The Company currently owns an office building in Boise, Idaho containing 50,000 rentable square feet of office space. During 1998, the Company entered into an agreement to sell this property and intends to enter into a ten year lease with the buyer. The Company also leases approximately forty sales offices and three service centers throughout the United States. The Company believes that its present facilities are adequate for its current needs.
The following historical financial data for the ten years ended December 31, 1997 have been derived from the Consolidated Financial Statements of the Company audited by Price Waterhouse LLP, independent accountants. The following selected financial data of the Company should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations and the Company's audited Consolidated Financial Statements appearing elsewhere herein.
Effective January 1, 1997, the Company adopted Statement of Financial Accounting Standard No. 128, "Earnings per Share". In accordance with this statement, per share amounts for each year presented have been restated to comply with the provisions of the statement.
(1) The pro forma statement of income data and other related data for the year ended December 31, 1992 were prepared assuming the Company's initial public offering of its common stock (the "IPO") occurred on January 1, 1992. The pro forma balance sheet data as of December 31, 1992 and related other data were prepared assuming the IPO occurred on December 31, 1992.
On March 9, 1998, the Company entered into an agreement to merge with a wholly-owned subsidiary of Fortis as a result of which, among other things, the Company will become a wholly-owned subsidiary of Fortis and each outstanding share of the Company's common stock will be converted into the right to receive $22.50 in cash. Consummation of the merger is subject to regulatory and stockholder approvals, as well as other customary terms and conditions. It is anticipated that the merger will be consummated during 1998. In connection with and as a condition to Fortis entering into the agreement to merge, the Company granted an option to Fortis to acquire, under certain circumstances, common stock of the Company representing up to 19.9% of the Company's outstanding common stock at an exercise price of $22.50 per share. See Note 2 to the Company's Consolidated Financial Statements. Further description of the merger agreement is set forth in the Company's current report on Form 8-K dated March 9, 1998 filed with the Securities and Exchange Commission.
On March 31, 1997, the Company sold its Annuity Operations to SunAmerica. The transaction included the sale of all of the common stock of JANY and the coinsurance of substantially all of the annuity business of JALIC. This coinsurance was initially on an indemnity basis and the parties agreed to transition the business to an assumption basis as soon as practical. In certain states, the transition to an assumption basis is subject to policyholder approval. To the extent that such transition does not take place with respect to any particular policy, the policy will remain reinsured on an indemnity basis. As of December 31, 1997, approximately 70% of the ceded annuity reserves have either transitioned to an assumption basis or lapsed. The majority of the remaining policies are expected to be assumed by December 31, 1998.
As consideration for the Annuity Operations, SunAmerica paid the Company approximately $238.2 million. The consideration represented an approximately $162.3 million premium paid to acquire the business and approximately $75.9 million of adjusted capital and surplus of JANY. It did not include any capital and surplus used to support the annuity business in JALIC, which remained in JALIC.
As a result of the sales of the Annuity Operations and Western Diversified Group, the Company recorded a net deferred gain of approximately $45.0 million. This amount was net of estimated transaction expenses, taxes, goodwill and other adjustments relating to these transactions. During the three months ended December 31, 1997, the Company recognized approximately $24.0 million of the net deferred gain in income as a result of the assumption of policy reserves by SunAmerica. The Company expects to recognize the majority of the remainder of the net deferred gain by December 31, 1998.
The Company's available capital was enhanced by both the after-tax gain generated from the transactions and by the release of the net capital previously allocated to support these businesses. The Company continues to evaluate the best uses of its capital, including the approximately $200 million of excess capital generated from the sale of the Company's annuity and credit businesses. In the event that the sale of the Company does not occur, this capital may be used to repurchase common stock, pay dividends, reduce debt, acquire blocks of business or for general corporate purposes, or for a combination of two or more of such uses. During December 1997 and January 1998, the Company repurchased approximately 1.1 million shares of common stock for a total purchase price of approximately $25.9 million.
(1) Applicable to common stock excluding net realized investment gains (losses) and is after preferred stock dividends.
(2) Net income from discontinued operations for the year ended December 31, 1997 includes $24.0 million of recognition of the deferred gain on the sale of the discontinued operations.
