Net loss applicable to common stock was $18.6 million or $1.84 per diluted share for 1997 compared to net income of $15.9 million or $1.36 per diluted share for 1996. The 1997 results were unfavorably impacted by higher health policy benefits, write-off of deferred acquisition costs, and transition costs associated with the HPS outsourcing. The 1996 results were primarily the result of a litigation settlement representing $14.6 million of net income plus related realized gains on the sale of stock received as a result of the settlement.
Accident and health gross premium was $84.7 million for 1997 compared to $57.2 million for 1996. Accident and health ceded premium was $39.5 million for 1997 compared to $25.7 for 1996. These increases were the result of increased new business relating to the Company's managed care health insurance products. The Company has expanded its group medical business through recent alliances and acquisitions. The Company has agreements with FHG for managed care cost containment and HPS for policy administration services which were effective in 1998. The Company outsourced its policy administration and claims to HPS in 1998 in an effort to achieve economies of scale and to provide enhanced policyholder services.
Life and annuity premium of $9.6 million for 1997 declined from $11.3 million for 1996 due to reduced pre-need premium. Individual life insurance lapse ratios for 1997 and 1996 were 11% and 10%, respectively. Life and annuity reinsurance ceded was $0.5 million for 1997 compared to $1.9 million recaptured for 1996, due to the Company's 1996 recapture of reinsurance originally ceded in 1995 on certain multi-pay pre-need life insurance policies.
Accident and health premiums, net of reinsurance Gross before reinsurance ceded $84,719 $57,195 Less reinsurance ceded (39,548) (25,670) ------- ------- Premiums, net of reinsurance $45,171 $31,325
Commissions, net of ceding allowance and deferred acquisition costs of $7.1 million for 1997 decreased from $7.9 million from 1996 due to the increased deferral of acquisition costs related to the Company's one-life managed-care products 1997. These costs were written-off in 1997 as amortization of deferred policy acquisition costs.
The Company has expanded its group medical business through alliances and acquisitions. The Company has agreements with FHG for managed care cost containment and HPS for certain policy administration services. The Company acquired all of the outstanding shares of REF and Associates, Inc. ("REF") in order to obtain full control and the rights to the Company's "The Provident Solution" plan and eliminates future commission expense between the Company and REF.
1996 results were not materially impacted as a result of the Company's acquisition of PALHIC, acquired for the purpose of expanding the number of available states which the Company is licensed to sell life and health insurance. PALHIC is licensed in 40 states while PILIC is licensed in 25 states and the District of Columbia. Together, the Company is licensed in 42 states and the District of Columbia.
Life and annuity premium of $11.3 million for 1996 declined from $13.2 million in 1995 due to reduced new premium growth caused by refinements in pre-need product and the Company's elimination of certain unprofitable marketing relationships selling the Company's pre-need products. The individual life insurance premium lapse ratios on an annualized basis for 1996 and 1995 were 10% and 9%, respectively.
"The Provident Solution" and HealthQuest products, introduced in 1995 represented 37% and 4% of accident and health policy benefits in 1996 and 1995, respectively.
Other operating expenses of $11.7 million in 1996 increased from $11.6 million in 1995, due to increased policy administration expenses resulting from increased sales volume and expenses associated with the acquired HealthQuest book of business. With the CSE acquisition, the Company insourced its accident and health policy and claims administration functions in order to better control costs and service levels. The Company acquired CSE's staff and administration systems. The acquired administration system supported the Company's managed care products and alliances with managed care networks. The Company later determined that it was advantageous to outsource these functions to HPS effective in 1998.
Cash and investments carried at market value at December 31, 1997 of $63.9 million. This included $45.1 million of bonds issued by the U.S. Government, government agencies, public utilities and other corporations, $2.0 million invested in policy loans, real estate and other invested assets and $16.8 million in cash and cash equivalents. Bonds are investment grade securities with fixed incomes ranging in maturity from one to 30 years. The gross average yield on fixed income bonds as of December 31, 1997, 1996 and 1995 was 6.8%, 6.5% and 6.3%, respectively. The Company's investment policy is to buy medium term U.S. government direct and agency bonds. All bonds are considered to be "available for sale". The Company and its subsidiaries invest in neither high-yield debt instruments, defined as securities below investment grade with interest rates or yields significantly above market rates, nor derivative financial instruments.
