Madison Life leases 16,800 square feet of office space in Middleton, Wisconsin as its corporate headquarters, 3,900 square feet in Birmingham, Alabama for its military and government individual life and annuity division, 1,300 square feet in Austin, Texas for executive office space, 1,200 square feet in San Francisco, California for a majority owned stop-loss MGU and 2,400 square feet in Wilkesboro, North Carolina for its credit agency.
The Selected Financial Data should be read in conjunction with the accompanying Consolidated Financial Statements and Notes thereto.
Amortization of deferred acquisition costs and general and administrative expenses for the Insurance Group increased $6.9 million. Madison Life's expenses remained constant. Standard Life's expenses increased $6.7 million due to an increase in commission expense of $3.1 million from the increase in volume; an increase of $.8 million in taxes, licenses and fees due to the increase in premiums and an increase in general expenses of $2.8 million due to higher administrative fees associated with the increase in premium volume. IndependenceCare's expenses increased $.2 million due to the increase in premium volume.
The Company's pre-tax income increased $5.7 million to $22.5 million for the year ended December 31, 2001 from $16.8 million for the same period in 2000. Net income was $14.4 million, or $1.80 per share, diluted, for the year ended December 31, 2001 compared to $11.4 million, or $1.42 per share, diluted, for the year ended December 31, 2000. The Company had net realized and unrealized gains of $4.3 million in 2001 compared to losses of $.2 million in 2000. Decisions to sell securities are based on cash flow needs, investment opportunities and economic and market conditions, thus creating fluctuations in gains and losses from year to year. Excluding net realized and unrealized gains and losses, the Company had pre-tax income of $18.2 million in 2001 as compared to $17.0 million in 2000, an increase of $1.2 million, which approximately consists of: an increase in profitability from the stop-loss line of business, an increase in income from the blocks of business acquired in 1999 by Madison Life ("1999 acquisitions"), slightly offset by a decrease in other lines of business. Income tax expense increased $2.6 million to $8.1 million in 2001 from $5.5 million in 2000 reflecting the increase in income and a higher effective income tax rate in 2001, principally due to an increase in state taxes in 2001.
Premium revenues increased $17.9 million to $108.2 million in 2001 from $90.3 million in 2000; premium revenues decreased $.4 million at Madison Life and increased $18.3 million at Standard Life. The decrease at Madison Life is comprised of: a $2.0 million decrease in the credit line of business, primarily due to the runoff of acquisitions of two single premium blocks of business effective in 1997; and a $.2 million decrease in other life and health lines of business; such decreases were offset by: a $1.7 million increase in the long-term disability ("LTD") line and a $.1 million increase in the group life line, both as a result of an increase in rates and premiums written in 2001. The increase at Standard Life is comprised of: a $2.0 million increase in its provider excess line due to reinsurance assumed in 2001; a $10.6 million increase in the medical stop-loss line due to an increase in retention and reinsurance assumed; a $.9 million increase in the short-term statutory disability ("DBL") line due to greater production; a $3.0 million increase in the HMO reinsurance line from a coinsurance agreement on a new block of business; a $1.2 million increase in a new blanket accident line; and a $.6 million increase in all other lines.
Insurance benefits, claims and reserves increased $15.3 million, reflecting an increase of $1.9 million at Madison Life and $13.4 million at Standard Life. Madison Life's increase resulted from: a $2.9 million increase in ordinary life and individual accident and health reserves, claims and surrenders; a $.3 increase in group term life benefits; and a $.7 million increase in LTD claims and reserves due to the increase in premium volume; such increases were offset by: a $1.9 million decrease in the credit line of business due to the runoff of acquisitions and a $.1 million decrease in claims and reserves in other life and health lines of business. The change at Standard Life is comprised of: a $4.9 million increase in medical stop-loss reserves due to the increase in premiums, slightly offset by lower loss ratios; a $1.4 million increase in the HMO reinsurance line due to the increase in volume; a $2.0 million increase in the closed block of ordinary life business due to the surrender by a large group of policyholders in 2000; a $1.7 million increase in DBL claims and reserves due to the increase in volume and slightly higher loss ratios; a $.8 million increase in blanket accident reserves resulting from this being a new line of business; a $.7 million increase in the provider excess line due to the increase in volume; a $.6 million increase in the personal accident line due to higher loss ratios; a $.7 million increase in point of service claims due to the increase in premiums, and a $.6 million increase in all other lines. The group life line at Standard Life would have reported a net decrease of $.4 million due to lower loss ratios except for a $.4 million loss in the Volunteer Fire Fighters Division as a consequence of the September 11th tragedy.
