The Company believes that its present facilities are adequate for its current needs.
On March 27, 1996, the Board of Directors of the Company authorized the sale of its Annuity Operations and the Western Diversified Group. As a result of this action, beginning in 1996, the Company has reported the results of operations of the Annuity Operations and Western Diversified Group as discontinued operations. The
Consolidated Statements of Income for the years ended December 31, 1995 and 1994 have been restated to reflect the results of these operations as discontinued operations. Accordingly, the Statement of Income Data for the years ended December 31, 1995 and 1994 has also been restated.
The Company has historically operated in three segments: HealthCare, Asset Accumulation, and Credit and Other. In addition, a Corporate Segment included certain activities that were not directly related to any operating division. Beginning in 1994 and throughout 1995, the Company conducted a strategic evaluation of its operations. The purpose of this evaluation was to maximize stockholder value and to increase the Company's focus on the major product lines within each segment that it believed had long-term financial viability and provided a significant contribution to the Company's operating results. On March 27, 1996, the Board of Directors of the Company authorized the sale of its Asset Accumulation Segment, which includes the annuity business, (the "Annuity Operations"), and the Western Diversified Group, the principal businesses which market credit life and disability and retail service warranty coverage (see "Sale of Annuity Operations and the Western Diversified Group" below). As a result of this action, the Company has reported the results of operations of the Annuity Operations and Western Diversified Group as discontinued operations and has reclassified prior period results of operations in the accompanying Consolidated Statements of Income. In addition, the Company has discontinued the reporting of segment information as management is now managing the Company as a single line company operating in the healthcare market. The current healthcare operations primarily include indemnity and managed indemnity products, healthcare stop-loss reinsurance products and health maintenance organization ("HMO") and HMO-like products. The Company also has certain product lines which are no longer being actively marketed (run-off operations). All references to the Company herein include the subsidiaries and predecessors of John Alden Financial Corporation, unless the context otherwise indicates.
The total purchase price is approximately $240 million. This represents approximately $165 million premium paid to acquire the business and $75 million of adjusted capital and surplus of JANY. It does not include any capital and surplus used to support the annuity business in JALIC, which will remain in JALIC. The Company's available capital will be enhanced by both the after-tax gain generated from the transaction and by the release of the net capital previously allocated to support the annuity business. The Company intends to use a portion of this available capital to strengthen its healthcare operations, after which it estimates there will be approximately $175 million to $200 million of capital available for other uses. Subject to applicable regulatory approvals, this additional capital may be used to repurchase common stock, pay dividends, pay down debt and, to a lesser extent, for general corporate purposes.
The Company is pursuing the execution of a definitive agreement for the sale of the Western Diversified Group and expects to enter into a non-binding letter of intent in the second quarter of 1997. Such sale may be in the form of a sale of all of the common stock of the subsidiaries which comprise the Western Diversified Group or the reinsurance of the applicable business and would be subject to applicable regulatory approvals. There can be no assurance that such sale will be consummated.
As a result of these sales, the Company expects to record a net deferred gain of approximately $45 million. This amount is net of transaction expenses, taxes, goodwill and other adjustments relating to these transactions including an adjustment to reduce the carrying value of the Western Diversified Group to its estimated net realizable value. The net deferred gain will be recognized as income as SunAmerica completes the assumption of policyholder liabilities. The Company expects to begin recognizing the net deferred gain in 1997 and to earn the majority of the gain by December 31, 1998.
See Note 2 to the consolidated financial statements for a discussion of the impact of the adoption of new accounting pronouncements.
As discussed above, the Company reports the results of operations of the Annuity Operations and the Western Diversified Group as discontinued operations. The Company's continuing operations primarily consist of its group health business, its joint venture HMO and its stop-loss reinsurance business.