The Loewen settlement, described in Note K to the financial statements, provided a significant source of cash and invested assets in 1996. The settlement contributed approximately $22.4 million of pre-tax income, represented by $3 million of cash and 718,519 shares of Loewen common stock valued at $19.4 million. The Company sold 85% of its Loewen stock representing $18.5 million of equity investments, which included a realized pre-tax gain of $2 million, in 1996. The Company sold its remaining Loewen shares during the first quarter of 1997 that resulted in $4.1 million of cash from sale of investments and included a corresponding pre-tax gain of $1 million.
Change in amounts due from reinsurers of $7.5 million in 1997 increased from $2.1 million in 1996, due to higher than expected claim payments which are recoverable from reinsurers in proportion to the percentage of risk they reinsure.
The Company has entered into agreements pursuant to which options to purchase shares of the Company's common stock will be granted to various agents as they achieve certain production quotas and performance levels. The Company also initiated a "1996 Employee Incentive Plan," granting options to purchase shares of the Company's common stock to key employees whom the Company believes are critical to the future success of the Company.
The statutory capital and surplus of PILIC which includes amounts related to its subsidiary PALHIC, was $11.4 million at December 31, 1997. At December 31, 1997, PILIC calculated its "Risk Based Capital" utilizing a formula required by the National Association of Insurance Commissioners. The results of this computation indicate PILIC's adjusted capital of $12.0 million exceeds the Company Action Level amount required by $2.7 million. PALHIC's results of this computation indicate PALHIC's adjusted capital of $4.3 million exceeds the Company Action Level amount required by $2.6 million. In concept, Risk Based Capital standards are designed to measure the acceptable amounts of capital an insurer should have based on inherent and specific risks of the insurers business. This formula is a primary measurement as to the adequacy of total capital and surplus of life insurance companies. Administrative rules and legal restrictions of state insurance departments presently prevent payment of dividends by PILIC and PALHIC to their parent companies without regulatory approval.
Inflation increases the need for insurance. Many policyholders who once had adequate insurance programs increase their life insurance coverage to provide the same relative financial benefits and protection. The effect of inflation on medical costs leads to accident and health policies with higher benefits. Thus, inflation has increased the need for life and accident and health products.
The higher interest rates which have traditionally accompanied inflation also affect the Company's investment operation. The market value of the Company's fixed rate long-term investments decreases as interest rates increase.
The Company's pre-need products include periodic adjustments to the face amount of the policy for increases in the consumer price index.
The Company announced an interactive marketing agreement with AOL in March 1998. This agreement provides the Company with an exclusive agreement to market health insurance products through AOL. The Company has agreed to pay AOL a $8 million cash of which the Company paid AOL $4 million as of June 30, 1998 with $4 million due on September 1, 1998. Additionally, the Company expects to incur certain initial operating costs which will require funding before the AOL-related venture becomes operational in October 1998. HPS paid the Company $0.750 million in March 1998 to be the exclusive administrator of this business. Insurion privately placed $5 million of convertible debt in May 1998 to partially fund these obligations.
Consolidated Statements of Operations Years ended December 31, 1997, 1996 and 1995
Consolidated Statements of Changes in Stockholders' Equity Years ended December 31, 1997, 1996 and 1995
We have audited the accompanying consolidated balance sheet of Provident American Corporation and Subsidiaries as of December 31, 1997 and the related consolidated statements of operations, stockholders' equity, and cash flows for the year then ended. We have also audited the financial statement schedules as of and for the year ended December 31, 1997 listed in the accompanying index. These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audit.
We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and schedules are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and schedules. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation of the financial statements and schedules. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Provident American Corporation and Subsidiaries as of December 31, 1997, and the results of its operations and its cash flows for the year then ended in conformity with generally accepted accounting principles.