Amortization of deferred acquisition costs and general and administrative expenses for the Insurance Group increased $3.2 million. Madison Life's expenses decreased $2.6 million representing a decrease in net commission expense due to the decrease in premium volume. Standard Life's expenses increased $4.3 million due to an increase in commission expense of $3.3 million from the increase in volume and an increase in general expenses of $1.0 million due to higher administrative fees associated with the increase in premium volume. IndependenceCare's expenses increased $1.5 million due to the increase in premium volume and the acquisition of two subsidiary MGUs.
Pre-tax income for the year ended December 31, 2001 decreased by $1.0 million, resulting from a loss of $3.7 million in 2001 compared to a loss of $2.7 million in 2000. This decrease in income is due to a decrease of $1.0 million in investment income due to lower returns on certain equity investments and an increase of $.5 million in general and administrative expenses due to salary related expenses, partially offset by a $.1 million increase in other income and a $.4 million decrease in interest expense due to lower interest rates and debt repayments in 2001.
The nature and quality of insurance company investments must comply with all applicable statutes and regulations which have been promulgated primarily for the protection of policyholders. Of the aggregate carrying value of the Insurance Group's investment assets, approximately 88.1% was invested in investment grade fixed income securities, resale agreements, policy loans and cash and cash equivalents at December 31, 2002. Also at such date, approximately 98.5% of the Company's fixed maturities were investment grade. These investments carry less default risk and, therefore, lower interest rates than other types of fixed maturity investments. At December 31, 2002 approximately 1.5% of the carrying value of fixed maturities was invested in diversified non-investment grade fixed income securities (investments in such securities have different risks than investment grade securities, including greater risk of loss upon default, and thinner trading markets). The Company had a negligible amount of mortgage loans. The Company does not have any non-performing fixed maturities.
stockholders' equity, the Company is never in a position where a decline in the market value of a security would have an unexpected economic impact on the net worth of the Company.
The Company manages interest rate risk by seeking to maintain a portfolio with a duration and average life that falls within the band of the duration and average life of the applicable liabilities. Options may be utilized to modify the duration and average life of such assets; see Note 1(F)(iv) of Notes to Consolidated Financial Statements.
a material exposure because the Company would have additional gains in its portfolio to help offset the future reduction of investment income. With respect to its investments, the Company employs (from time to time as warranted) investment strategies to mitigate interest rate and other market exposures.
The Company had net receivables from reinsurers of $119.6 million at December 31, 2002. Substantially all of the business ceded to such reinsurers is of short duration. All of such receivables are either due from highly rated companies or are adequately secured. No allowance for doubtful accounts was necessary at December 31, 2002.
Total Corporate liquidity (cash, cash equivalents, resale agreements, fixed maturities, equity securities and partnership interests) amounted to $12.7 million at December 31, 2002. During 2002, IHC repurchased 92,055 shares of common stock for $1.8 million under a repurchase program initiated in 1991, and announced that it would purchase up to 250,000 additional shares of its common stock under its repurchase program. On September 4, 2001 IHC completed a "Modified Dutch Auction" tender offer by repurchasing 202,680 shares of its common stock at a purchase price of $16.75 per share. During 2001, including those shares from the Modified Dutch Auction, IHC repurchased 219,433 shares of common stock for $3.6 million under its repurchase program. In the second quarter of 2001, IHC received $1.7 million upon exercise of 68,100 Warrants for 114,337 shares of common stock. All unexercised Warrants have now expired in accordance with their terms.
