The Company's principal offices are located at 110 West Seventh Street, Fort Worth, Texas. The lease for this facility expires in April, 2003. Westbridge Printing Services, Inc., the Company's wholly owned printing subsidiary, maintains its facility at 7333 Jack Newell Boulevard North, Fort Worth, Texas, under a lease agreement which expires in October, 2005. Precision Dialing Services, the Company's wholly owned telemarketing subsidiary, maintains its facility at 9550 Forest Lane, Dallas, Texas under a lease agreement which expires in December, 2003. The Company believes that its leased facilities will meet its existing needs and that the leases can be renewed or replaced on reasonable terms if necessary.
Critical Accounting Policies. The following discussion provides management's assessment of financial results and material changes in financial position for the Company. This discussion is based upon the Company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. The Company's significant accounting policies relate to investments, agent receivables, deferred policy acquisition costs, deferred tax assets, claim reserves, future policy benefit reserves, reinsurance and statutory accounting practices. These policies are discussed below under "Financial Condition" and in Notes 2 and 10 to the Company's consolidated financial statements at Item 8. The application of these accounting policies requires management to make significant estimates and judgments that affect the reported amounts of assets, liabilities and expenses in the Company's consolidated financial statements. Such estimates and judgments are based on historical experience, changes in laws and regulations, observance of industry trends and various information received from third parties. While the estimates and judgments associated with the application of these accounting policies may be affected by different assumptions or conditions, the Company believes the estimates and judgments associated with the reported consolidated financial statement amounts are appropriate in the circumstances. For a better understanding of this analysis, reference should be made to Item 1 - "Business" and to Item 8 - "Financial Statements and Supplementary Data". Certain reclassifications of prior years' amounts have been made to conform with the 2001 presentation.
Forward-Looking Statements. Statements contained in this analysis and elsewhere in this document that are not based on historical information are forward-looking statements and are based on management's projections, estimates and assumptions. In particular, forward-looking statements can be identified by the use of words such as "may", "will", "should", "expect", "anticipate", "estimate", "continue", or similar words. Management cautions readers regarding its forward-looking statements. The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward-looking statements. Various statements contained in Item 1 - "Business" and Item 7 - "Management's Discussion and Analysis of Results of Operation and Financial Condition", are forward-looking statements. These forward-looking statements are based on the intent, belief or current expectations of the Company and members of its senior management team. While the Company believes that its expectations are based on reasonable assumptions within the bounds of its knowledge of its business and operations, prospective investors are cautioned that any such forward-looking statements are not guarantees of future performance, and involve risks and uncertainties, and that actual results may differ materially from those contemplated by such forward-looking statements. Important factors known to management that could cause actual results to differ materially from those contemplated by the forward-looking statements in this Report include, but are not limited to:
the ability of the Company to maintain adequate liquidity for its non-insurance subsidiary operations including financing by NCM of commission advances to agents;
Results of operations for Ascent are reported for 2001, 2000 and on a pro forma basis as if Ascent and Westbridge adopted fresh start accounting on January 1, 1999 and operated as a single entity for the year ended December 31, 1999. (In thousands except insurance operating ratios.)
As a result of losses from the GPPO product, FLICA required significant capital contributions during 2000 and 2001 to comply with minimum statutory capital and surplus requirements. In April 2001, Ascent obtained debt financing of $11 million from an affiliate of its largest stockholder. The proceeds of this loan were used to fund an $11 million capital contribution to FLICA. The $1.3 million increase in interest expense for 2001 as compared to 2000 is due primarily to this loan. Adverse claims experience for the GPPO product in excess of management's current expectations or adverse claims experience for other insurance products could have a material adverse impact on the Insurance Subsidiaries' ability to meet minimum statutory capital and surplus requirements and maintain new business production at current levels and therefore have a material adverse impact on Ascent's liquidity and capital resources and results of operations (see "Liquidity, Capital Resources and Statutory Capital and Surplus" and Item 1 - Business - "Regulation").