Bonds are classified as "available-for-sale", reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of stockholders' equity, net of applicable deferred income taxes.
Deferred policy acquisition costs are costs which vary with and in direct proportion to new business volume and include excess first year commissions, policy issue and underwriting expenses net of application fees and reinsurance ceding allowances. Accordingly, policy acquisition costs are deferred and amortized in order to match the costs of writing new business against the expected future revenues. Amortization of deferred policy acquisition costs relating to managed care business ("The Provident Solution" and HealthQuest) are established when polices are issued and is based on projected premium over a four-year period incorporating current lapse experience and for life insurance business based on the same projected premium assumptions used in computing reserves for future policy benefits. Unamortized costs are compared to the estimated future profitability for these products. If the unamortized costs exceed the estimated future profitability for these products, the unamortized cost will be written down to equal the estimated future profitability. The Company's estimates of future profitability consider investment income.
Reinsurance: The Company uses reinsurance to limit the impact of large losses by spreading the risk, and therefore limiting adverse claims experience. A significant portion of the reinsurance is effected under quota-share reinsurance contracts and, in some instances, by excess-of-loss reinsurance contracts. The Company's consolidated statements of operations present premium on a gross basis before reinsurance ceded together with the ceded premiums while policy benefits are presented net of reinsurance and commissions are presented net of reinsurance allowances.
Earnings (loss) per share of common stock: In 1997, the Company adopted SFAS No. 128 "Earnings Per Share" resulting in the presentation of basic and diluted earnings per share ("EPS"). Prior years' EPS data presented have been restated. Equivalents were anti-dilutive in 1997 and 1995.
Impairment of Long-lived Assets: Long-lived assets and certain identifiable intangibles including goodwill are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In 1995 management determined that certain intangible assets and equipment should be written off. Approximately $2,200 was charged against operations in 1995. The assets related to systems development and hardware costs were replaced with systems acquired through acquisitions. In addition, goodwill and value of insurance in force purchased was written off. During 1997 the Company wrote off certain computer hardware, equipment, software and goodwill as described in Note R.
SFAS 131 "Disclosure about Segments of a Business Enterprise" establishes standards for reporting information about operating segments in annual financial statements and requires reporting of selected information about operating segments in interim financial statements issued to the public. It also establishes standards for disclosures regarding products and services, geographic areas and major customers. SFAS 131 defines operating segments as components of an enterprise about which separate financial information is available and that is regularly used by the chief operating decision maker in deciding how to allocate resources and in assessing performance.
SFAS 132 "Employers' Disclosures about Pensions and other Postretirement Benefits" revises and standardizes disclosure requirements about pensions and other postretirement benefit plans to the extent practicable. SFAS 132 requires additional information on changes in benefit obligations and the fair values of plan assets that will facilitate financial analysis.
SFAS 130, SFAS 131 and SFAS 132 are effective for periods ending after December 15, 1997. The Company has not been able to fully evaluate the impact, if any, that adoption of these recent pronouncements will have on future financial statement disclosures.
Effective March 1, 1996, PILIC acquired all of the issued and outstanding stock of Union Benefit Life Insurance Company, a Pennsylvania stock life insurance company, ("UBLIC") for an amount equal to its adjusted capital and surplus (approximately $3,750), $500 in cash, plus the issuance of 100,000 shares of PAMCO's common stock. The Company has changed UBLIC's name to PALHIC. The shares issued are registered securities but have trading restrictions attached. Concurrently, the Company, PALHIC and PILIC entered into an agreement for the purchase and sale of the PALHIC business with Life and Health Insurance Company of America, a Pennsylvania insurer ("LHI"), pursuant to which all of the insurance business of PALHIC was purchased by LHI immediately prior to the purchase of the PALHIC stock by PILIC. The purchase price payable by LHI to PALHIC for the purchase of the PALHIC business was $1,800. PALHIC is licensed to transact life, accident and health insurance in forty (40) states and the District of Columbia. PALHIC began underwriting the Company's life, accident and health insurance products in 1997. This transaction was accounted for as a purchase.