Due to its strong capital ratios, broad licensing and excellent asset quality and credit-worthiness, the Insurance Group remains well positioned to increase or diversify its current activities. It is anticipated that future acquisitions or other expansion of operations will be funded internally from existing capital and surplus and parent company liquidity. In the event additional funds are required, it is expected that they would be borrowed or raised in the public or private capital markets to the extent determined to be necessary or desirable. In March 2003, the Company borrowed $10.0 million in a pooled trust preferred issuance. (See Note 21 of the Notes to Consolidated Financial Statements in Item 8.)
The Company has expected contractual obligations relating to debt repayments and non-cancelable leases of the following at December 31, 2002: 2003 - $4,841,000; 2004 - $4,730,000; 2005 - $1,720,000; 2006 - $741,000; 2007 - $710,000; and $2,978,000 thereafter.
The Company anticipates continued favorable operating performance in 2003 as a result of (i) expansion of the distribution of its Medical Stop-Loss business through greater production by current MGUs, appointment of additional MGUs, and acquisition of new MGUs, (ii) increased retention of its Employer Medical Stop-Loss business, (iii) its expected increased equity interest in AMIC, as a result of its tender offer for AMIC shares, and AMIC's anticipated increase in income, and (iv) increased premium and improved loss ratios from Madison Life's group LTD, group term life and government employees lines and acquisition of blocks of business.
Madison Life anticipates some growth in its group LTD and term life as a result of increased production and improved loss ratios. Premiums from Madison Life's military/government personnel line increased 137% in 2002, as a result of significant expansion of the distribution network for this product, which was introduced in 2000. The Company expects greater production from this line of the business as a result of expansion of distribution sources. The Company believes that there will be an increase in blocks of business available for acquisition in 2003 as a result of underwriting, investment and capital losses suffered by the insurance industry in recent years. The Company will continue to review actively acquisitions, and believes that it is well positioned to consummate additional acquisitions should the opportunity arise.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation -Transition and Disclosure" ("SFAS 148"). SFAS 148 amends SFAS 123 to provide alternative methods of transition for a voluntary change from the intrinsic value method to the fair value based method of accounting for stock-based compensation. At December 31, 2002, the Company continued to apply the intrinsic value method. SFAS 148 also requires more prominent disclosures in both annual and interim financial statements about the method used and the effect of the method used on reported results. The required disclosures applicable to the Company are included in Note 1(R) to the Consolidated Financial Statements.
In November 2002, the FASB issued FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees Including Indirect Guarantees of Indebtedness of Others" "("FIN 45"). This interpretation requires that certain disclosures be made by a guarantor in its financial statements about its obligations under guarantees, effective for financial statements for periods ending after December 15, 2002. FIN 45 also requires the recognition, at fair value, of a liability by a guarantor at the inception of certain guarantees issued or modified after December 31, 2002. The disclosure requirement did not have, and the recognition requirement is not expected to have, a material impact on the Company's Consolidated Financial Statements.
The results of companies in the insurance and reinsurance industry historically have been subject to significant fluctuations and uncertainties. Factors that affect the industry in general could also cause the Company's results to fluctuate. The industry's and the Company's financial condition and results of operations may be affected significantly by:
Fluctuations in interest rates, inflationary pressures and other changes in the investment environment, which affect returns on invested capital and may impact the ultimate payout of loss amounts;
Rising levels of actual costs that are not known by companies at the time they price their products;
Ratings have become an increasingly important factor in establishing the competitive position of insurance companies. Standard Life is rated "A" (Excellent) and Madison Life is rated "A-" (Excellent) by A.M. Best Company, Inc., ("Best"). Best's ratings reflect its opinions of an insurance company's financial strength, operating performance, strategic position, and ability to meet its obligations to policyholders and are not evaluations directed to investors. The ratings of Standard Life and Madison Life are subject to periodic review by Best. If Best reduces either or both Madison Life's or Standard Life's ratings from its current levels, the Company's business could be adversely affected.
The Company's Inability to Assess Underwriting Risk Accurately Could Reduce Its Net Income
If the Company Fails to Comply With Extensive State and Federal Regulations, the Company Will Be Subject to Penalties, Which May Include Fines and Suspension and Which May Adversely Affect the Company's Results of Operations and Financial Condition
See Index to Consolidated Financial Statements and Schedules on page 39.