The Company is an insurance holding company representing the strategic combination of three life insurance companies, American Progressive, American Pioneer and American Exchange, and WorldNet. Management is focused on growth, both internal, through aggressive marketing and product development programs directed at specialty life and accident & health insurance products, and by seeking further acquisitions of insurance companies or blocks of business. It also has embarked on a program to streamline operations through consolidation of administrative and processing facilities.
The Insurance Subsidiaries had consolidated revenues of approximately $51.1 million, $49.3 million and $53.7 million for the years ended December 31, 1996, 1997, and 1998, respectively, representing 95%, 96% and 96%, of the Company's total revenues for each period, respectively. Although American Progressive, domiciled in New York, primarily sells its products in New York and the northeastern United States, American Pioneer, domiciled in Florida, primarily sells its products in Florida and the southeastern United States and American Exchange, domiciled in Texas, exclusively sells its products in Texas, one or more of the Insurance Subsidiaries is licensed in 45 states and in the District of Columbia.
1998 Total Product Premium Increase Premium Earned ------------------------------- ---------------- --------------- (in millions) (in millions) Senior market accident & health $ 9.79 $ 21.16 Senior market life insurance .91 3.30 Specialty life insurance 1.51 2.60 Specialty medical 3.25 6.35 Group life insurance - 3.39 --------------- -------------- Totals $ 15.46 $ 36.80 =============== ==============
While the Company was able to increase its gross premium revenue from its core products, it continues to reinsure a portion of these risks to unaffiliated reinsurers. Reinsurance premiums ceded for the year ended December 31, 1998 amounted to $89.5 million, a $26.9 million increase from the 1997 amount of $62.6 million. Details of the changes in reinsurance premiums ceded is as follows:
Ceded Premium 1998 Total Product Increase (Decrease) Premium Ceded ------------------------------- ------------------- -------------- (in millions) (in millions) Business acquired American Exchange $ 15.36 $ 15.36 Dallas General 8.41 8.41 Senior market accident & health 5.74 10.62 Senior market life insurance .51 1.67 Specialty life insurance .68 1.43 Specialty medical 2.90 5.71 First National assumed business (3.37) 38.38 Other lines (3.29) 7.96 ------------------ -------------- Totals $ 26.94 $ 89.54 ================== ==============
Net investment income of the Company increased $0.7 million to $10.7 million for the year ended December 31, 1998, compared to $10.0 million in 1997. This increase is attributable to the increase in invested assets outstanding during 1998 compared to 1997. Realized gains on investments amounted to $0.3 million for the year ended December 31, 1998 compared to $1.1 million in 1997. Included in the 1998 amount is the $0.5 million write down of certain securities determined by management to be permanently impaired. Included in the 1997 amount is the $0.6 million realized gain on the sale of Amerifirst Insurance Company to an unaffiliated third party.
Fee income amounted to $2.6 million for the year ended December 31, 1998, an increase of $0.2 million from the $2.4 million amount from 1997.
Benefits, Claims and Other Deductions. Total benefits, claims and other deductions increased approximately $4.0 million to $52.2 million for the year ended December 31, 1998, compared to $48.1 million for the year ended December 31, 1997.
Claims and other benefits increased $1.9 million to $25.6 million for the year ended December 31, 1998 compared to $23.7 million in 1997. The change in reserves for the year ended December 31, 1998 amounted to an increase of $5.4 million compared to an increase of $0.4 million in 1997 generating a variance of $4.9 million. These increases in claims and change in reserves are the result of the $4.8 million increase in net premiums earned for the year ended December 31, 1998 discussed above.
Commissions increased $6.0 million in the year ended December 31, 1998 to $27.1 million, compared to $21.1 million in 1997. This increase is the direct result of the $31.7 million increase in total premium discussed above. Commissions and expense allowances on reinsurance ceded increased $10.9 million in the year ended December 31, 1998 to $31.2 million, compared to $20.3 million in 1997. This increase is the direct result of the $26.9 million increase in reinsurance premium ceded discussed above.