On August 15, 1996, the Company acquired Coastal Services Eastern, Inc. ("CSE") from its shareholders for 123,937 shares of the Company's common stock. CSE's sole business was providing the Company with policy and claims administration at the Company's facility using CSE's administration system along with its employees. This transaction was accounted for as a purchase.
The amortized cost and fair value (book value) of bonds at December 31, 1997, by contractual maturity, is shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
The Company's investment in equity securities are classified as "available for sale" and carried at fair value. Equity securities as of December 31, 1996 represents the Company's investment of 100,000 shares of National Media Corp. and 108,119 shares of Loewen common stock (NYSE: LWN) acquired as a result of litigation (See note K). All shares of both companies owned as of December 31, 1996 were sold during 1997.
Based on the Company's estimates of the future profitability of it's group medical products, deferred acquisition costs of approximately $6,500 have been written off as amortization of deferred policy acquisition costs in the fourth quarter of 1997. Management believes that the estimated future profitability of the life business exceeds the unamortized deferred policy acquisition costs for life products.
The loans, bearing interest at rates ranging from 5.33% to 9%, are due from April 1999 through June 2003 and are collateralized primarily by the Company's common stock.
During 1997 the Company entered into a $1,000 bank line of credit, of which $1,000 was outstanding as of December 31, 1997. This loan bears interest at 1% above the prime rate. Interest payments are due monthly and the principal balance is due July 2, 1998.
During 1997 and 1996, the average amount of all bank borrowings outstanding was $131 and $577, respectively, the weighted average interest rate was approximately 6.7% and 9.3%, respectively, and the maximum amount outstanding was $1,000 and $830, respectively.
During 1997, the Company entered into capital lease obligations with Harleysville National Bank in the amount of $1,390 on data processing and other equipment. The obligation outstanding at December 31, 1997 was $1,151 with $92 of interest being paid on these leases during 1997.
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax liabilities and assets as of December 31, 1997 and 1996 are as follows:
The Company has established a valuation allowance for deferred tax assets reflecting the Company's lack of a history of consistent earnings which give rise to uncertainty as to whether the deferred tax asset is fully realizable. The change in valuation allowance in 1997 amounting to $2,638 results from a net increase in temporary differences for which recovery is uncertain primarily caused by the 1997 loss from operations.
Series A Cumulative Convertible Preferred Stock, $1 par value, entitles its holder to vote on an "as-converted" basis at a rate of four common votes per one share of Preferred Stock, to receive an annual cash dividend of $.25 per share, to convert after March 1995 into either common voting stock or Class A Common Stock on a share-for-share basis (each Class A Common Share has four votes) adjusted for future dilution and to receive $3.65 per share plus all accrued and unpaid dividends in the event of voluntary or involuntary liquidation and may be redeemed at the option of the Company on June 30, 1998, at the greater of (a) the current market price of the Class A Common Stock or the Common Voting Stock or (b) $5.45 per share, plus in each case all accrued and unpaid dividends. Redemption payments shall be payable in up to three annual installments, with interest at the then-current prime rate. However, no redemption shall be made unless, immediately thereafter, the Company and all of its subsidiaries shall be in compliance with the applicable laws, rules and regulations relating to insurance companies in the various states in which a subsidiary of the Company may be licensed to do business.
Series B Cumulative Convertible Preferred Stock, $1 par value, is identical to the Series A Cumulative Convertible Preferred Stock except it has only one vote per share. During 1996 all of the outstanding Series B Cumulative Convertible Preferred Stock was converted into common voting stock on a share-for-share basis.
(1) PILIC's total capital and surplus, adjusted capital and surplus and company action level Risk Based Capital includes amounts for its subsidiaries including PALHIC. PALHIC is included in 1997 and 1996 amounts.