Operating loss from continuing operations increased to $12.3 million, or $0.48 per common share, for the year ended December 31, 1997 from $5.0 million, or $0.20 per common share, for the year ended December 31, 1996. The increase in operating loss was primarily due to $38.5 million of pre-tax severance and related charges and other expenses attributable to discontinued product lines incurred during the year ended December 31, 1997 as a result of the Company's reduction in force and continued strategic evaluation of its operations. During the year ended December 31, 1996, $6.7 million of pre-tax severance and other charges were incurred. Excluding these charges, continuing operations improved to operating income of $12.7 million, or $0.51 per common share, for the year ended December 31, 1997 from an operating loss of $0.6 million, or $0.03 per common share, for the year ended December 31, 1996. This improvement was primarily attributable to increased investment income earned on the proceeds from the sale of the Annuity Operations on March 31, 1997, the discontinuance of certain products included in the Company's stop-loss reinsurance product line in 1996 and a reduction in corporate expenses. See further discussion below regarding these variances. These improvements were partially offset by a reduction in income earned from the Company's group division resulting primarily from a decrease in gross earned premiums to $1,105.6 million in 1997 from $1,523.4 million in 1996. The group gross medical loss ratio decreased to 75.4% for the year ended December 31, 1997 from 76.3% for the year ended December 31, 1996 and the group gross expense ratio, excluding the severance and other charges discussed above, increased to 26.0% from 24.5% during these periods.
(1) For the year ended December 31, 1997, the effects of the assumption of a block of life insurance under a reinsurance treaty, which increased gross premiums and contract charges earned ("gross premiums") and benefits by approximately $35.9 million, have been excluded from this table. The transaction resulted in no net income or loss.
(2) Includes 22,000, 32,000 and 40,000 groups, each group made up of one individual, as of December 31, 1997, 1996 and 1995, respectively, marketed through an association trust.
(3) For the year ended December 31, 1997, group covered lives includes 45,000 lives insured under the Company's new product introduced in April 1997, as discussed below.
During the year ended December 31, 1997, the Company assumed a block of life insurance, which had the effect of increasing gross premiums and benefits by approximately $35.9 million. This reinsurance treaty had no effect on the net results of operations for the year ended December 31, 1997. All subsequent discussion of results of operations will exclude the effects of this reinsurance treaty. Excluding the effects of this treaty, gross premiums decreased 18.6% to $1,495.7 million for the year ended December 31, 1997 from $1,838.3 million for the year ended December 31, 1996 and 5.1% to $1,838.3 million in 1996 from $1,936.3 million for the year ended December 31, 1995. These decreases were primarily attributable to a decrease in group covered lives during these periods, partially offset by premium rate increases and growth in the premiums earned in the Company's joint venture HMO. Group covered lives have declined from 1,190,000 at December 31, 1995 to 901,000 at December 31, 1996 and to 544,000 at December 31, 1997. The NHP joint venture was formed in the third quarter of 1994 with a physician hospital organization. Covered lives in the HMO have increased from 43,000 at December 31, 1995 to 81,000 at December 31, 1996 and to 111,000 at December 31, 1997. The Company's 50% share of the net income (loss) of NHP was $1.0 million, $2.1 million and ($2.0) million for the years ended December 31, 1997, 1996 and 1995, respectively. As discussed below, net income of NHP for the year ended December 31, 1996 included release of a valuation allowance relating to prior year tax losses.
Consistent with the Company's objective of maintaining profit margins at the risk of reducing market share, the Company began to significantly increase rates on its new and renewal business effective January 1, 1995, with larger increases targeted to the higher risk business. The Company raised its 1995 premium rates higher than the majority of the competition as it believes it was among the first major participants in the small group market to recognize the increased level of utilization and the rising medical cost trends. The Company also began to take additional actions that were designed to enable it to better control the future medical loss ratios on its group business with a strong emphasis on the high risk business. These actions included, where appropriate or available, improving discounts from providers, redesigning benefits, improving underwriting techniques, implementing a lower commission structure and discontinuing portions of such business, if warranted.
During 1996, the Company continued to experience relatively high gross medical loss ratios. The group gross medical loss ratio increased to 76.3% for the year ended December 31, 1996 from 75.0% for the year ended December 31, 1995. In response, the Company significantly increased premium rates, improved provider discount arrangements, redesigned benefit packages, modified commission structures and discontinued portions of the business as deemed advisable. In 1996, the Company ceased marketing in the State of Kentucky and terminated certain other marketing arrangements. While the number of group covered lives decreased 24.3% to 901,000 at December 31, 1996 from 1,190,000 at December 31, 1995, the rate increases offset, in part, the decline in covered lives. Additionally, gross premiums from the Company's HMO joint venture increased 191.8% in 1996 to $107.4 million from $36.8 million in 1995.
The amount of these profit sharing provisions has fluctuated between these periods due primarily to changes in the group gross medical loss ratio.
