to the Insurance segment based on policy liabilities. The interest rate for the allocation is based on a high credit quality investment portfolio with a duration consistent with the duration of the segment's policy liabilities.
Investment income. Investment income decreased to $74.9 in 1998 from $78.0 million in 1997, a decrease of $3.1 million or 4%. The decrease is due to a decrease in investment yield.
Other interest income. Other interest income increased to $41.9 million in 1998 from $6.2 million in 1997, an increase of $35.7 million. The increase was due to the investment income earned on student loans in 1998 and the increase in interest earned on credit card receivables.
Credit card fees. Credit card fees increased to $112.9 million in 1998 from $48.1 million in 1997, an increase of $64.8 million. The increase is due to the growth in new sales from a program started in 1997.
Gains on sale of investments. The Company recognized gains on sale of investments of $4.9 million in 1998 compared to $4.0 million in 1997. The amount of realized gains or losses on the sale of investments is a function of interest rates, market trends and the timing of sales. In addition, the net unrealized investment gains on securities classified as "available for sale", reported in accumulated other comprehensive income as a separate component of stockholders' equity and net of applicable income taxes and minority interests, was $13.4 million at December 31, 1998 compared to $14.3 million at December 31, 1997.
Underwriting, acquisition and insurance expenses. Underwriting, acquisition and insurance expenses increased to $275.8 million in 1998 from $253.4 million in 1997, an increase of $22.4 million or 9%. The increase was primarily due to the growth in premium volume.
Provision for doubtful accounts. Provision for doubtful accounts increased to $75.0 million in 1998 from $13.5 million in 1997, an increase of $61.5 million. The increase is attributed to the growth in the Credit Services Division.
Self Employed Agency Division ("SEA"). The SEA Division reported a loss of $4.8 million in 1998 compared to income of $47.6 million in 1997. The lower earnings of SEA are the result of the losses on certain managed care products and adjustments in the estimates of claim reserves based on an analysis completed in 1998.
The losses on the managed care products are primarily the result of the losses from a specific PPO insurance product, for which marketing of new policies was discontinued in the first
quarter of 1998. The operating losses for the managed care products were a continuation of the problems recognized in the fourth quarter of 1997 while the traditional indemnity products continued to produce acceptable profits. The losses were due to higher loss ratios on those managed care products and a slower than anticipated implementation of rate increases on the managed care products. The Company also encouraged current inforce policyholders to raise their deductibles and co-payment amounts.
The Company implemented a substantial rate increase on these PPO policies beginning in April 1998 which was completed in October 1998. A new round of rate increases was also started in October. The marketing organizations have also been successful in directing a larger portion of new sales to the traditional indemnity products in which the Company has not experienced the pricing problems and higher claims volume it has had with the PPO products.
Student Insurance. The Student Insurance Division reported income of $6.1 million in 1998 compared to $15.5 million in 1997. The reduced earnings reflect lower margins resulting from aggressive pricing in response to increased price competition and the impact of regulatory and compliance issues, particularly in the university health insurance market. Profit margins in this Division are expected to provide an adequate return on investment. However, margins are not expected to return to pre-1998 levels. Revenue for the Student Insurance Division increased to $111.0 million in 1998 from $97.6 million in 1997, an increase of 14%.
OKC Division. Operating income for the OKC Division increased to $20.4 million for the year ended in 1998 from $18.9 million in 1997, an increase of 8%. The earnings of this Division continued to increase while the capital invested in this Division decreased. The reduced capital is attributable to the fact that no major purchases of closed blocks of life insurance policies were made during the last two years. The increased earnings are the result of the development and marketing of new products and continuing efforts to realize more profits from the closed blocks of policies. Revenue for the OKC Division decreased to $98.8 million in 1998 from $100.5 million in 1997, a decrease of 2%. The decrease in revenue is the result of lower revenues on the closed blocks of life policies.