The Company reported no income tax benefit for 2001 and incurred income tax expense for 2000 of $6.0 million due to the establishment of a valuation allowance beginning December 31, 2000 for all net deferred tax assets. Due to GPPO product losses during 2000, the Company had reported a cumulative loss before income taxes of ($9.7) million since the fresh start date of March 31, 1999 through December 31, 2000. Principally as a result of this cumulative pre-tax loss position, generally accepted accounting principles ("GAAP") require that a valuation allowance be provided for any net deferred tax asset. Accordingly, an additional deferred tax asset valuation allowance of $10.4 million was established at December 31, 2000. This adjustment had no impact on the Company's cash position and did not impact statutory capital and surplus of the Insurance Subsidiaries. As more fully discussed below under "Financial Condition - Deferred Tax Asset", the Company expects to record no future GAAP income tax benefit or expense until the Company achieves a cumulative pre-tax income position since the fresh start date of March 31, 1999.
Total premiums increased by $5.3 million, or 4.4%, for 2001 and $3.6 million, or 3.1% for 2000 as compared to the corresponding prior year, as new business production exceeded the expected decline in renewal premiums from older, closed blocks of business. Comprehensive major medical products comprised 97% of new business sales for 2001 and represented 62% of consolidated premium revenue for 2001 as compared to 55% for 2000 and 48% for 1999.
Premium revenue from the unprofitable GPPO major medical product was $36.0 million, $38.2 million and $17.5 million for 2001, 2000 and 1999, respectively. The Company discontinued marketing this product in June 2000 and has been continuously implementing significant premium rate increases since that date. The premium rate increase actions have accelerated the policy lapse rate and reduced policies in force while increasing the premium received per policy. Annual premiums for GPPO policies in force declined by $16.6 million, or 37.5%, to $27.7 million at December 31, 2001 as compared to December 31, 2000 while policies in force declined by 62.5%. Management expects that premium revenue from the unprofitable GPPO product will continue to decline in 2002.
Commissions. The commissions to premiums ratio declined by 0.8 percentage point in 2001, as compared to 2000, due to a higher percentage of renewal premiums to total premiums. For 2000, the commissions to premium ratio increased over 1999 by 1.0 percentage point as a result of the increase in first year major medical premiums. Commission rates on first year premiums are significantly higher than those for renewal premiums.
General and Administrative Expense. The general and administrative expense ratio declined by approximately three percentage points in 2001, as compared to 2000, due to non-recurring expenses incurred in 2000 related to the implementation in May 2000 of the Company's new policy administration and claims data processing systems.
Net Investment Income and Realized Gains. Net investment income and realized investment gains and losses totaled $9.3 million for 2001 and 2000 and $9.1 million for 1999. During 2001, interest rates declined which reduced reinvestment rates; however, the market value of the Company's fixed maturity bond portfolio increased which resulted in gains from bond sales in the normal course of business. Conversely, market interest rates were generally higher in 2000; but the market value of the Company's fixed maturity bond portfolio was lower and the Company realized losses on bond sales.
Investment policy is determined by the Board of Directors of the Company and each of the Insurance Subsidiaries. The Company's current investment policy is to balance its portfolio between long-term and short-term investments so as to achieve long-term returns consistent with the preservation of capital and maintenance of adequate liquidity to meet the payment of the Company's policy benefits and claims. The current schedule of the Company's invested asset maturities corresponds with the Company's expectations regarding anticipated cash flow payments based on the Company's policy benefit and claim cycle, which the Company believes is medium term in nature. The Company invests primarily in fixed-income securities of the U.S. Government and its related agencies, investment grade fixed-income corporate securities and mortgage-backed securities. Also, up to 5% of the Company's fixed maturity securities may be invested in higher yielding, non-investment grade securities.
(1) Excludes interest on receivables from agents of $2.0 million, $1.9 million and $1.3 million for the years ended December 31, 2001, 2000 and 1999, respectively.