Federal Income Tax Expense. Federal income tax expense increased approximately $0.2 million to $1.3 million for the year ended December 31, 1998, compared to $1.1 million for the year ended December 31, 1997. This increase is the result of the increase in operating income before taxes to $3.9 million in 1998 from $3.2 million in 1997. The effective tax rate in 1998 was 33.7% compared to 34.0% in 1997.
Revenues. Total revenues decreased approximately $2.1 million to approximately $51.3 million for the year ended December 31, 1997, compared to total revenues of approximately $53.4 million in the prior year, which decrease is primarily attributable to the Company's decision to restructure its operations and exit certain product lines (See "Business - Restructuring Activity").
In the year ended December 31, 1997, the Company's gross premium and policyholder fees earned (including reinsurance assumed) amounted to $100.3 million, a $34.5 million increase over the $65.8 million amount in 1996. This gross premium increase is significantly attributable to the increase of $37.1 million of premiums received on the policies assumed in the fourth quarter of 1996 from First National, which premiums amounted to $51.3 million in 1997 compared to $14.2 million in 1996. In addition, the gross premiums on the Company's currently marketed programs increased as follows:
While the Company was able to increase its gross premium revenue from its core products, it continues to reinsure a portion of these risks to unaffiliated reinsurers. Reinsurance premiums ceded for the year ended December 31, 1997 amounted to $62.6 million a $37.0 million increase from the 1996 amount of $25.7 million. Of this increase, $31.0 million relates to the business acquired from First National, while $1.9 million relates to senior market accident & health and $0.2 million relates to senior market life insurance. In addition to these increases, the reinsurance on the international medical insurance discussed above increased $1.1 million in 1997, while premiums ceded on life insurance increased $2.2 million.
Fee income amounted to $2.4 million for the year ended December 31, 1997, a decrease of $0.5 million from the $2.9 million amount for the prior year. This decrease is the result of the cancellation of WorldNet's Ontario Blue Cross contract in 1996. The amortization of deferred revenue amounted to $93,000 for the year ended December 31, 1997, compared to $0.3 million in the prior year. This $0.2 million decrease is the result of the full amortization of the deferred revenue generated by the reinsurance of the major medical business on June 30, 1995, which agreement was terminated by the reinsurer on December 31, 1996 (See "Business -Reinsurance Ceded").
Benefits, Claims and Other Deductions. Total benefits, claims and other deductions decreased approximately $4.9 million to $48.1 million for the year ended December 31, 1997, compared to $53.0 million in the prior year.
The change in reserves for the year ended December 31, 1997 amounted to an increase of $0.4 million compared to an increase of $1.9 million in the prior year generating a decrease of $1.4 million. Included in the 1996 change in reserves is $0.3 million generated by the NAIU accident pool business that the Company has exited. Interest credited to policyholders increased $32,000 to $6.6 million.
The change in deferred acquisition costs increased $0.7 million for the year ended December 31, 1997 compared to 1996. The amount of acquisition costs capitalized increased $1.7 million from $5.0 million in 1996 to $6.7 million in 1997. This increase is the result of the increase in new premium production in the year ended December 31, 1997 compared to the prior year. The amortization of deferred acquisition costs increased $1.0 million from $2.8 million in 1996 to $3.8 million in 1997. This increase is the result of the increase in the asset balance. In the year ended December 31, 1997, the Company amortized $0.1 million of the goodwill generated in the First National acquisition.
Commissions increased $5.0 million in the year ended December 31, 1997 to $21.1 million, compared to $16.1 million in the prior year. This increase is the direct result of the $34.5 million increase in gross premium earned discussed above. Commissions and expense allowances on reinsurance ceded increased $9.3 million for the year ended December 31, 1997 to $20.3 million, compared to $11.4 million in the prior year. This increase is the direct result of the $37.0 million increase in reinsurance premium ceded discussed above and reduces the amounts of commissions and expenses capitalized for deferred acquisition costs.
Federal Income Tax Expense. Federal income tax expense increased approximately $0.8 million to $1.1 million for the year ended December 31, 1997, compared to $0.3 million for the year ended December 31, 1996. This increase is the result of the increase in operating income before taxes to $3.2 million in 1997 from $0.4 million in 1996. The operating loss of the non-insurance companies amounted to $0.6 million in 1996 and a valuation allowance was recorded for this net operating loss. The effective tax rate in 1997 was 34.0% compared to 72.3% in 1996 (29.1% after backing out the non-insurance companies operating loss).
