The Company's principal office, which is located at 2500 DeKalb Pike, Norristown, Pennsylvania, is owned by PILIC. This property is comprised of approximately 6.5 acres of land and buildings containing approximately 26,250 square feet of space. In 1997, the Company intends to purchase a parcel of adjoining land and to construct an 18,000 square foot addition to its offices at a cost of approximately $2.5 million. PILIC also owns a three-story office building located in Abington, Pennsylvania. As of December 31, 1996, all offices were leased to unaffiliated third parties. PILIC entered into an open-end lease for additional office space, in Norristown, Pennsylvania, in November 1996 for 4,893 square feet.
NIA, a wholly-owned subsidiary of PILIC, leases commercial office space in Lakewood, Colorado. NIA's lease is for 12,419 square feet and a term of five years which commenced on July 1, 1996.
(2) Restated for the acquisition of REF Associates, Inc. accounted for as a "Pooling of Interest".
The Company has expanded its group medical business through recent alliances and acquisitions. The Company has agreements with HealthCare COMPARE for managed care cost containment and HealthPlan Services Corporation for certain policy administration services. The Company acquired all of the outstanding shares of REF in order to obtain full control and the rights to the Company's "Provident Solution" plans and eliminates future commission expense between the Company and REF.
1996 results have not been 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 can write business in 42 states and the District of Columbia. PALHIC is in the process of obtaining regulatory approval to sell life and health plans in various states to be marketed by the Company's MGA, NIA and other distribution channels.
With the NIA acquisition the Company acquired a 3,500 customer inforce book of business representing approximately $6.5 million of annualized premium at the date of acquisition. This book consists primarily of the "HealthQuest" product which is a managed care one-life PPO product similar to the Company's "Provident Solution" Plan. The impact of the NIA Acquisition and the HealthQuest book of business on 1996 results accounted for the following amounts; Accident and Health Premiums gross before reinsurance ceded of $6.1 million, Accident and Health Premiums net of reinsurance ceded of $3.1 million, Total revenue of $3.6 million, Benefits net of reinsurance of $1.7 million, Total expenses of $3.5 million and Pre-tax income of $0.1 million. These amounts represent the book of business acquired on May 1, 1996 together with post acquisition HealthQuest sales and lapsation and NIA's operations. The impact on Goodwill is found in Note B Significant Accounting Policies, Goodwill and a description of the acquisition is found in Note C Acquisitions and Sales of Business.
At December 31, 1996 and 1995, annualized accident and health premium inforce on small group and managed care business amounted to $68.2 million and
1996 1995 ---- ---- Accident and health policy claims, net of reinsurance $18,963 $14,458
As described in Note B - Significant Accounting Policies, Policy Claims and the related policy benefit expense are based on a variety of estimation methods which are continually revised incorporating the Company's benefit experience. The Provident Solution and HealthQuest products, introduced in 1995 make up 37% and 4% of accident and health policy benefits in 1996 and 1995, respectively. Although the Company believes the Company's policy claim liabilities are adequate, the Company's experience with these relatively new products is limited and continues to emerge.
Other operating expenses of $13.4 million in 1996 increased from $12.2 million in 1995, due to increased policy administration expenses caused by increased policy administration 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 supports the Company's recently introduced managed care products and alliances with managed care networks.
Deferred policy acquisition costs of $2.7 million for 1996 increased $2 million from 1995 due to $2.1 million of deferred managed care policy acquisition costs related to "The Provident Solution" and HealthQuest products. The Company began deferring costs for its managed care products in the third quarter of 1996 coinciding with management's estimation that costs are recoverable against future profits on these products. Amortization of deferred acquisition costs of $0.6 million increased $0.5 million from $0.1 million in 1995 primarily due to $0.4 million of managed care amortization in the second half of 1996 relating to deferrals in the third and fourth quarters of 1996. Increased lapsation over current levels or future unprofitability in managed care and certain life products could result in an increase in the amortization rate of DAC, which would adversely impact future earnings.