The following table indicates by rating the composition of the Company's fixed maturity securities portfolio, excluding short-term investments and certificates of deposit, at December 31: 2001 2000 ------------------ ------------------- Market Market Value % Value % ---------- ------- ---------- ------- (in (in thousands) thousands) Ratings (1) Investment grade: U.S. Government and agencies $ 20,451 22.7 $ 22,754 22.6 AAA 2,180 2.4 2,885 2.9 AA 9,160 10.2 8,305 8.3 A 28,318 31.4 38,552 38.3 BBB 29,723 32.9 27,168 27.0 Non-Investment grade: BB 250 0.3 674 0.7 B and below 135 0.1 252 0.2 ---------- ------- ---------- ------- Total fixed maturity securities $ 90,217 100.0 $ 100,590 100.0 ========== ======= ========== =======
The NAIC assigns securities quality ratings and uniform prices called "NAIC Designations," which are used by insurers when preparing their annual statutory reports. The NAIC assigns designations to publicly-traded as well as privately-placed securities. The ratings assigned by the NAIC range from Class 1 (highest quality rating) to Class 6 (lowest quality rating). At December 31, 2001, 66.2%, 29.9% and 3.9% of the market value of the Company's fixed maturity securities were rated NAIC 1, NAIC 2, and NAIC 3 and below, respectively.
2001 2000 ------------------- ------------------- Market Market Value % Value % ---------- ------- ---------- ------- (in (in thousands) thousands) Scheduled Maturity Due in one year or less $ 5,909 6.6 $ 7,073 7.0 Due after one year through five years 27,451 30.4 28,877 28.7 Due after five years through ten years 24,165 26.8 26,327 26.2 Due after ten years 21,961 24.3 25,011 24.9 Mortgage-backed securities 10,731 11.9 13,302 13.2 ---------- ------- ---------- ------- Total fixed maturity securities $ 90,217 100.0 $ 100,590 100.0 ========== ======= ========== =======
Deferred Tax Asset. The Company's net deferred tax asset before valuation allowance at December 31, 2001 and 2000 was $17.8 million and $18.3 million, respectively. As the Company reported cumulative pre-tax losses of ($9.7) million since the fresh start date of March 31, 1999 through December 31, 2000, principally due to GPPO product losses, applicable GAAP literature required that the Company's net deferred tax asset be fully reserved as of December 31, 2000. The Company reported additional pre-tax losses of ($2.1) million in 2001 and has now reported cumulative pre-tax losses since the fresh start date of ($11.8) million. Accordingly, the Company has reported no income tax benefit for 2001 and the net deferred tax asset remains fully reserved. The Company expects to record no income tax benefit or expense until the Company achieves a cumulative pre-tax income position since the fresh start date of March 31, 1999. Applicable GAAP literature provides that the deferred tax asset valuation allowance may be eliminated once the Company is no longer in a cumulative loss position, as defined.
At December 31, 2001, approximately $0.9 million of the $3.1 million recoverable from reinsurers related to paid losses. Of this balance, all was recoverable from reinsurers rated "A" or higher by the A.M. Best Company.
Statutory Accounting Practices. The Company's Insurance Subsidiaries are required to report their results of operations and financial position to state regulatory agencies based upon statutory accounting practices ("SAP"). Under SAP, certain assumptions used in determining the policy benefit reserves, such as claim costs and investment return assumptions, are often more conservative than those appropriate for use by the Company under GAAP. In particular, SAP interest rate assumptions for investment results are fixed by statute and are generally lower than those used by the Company under GAAP. Another significant difference is that under SAP, unlike GAAP, the Company is required to expense all sales and other policy acquisition costs as they are incurred rather than capitalizing and amortizing them over the expected life of the policy. The effect of this requirement is moderated by the allowance under SAP of an accounting treatment known as the "two year preliminary term" reserve valuation method. This reserve method allows the Company to defer any accumulation of policy benefit reserves until after the second policy year. The immediate charge off of sales and acquisition expenses and the sometimes conservative claim cost and other valuation assumptions under SAP generally cause a lag between the sale of a policy and the emergence of reported earnings. Because this lag can reduce the Company's gain from operations on a SAP basis, it can have the effect of reducing the amount of funds available for dividend distributions from the Insurance Subsidiaries (see "Liquidity, Capital Resources and Statutory Capital and Surplus").
