During 1996, premiums increased 11% to $258,175,337 from $233,168,529 in 1995. The increase was primarily in the group life and health segment which accounted for about 98% of total premiums. Group
certificates in force increased about 2% to 116,304 in 1996 compared to 113,720 at the end of 1995. Certificates issued for new group policies were 36,574 in 1996, down 18% from 44,398 in 1995. A more aggressive pricing in 1996 and additional competition were the cause for the decrease. Total lapses (net of additions/decreases) in 1996 were 33,990 up slightly from 33,637 in 1995. Overall, the lapse ratio was in line with the Company's expectations and consistent with the industry average for small group business.
Not included in premiums, for generally accepted accounting principles (GAAP) purposes, were annuity considerations in the amounts of $2,926,416 and $3,498,442 for 1996 and 1995.
Benefits and claims incurred expenses increased 23% in 1996 to $203,677,232 from $165,472,603 in 1995. The incurred loss ratio was 78.9% for 1996 compared to 71% for 1995. The major reasons for the increase in the claims loss ratio and the level of claims were (a) the underpricing of a new product (PMO) introduced in late 1994 and sold heavily in 1995, (b) greater utilization than anticipated and (c) new state mandates such as guaranteed issue and preventive benefits. By far the biggest cause was the underpriced PMO product which contributed to an estimated 80% of the loss before net investment income. Higher premiums and aggressive rate renewal actions started April 1, 1996. Because the business is primarily sold on a monthly basis the full renewal action will take 12 months ending March 31, 1997.
The net loss for 1996 was $9,288,365 or $2.20 per share, after a net tax benefit of $2,845,585 compared to a net income of $4,504,607 or $1.07 per share after a tax expense of $1,442,618 in 1995. Because group accident and health represents 98% of Central's business, a higher loss ratio from this segment has a negative effect on the Company's earnings. The statutory loss ratio in the group accident and health segment increased to 77.9% in 1996 from 69.4% in 1995.
The Federal income tax returns for the Company and its subsidiaries have been examined by the Internal Revenue Service (IRS) for 1991 and 1992. During the third quarter of 1994, the IRS issued a proposal for adjustments to the Company's returns for 1991 and 1992. The proposed deficiencies are approximately $2.4 million of which $215,303, pertaining to some non-deductible expenses and certain assets expensed and not capitalized, was agreed to and paid in 1994. The balance primarily deals with whether or not the Company's primary subsidiary, Central, qualified as a life company, for tax purposes. The Company is vigorously protesting the proposed deficiency and management believes existing law supports the Company's position. Therefore, the Company has not recorded a liability for the difference. Trial of the matter is scheduled to begin June 2, 1997.
If the IRS were to prevail in its position that Central no longer qualifies as a life company for tax purposes, the asserted $2.4 million deficiency would be payable and Federal income taxes would increase in the future. Presently, as a small life company, Central is permitted, among other things, a deduction from the first $3 million of income of 60% or $1.8 million. As Central's income increases above $3 million, the special deduction is reduced proportionately. Besides relying on favorable existing case law, Central may have, under certain circumstances, the ability to change and market policies that could insure its qualifications as a life company for tax purposes in the future, if the need arises.
During 1995, premiums increased 4% to $233,168,529 from $223,679,071 in 1994. The increase was primarily in the group life and health division which accounted for about 98% of total premiums. Group
Benefits and claims incurred expenses increased 7% in 1995 to $165,472,603 from $155,257,560 in 1994. This compares to a 6% increase in 1994 over 1993. The incurred loss ratio was 71% for 1995 and 69.4% for 1994. The major increase in claims was during the last quarter, primarily the last month. The loss ratio increased to 73.6% for the fourth quarter of 1995 compared to 67.7% in the same quarter in 1994. During the fourth quarter the Company experienced, as many small group carriers did, an increase in claims due to utilization, state mandates and accidents. This trend continued into January 1996. In response, the Company increased premium rates, did not renew certain blocks of business and updated several managed care controls.
In 1996 Congress passed the Health Portability and Accountability Act of 1996, which provides for changes in the health insurance market and is scheduled to go into effect in July 1997. It guarantees the availability and renewability of health insurance coverage for certain employees and individuals, and limits the
use of preexisting condition restrictions. The Act creates federal standards for insurers, health maintenance organizations (HMO's), and employer plans, including those who self-insure. It permits, however, substantial state flexibility for compliance with the requirements on insurers. The Company cannot predict the ultimate timing or effect of any legislative efforts, and no assurance can be given that any such efforts will not have a material adverse effect on the Company's business and results of operations.
In June 1996, FASB issued SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities". SFAS No. 125 provides new accounting and reporting standards for sales, securitizations, and servicing of receivables and other financial assets, for certain secured borrowing and collateral transactions, and for extinguishments of liabilities occurring after December 31, 1996. SFAS No. 127, "Deferral of the Effective Date of Certain Provisions of FASB Statement No. 125", was issued in December 1996. The impact of SFAS No. 125 and SFAS No. 127 is not expected to be material to the consolidated financial statements.