The following tables recast the accompanying Consolidated Statements of Income for continuing operations for the years ended December 31, 1996, 1995 and 1994 as a percent of net insurance premiums and contract charges earned and provide other relevant information:
Gross insurance premiums and contract charges earned ("gross premiums") increased 8.0% to $1,936.3 million for the year ended December 31, 1995 from $1,792.1 million for the year ended December 31, 1994. Consistent with the Company's objective of maintaining profit margins at the risk of reducing market share, the Company began to significantly increase rates on its new and renewal business effective January 1, 1995, with larger increases targeted to the higher risk business. The Company raised its 1995 premium rates higher than the majority of the competition as it believes it was among the first major participants in the small group market to recognize the increased level of utilization and the rising medical cost trends. The Company also began to take additional actions that were designed to enable it to better control the future medical loss ratios on its group business with a strong emphasis on the high risk business. These actions included, where appropriate or available, improving discounts from providers, redesigning benefits, improving underwriting techniques, implementing a lower commission structure and discontinuing portions of such business, if warranted. While these actions resulted in a decline in group covered lives of 6.6% to 1,190,000 at December 31, 1995 from 1,274,000 at December 31, 1994, the rate increases resulted in the net increase in gross insurance premiums and contract charges earned in 1995.
level, pertaining to small group and individual healthcare. The Company believes it was among the first major participants in the small group market to recognize the increasing medical cost trends. The Company identified the increase during its periodic hindsight review of its estimates of unpaid claims based on its actual claims experience. Upon such a review completed in late March of 1995 utilizing the most recent available submitted claim data, the Company discovered that claims submitted in 1995 relating to medical services provided in 1994 were at higher levels than originally estimated. As a result of this review, the Company increased its claim reserves as of December 31, 1994 by $15.0 million. Upon a hindsight review performed in April 1995 based on claims received in April 1995 for medical services provided in 1994, it became apparent that the claim reserves for 1994 would have to be further increased to reflect an even higher level of utilization. Therefore, the Company recorded a charge of $10.0 million in the first quarter of 1995 for claims incurred in 1994. During the remainder of 1995, the Company continued to experience loss ratio increases over the 1994 levels. The group gross medical loss ratio increased to 75.0% in 1995 from 69.7% in 1994.
During 1995, the Company recorded additional medical benefits in its provider excess stop-loss reinsurance product line. The Company began selling this product in late 1993. Since this was a relatively new product throughout the industry, the Company entered into a 50% reinsurance arrangement with a pool of reinsurers. During the third and fourth quarters of 1995, the Company received sufficient information to enable it to conclude that the initial premium rates were insufficient to pay the anticipated claims on pre-1995 business. Accordingly, the Company recorded charges of $5.8 million relating to its 50% exposure in this business. In 1996, the Company increased premium rates, revised benefits and coverage allowances, raised the amount of business ceded to 100% and ultimately reached a decision to discontinue this product line. Estimated losses during the run-off period have been accrued in 1996.
General expenses, as a percent of net premiums, were 28.4% in 1994 and 1995, but decreased to 24.0% in 1996. Included in general expenses are direct costs to support the group, HMO and stop-loss reinsurance product lines, as well as the Company's overhead costs. Also included in general expenses are charges recorded in connection with the Company's strategic evaluation of its operations, excluding the Annuity Operations and the Western Diversified Group. During 1994, the Company recorded a $0.9 million charge for the discontinuance of the Emperion Corporation joint venture. During 1995, the Company recorded $20.8 million of intangible asset write-offs, severance and other charges related to the strategic evaluation. The severance charges were related to an approximate 400 position elimination, which approximated 10% of the work force that then existed. An additional $6.7 million of severance and related charges were recorded in 1996 for further actions related to the strategic evaluation.
The Company's income from continuing operations was 7.6% of net premiums in 1994. Due primarily to the increase in the group gross medical loss ratio and the $20.8 million of charges related to the strategic evaluation, the Company recorded a loss from continuing operations in 1995, which equated to 2.9% of net premiums. The loss from continuing operations was reduced in 1996, primarily as a result of the expense reductions discussed above, to 0.1% of net premiums.
The Company's income tax provisions differ from the amounts determined by multiplying total income before income taxes by the statutory federal income tax rate of 35% primarily due to permanent differences including goodwill amortization, non-taxable investment income, non-deductible expenses, changes in tax valuation allowances and other items. During 1994, the Company also recognized a $3.3 million tax benefit from the dissolution of the Emperion joint venture. During 1995, the Company increased its valuation allowance for
the tax losses from NHP by $1.5 million, bringing the total for such valuation allowance to $3.7 million at December 31, 1995. During 1996, the Company determined that the valuation allowance was no longer necessary and it was released.