CSFB Financing. Ascent received debt financing to fund an $11 million capital contribution to FLICA in April 2001 from Credit Suisse First Boston Management Corporation, ("CSFB"), which is an affiliate of Special Situations Holdings, Inc. -- Westbridge (Ascent's largest stockholder). The credit agreement relating to that loan ("CSFB Credit Agreement") provided Ascent with total loan commitments of $11 million (all of which has been drawn). The loan bears interest at a rate of 12% per annum and matures in April, 2004. Absent any acceleration following an event of default, the Company may elect to pay interest in kind by issuance of additional notes. During 2001, Ascent issued $987,000 in additional notes for payment of interest in kind which increased the notes payable balance to CSFB at December 31, 2001 to approximately $12 million. The CSFB Credit Agreement provides for a facility fee of $1.5 million which is payable upon maturity or upon a change in control, as defined. This facility fee is being accrued as additional interest payable over the term of the loan.
Ascent's obligations to CSFB are secured, pursuant to a guarantee and security agreement and pledge agreements, by substantially all of the assets of Ascent and its subsidiaries (excluding the capital stock and the assets of AICT, FLICA, NFL, NFIC, NCM, Ascent Funding, Inc. and Ascent Management, Inc., some or all of which is pledged as collateral for bank financing described below). Ascent's subsidiaries (other than those listed above) have also guaranteed Ascent's obligations under the CSFB Credit Agreement. At December 31, 2001, there were no events of default; however, adverse claims experience in excess of management's current expectations could result in events of default under the CSFB Credit Agreement.
Preferred Stock. Dividends on Ascent's redeemable convertible preferred stock (which is 100% owned by Special Situations Holdings, Inc. - Westbridge) may be paid in cash or by issuance of additional shares of preferred stock, at the Company's option. During 2001, the Company paid preferred stock dividends through the issuance of 2,930 additional shares of preferred stock. In December 2000, the Company paid preferred stock dividends through the issuance of 2,575 additional shares of preferred stock. Preferred stock dividends accrued at December 31, 1999 were paid in January 2000 through issuance of 1,873 additional shares of preferred stock.
In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Ascent Assurance, Inc. and its subsidiaries at December 31, 2001 and December 31, 2000, and the results of their operations and their cash flows for the years ended December 31, 2001 and 2000 and nine months ended December 31, 1999 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the accompanying index present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedules are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the results of operations and cash flows of Westbridge Capital Corp. and its subsidiaries for the three months ended March 31, 1999, in conformity with accounting principles generally accepted in the United States. In addition, in our opinion, the financial statement schedules listed in the accompanying index present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedules are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.
WESTBRIDGE CAPITAL CORP. (now ASCENT ASSURANCE, INC.) CONSOLIDATED STATEMENT OF OPERATIONS
Three Months Ended March 31, 1999 ---------------- (In thousands, except Revenues: per share data) Premiums: First-year $ 3,121 Renewal 26,827 ---------------- Total Premiums 29,948
Income before income taxes 275 Federal income tax expense 67 ---------------- Net Income 208
Preferred stock dividends - ---------------- Income applicable to common stockholders $ 208 ================
Basic and diluted net income per common share $ 0.03 ================
Three Months Ended March 31, 1999 ---------------- (in thousands) Net income $ 208 Other comprehensive income (loss): Unrealized holding loss arising during period, net of tax (1,959) Reclassification adjustment of gain on sales of investments included in net income, net of tax (27) ---------------- Comprehensive Loss $ (1,778) ================
WESTBRIDGE CAPITAL CORP. (now ASCENT ASSURANCE, INC.) CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
Basis of Presentation. The consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States ("GAAP") and include the accounts of Ascent Assurance, Inc. and its subsidiaries. All significant inter-company accounts and transactions have been eliminated. Certain reclassifications of prior years' amounts have been made to conform with the 2001 financial statement presentation.