A reconciliation of the numerator and denominator of the basic and diluted earnings per share computation for 1996 is as follows:
The Non-Qualified Stock Option Plan for Directors ("Directors' Plan") was amended in 1996 to increase the number of shares authorized for the issuance thereunder from 585,000 shares to 1,010,000 shares and to incorporate prior amendments. Options granted under the Directors' Plan are exercisable for up to ten years from the date of grant at a price of not less than the fair market value of the shares on the date of the grant. All options granted under the Directors' Plan have been granted at 100% of the fair market value of the shares on the date of grant. During 1997, pursuant to the Directors' Plan, the Company granted to each Director with the exception of Mr. Clemens an option to purchase 30,000 shares of the Company's Common Stock at an exercise price of $2.75 per share.
The incentive Stock Option Plan for Field Representatives and Agents authorize the granting of options for up to 750,000 shares of the Company's Common Stock, which are market value of the shares on the date of grant. All options granted under the Incentive Stock Option Plan for Field Representatives and Agents have been granted at 100% of the fair market value of the shares on the date of grant. The Company terminated the Incentive Stock Option Plan for Field Representatives and Agent in 1997.
The Premium Production Stock Option Plan authorizes the granting of options to agents, managers and employees of the Company's common stock, which are exercisable for up to five years from the date of grant, but in no event later than December 31, 2002, at a price equal to the lesser of $3.50 per share or the market price thereof. The Company has discontinued the granting of additional options under this plan. Since the fair market value of options granted during 1996 exceeded the option price, a charge was made to 1996 operations in the amount of $67. This plan was terminated as of June 30, 1997.
Also during 1997, the Company approved the adoption of a Military Stock Option Plan and a 1997 Insurance Agent Stock Option Plan ("Agents Plan"), designed to replace and supercede all previous stock option plans for non-employee agents. Each Plan is administered by the Option Administration Committee, options are granted at fair market value and subject to certain other vesting or performance conditions, and the Company has reserved 750,000 shares of the Company's common Stock for issuance under each Plan. Options will be issued under each Plan only to insurance agents who are licensed to sell insurance by a life insurance subsidiary of the company, and are exercisable for up to five years from the effective date of the grant.
In addition, Mr. Clemens directly owns options to purchase 253,376 shares of the Company's Common Stock at $ .9091 per share expiring from time to time between November 1999 through December 2002. Mr. Clemens indirectly owns options to purchase 82,080 shares of the Company's common stock at $.9091 per share expiring from time to time between November 1999 and December 2002. Mr. Clemens disclaims beneficial ownership of all other options of any partnership in which Mr. Clemens directly or indirectly is a partner.
In addition, a partnership of which Mr. Clemens is a partner owns options to purchase 1,000,000 shares of the Company's Common Stock at $ .9091 per share expiring from time to time between November 1999 through December 2002. Mr. Clemens also owns an option to purchase up to 550,000 shares of Series A Cumulative Convertible Preferred Stock at $3.64 per share (fair market value at date of grant) exercisable on or before March 31, 2003.
The Stock Option Plan for Executives ("Executive Plan") was amended in 1996 and authorizes the granting of options to purchase up to 3,850,000 shares of the Company's Series A Cumulative Convertible Preferred Stock ("Series A Preferred Stock"), which are exercisable for up to ten years from the effective date of grant at a price of not less than the fair market value of the shares on the date of grant. Also in 1997, the Company granted Alvin H. Clemens an option to purchase shares of the Company s Series A Preferred Stock successively upon each exercise by Mr. Clemens of his existing option and each subsequently granted option to purchase shares of Series A Preferred Stock from time-to-time, limited in the aggregate to (i) that the number shares of Series A Preferred Stock which, when exercised, shall permit Mr. Clemens to acquire the right to vote not more than 55% of the shares of the Company's Common Voting Stock owned, either directly or beneficially, by Mr. Clemens at such time, (ii) the shares of Series A Preferred Stock which are, as of the date of any such exercise, authorized and unissued; and (iii) an option to purchase more than 550,000 shares of Series A Preferred Stock in any six month period shall be prohibited except upon the occurrence of a "change of control" (within the meaning of the Securities Exchange Act of 1934, as amended).