On March 27, 1996, the Board of Directors of the Company authorized the sale of the Annuity Operations and the Western Diversified Group. On December 2, 1996, the Company announced that it had entered into a definitive agreement to sell the Annuity Operations to SunAmerica. The transaction includes the sale of all of the common stock of JANY and the coinsurance of substantially all of the annuity block of JALIC. This coinsurance will initially be on an indemnity basis and, pursuant to the agreement, will transition to an assumption basis as soon as practical. In certain states, the transition to an assumption basis is subject to policyholder approval. To the extent that such transition does not take place with respect to any particular policy, such policy will remain indemnity reinsured. A substantial portion of the transition to an assumption basis is expected to be completed within two years. The transaction is contingent upon customary terms and conditions, including required regulatory approvals and is scheduled to close by the end of the first quarter of 1997.
The net spread earned in 1995 decreased 36.1% to $33.8 million from $52.9 million in 1994. The decrease in net spread earned in 1995 as compared to the high spreads earned in 1994 was primarily due to the tightening of spreads during the period of declining interest rates in 1995. The net spread earned in 1995 was also reduced by $8.2 million in charges from two significant adjustments. In January 1996, the National Organization of Life and Health Guaranty Associations revised its prior estimates of certain insolvencies and, accordingly, the Company increased its existing 1995 liability for guaranty fund assessments by $3.8 million. In addition, during 1995, the Company entered into a reinsurance agreement to cede 90% of certain annuity contracts. The Company liquidated available-for-sale securities to fund the ceding of the annuity contracts, resulting in $13.8 million of net realized investment gains. As a result of the agreement, the Company recognized $4.4 million of accelerated amortization of deferred policy acquisition costs. Therefore, 1995 pre-tax income increased $9.4 million from this agreement. The assets transferred to the reinsurer were placed in trust for the Company's protection.
Net spread earned increased 77.8% to $60.1 million for the year ended December 31, 1996 from $33.8 million for the year ended December 31, 1995. The increase in net spread is due to changes in the mix of annuity contracts caused by the ceding of a large block of contracts in the third quarter of 1995 which carried high surrender penalties and changes in the average credited rate on outstanding annuity contracts during 1996 as compared to the tightening of spreads during the period of declining interest rates in 1995 as well as a reduction in marketing and administration expenses incurred in 1996 due to the anticipated sale. Also, investment income on JANY equity increased due to an increase in capital, including a contribution made in late 1995. In addition, the Company recognized $2.6 million of premium and intangible tax refunds and guaranty fund liability reductions during 1996.
The actions described above are designed to make the Company's products more competitive and to ultimately increase the total group gross insurance premiums and contract charges earned, as well as to restore profit margins to an acceptable level. During the short-term, these actions may result in a decrease in group gross insurance premiums and contract charges earned. There can be no assurance that these actions will restore profit margins to acceptable levels.
The Company maintains a Credit Agreement with The Chase Manhattan Bank which was amended in July 1994 to increase the commitment amount of the term loan to $110.0 million and to establish a revolving credit loan with a commitment amount of $40.0 million and an expiration of July 1998 (the "Credit Agreement"). As of December 31, 1996, the Company has $23.5 million available under the revolving credit loan. The Credit Agreement is collateralized by the capital stock and the surplus debentures of Houston National Life Insurance Company ("HNLIC"), as well as the stock of all of the Company's other direct and indirect non-insurance subsidiaries, other than those owned through an insurance subsidiary. The Credit Agreement contains restrictive covenants which, among other things, limit additional indebtedness, payments of dividends, sale of assets and reinsurance arrangements. It also requires the Company to satisfy certain financial covenants. The Credit Agreement's interest rate per annum is based on certain economic indices and ranged from 5.6% to 9.0% during 1996, 1995 and 1994. Future required principal payments are $25.0 million in 1997, $41.5 million in 1998, and $35.0 million in 1999.