(b) Reflects issuance of 6,500,000 shares of New Common Stock in exchange for Convertible Notes, Old Preferred Stock , Old Common Stock and settlement of general unsecured claims. Includes 32,500 shares of New Common Stock issued to management on the Effective Date, and includes write-off of unamortized debt issuance costs of $3.1 million.
Cash Equivalents. Cash equivalents consists of highly liquid instruments with maturities at the time of acquisition of three months or less. Cash equivalents are stated at cost, which approximates market.
Claim Reserves. Claim reserves represent the estimated liabilities on claims reported plus claims incurred but not yet reported. No changes were made to claim reserve estimates for purposes of fresh start accounting. The process of estimating claim reserves involves the active participation of experienced actuarial consultants with input from the underwriting, claims, and finance departments. The inherent uncertainty in estimating claim reserves is increased when significant changes occur. Changes impacting the Company include: (1) changes in economic conditions; (2) changes in state or federal laws and regulations, particularly insurance reform measures; (3) writings of significant blocks of new business and (4) significant changes in claims payment patterns as a result of the implementation of a new claims administration system in May 2000. Because claim reserves are estimates, management monitors reserve adequacy over time, evaluating new information as it becomes available and adjusting claim reserves as necessary. Such adjustments are reflected in current operations.
Earnings Per Share. Under GAAP, there are two measures of earnings per share: "basic earnings per share" and "diluted earnings per share." Basic earnings per share is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were converted or exercised. For the years 2001 and 2000, stock options of 1,085,850 and 944,600, respectively, that could potentially dilute basic earnings per share in the future were not included in the computation of diluted earnings per share because to do so would have been anti-dilutive.
the impact of changing health care trends on the Company's ability to accurately estimate claim and settlement expense reserves;
default by issuers of fixed maturity investments owned by the Company;
Recently Issued Accounting Pronouncements. In 1998, the NAIC adopted the Codification of Statutory Accounting Principles guidance replaced the Accounting Practices and Procedures manual as the NAIC's primary guidance on statutory accounting. The Codification provides guidance for areas where statutory accounting has been silent and changes current statutory accounting in certain areas. The Insurance Department of the State of domicile of the Company's Insurance Subsidiaries adopted the Codification effective January 1, 2001. Codification did not materially impact the statutory surplus of the Company's Insurance Subsidiaries.
In March 2000, the FASB issued FASB Interpretation No. 44, "Accounting for Certain Transactions Involving Stock Compensation - an interpretation of APB Opinion No. 25" ("FIN 44"). The Company adopted FIN 44 on a prospective basis effective July 1, 2000. The adoption of FIN 44 did not have a material impact on the Company's results of operations, liquidity or financial position.
In June 2001, the FASB issued SFAS 142, "Goodwill and Other Intangible Assets". SFAS 142 supersedes APB 17, "Intangible Assets," and is effective for fiscal years beginning after December 15, 2001. SFAS 142 primarily addresses the accounting for goodwill and intangible assets subsequent to their initial recognition. SFAS 142 (1) prohibits the amortization of goodwill and indefinite-lived intangible assets, (2) requires testing of goodwill and indefinite-lived intangible assets on an annual basis for impairment (and more frequently if the occurrence of an event or circumstance indicates an impairment), (3) requires that reporting units be identified for the purpose of assessing potential future impairments of goodwill and (4) removes the forty-year limitation on the amortization period of intangible assets that have finite lives. The Company will adopt SFAS 142 on January 1, 2002. The Company does not expect to recognize an impairment loss upon adoption of SFAS 142. The Company has no goodwill or indefinite-lived intangible assets. The Company has identified intangible assets totaling $3.0 million included in deferred policy acquisition costs representing the estimated present value of future profits of certain insurance policies acquired prior to March 1999. The Company has determined that there is no indication of impairment related to these assets and that the useful lives assigned to the assets are appropriate. Going forward, the Company will test these intangibles for impairment annually or more frequently if the occurrence of an event or circumstances indicates impairment.