Credit Services. Operating income for Credit Services increased to $46.3 million in 1998 from $20.5 million in 1997. Revenue for Credit Services increased to $123.2 million in 1998 from $50.3 million in 1997, an increase of 145%. The increase is primarily due to growth in new sales from a program started in 1997. The program was monitored in its early stages to fine tune the marketing program and evaluate the risk through actual performance of the credit cards. This growth resulted in the number of accounts increasing to 776,000 at December 31, 1998 from 252,000 at December 31, 1997. Of the accounts added during 1998 under the new program, 67% were added during the last four months. During this time, the net managed credit card receivables increased to $233.4 million from $95.5 million. A substantial portion of the increased receivables was financed through a securitization of $60 million of receivables in December 1998 and a growth in time deposits to $98.9 million at December 31, 1998 from $7.6 million at December 31, 1997.
In 1998, there was a radical change in the business of EFG as it evolved from a marketing company to an originator, holder, and servicer of student loans. Student loans increased to $670.4 million at December 31, 1998 from $11.3 million at December 31, 1997. With this change, EFG also had to establish funding sources for the student loans. The first facility was entered into in March 1998 and subsequently increased to $750 million.
In December 1998, EFG completed a $550 million Variable Rate Note ("VRN") facility which replaced $550 million of the $750 million repo facility. The advantage of the VRN is 97% of the notes are rated AAA, with the remainder rated BBB, by both Standard and Poor's and Moody's. These high quality credit ratings greatly enhance the marketability of the notes. The balance of the $750 million repo facility, or $200 million remains in place. EFG continues to explore additional funding facilities which will provide the short term, intermediate, and long term funding for the student loans which will be originated.
will not be completed in the foreseeable future. Revenue for Insurdata increased to $41.2 million in 1998 from $25.1 million in 1997, an increase of 64%. Insurdata revenue from other divisions of the Company were $21.1 million and $10.4 million in 1998 and 1997, respectively.
Other Key Factors. Other key factors include investment income not allocated to the other segments, interest expense, general expenses relating to corporate operations, amortization of goodwill, realized gains or losses on sale of investments and the AMLI operations. Operating income for other key factors decreased to $16.1 million in 1998 from $24.5 million in 1997. The decrease in 1998 is mainly attributed to an increase in amortization of goodwill of $3.4 million and a decrease of $4.4 million in investment income on equity. The decrease in investment income on equity is attributed to a decrease in investment yield.
Revenues. Revenues increased to $955.8 million in 1997 from $730.6 million in 1996, an increase of $225.2 million, or 31%. The increase is mainly attributed to an increase in premiums and the growth in the other revenue categories.
Health premiums. Health premiums increased to $653.9 million in 1997 from $501.2 million in 1996, an increase of $152.7 million, or 30%. The increase in health premiums for the year was the result of increased premiums in the SEA and Special Risk divisions. The increase in SEA is due to increased sales of new health policies by the marketing organizations and due to discontinuing the coinsurance arrangement in 1996 for new business written by UGA. The increase in Special Risk premiums is due to the acquisition of a managing general underwriter and the assumption of a block of business in 1997. In 1997, the coinsurance percentage on both in force and new health insurance policies issued by AEGON increased to 60% from 57.5% in 1996.
Life premiums and other considerations. Life premiums and other considerations increased to $49.4 million in 1997 from $46.6 million in 1996, an increase of $2.8 million, or 6%. The increase was a result of the sale of new life policies and the recognition of the Company's share of the profits on a closed block of business. The increase was partially offset by the decrease in premiums and other considerations from closed blocks of life and annuity business.
Credit card fees. Credit card fees increased to $48.1 million in 1997 from $38.6 million in 1996, an increase of $9.5 million. The increase related primarily to increase in fees from Credit Services Division.
Other income. Other income increased to $45.9 million in 1997 from $25.4 million in 1996, an increase of $20.5 or 81%. The increase is due to the HealthCare Solutions Companies acquired in 1995 and 1996 and the AMLI operations acquired in 1996.
Gains on sale of investments. The Company recognized gains on sale of investments of $4.0 million in 1997 compared to $652,000 in 1996. The amount of realized gains or losses on the sale of investments is a function of interest rates, market trends and the timing of sales. In addition, due primarily to decreasing long-term interest rates in 1997, the net unrealized investment gains on securities classified as "available for sale", reported in accumulated other comprehensive income as a separate component of stockholders' equity and net of applicable income taxes and minority interests, was $14.3 million at December 31, 1997 compared to $2.2 million at December 31, 1996.
Provision for doubtful accounts. Provision for doubtful accounts remained comparable in 1997 when compared to 1996.
