American Medical Security Group, Inc., together with its subsidiary companies ("AMSG" or the "Company"), is a provider of health care benefits and insurance products for individuals and small employer groups. The Company's principal product offering is health insurance for small employer groups and health insurance for individuals and families ("MedOne"). The Company also offers life, dental, prescription drug, disability and accidental death insurance, and provides self-funded benefit administration. The Company's products are actively marketed in 32 states and the District of Columbia through independent agents. Approximately 70 Company sales managers located in sales offices throughout the United States support the independent agents. The Company's products generally provide discounts to insureds that utilize preferred provider organizations ("PPOs"). AMSG owns a preferred provider network and also contracts with other networks to ensure cost-effective health care choices to its customers.
One of the most significant challenges for the Company is keeping pricing ahead of claim costs and technology-driven larger claims. In the face of escalating claim costs, the Company repriced its block of business and has developed pricing strategies which benefited the Company's financial performance in 2000 and are expected to benefit the Company in the future. Average fully insured medical premium per member per month increased to $136 in 2000 from $127 in 1999. Faced with significantly higher premiums, consumers appear to be willing to bear more of the financial risk. Management has identified a shifting trend where, in exchange for lower premiums, consumers are willing to pay more for routine health care needs out of their own pockets, while still insuring themselves against catastrophic medical costs.
The aggressive premium increases caused new member enrollment to decline from 1999 to 2000. As the impact of premium increases by other insurance carriers began to hit the market, new member enrollment began to level and even grow slightly for the last two quarters of 2000. Management expects sales measured by new member enrollment to continue to grow throughout 2001.
During the third quarter of 1999, the Company ceased marketing and terminated small group business in Florida and all remaining business in Maryland and Minnesota over a period of 18 months. This decision contributed to the significant improvement in 2000 financial performance for the small group market. At December 31, 2000, remaining membership in the exited markets was approximately 10,000 or 14% of the membership at September 30, 1999. Substantially all of the remaining members in exited markets will lapse by the end of the first quarter of 2001. Management continues to carefully analyze the Company's geographic markets. Where returns are inadequate due to regulatory or competitive barriers, management intends to reduce the Company's presence in those markets and to reinvest its resources in more profitable areas. The exit from these markets, along with significant premium increases, resulted in a considerable decrease in total in-force membership from 1999 to 2000.
Management completed a formal strategic planning process during 2000. As a result of this process, management identified key opportunities for future earnings potential. Management intends to further expand the distribution of the Company's MedOne product reflecting a fundamental shift from primarily a small group provider. As this expansion continues, management expects a more even split in membership between MedOne and small group by the end of 2003.
Management has also identified potential for earnings opportunities in some of the Company's specialty product offerings. Historically, the Company's dental product was sold as a component of its small group health package. The Company's core competency in this profitable product line has caused management to seek to sell this product on a stand-alone basis. In an effort to establish the Company as a successful and well-recognized competitor in the stand-alone dental market, the Company is in the process of expanding its stand-alone dental distribution capability and enhancing the dental product portfolio. In addition, management intends to increase external membership in its PPO network in order to increase fee income and create enhanced bargaining power with providers. Management is also evaluating the Company's self-funded product for potential low-risk income opportunities.
Looking forward, claims cost trends represent the largest variable in the Company's 2001 earnings expectations. The 2000 claims cost trend was higher than anticipated at approximately 15.5%. Management expects the claims cost trend to continue to rise slightly in 2001. Through continued rate actions, product redesign and claim costs control initiatives, management expects the overall loss ratio to improve and earnings per share to continue to improve. The current estimate for 2001 is between $0.35 to $0.45 per share. See "Cautionary Factors" below for a detailed description of inherent risks and uncertainties that may cause actual results or events to differ materially from those described.
The Company experienced unrelated nonrecurring charges during 1999 and 1998. As these nonrecurring items were not reflective of the ongoing operations of the Company, management has chosen to exclude their effects from the "Comparison of Results of Continuing Operations" and to describe each item separately. The following table illustrates the effect of nonrecurring items on the Company's results:
The Company's intangible distribution system asset was acquired in 1996 as part of a merger. During 1997 and 1998, the Company experienced significant turnover of sales managers and began to reorganize sales offices. During that period, the Company replaced commissioned independent sales managers with salaried sales offices, while it evaluated the Company's distribution strategy. In the fourth quarter of 1998, management concluded that a salaried sales office structure was more consistent with current strategy and that the Company's intangible distribution system asset was impaired. As a result, the Company recorded an after-tax charge of $9.3 million in 1998 to write off the intangible asset and other related costs.