Warrants: During 1995, the Company issued stock purchase warrants for the purchase of 250,000 shares of the Company's common stock. Warrants to purchase 200,000 shares were issued to a director of the Company on July 5, 1995, at $2.875 per share, 100,000 of these warrants are exercisable at any time through July 5, 2000, and 100,000 of the warrants are exercisable through July 5, 2000, in increments of 5,000 warrants for each $1,250 of pre-need insurance premium produced between August 1995 and July 1997. On October 1, 1996, the 100,000 warrants exercisable at any time and 21,267 warrants earned under this arrangement were exercised; the remaining 78,733 warrants were then terminated. 50,000 warrants were issued on November 1, 1995, to an unaffiliated party at $5.00 per share and are exercisable through November 1, 1998.
During 1997 the Company issued warrants to two exclusive agents, who are also directors of a subsidiary of PAMCO, for the purchase of 50,000 shares of the Company's common stock at $5.00 per share. These warrants become exercisable throughout 2001. The Company also issued a warrant exercisable at any time to an employee for the purchase of 25,000 shares of the Company's common stock at $4.00 per share.
The Company sold 610,400 shares of Loewen stock in 1996 realizing a $2,023 gain. During the first quarter of 1997 the Company sold its remaining shares of Loewen stock realizing a gain of $961.
The Company entered into an outsourcing agreement as described in Note - - R HPS Outsourcing Agreement which guarantees certain minimum payments which at December 31, 1997, are: 1998 - $935; 1999 - $120; 2000 - $120; 2001 - $120; 2002 - - $120; and thereafter $10.
The Company has a sixty-five month agreement with First Health Group Corporation ("FHG") whereby the Company pays FHG the greater of $50 per year or the sum of a sliding scale percentage of the discount recognized when policyholders utilize the FHG network (primarily for the Solution product), pre-certification of hospital admissions and large case management at agreed upon rates. This agreement has resulted in claim savings, better control of claim costs and competitively priced products.
The Company is involved in litigation in the customary settlement of insurance claims. Management is of the opinion that neither the litigation nor these claims will have a material adverse effect on the results of operations or financial position of the Company.
The Company's business is subject to a changing legislative and regulatory environment. Some of the proposed changes include initiatives to restrict insurance pricing and the application of underwriting standards; reform health care; and restrict investment practices. Proposals on national health care reform have been under consideration that could significantly change the way healthcare is financed and provided. The effects on the Company of comprehensive healthcare reforms, which, if enacted, may have a material adverse impact upon the ability of the Company to profitably engage in the writing of accident and health insurance. Additionally, competition in the insurance industry may effect the Company's ability to reach critical mass while remaining competitive in agent compensation and product pricing. In response to these developments the Company entered into an outsourcing agreement described in Note R and continually reviews agent compensation and product pricing.
All employee contributions are immediately vested, and the Company contribution becomes 20% vested after two years of service. Thereafter, an additional 20% becomes vested for each year of service up to 5 years, at which time all contributions become completely vested. Pension expense under this plan amounted to $78, $57 and $54 for 1997, 1996 and 1995, respectively.
In addition, the Company generally assumes 30% (up to $150 per individual) of the liability on its limited self-funded accident and health business, which consists generally of policies issued to limit the claims expenses of employers that self-insure group medical benefits with respect to any individual employee and in the aggregate.
Computer software development and consulting expense paid to an entity controlled by an employee of the Company in 1997 amounted to $107.
In October 1997 the Company and HealthPlan Services Corporation ("HPS") entered into a 5 year agreement under which the Company outsourced to HPS all of its current health insurance policy issuance, billing, and claims, effective February 1998 for certain claim processing and February 1998 for all remaining outsourced functions (the "Outsourcing Agreement"). The Company's life and stop loss operations are unaffected. The Company expects to benefit from a reduction in expenses over the life of the contract. HPS will charge the Company a fixed service fee plus a sliding scale variable percentage of premiums for customer service and claim processing. HPS will also charge the Company a fixed amount per policy submitted for underwriting services.
The Company received $5,000 from HPS in the fourth quarter of 1997 as an inducement to enter into the Outsourcing Agreement. The liability is to be repaid at a rate of $85 per month over the five year term of the Outsourcing Agreement commencing March 1998.