National Motor Club. Operating income for National Motor Club was $2.0 million in 1997. National Motor Club was acquired by the Company in the third quarter of 1997.
Educational Finance Group. EFG reported revenue of $8.0 million and income of $2.0 million in 1997. EFG was acquired during the second quarter of 1997.
Insurdata. Operating income for Insurdata was $2.6 million in 1997 compared to a loss of $483,000 in 1996. The loss in 1996 is attributed to two entities that had losses of $2.3 that had previously been reported in other business units. Revenue for Insurdata increased to $25.1 million in 1997 from $12.7 million in 1996, an increase of 98%. A majority of the increase in revenue and operating income was due to Insurdata's contract to provide services to the SEA and Student Insurance Divisions.
Other Key Factors. Other key factors include investment income not allocated to the other segments, interest expense, general expenses relating to corporate operations, amortization of goodwill, realized gains or losses on sale of investments and the AMLI operations. Operating income for other key factors was $24.5 million in 1997 compared to $11.4 million in 1996. The increase was primarily due to reporting a full year's operations for AMLI in 1997 compared to 1996 and to an increase in investment income not allocated to the other segments and an increase in realized gains on the sale of investments from $652,000 in 1996 to $4.0 million in 1997.
QUARTERLY RESULTS. The following table sets forth consolidated results of operations for each of the Company's fiscal quarters in 1998 and 1997. This information is unaudited and has been prepared on the same basis as the audited Consolidated Financial Statements of the Company included herein and, in management's opinion, reflects all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the information for the periods presented. The operating results for any quarter are not necessarily indicative of results for any future period.
Computation of earnings per share for each quarter are made independently of earnings per share for the year. The lower earnings of the first quarter of 1998 are the results of the SEA Division reporting losses on certain managed care products. Included in the first quarter of 1998 is a $2.3 million gain from the sale of certain assets of an ATM processing company in February 1998. The $2.3 million gain was reported in the Other Business Units segment and was partially offset by $2.5 million in operating losses from a company that was disposed of in the third quarter of 1998. During the second quarter, a dispute arose among the Company and its Chairman on one side and the minority shareholder of one of the Company's subsidiaries on the other, as to the contract interpretation and the distribution of the proceeds from the sale of the assets of this subsidiary. A liquidator was appointed to rule on the proper distribution based upon the interpretation of the agreement among the Company, its Chairman, and the minority shareholder. The liquidator ruled that the proceeds should be distributed differently than had previously been determined by the Company. Accordingly, the Company recorded its additional portion of the gain of $7.4 million in the second quarter of 1998 based on that ruling. Although by interlocutory appeal the court of appeals divested the liquidator of his authority, the trial court ultimately endorsed the liquidator's ruling. The additional $7.4 million gain was reported in the Other Business Units segment. The second quarter included $8.0 million in operating losses from a company that was disposed of in the third quarter of 1998. The higher earnings of the fourth quarter of 1998 are the result of the SEA Division returning to profitability and the Credit Services Division reporting significant growth in sales and profits from a program started in 1997.
At the federal level, several competing proposals have been introduced or passed in Congress. One law which was introduced by Senators Nancy Kassebaum and Edward Kennedy (the "Kassebaum-Kennedy legislation") was passed in 1996. The Kassebaum-Kennedy legislation
builds upon state initiatives by guaranteeing "group-to-individual" portability. Under the legislation, any person governed by a group insurance plan for at least eighteen months will, on leaving the group plan, have the right to buy an individual policy from any insurance company selling individual health insurance policies in that person's state regardless of whether that person has a pre-existing condition. This provision could result in the Company insuring individuals who under the Company's current underwriting standards would not be insured by the Company, which could have a material adverse effect on the Company.
The Company's effective tax rate was 31.0% for 1998 compared to 31.9% for 1997 and 32.5% in 1996. The 1998, 1997, and 1996 effective rate varied from the federal tax rate of 35% primarily due to the small life insurance company deduction allowed for certain insurance subsidiaries of the Company and the change in the valuation allowance related to deferred tax assets.
The primary sources of cash for the Company are premium revenues from policies issued, investment income, fees and other income deposits to fund the credit card receivables, and borrowings to fund the student loans. The primary uses of cash are payments for benefits, claims and commissions under those policies, operating expenses and the funding of the credit card receivables and student loans. Net cash provided from operations totaled approximately $140 million in 1998, $146 in 1997, and $126 million in 1996. The Company's insurance subsidiaries invest a substantial portion of these funds, pending payment of their pro rata share of future benefits and claims.