The Company reported net income of $2.7 million or $0.18 per share for 2000, compared to a net loss of $25.9 million or $1.58 per share for 1999. Excluding the nonrecurring charge in 1999, the Company reported a loss of $12.2 million or $0.74 per share for that year. The significant improvement in earnings resulted primarily from an improved loss ratio due to the corrective actions implemented by management as described in more detail above.
The health segment loss ratio improved 3.2% to 77.2% in 2000 from 80.4% reported in 1999, excluding the nonrecurring charge. The significant improvement is due to management's actions and strategies to manage medical inflation implemented during 2000. These actions included premium increases, claims cost control initiatives and the exit from unprofitable small group markets and the related release of premium deficiency reserves. The improvement also reflects increased sales of MedOne products, which are priced for a lower loss ratio due to its increased deductibles and copayments. As previously mentioned, management expects the health segment loss ratio to continue to improve in 2001. The life segment loss ratio improved to 34.5% for 2000 from 39.2% in 1999.
Net investment income includes investment income and realized gains and losses on investments. Net investment income remained relatively stable at $18.7 million in 2000 from $18.9 million in 1999. The decrease resulted from a slight decrease in average invested assets from 1999 to 2000. Investment gains and losses are realized in the normal investment process in response to market opportunities.
during 2000, has higher agent commissions and issue costs than small group products, but lower claim costs. In addition, in the third quarter of 2000, the Company received a one-time assessment from the State of Minnesota related to the Company's exit from the MedOne health insurance market in that state in early 1999. The assessment was $1.2 million in excess of the Company's original provision for such assessment. Management expects no similar assessments from other exited markets. The decrease in premium volume also contributed to the increase in the health expense ratio.
Other revenue, which primarily consists of administrative fee income from claim processing and other administrative services, remained relatively stable, decreasing to $22.4 million in 1999 from $22.6 million in 1998.
The Company's cash used in operations was $3.2 million for 2000 and cash provided by operations was $26.4 million for the year ended 1999. The decline in cash flows from operations is the result of the expected decline in business in force from 1999 to 2000, along with faster claim payment patterns in 2000 compared to 1999. Positive cash flows from operations in 1999 were principally the result of growth in membership during that year. Management believes that cash flows for 2001 will be positive as membership begins to grow again.
The National Association of Insurance Commissioners has adopted risk-based capital ("RBC") standards for life and health insurers designed to evaluate the adequacy of statutory capital and surplus in relation to various business risks faced by such insurers. The RBC formula is used by state insurance regulators as an early warning tool to identify insurance companies that potentially are inadequately capitalized. At December 31, 2000, the Company's principal insurance company subsidiaries had an RBC ratio that was substantially above the levels that would require regulatory action.
During 2000, the Company's Board of Directors authorized an increase to the Company's share repurchase program to a maximum allowable repurchase of $18.0 million. The Company purchased 1.3 million shares of its outstanding common stock at an aggregate purchase price of $8.3 million during 2000. Since the inception of the program in 1999, the Company has purchased 2.4 million shares at an aggregate purchase price of $15.8 million.
In determining when and whether to purchase future shares under the stock repurchase program, management considers market price, the number of shares actively traded in the market, indications of seller interest, the number of shares held by large shareholders, the effect of purchases on shareholder value and other
In addition to internally generated funds and periodic borrowings on its existing bank line of credit, the Company believes that additional financing could be obtained as market conditions may permit or dictate.
The primary investment objective of the Company is to maximize investment income while controlling risks and preserving principal. The Company seeks to meet this investment objective through diversity of coupon rates, liquidity, investment type, industry, issuer and geographic location. Investment grade debt securities make up 96% of the Company's total investment portfolio. The below investment grade debt securities were principally at investment grade upon purchase and subsequently downgraded. The Company uses outside investment managers who seek to maximize return on the portfolio within the Company's investment guidelines. At December 31, 2000, $267.0 million or 99.1% of the Company's total investment portfolio was invested in debt securities.