Sale of Montgomery Management: In February 1998 the Company sold a portion of its interest in its wholly owned subsidiary, Montgomery Management Corporation ("MMC"), to HPS for $4,000 in cash and other consideration, effective January 1, 1998. The Company sold 49% of MMC's outstanding common stock along with a warrant to purchase an additional 31% of MMC's common stock for one dollar, which if exercised would result in the Company owning a 20% interest in MMC. Immediately prior to the sale MMC declared a dividend payable to its parent PILIC equal to its total equity. During the first quarter of 1998 the Company will recognize a $4,000 pre-tax gain on the sale of MMC and no longer include MMC in the Company's consolidated financial statements. The Company will account for its 20% ownership of MMC as an equity investment. MMC retains its headquarters at the Company's home office. The Company, through its subsidiary PILIC, continues to assume via reinsurance approximately 30% of the premiums, benefits, commissions and expenses of the stop-loss business administered by MMC. During 1997 MMC's impact on the Company's results from operations excluding intercompany amounts was $945 of other income and $718 of expense.
The AOL Agreement has an initial term commencing on February 1, 1998 and ending on September 30, 1999, with a renewal period of two additional years at PHS's election. As consideration under the AOL Agreement, PHS will pay $8,000 to AOL during 1998 and the Company agreed to issue warrants to AOL. PHS paid AOL $1,500 and $2,500 during the first and second quarters of 1998, respectively with $4,000 due AOL during the third quarter of 1998. The Company will account for the $8,000 that PHS will pay to AOL as a deferred cost asset, which will be amortized over the balance of the initial term. In addition, the Company issued to AOL warrants to purchase 300,000 shares of the Company's common stock at an exercise price of $4.48 (based on the average NASDAQ closing prices for the last 20 days preceeding the determination date as defined in the agreement) per share, for a period of five years commencing February 1, 1998 which are immediately exercisable. The fair value of these warrants (approximately $990) will be recognized as a deferred cost asset as of March 31, 1998 and will be amortized over the initial term of the AOL Agreement starting October 1, 1998. The AOL Agreement also provides for the issuance of warrants subject to the terms and conditions of the AOL Agreement.
Lynx Consulting Agreement: In March 1998 Insurion entered into a consulting agreement ("Lynx Consulting Agreement ") with Lynx Capital Group, LLC ("Lynx") to provide consulting services in regards to entering into online and internet commerce agreements and the subsequent development of Insurion's capabilities and business. Insurion will pay Lynx a monthly fee, travel expenses and issue warrants to purchase up to 350,000 PAMCO's common stock subject to the terms of the Lynx Consulting Agreement. The fair value of the warrants has not been determined.
Insurion Convertible Note: In May of 1998 Insurion issued a $5,000 Convertible Note due June 30, 2003. The Convertible Note pays interest at an annual rate of 5.5% payable together with interest on conversion or June 30, 1999 whichever occurs first. Insurion may repay the Convertible Note subject to the terms of the Convertible Note. The Convertible Note is convertible based upon certain terms and conditions into the greater of 125,000 shares of Insurion's Class A Common Stock or 12.5% of Insurion's outstanding common stock as calculated on a fully diluted basis. The Convertible Note may also be converted at a conversion price of one a share of Insurion's Class A Common Stock for each $40.00 of principal to be converted. The conversion price is subject to adjustment subject to the terms of the Convertible Note. The Convertible Note further provides that the holder of Insurion's Convertible Note agrees to purchase and Insurion agrees to sell additional securities in an aggregate amount up to or equal to $5,000 in the form of Insurion stock or convertible securities whose conversion terms are acceptable to the holder of Insurion's Convertible Note, subject to the following conditions occurring prior to September 30, 1998: 1) Insurion sells the same amount of similar securities to accredited investors as defined in Rule 501 of Regulation D under the Securities Act of 1933, 2) Insurion executes its business strategy to the sole satisfaction of the holder of Insurion's Convertible Note, and 3) the fully diluted market capitalization of Insurion shall be less than or equal to $100,000.