The Company requires cash to pay the operating expenses necessary to support its status as an insurance holding company (which under applicable Insurance Department regulations must bear its own expenses), and to meet the cost involved in being a publicly-owned company. In addition, it requires cash to meet Universal's obligations under the debentures outstanding with American Progressive and to meet the quarterly amortization of the bank loan entered into on December 10, 1997, as amended on September 30, 1998.
On December 31, 1998 the Company issued 22,500 shares of Series D Preferred Stock for $2.25 million. (See "Private Placement Financing-Series D Preferred Stock). The proceeds were used to make a $1.0 million capital contribution to American Pioneer on December 31, 1998 and for working capital,
The loan remains to be secured by a first priority interest in all the assets of WorldNet Services Corp. and Quincy Corp., a pledge of 9.9% of the outstanding common shares of American Progressive and 100% of the shares of Quincy Coverage Corp. The Company believes that the cash flow from WorldNet will be able to sufficiently service the installment payments required by the loan agreement.
American Progressive, American Pioneer and American Exchange are required to maintain minimum amounts of capital and surplus as determined by statutory accounting. The minimum statutory capital and surplus requirements of American Progressive, American Pioneer and American Exchange as of December 31, 1998 for the maintenance of authority to do business were $2.5 million, $2.7 million and $0.8 million, respectively. However, in these states substantially more than such minimum amounts are needed to meet statutory and administrative requirements of adequate capital and surplus to support the current level of the Insurance Subsidiaries' operations. At December 31, 1998 the adjusted statutory capital and surplus, including asset valuation reserve, of American Progressive, American Pioneer and American Exchange was $9.7 million, $12.6 million and $3.8 million, respectively.
During 1998, the Company made capital contributions totaling $2 million to American Pioneer. These amounts were generated by the proceeds of the First Amendment to the Company's credit agreement and from the proceeds of the Series D Preferred Stock issuance. The capital contributions were made to support the growth in new business production at American Pioneer.
The NAIC risk based capital ("RBC") rules have been adopted by New York, Florida and Texas. See "Regulation Risk-Based Capital Requirements." The RBC rules provide for various actions when the ratio of a company's total adjusted surplus to its RBC falls below 200%. At December 31, 1998, American Progressive, American Pioneer and American Exchange had RBC ratios of approximately 633%, 568% and 1,781% of the Authorized Control Level, respectively.
Liquidity is also affected by unscheduled benefit payments including death benefits, benefits under accident & health policies and interest-sensitive policy surrenders and withdrawals. The amount of surrenders and withdrawals is affected by a variety of factors such as credited interest rates for similar products, general economic conditions and events in the industry that affect policyholders' confidence. Although the contractual terms of substantially all of the Company's in force life insurance policies and annuities give the holders the right to surrender the policies and annuities, the Company imposes penalties for early surrenders. At December 31, 1998 the Company held reserves that exceeded the underlying cash surrender values of its in force life insurance and annuities by more than $12.0 million. The insurance companies, in management's view, have not experienced any material changes in surrender and withdrawal activity in recent years.
The Company's investment policy is to balance the portfolio between long-term and short-term investments so as to continue to achieve investment returns consistent with the preservation of capital and maintenance of liquidity adequate to meet payment of policy benefits and claims. The Company invests in assets permitted under the insurance laws of the various states in which it operates. Such laws generally prescribe the nature, quality of and limitations on various types of investments that may be made. The Company currently engages the services of an investment advisor, Asset Allocation and Management Company, an affiliate of AAM, to manage the Company's fixed maturity portfolio, under the direction of the management of the Insurance Subsidiaries and in accordance with guidelines adopted by their respective Boards of Directors. The Company's policy is not to invest in derivative programs or other hybrid securities, except for GNMA's, FNMA's and investment grade corporate collateralized mortgage obligations. It invests primarily in fixed maturity securities of the U.S. Government and its agencies and in corporate fixed maturity securities with investment grade ratings of "Baa3" (Moody's), "BBB-" (Standard & Poor's) or higher. However, the Company does own some investments that are rated "BB" or below (together 2.1% and 2.5% of total fixed maturities as of both December 31, 1997 and 1998, respectively). As of December 31, 1998 all securities were current in the payment of principal and interest.