At December 31, 2000, the fair value of the Company's borrowings under the line of credit facility approximated the carrying value. Market risk was estimated as the potential increase in the fair value resulting from a hypothetical 1% decrease in the Company's weighted average short-term borrowing rate at December 31, 2000, and was not materially different from the year end carrying value.
- - The Company's ability to profitably distribute and sell its products, including changes in business relationships with independent agents who sell the Company's products, the Company's ability to retain key producing sales agents, the Company's ability to expand its distribution network for MedOne products, competitive factors such as the entrance of additional competitors into the Company's markets, competitive pricing practices, demand for the Company's existing and new products, and the Company's ability to predict future health care cost trends and adequately price its products.
- - The development of and changes in claims reserves, particularly for highly regulated markets and exited markets where insureds may be inclined to increase utilization prior to termination of their policies.
- - Possible restrictions on cash flow resulting from a denial by state regulators of the payment of dividends by the Company's insurance company subsidiaries.
- - General economic conditions, including changes in interest rates and inflation that may impact the performance on the Company's investment portfolio or decisions of individuals and employers to purchase the Company's products.
American Medical Security Group, Inc., together with its subsidiary companies ("AMSG" or the "Company"), is a provider of health care benefits and insurance products for individuals and small employer groups. The Company's principal product offering is health insurance for small employer groups and health insurance for individuals and families ("MedOne"). The Company also offers life, dental, prescription drug, disability and accidental death insurance, and provides self-funded benefit administration. The Company's products are actively marketed in 32 states and the District of Columbia through independent agents. Approximately 70 Company sales managers located in sales offices throughout the United States support the independent agents. The Company's products generally provide discounts to insureds that utilize preferred provider organizations ("PPOs"). AMSG owns a preferred provider network and also contracts with several other networks to ensure cost-effective health care choices to its customers.
The fair values of investments are reported in Note 3. The fair values of all other financial instruments approximate their December 31, 2000 and 1999 carrying values.
The Company periodically evaluates whether events and circumstances have occurred that may affect the estimated useful life or the recoverability of the remaining balance of its intangibles. A study conducted during 1998 determined that the Company's sales distribution system intangible assets were impaired. The sales distribution system was acquired on December 3, 1996 in conjunction with the purchase of the Company's small group business. Since the acquisition, the Company has largely eliminated its commission-based sales distribution system, replacing it with salaried sales offices. This resulted in an after-tax charge to 1998 operations of $9,251,000 or $0.56 per share, including $7,683,000 of intangible distribution system assets and $1,568,000 of related costs. The Company's management believes that no impairment of goodwill or other intangible assets exists at December 31, 2000.
The liabilities for medical and other benefits are determined using statistical analyses and represent estimates of the ultimate net cost of all reported and unreported claims that are unpaid at year end. The Company's year-end claim liabilities are substantially satisfied through claim payments in the subsequent year. Management believes that the liabilities for insurance claims are adequate. The liability for unpaid claims of $139,457,000 at December 31, 1999, developed redundant in the subsequent year by $3,397,000. The liability for unpaid claims of $101,721,000 at December 31, 1998, developed deficient by $10,398,000 in the subsequent year. The liability for unpaid claims of $123,907,000 at December 31, 1997, developed deficient by $1,228,000 in the subsequent year. The estimates are reviewed periodically and, as adjustments to the liabilities become necessary, the adjustments are reflected in current operations.
The Company recognizes premium deficiency reserves on an existing group of insurance contracts when the sum of expected future claim costs, claim adjustment expenses and related maintenance expenses exceeds the expected future premium revenue and investment income. Insurance contracts are grouped as relating to highly regulated markets or all other markets consistent with the Company's manner of acquiring, servicing and measuring the profitability of its business. Highly regulated markets are identified based on significant rating restrictions, states' general legislative and regulatory environments, and the Company's ability to effectively underwrite risk. The Company continues to evaluate assumptions and updates the premium deficiency reserves as necessary.