Total benefits decreased 10.9% to $683.6 million for the year ended December 31, 1997 from $767.6 million for the year ended December 31, 1996 and 1.4% to $767.6 million for 1996 from $778.3 million for the year ended December 31, 1995. During 1995, the Company received sufficient information to enable it to conclude that the initial premium rates on its provider excess stop-loss reinsurance product line were insufficient to pay the anticipated claims on pre-1995 business. Accordingly, the Company recorded charges of $5.8 million relating to its 50% exposure in this business. In 1996, the Company increased premium rates, revised benefits and coverage allowances, raised the amount of business ceded to 100% and ultimately reached a decision to discontinue this product line. Estimated losses during the run-off period were accrued for in 1996. Also, in the first quarter of 1995, the Company recorded a charge of $10.0 million for claims incurred in 1994 relating to the group product. As a percentage of net premiums, total benefits were 76.5%, 74.9% and 73.9% for the years ended December 31, 1997, 1996 and 1995, respectively. These increases are primarily attributable to the decrease in the size of the group division relative to the other product lines of the Company which generally incur a higher ratio of benefits to net premiums than the group division. The group gross medical loss ratio was 75.4%, 76.3% and 74.3% (excluding the $10.0 million charge discussed above) for the years ended December 31, 1997, 1996 and 1995, respectively. The decrease in the medical loss ratio from 1996 to 1997 is generally attributable to the premium rate increases and other actions which have been taken by the Company during the past two years. Much of the gross medical loss ratio improvement over the prior year is recorded as an experience refund under the Group Reinsurance Agreement and is included in other income, as discussed above.
The Company has generally experienced a higher gross medical loss ratio in the fourth quarter versus other quarters of the year. The Company believes that these higher medical loss ratios are primarily due to increased incidence of claims associated with the colder, winter climate and the fact that insureds generally exceed the calendar year deductible and out-of-pocket expense limits of their policies by that time of year. The Company has also generally experienced relatively higher gross medical loss ratios with groups that have been inforce for a longer period of time. New business has generally provided relatively lower gross medical loss ratios compared to the renewing inforce business. The Company cannot predict the extent to which these historical patterns will continue, increase or decrease in the future.
Historically, group insurance business has been subject to pricing and profitability cycles that are driven by competitive price pressures within the industry. These pressures and other factors make it difficult to predict with certainty the effect pricing changes will have on the Company's profitability. Traditionally, the cycle has been characterized by a period of higher profitability, which has fostered intense price competition and aggressive marketing by new entrants and existing companies striving to increase market share, thereby resulting in lower profitability. The lower profitability typically resulted in a withdrawal of competitors and a firming of prices, resulting once again in increased profitability and a renewal of the cycle. There are factors in the current cycle that were not present in previous cycles. One significant factor is small group and individual healthcare legislative reform and its effect on medical underwriting and pricing. Small group and individual healthcare reforms, primarily at the state level and increasingly at the federal level, include legislation on matters such as guaranteed issue, mandated benefits, premium rate limits (including community rating and modified community rating), guaranteed renewability, minimum loss ratio mandates, risk adjustment mechanisms which allocate losses of individual carriers to group carriers, and other reforms. Additionally, managed care providers, the most significant of which are HMO's, now represent a more significant source of competition than in previous cycles.
In 1996, Congress enacted HR 3103 ("Health Insurance Portability and Accountability Act", or "HIPAA"), also commonly referred to as the Kennedy-Kassenbaum Bill. HIPAA provisions applicable to both insured and self-funded employer group coverage include minimum standards for pre-existing condition exclusions, waiver of pre-existing condition exclusions for individuals meeting minimum prior coverage requirements and prohibition of health related exclusion of individuals from employer group coverage. HIPAA also provides guaranteed acceptance of small employers with 2 to 50 employees for insured coverage. In other respects, HIPAA's group and small group provisions are largely in line with state small group reform laws already enacted by the large majority of states. In the individual market, HIPAA requires guaranteed acceptance for eligible individuals moving out of group plans who have at least 18 months of prior coverage. However, most states have or are expected to amend their laws to alleviate any inconsistencies with the federal minimum standards. States which
The Company maintains a Credit Agreement with The Chase Manhattan Bank which was amended in July 1994 to increase the commitment amount of the term loan to $110.0 million and to establish a revolving credit loan with a commitment amount of $40.0 million and an expiration of July 1998 (the "Credit Agreement"). As of December 31, 1997, the Company has $23.5 million available under the revolving credit loan. In April 1997, the Company made a scheduled principal payment under the Credit Agreement of $25.0 million. The principal amount of outstanding indebtedness of the Company was $76.5 million as of December 31, 1997 as compared to $101.5 million and $107.1 million as of December 31, 1996 and 1995, respectively. Future required principal payments as of December 31, 1997 are $41.5 million in 1998 and $35.0 million in 1999. As of December 31, 1997, the Company's ratio of debt and redeemable securities to stockholders' equity was 0.20 to 1 as compared to 0.26 and 0.27 to 1 as of December 31, 1996 and 1995, respectively. The weighted average interest rates on the Company's indebtedness were approximately 6.4%, 6.3% and 6.9% for 1997, 1996 and 1995, respectively.