In August 2001, the FASB approved SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." The Statement requires that long-lived assets to be disposed of other than by sale be considered held and used until they are disposed of. SFAS No. 144 requires that long-lived assets to be disposed of by sale be accounted for under the requirements of SFAS No. 121. SFAS No. 121 requires that such assets be measured at the lower of carrying amounts or fair value less cost to sell and to cease depreciation (amortization). SFAS No. 144 requires a probability-weighted cash flow estimation approach in situations where alternative courses of action to recover the carrying amount of a long-lived asset are under consideration or a range of possible future cash flow amounts are estimated. As a result, discontinued operations will no longer be measured on a net realizable basis, and future operating losses will no longer be recognized before they occur. Additionally, goodwill will be removed from the scope SFAS No. 121. As a result goodwill will no longer be required to be allocated to long-lived assets to be tested for impairment. SFAS No. 144 is effective for financial statements issued for fiscal years beginning after December 15, 2001, and interim periods within those fiscal years. The Company does not expect the adoption of the statement to materially impact the Company's results of operations and financial position.
Unrealized (depreciation) appreciation on investments is reflected directly in stockholders' equity as a component of accumulated other comprehensive (loss) income and is summarizes as follows:
The amortized cost and estimated market value of investments in available-for-sale fixed maturities as of December 31, 2001, are shown below, in thousands, summarized by year to contractual maturity. Mortgage-backed securities are listed separately. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalties.
A summary of unrealized depreciation on investments in fixed maturities and equity securities available-for-sale, which is reflected directly in stockholders' equity as a component of accumulated other comprehensive loss, is as follows:
December 31, -------------------------- 2001 2000 ----------- ----------- (in thousands) Amortized cost $ 91,907 $ 105,446 Estimated market value 91,786 101,925 ----------- ----------- Deficit of market value to amortized cost (121) (3,521) Estimated tax benefit - (1,197) ----------- ----------- Unrealized depreciation, net of tax $ (121) $ (2,324) =========== ===========
At December 31, 2000, the estimated tax benefit related to unrealized investment losses has been fully reserved (see Note 9).
Investment securities on deposit with insurance regulators in accordance with statutory requirements at December 31, 2001 and 2000 had a par value totaling $26.4 million and $27.2 million, respectively. At December 31, 2001 and 2000, the Company had pledged short-term investments totaling $2.6 million in connection with its receivables financing program (see Note 6).
Withdrawals Issues through 1980 are based on industry experience; 1981 through 2001 issues are based on industry experience and Company experience, where available. Policies acquired in acquisitions are based on recent experience of the blocks acquired.
Interest Issues through 1980 are 6% graded to 4.5% in 25 years; most 1981 through 1992 issues are 10% graded to 7% in 10 years except for certain NationalCare and Supplemental Hospital Income issues which are 8% graded to 6% in 8 years and LifeStyles Products which are 9% graded to 7% in 10 years. 1993 and later issues are 7% level. Certain policies acquired in 1992 are 6.4% level while other policies acquired in 1993 and 1994 are 6% level. Policies acquired in the acquisition of NFIC and AICT are 7% level.
Mortality Issues through 1980 use the 1955-1960 Ultimate Table; issues subsequent to 1980 through 1992 us the 1965-1970 Ultimate Table. 1993 and later issues use the 1975-1980 Ultimate Table. Policies acquired in acquisitions use the 1965-1970 Ultimate Table.