In December 1998, the Company obtained a $50 million unsecured line of credit from a bank. The line of credit matures in December 1999 and bears interest at LIBOR plus 0.75%. At December 31, 1998, the Company had borrowed $25 million under the line of credit. A portion of the funds were used to repay the AEGON revolving credit note.
In 1998, the Company borrowed $12.0 million on its AEGON revolving credit note. The funds were used to fund the student loan credit facility. The Company had no outstanding balance on its revolving credit note with AEGON at December 31, 1998. The note has a maximum line of credit of $12.0 million through August 1, 2002 and bears interest at prime plus 0.875%.
Effective April 25, 1996, the Company commenced a public offering of 5,175,000 shares of common stock at a price of $20.50 per share. The net proceeds to the Company (after deducting underwriting discounts and commissions and offering expenses) from the sale of the shares was approximately $100.1 million. During 1996, the Company used $10.3 million of the proceeds to repay the AEGON revolving credit note. The majority of the remaining proceeds were used for acquisitions during 1997.
During October 1995, the Company acquired the majority interest in Insurdata. The acquisition was funded with cash and the issuance of promissory notes to the former stockholders in the amount of $12.0 million, which were repaid in January 1996. Effective December 31, 1996, the Company acquired the remaining interest of Insurdata, based on a predetermined formula price of $15.1 million.
The Company securitized $60.0 million, $30.0 million and $29.0 million of credit card loans in 1998, 1997 and 1996, respectively of asset backed securities in which the Company purchased participating interests totaling $6.0 million, $3.0 million and $2.9 million in 1998, 1997 and 1996, respectively.
In September 1996, the Company entered into three separate stock purchase agreements to sell its three dental benefit companies. The Company completed one sale in October 1996 and the other two in 1997, for a gain of $2.0 million and $4.7 million, respectively. The operations of the dental benefit companies were not material to the operations of the Company.
Dividends paid by domestic insurance companies out of earned surplus in any year are limited by the law of the state of domicile. See "Item 5. Market for Registrant's Common Stock and Related Stockholder Matters" and Note K to the Audited Consolidated Financial Statements.
Investments are selected based upon the parameters established in the Company's investment policies. Emphasis is given to the selection of high quality, liquid securities that provide current investment returns. Maturities or liquidity characteristics of the securities are managed by continually structuring the duration of the investment portfolio to be consistent with the duration of the policy liabilities. Consistent with regulatory requirements and internal guidelines, the Company invests in a range of assets, but limits its investments in certain classes of assets, and limits its exposure to certain industries and to single issuers.
maturity securities portfolio was invested in below investment grade securities (less than BBB). A quality distribution for fixed maturity securities is as follows:
assessing non-information technology systems, including embedded technology, relating to, among other systems, security systems, elevator systems and heating, ventilating and air conditioning systems ("Non-IT Systems"). The Year 2000 project consists of five phases: (i) awareness, (ii) assessment, (iii) analysis, design and remediation, (iv) testing and validation and (v) creation of contingency plans in the event of Year 2000 failures.
Non-IT Systems. The Company believes that Year 2000 non-readiness of its own Non-IT Systems would not have a material adverse effect on the Company's business or operations. Accordingly, the Company has primarily focused its efforts on its IT Systems.
The expected costs of the Year 2000 project and the date on which the Company believes it will complete the Year 2000 modifications are based on management's best estimates, which were derived utilizing numerous assumptions of future events, including the continued availability of certain resources and other factors. However, there can be no guarantee that these estimates will be achieved and actual results could differ materially from those anticipated. Specific factors that might cause such material differences include, but are not limited to, the availability and cost of personnel trained in this area, the ability to locate and correct all relevant computer codes and similar uncertainties, the success in becoming Year 2000 Ready of third parties whose software and hardware systems interface with the Company, the outcome of possible Year 2000 litigation involving the Company and similar uncertainties.
In June 1998, the Financial Accounting Standards Board issued Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, which is required to be adopted in years beginning after June 15, 1999. Because of the Company's minimal use of derivatives,