The Credit Agreement restricts dividends and other distributions payable by the Company. In any period of 12 consecutive months, the Company may pay cash dividends on, or repurchase for cash, capital stock in an amount not to exceed 15% of net worth (representing stockholders' equity excluding net unrealized gains (losses) on investments plus redeemable securities) as of the end of the fiscal quarter ending on or most recently prior to the last day of such 12 month period ($67.3 million for the 12 months ended December 31, 1997).
The Company paid preferred stock dividends of approximately $0.7 million in each April and October of 1997, 1996 and 1995. On March 8, 1998, the Company declared a preferred stock dividend in the amount of approximately $0.7 million and a common stock dividend of approximately $2.9 million which are both to be paid in April 1998. A summary of common stock dividends declared or paid during 1996, 1997 and 1998 is as follows (dollars in millions, except per share amounts):
The Company's sources of cash are payments of principal and interest on the Surplus Debentures of, and dividends from, its direct life insurance subsidiary, HNLIC, and dividends, management fees and tax allocation payments from the Company's principal non-insurance subsidiary, JA Services, Inc. ("JASI") and JASI's subsidiaries. HNLIC's primary sources of cash are dividends from its subsidiary, JALIC, and tax allocation payments from JALIC and its subsidiaries. The Surplus Debentures require HNLIC to make a principal payment to the Company of $11.0 million in 1998 and $32.0 million in 1999. JALIC paid cash dividends to HNLIC of $225.0 million in 1997, $12.0 million in 1996 and $30.0 million in 1995.
Net cash provided by (used in) investing activities (reflecting principally investments purchased and loans made, less investments sold or matured, and loans repaid) was $21.0 million, $36.6 million and $(186.5) million in 1997, 1996 and 1995, respectively. In conjunction with the Company's announcement in March 1996 that it was selling its Annuity Operations, the Company reduced production of new mortgages in 1996 while experiencing increased repayments. In anticipation of cash needs relating to the sale of the Annuity Operations and the possible use of the proceeds as discussed below, the Company maintained the additional cash generated from the mortgage repayments in cash equivalents, as opposed to reinvesting these funds in other instruments. This resulted in the increase in cash provided by investing activities in 1996.
In addition to the $238.2 million purchase price for the Annuity Operations, SunAmerica paid $33.1 million to the Company for accrued interest and related items. In turn, the Company paid SunAmerica $360.4 million of cash and cash equivalents because policy reserves transferred exceeded invested assets transferred. Additionally, the Company's cash and cash equivalent position was decreased by JANY's cash and cash equivalent balance at the time of the sale of $88.5 million, which was retained by JANY. Therefore, the Company incurred a net outflow of cash and cash equivalents due to the sale of the Annuity Operations of $177.6 million, as reflected in the accompanying consolidated statement of cash flows. Additionally, the Company increased its cash position by $23.3 million as a result of the sale of the Western Diversified Group.
Cash flow from financing activities consists of net proceeds from exercise of stock options, purchases of treasury shares, dividend payments on preferred and common stock, additions to and repayments of indebtedness, as well as receipts and payments on the Company's annuity and universal life products. Net cash used in financing
Substantially all of the group accident and health insurance business has been reinsured under the Group Reinsurance Agreement which provides for the Company and the reinsurers to share on a 50-50 basis all premiums and claims expense. Annually, the Company receives profit sharing payments from the reinsurers equal to the excess of reinsurers' profits over contractual floor amounts. For years where such profits fall short of floor amounts, the shortfalls are carried forward with interest to be applied as reductions against future profit sharing payments. In addition, under the Group Reinsurance Agreement, to the extent the combined ratio of the group accident and health
As discussed above, in conjunction with the sale of the Annuity Operations, the Company entered into a coinsurance agreement with SunAmerica relating to substantially all of the JALIC annuity business. This coinsurance was initially on an indemnity basis and the parties agreed to transition the business to an assumption basis as soon as practical. In certain states, the transition to an assumption basis is subject to policyholder approval. To the extent that such transition does not take place with respect to any particular policy, the policy will remain reinsured on an indemnity basis. As of December 31, 1997, approximately 70% of the ceded annuity reserves have either transitioned to an assumption basis or lapsed. The majority of the remaining policies are expected to be assumed by December 31, 1998. At December 31, 1997, there are assets held in trust directly or indirectly available for payments to policyholders supporting the remainder of the ceded reserves. SunAmerica is rated "A+ (Superior)" by A.M. Best and Company.
Receivables from reinsurers and investment deposits recoverable were $187.1 million at December 31, 1997. Additionally, included in other assets at December 31, 1997 in the accompanying consolidated balance sheet was approximately $1.4 billion of investment contract deposits recoverable on the JALIC coinsurance, net of a similar amount of contract holder liabilities related to the discontinued operations.
The Company's consolidated financial statements, together with the report thereon of Price Waterhouse LLP dated March 20, 1998, are filed as part of this Report, beginning on page. Unaudited quarterly financial information is filed as a part of this Report on page.