Accident and health gross premium: Accident and health gross premium for 1995 was $39 million, down from $46.2 million in 1994 and Accident and health ceded premium in 1995 was $15.9 million, down from $20 million in 1994 both due to increased lapsation in 1995 without sufficient health sales to offset lapsation. The Company's new managed care product "The Provident Solution" was introduced in mid 1995 and for that reason did not have sufficient earned premium volume to offset lapsation of the Company's traditional group accident and heath plans. The accident and health insurance lapse ratios for small group and managed care business in 1995 and 1994 were 41% and 35%, respectively. The overall lapse ratio increased due to an increased proportion of small group and managed care business which by their nature have higher lapsation. The small group medical business for 1995 and 1994 accounted for approximately 61.5% and 49.8%, respectively, of the group accident and health business. The lapse ratios reflect the results of continued premium rate increases as well as the increasing trend away from traditional healthcare insurance to managed care plans which have lower premium amounts. While some policyholders have switched to less expensive insurance plans, the Company does not believe such plans are less profitable.
At December 31, 1995 and 1994, annualized accident and health premium inforce on small group and managed care business amounted to $41.7 million and $39.6 million, respectively, consisting of approximately 23,000 and 16,000 certificate holders, respectively. The net increase in annualized premium in 1995 resulted from new business amounting to approximately $19.9 million primarily The Provident Solution plus premium rate increases of approximately $13 million net of lapses amounting to approximately $30.8 million. In 1995, "The Provident Solution" was introduced in mid 1995 and accounted for $11.1 million of annualized premium or 25% of total annualized accident and health premium at December 31, 1995.
Deferred policy acquisition costs of $0.8 million for 1995 increased $0.4 million from 1994 due to increased sales of final expense life policies. No accident and health policy acquisition costs were deferred in 1995 or 1994.
The Loewen settlement provided a significant source of cash and invested assets in 1996. The settlement contributed approximately $22.4 million of pre-tax income made up of $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 sale of equity investments which includes a realized pre-tax gain of $2 million. The Company sold its remaining Loewen Equity during the first quarter of 1997 resulting in $4.1 million of cash from sale of investments which includes a realized pre-tax gain of $1 million.
Change in amounts due to/from reinsurers in 1996 of $2.1 million declined from 1995 due to the recapture of reinsurance ceded on certain multi-pay pre-need life insurance policies which contributed to net cash from operating activities in 1995.
Change in accrued commissions and expenses in 1996 of $1.9 million increased compared to 1995 due to increased accident and health premium volume along with the timing of December 1996's commission payments. These accruals are anticipated to be paid in 1997 though net cash from operations.
(Increase) decrease in loans receivable in 1995 and 1994 represents a loan of $1 million originated in 1994 to six agents repayable over a period of 30 months, together with interest at the rate of prime plus one percent. The loans, collateralized by their commissions to be earned in the future and approximately 255,000 shares of the Company's common stock purchased with the loan proceeds in market transactions, were repaid in 1994 and 1995. Concurrent with the origination of the agent loan, the Company entered into a term loan agreement with a bank and borrowed $1,000,000 included in Proceeds from note payable - bank in 1994. Under the terms of the loan agreement, the loan is repayable in 30 monthly installments of $33,333 from January 1995 and bears interest at 1% above prime rate. The Company anticipates timely repayment of the loan from cash from operations.
Acquisition of business, net of cash received represents the consideration paid for PALHIC, NIA and CSE acquisitions as described in Note C - Acquisitions and Sale of Subsidiaries and Businesses in Notes to Consolidated Financial Statements. The Company's acquisition of PALHIC included a high quality bond portfolio whose market and book value was approximately $3.6 million as of the date of acquisition and $5.4 million at December 31, 1996. In connection with these acquisitions the Company issued $1.9 million of its common stock.
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 and the Company 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 $13.9 million at December 31, 1996 which includes the benefits of certain permitted practices as described in Note P - Reconciliation From Statutory Basis (Unaudited) to Generally Accepted Accounting Principles Basis in the Notes to Consolidated Financial Statements. At December 31, 1996, 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, amounting to approximately $14.8 million, exceeds the Company Action Level amount required by approximately $8.3 million. PALHIC's results of this computation indicate PALHIC's adjusted capital, amounting to approximately $5.4 million, exceeds the Company Action Level amount required by approximately $5.3 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.