In December 1993, the Company entered into a revolving credit agreement with three banks, allowing the Company to borrow up to $35.0 million to finance purchases of fixed assets and capitalized software. In December 1995, the remaining principal balance of $20.4 million was repaid in full utilizing the net proceeds of a sale and leaseback of certain fixed assets and capitalized software. Fixed assets with a net book value of $13.4 million and unamortized capitalized software with a net book value of $13.9 million were sold to a bank for book value and leased back to the Company. The lease is for a five-year term and is accounted for as an operating lease.
The Credit Agreement restricts dividends and other distributions payable by the Company. In any period of 12 consecutive months, the Company may pay cash dividends on, or repurchase for cash, capital stock in an amount not to exceed 15% of net worth (representing stockholders' equity excluding net unrealized gains (losses) on investments plus redeemable securities) as of the end of the fiscal quarter ending on or most recently prior to the last day of such 12 month period ($65.8 million for the 12 months ended December 31, 1996).
On December 2, 1996, the Company announced that it had entered into a definitive agreement to sell the Annuity Operations to SunAmerica for a total purchase price of $240 million. The transaction includes the sale of all of the common stock of JANY and the coinsurance of substantially all of the annuity block of JALIC. This coinsurance will initially be on an indemnity basis and, pursuant to the agreement, will transition to an assumption basis as soon as practical. In certain states, the transition to an assumption basis is subject to policyholder approval. To the extent that such transition does not take place with respect to any particular policy, such policy will remain indemnity reinsured. A substantial portion of the transition to an assumption basis is expected to be completed within two years. The transaction is contingent upon customary terms and conditions, including required regulatory approvals and is scheduled to close by the end of the first quarter of 1997. The Company is pursuing the execution of a definitive agreement for the sale of the Western Diversified Group and expects to enter into a non-binding letter of intent in the second quarter of 1997. Such sale may be in the form of a sale of all of the common stock of the subsidiaries which comprise the Western Diversified Group or the reinsurance of the applicable business and would be subject to applicable regulatory approvals. There can be no assurance that such sales will be consummated. For further discussion, see "General Overview - -- Sale of Annuity Operations and Western Diversified Group".
the foreseeable future to allow the Company to service its debt, redeem preferred stock and meet anticipated dividend requirements.
See Notes 5, 11, 12 and 14 to the Consolidated Financial Statements for a discussion of liquidity, quality, composition and fair values of the Company's invested asset portfolio.
Substantially all of the group accident and health insurance business has been reinsured under the Group Reinsurance Agreement which provides for the Company and the reinsurers to share on a 50-50 basis all premiums and claims expense. Annually, the Company receives profit sharing payments from the reinsurers equal to the excess of reinsurers' profits over contractual floor amounts. For years where such profits fall short of floor amounts, the shortfalls are carried forward with interest to be applied as reductions against future profit sharing payments. In addition, under the Group Reinsurance Agreement, to the extent the combined ratio of the group accident and health insurance business for a rolling 12-month period exceeds contractual amounts, the Company receives a reduced profit sharing payment. As originally contracted, the Company's 1996 profit sharing payment would have been reduced as its combined ratio exceeded the contractual amount. However, in December 1996, the reinsurers agreed to amend the agreement. Under the terms of the amended agreement, the Company and the reinsurers agreed to suspend the contractual combined ratio requirement for 1996. Accordingly, the Company is not obligated to return any portion of the 1996 profit sharing payments to the reinsurers. In addition, the contractual amount was increased by one percentage point for 1997. The contractual amount is then reduced by one percentage point for 1998 and subsequent years. To the extent the combined ratio for 1997 exceeds contractual amounts, the Company's profit sharing amounts will be reduced by 25%. To the extent the combined ratio in years subsequent to 1997 exceeds the contractual amounts, the Company's profit sharing amounts will be reduced by 50%. Further, to the extent the reinsurers incur a loss in relation to the agreement in 1997, the Company has agreed to reimburse the first $5.0 million of net losses incurred by the reinsurers.