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 ================================================================================
Central is a life and accident and health insurer licensed in 35 states. Central principally sells group insurance, however, it offers a full range of life, health, and annuity products through general agents and independent writing agents and is subject to competition from other insurers throughout the United States. Central is subject to regulation by the insurance department of states in which it is licensed, and undergoes periodic examinations by those departments.
Inadequate Pricing Risk is the risk that the premium charged for insurance and insurance related products is insufficient to cover the costs associated with the distribution of such products which include: benefits, claims and losses, settlement expenses, acquisition expenses and other corporate expenses. Central utilizes a variety of actuarial and/or qualitative methods to set such pricing levels.
Interest Rate Risk is the risk that interest rates will change and cause a decrease in the value of an insurer's investments. This change in rates may cause certain interest-sensitive products to become uncompetitive or may cause disintermediation. Central attempts to mitigate this risk by charging fees for non-conformance with certain policy provisions and/or by attempting to match the maturity schedule of its assets with the expected payouts of its liabilities. To the extent that liabilities come due more quickly than assets mature, an insurer would have to sell assets prior to maturity and recognize a gain or loss.
Effective January 1, 1994, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity Securities". SFAS 115 requires that investments in all debt securities and those equity securities with readily determinable market values be classified into one of three categories: held to maturity, trading or available for sale. Classification of investments is based upon management's current intent. Debt securities which management has a positive intent and ability to hold until maturity are classified as securities held to maturity and are carried at amortized cost. Unrealized holding gains and losses on securities held to maturity are not reflected in the consolidated financial statements. Debt and equity securities that are purchased for short-term resale are classified as trading securities. Trading securities are carried at estimated fair value, with unrealized holding gains and losses included in earnings. All other debt and equity securities not included in the above two categories are classified as securities available for sale. Securities available for sale are carried at estimated fair value, with unrealized holding gains and losses reported as a separate component of shareholders' equity, net of tax. At December 31, 1996, the Company did not have any investments classified as trading securities.
Certain costs, principally commissions, which vary with and are directly related to the production of ordinary life business, have been deferred. The deferred costs are being amortized through the use of factors over the benefit period of the related policies. These factors were developed using assumptions which are consistent with those used in setting rates. Due to the nature of the business and its persistency experience, the Company does not defer policy acquisition costs for Central's group business. Deferred policy acquisition costs at December 31, 1996 and 1995 were $321,567 and $209,760, respectively. The net amounts amortized to income were $111,807 in 1996, $59,834 in 1995 and $60,116 in 1994. The increase in 1996 was due to the increase in sales of Central's 10-year term policies.
The liabilities for unpaid accident and health and death claims are estimated principally based upon past experience for pending, incurred but not reported, and reopened claims. The liability includes a provision for the estimated cost of investigating and settling the claim liability. The estimate of accident and health claim reserves incurred, but not yet due, are computed using actuarially determined factors based on a combination of claim completion and loss ratio methods, utilizing durational experience, seasonal cycle, changes in health care practice, changes in inflation rates and the claims backlog. The liability is particularly sensitive to recent claims frequency and severity experience of Central. Management believes the liabilities for unpaid claims are adequate.
Contracts that do not subject Central to risks arising from policyholder mortality or morbidity are referred to as investment contracts. Certain deferred and flexible annuities are considered investment contracts. Amounts received as payments for such contracts are accounted for as deposits and included in future policy benefits, losses and claims.
Net income per share is computed using the weighted average number of common shares outstanding. The number of shares was increased to reflect shares issuable on the exercise of options, reduced by the number of shares assumed to have been purchased with the proceeds from the exercise of these common stock equivalents. The number of shares used to calculate the earnings per share was 4,221,416 in 1996, 4,221,636 in 1995 and 4,201,069 in 1994.
The Company recognizes expense for stock-based employee compensation arrangements in accordance with the provisions of APB No. 25, "Accounting for Stock Issued to Employees."
The amortized cost and estimated fair value of securities held to maturity and available for sale as of December 31, 1996, are as follows. The estimated fair value is based on quoted market prices, where available, or on values obtained from independent pricing services.
The amortized cost and estimated fair value of fixed maturities at December 31, 1996, by contractual maturity, are as follows. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalties.
At December 31, 1996 cash includes approximately $3.8 million held for self-funded accident and health accounts, which is restricted as to its use. A corresponding amount is included in liabilities in the accompanying consolidated financial statements.
The Ohio Department of Insurance imposes risk-based capital (RBC) requirements on insurance enterprises, including Central. The RBC Model serves as a benchmark for the regulation of life insurance companies by state insurance regulators and provides for targeted surplus levels based on formulas which specify various weighting factors that are applied to financial balances or various levels of activity based on the perceived degree of risk, and are set forth in the RBC requirements. Such formulas focus on four general types of risk: (a) the risk with respect to the company's assets (asset or default risk); (b) the risk of adverse insurance experience with respect to the company's liabilities and obligations (insurance or underwriting risk); (c) the interest rate risk with respect to the company's business (asset/liability matching); and, (d) all other
Under the Life Insurance Company Income Tax Act of 1959, a portion of insurance companies' net income, prior to 1984, is not subject to Federal income taxes (within certain limitations) until it is distributed to stockholders, at which time it is taxed at regular corporate rates. For Federal income tax purposes, this untaxed income is accumulated in a memorandum account designated "policyholders' surplus". The accumulated untaxed policyholders' surplus for Central is $2,869,768.