During 1999, the Company established a premium deficiency reserve of $19,200,000 for its highly regulated markets. At December 31, 2000 and 1999, the Company had remaining recorded premium deficiency reserves totaling $1,142,000 and $16,700,000, respectively, which are included in medical and other benefits payable in the accompanying balance sheets. No premium deficiency reserves were recorded prior to 1999.
The net assets of Newco/UWS consisted of assets and liabilities of the managed care and specialty management business along with $70,000,000 in debt that was assumed by Newco/UWS in conjunction with the Distribution. Newco/UWS was renamed "United Wisconsin Services, Inc." The operations of Newco/UWS, along with direct costs of approximately $4,900,000 associated with the spin-off, are reflected in discontinued operations. Discontinued operations reported total revenues of $488,033,000 for 1998. Interest expense on the $70,000,000 debt assumed by Newco/UWS is reflected in continuing operations only through September 11, 1998.
The amortized cost and estimated fair values of debt securities at December 31, 2000 by contractual maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations.
At December 31, 2000, the insurance subsidiaries had fixed securities and cash equivalents on deposit with various state insurance departments with carrying values of approximately $4,520,000.
The Company had a net federal income tax receivable of $2,094,000 and $6,377,000 at December 31, 2000 and 1999, respectively. The Company and its subsidiaries had state net business loss carryforwards totaling $98,927,000 at December 31, 2000, which will begin to expire in the year 2008. The Company received net federal and state income tax refunds of $6,910,000 in 2000 and paid net federal and state income taxes of $1,496,000 in 1999 and $710,000 in 1998.
On August 26, 1999, a $6.9 million verdict was entered against the Company in a lawsuit which principally alleged breach of contract involving the timing of claims payments. On April 17, 2000, the Company filed its notice of appeal of this decision with a Federal Appeals Court. Management expects the verdict to be reversed or substantially reduced following appeal. As a result, the Company's accrual related to this case is not material.
The National Association of Insurance Commissioners revised the Accounting Practices and Procedures Manual in a process referred to as Codification. The revised manual will be effective January 1, 2001. Codification has changed certain prescribed statutory accounting practices and will result in changes to the accounting practices that the insurance subsidiaries of the Company use to prepare their statutory-basis financial statements. Management believes that the impact of Codification to the Company's insurance subsidiaries' statutory-basis capital and surplus will not be material.
Dividends paid by the insurance subsidiaries to the Company are limited by state insurance regulations. The insurance regulator in the state of domicile may disapprove any dividend that, together with other dividends paid by an insurance company in the prior twelve months, exceeds the regulatory maximum as computed for the insurance company based on its statutory surplus and net income. Based upon the financial statements of the Company's insurance subsidiaries as of December 31, 2000, as filed with the insurance regulators, no dividends may be paid without prior regulatory approval prior to December 2001, at which time the aggregate amount available without regulatory approval is $7,274,000.
The Company's employees are included in a qualified defined contribution plan (the "Retirement Savings Plan") with profit sharing and discretionary savings provisions covering all eligible salaried and hourly employees. Participant contributions up to 6% of the participant's compensation are matched 60% by the Company. Profit sharing contributions to the Retirement Savings Plan are determined annually by the Company. Participants vest in Company contributions in three years. The Company recognized expense associated with the Retirement Savings Plan of $1,944,000, $1,610,000 and $1,449,000 in 2000, 1999 and 1998, respectively.
The Company has a stock-based compensation plan, the Equity Incentive Plan (the "Plan"), for the benefit of eligible employees and directors of the Company. The Plan permits the grant of nonqualified stock options ("NQSO"), incentive stock options, stock appreciation rights, restricted stock awards and performance awards. Persons eligible to participate in the Plan include all full-time active employees and outside directors of the board of directors. The Plan allows for the granting of up to 4,000,000 shares of which 282,690 shares are available for grant as of December 31, 2000. No benefits other than NQSOs have been granted under the plan.
Effective January 1, 2000, the Company adopted a deferred compensation plan for the benefit of certain outside directors of the Company who wish to defer the receipt of eligible compensation which they may otherwise be entitled to receive from the Company. Directors who choose to participate in the plan may elect to have their deferred compensation credited to, in whole or in part, either an interest account or a Company stock unit account.