On December 2, 1996, the Company announced that it had entered into a definitive agreement to sell the Annuity Operations to SunAmerica for a total purchase price of $240 million. The transaction includes the sale of all of the common stock of JANY and the coinsurance of substantially all of the annuity block of JALIC. This coinsurance will initially be on an indemnity basis and, pursuant to the agreement, will transition to an assumption basis as soon as practical. In certain states, the transition to an assumption basis is subject to policyholder approval. To the extent that such transition does not take place with respect to any particular policy, such policy will remain indemnity reinsured. A substantial portion of the transition to an assumption basis is expected to be completed within two years. The transaction is contingent upon customary terms and conditions, including required regulatory approvals and is scheduled to close by the end of the first quarter of 1997. The Annuity Operations have generally resulted in fairly stable earnings per share, which has had the effect of reducing the volatility in the Company's earnings per share caused by fluctuations in the gross group medical loss ratio. The Company believes, therefore, that the relative volatility of the earnings per share may increase following the proposed sale of the Annuity Operations. In addition, cash flow and liquidity will be reduced. See "Liquidity and Capital Resources -- Cash Flows". During 1997, the Company will assist SunAmerica in the
The Company has continued its strategy to strengthen its products and negotiate new and better contracts with its providers. This strategy is designed to reduce the risks created in its marketplace by healthcare reforms and changing patterns of behavior by providers while offering customers attractive, high quality, affordable products. In this pursuit, during early 1996, the Company began a major project to design benefit plans that are more easily understood and administered by providers and which steer customers into selected provider networks. The strategy has resulted in the development of a new product which is anticipated to be introduced in 17 states in the second quarter of 1997 and should be available in most of the states in which the Company expects to continue its marketing efforts by the end of the third quarter of 1997. It is designed to offer customers the high quality, affordable features they demand, reward policyholders for using the Company's selected local provider system, generate stronger relationships with providers and reduce the risks healthcare reforms have created in the marketplace. The new product will employ greater use of co-pays, increase steerage to contracted providers and has been designed to minimize exposure to anti-selection. Although there can be no assurance as to the success of this new product in the competitive healthcare industry, it has been designed to be more attractive to providers and customers thereby increasing demand in the marketplace and sales. In addition, the Company will be enhancing provider incentives and risk-sharing programs that encourage and reward networks for effective medical cost management. It is anticipated that the cost of implementing this strategy will result in an increase in the group gross expense ratio over the next several quarters and possibly thereafter.
In January 1997, the Company announced that it would be focusing its marketing efforts and resources in those markets and states in which it believes it can best increase profitability and market share. In these markets, provider relationships are continuing to be strengthened and the new product discussed above will be introduced. Conversely, the Company intends to reduce its marketing efforts and significantly reduce its financial exposure and may, in some cases, withdraw from business in those states where legislative reform and intense competition have significantly increased the risk profile of writing small employer health coverage. Approximately 25% of 1996 group health premiums were generated in these states. In line with this strategy, the Company has decided to stop selling small group insurance plans in California, Maryland and New Jersey, and to terminate existing small group insurance plans in these states. In addition, the Company continues to closely manage its expense structure, including maintaining its workforce proportionate to its business.
As discussed above, the Company has recently developed a new small group health insurance product which will be introduced into the marketplace beginning in the second quarter of 1997. In addition, the Company will be enhancing its management of provider relationships and risk-sharing programs. In conjunction with these actions, the Company will be reviewing its current and future information systems needs. As a result, the Company may need to make additional investments in its information systems in the future to support the operations of the business and as the Company prepares for the transitioning of operations into the year 2000.
The Company has recently announced that it would be focusing its small group health insurance marketing efforts and resources in those markets and states in which it believes it can best increase profitability and market share. The Company intends to reduce its marketing efforts and significantly reduce its financial exposure and may, in some cases, withdraw from business. As a result of these changes and the sale of the Annuity Operations and Western Diversified Group as discussed above, the Company will be reviewing its workforce and the structure of its operations, including overhead functions. It is anticipated that functions will be reduced or eliminated and that the size of the Company's workforce will be decreased. As a result, the Company anticipates that additional costs including severance and other charges will be incurred in the future.