The Federal income tax returns for the Company and its subsidiaries have been examined by the Internal Revenue Service (IRS) for 1991 and 1992. During the third quarter of 1994, the IRS issued a proposal for adjustments to the Company's returns for 1991 and 1992. The proposed deficiencies are approximately $2.4 million of which $215,303, pertaining to some non-deductible expenses and certain assets expensed and not capitalized, was agreed to and paid in 1994. The balance primarily deals with whether or not the Company's subsidiary, Central, qualified as a life company, for tax purposes. The Company intends to vigorously protest the proposed deficiency and management believes existing law supports the Company's position. Therefore, the Company has not recorded a liability for the difference. Trial of the matter is scheduled to begin June 2, 1997.
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1996 and 1995 are presented below:
The Company establishes a valuation allowance based on its analysis (scheduling) of future deductible amounts. The Company determines a valuation allowance based on their analysis of amounts recoverable in the statutory carryback period and does not consider future taxable income. Fluctuation in the valuation allowance is attributed to changes in the effect of the small life insurance company deduction and to a 100% valuation allowance on the deferred tax benefits on the net unrealized holding loss at December 31, 1996 and no valuation allowance applicable to the deferred tax expense on the net unrealized holding gain at December 31, 1995.
Central has operating leases for certain computer processing equipment and laser printing, publishing equipment which expire at various dates through 2000.
Charges for the leases were $768,352, $1,069,723 and $854,358 for 1996, 1995 and 1994, respectively. Future net minimum payments for the operating leases are as follows:
The Company's employment agreement with its Chief Executive Officer was entered into in 1982 and amended in 1983. The agreement expires December 31, 2001 and calls for annual increases of 11% per year through 1996. The 1996 compensation under the agreement was $966,994. The agreement has a change of control provision, which if exercised, upon such a change would require a lump sum payment for the unexpired term.
Central has a $1 million line of credit with a major bank, which was unused as of December 31, 1996 and 1995.
Outstanding stock options consist of options granted by the Company at prices equal to or above market price on the date of grant. On March 15, 1983, an Incentive Stock Option Plan was adopted. The plan, which expired in May 1993, provided that key full-time employees of the Company and its subsidiaries were eligible for participation in the Plan. Also 300,000 options were granted to the CEO in 1984, expiring in 1997, of which 235,000 at $2.83 per share remain outstanding at December 31, 1996. As of December 31, 1996, 1995 and 1994, all options were fully vested, subject to employment. The following table summarizes data regarding all stock options:
The exercise price of options outstanding at December 31, 1996, were $2.83 and $6.75 per share and those options expire in 1997 and 1998.
In addition to the Company's defined contribution pension plan, the Company, beginning in 1995, sponsors a retiree health benefit program for certain officer-class employees who meet specified age and service criteria. The Company and, as applicable, eligible retirees, fund the payment of benefits under the program in amounts and at such times as claims are incurred. Benefits for under age 65 retirees are based on continuation of prevailing active employee health coverage, and for over age 65 retirees are based on reimbursement of expenses for Medicare Part B and a Medicare Supplement Insurance Policy. The Company
The assumed annual health care cost trend rate used to measure the expected cost of benefits under the program is initially 8% (10% in 1995), declining by approximately 1% per annum to an ultimate assumed trend rate of 5% in the year 2003.
The assumed health care cost trend rates have a significant effect on determining the cost of benefits provided under the program. The effect of a 1% increase in the health care cost trend rates as noted above would be an increase of $17,000 or 22% in the service and interest cost components of net periodic benefit cost for the period reported, and an increase of $89,000 or 18% in the accumulated postretirement benefit obligation amount as of the date reported.
The discount rate used to measure the program's obligations was 7% in 1996 and 1995.
Effective December 31, 1995, the Company redefined its reporting segments, merging the group life and group accident health segments together, as well as combining the life and annuity segments. These alignments fit the Company's current operating organization and produce three segments: group life and health; life insurance and annuities; and corporate and other.
Statement of Financial Accounting Standards No. 107 (SFAS 107) "Disclosures about Fair Value of Financial Instruments" requires disclosure of fair value information about existing on and off-balance sheet financial instruments. In cases where quoted market prices are not available, fair value is based on estimates using present value or other valuation techniques.
OTHER POLICYHOLDERS' FUNDS: The carrying amount reported in the consolidated balance sheets for these instruments approximate their fair value.
MORTGAGE NOTE PAYABLE: The carrying amount reported in the consolidated balance sheets for the mortgage note payable approximates its fair value.
The following is a summary of quarterly results of operations for the years ended December 31, 1996 and 1995.