At December 31, 1997 and 1998, the Company has established valuation allowances of $1,342,838 with respect to these net operating loss carryforwards (deferred tax assets). The Company determines a valuation allowance based upon an analysis of projected taxable income and through its ability to implement prudent and feasible tax planning strategies. The tax planning strategies include the Company's recent reorganization and use of its administration company WorldNet to generate taxable income. These changes resulted in the Company increasing taxable income in the non-life companies by $1.2 million and $0.4 million in 1997 and 1998, respectively. Management believes it is more likely than not that the Company will realize the recorded net deferred tax assets.
The Insurance Subsidiaries are taxed as life insurance companies as provided in the Tax Code. The Omnibus Budget Reconciliation Act of 1990 amended the Tax Code to require a portion of the expenses incurred in selling insurance products to be capitalized and amortized over a period of years, as opposed to an immediate deduction in the year incurred. Instead of measuring actual selling expenses, the amount capitalized for tax purposes is based on a percentage of premiums. In general, the capitalized amounts are subject to amortization over a ten-year period. Since this change only affects the timing of the deductions, it does not, assuming stability of rates, affect the provisions for taxes reflected in the Company's financial statements prepared in accordance with GAAP. However, by deferring deductions, the change does have the effect of increasing the current tax expense, thereby reducing statutory surplus. Because of the Insurance Subsidiaries' net operating loss carry forwards, there was no material increase in the Company's current income tax provision for the three years ended December 31, 1998 due to this provision.
The Company's plan to resolve the Year 2000 issue involves the following phases: (1) the assessment phase, which determines the impact of the Year 2000 issue, (2) the remediation phase, which is the updating or modifying of affected systems, (3) the testing phase, which determines the effectiveness of the remediation phase, (4) the implementation phase, which applies all proven systems to the operating environment and (5) the contingency planning phase, which develops plans in the event that the Year 2000 issue was not appropriately addressed.
The Company has completed its assessment of the systems that could be significantly affected by the Year 2000 issue. The completed assessment indicated that the Company's main policy administration system utilizes programs that were written using four digit codes to define the applicable year. This main policy administration system was tested to determine the system's ability to operate after January 1, 2000. Test results indicated that the system should continue to process transactions without disruption. Some of the Company's computer programs used to process portions of the Company's business outside of the main policy administration system were written using two digits rather than four to define the applicable year and therefore have to be modified or replaced. As a result, the Company began a conversion process to bring all of the Company's products onto its main policy administration system. All of the Company's products were placed on this system by January 1, 1999.
In addition to resolving the internal Year 2000 issue, the Company is working with all external organizations, business partners and vendors to assess Year 2000 issues associated with the exchange of electronic data. The Company is in the process of testing the interfaces with these business partners. The Company has also begun the process of obtaining Year 2000 readiness statements from all its external business partners to determine the extent to which The Company might be vulnerable to those third parties' failure to remediate their own Year 2000 issues. There is no guarantee that the systems of other companies on which the Company's systems rely will be timely converted and will not have an adverse effect on the Company's systems.
Currently, the Company expects the Year 2000 project costs to be limited to the allocation of its data processing department resources, and significant external expenses are not expected. Accordingly, no specific budget for such costs has been allocated. The costs of the 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. 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.
As of January 1, 1998, the Company adopted Statement 130, "Reporting Comprehensive Income." Statement 130 establishes new rules for the reporting and display of comprehensive income and its components; however, the adoption of this Statement had no impact on Universal's net income or shareholders' equity. Statement 130 requires unrealized gains or losses on Universal's available-for-sale securities, which prior to adoption were reported separately in shareholders' equity, to be included in other comprehensive income. Prior year financial statements have been reclassified to conform to the requirements of Statement 130.