Ascent's obligations to CSFB are secured, pursuant to a guarantee and security agreement and pledge agreements, by substantially all of the assets of Ascent and its subsidiaries (excluding the capital stock and the assets of AICT, FLICA, NFL, NFIC, NCM, Ascent Funding Corporation and Ascent Management, Inc., some or all of which is pledged as collateral for bank financing described below). Ascent's subsidiaries (other than those listed above) have also guaranteed Ascent's obligations under the CSFB Credit Agreement. At December 31, 2001, there were no events of default; however, adverse claims experience in excess of management's current expectations could result in events of default under the CSFB Credit Agreement.
Bank Financing. The majority of commission advances to NCM's agents are financed through Ascent Funding, Inc. ("AFI"), an indirect wholly owned subsidiary of Ascent. AFI has entered into a Credit Agreement (the "Credit Agreement") with LaSalle which currently provides AFI with a $7.5 million revolving loan facility, the proceeds of which are used to purchase agent advance receivables from NCM and other affiliates. As of December 31, 2001, $4.4 million was outstanding under the Credit Agreement (weighted average interest rate of 7.7%). AFI incurs a commitment fee on the unused portion of the Credit Agreement at a rate of 0.50% per annum. Interest of $0.4 million, $0.5 million and $0.3 million was expensed and paid in 2001, 2000 and 1999, respectively.
AFI's obligations under the Credit Agreement are secured by liens upon substantially all of AFI's assets. AFI's principal assets at December 31, 2001 are net agent receivables of $7.4 million and a short-term investment account, pledged to LaSalle, of $2.6 million. In addition, Ascent has guaranteed AFI's obligations under the Credit Agreement , and has pledged all of the issued and outstanding shares of the capital stock of AFI, NFL, FLICA and NFIC as collateral for that guaranty (the "Guaranty Agreement"). As of December 31, 2001, there were no events of default under the Credit or Guaranty Agreements. However, adverse claims experience in excess of management's current expectations could result in events of default under the Guaranty Agreement, Credit Agreement and the term loan facility discussed below.
In July 1999, Ascent Management, Inc. ("AMI") entered into a $3.3 million term loan agreement with LaSalle, secured by substantially all of AMI's assets and the guarantee of Ascent. Principal is payable in 60 equal monthly installments beginning January 31, 2000. As of December 31, 2001, $2.2 million was outstanding under the term loan facility (weighted average interest rate of 6.16%). Interest of $0.2 million was expensed and paid in 2001 and 2000. Interest of $0.1 million was capitalized and paid in 1999.
The preferred stock is mandatorily redeemable in cash on March 24, 2004 in an amount equal to the stated value per share plus all accrued and unpaid dividends thereon to the date of redemption.
During 2001, Ascent paid preferred stock dividends through the issuance of 2,930 additional shares of preferred stock and $1,603 in distributions of cash. In December 2000, the Company paid preferred stock dividends through the issuance of 2,575 additional shares of preferred stock and a $825 distribution of cash. Preferred stock dividends accrued at December 31, 1999 were paid in January 2000 through the issuance of 1,873 additional shares of preferred stock and a $965 distribution of cash.
The Company routinely evaluates the recoverability of deferred acquisition costs in accordance with GAAP. In general, a premium deficiency exists if the present value of future net cash flows plus future policy benefit and claim reserves at the calculation date is negative or less than net deferred policy acquisition costs. The calculation of future net cash flows includes assumptions as to future rate increases and persistency. As a result of losses in 2000 for certain major medical products, the Company determined that a premium deficiency of $1.5 million existed at December 31, 2000 related to medical expense reimbursement products issued subsequent to the fresh start date of March 31, 1999. Accordingly, deferred policy acquisition costs were reduced by $1.5 million at December 31, 2000 by a non-cash charge to expense.
No taxes were paid in 2001. Taxes (recovered) paid in 2000 and 1999 were $(1.2) million and $80,000 respectively. The Company and its wholly owned subsidiaries, other than FLICA, file a consolidated federal income tax return. FLICA files a separate federal income tax return. Prior to 2000, NFIC and AICT filed a separate consolidated tax return. NFIC and AICT entered the Ascent consolidated return in 2000.
Deferred taxes are recorded for temporary differences between the financial reporting basis and the federal income tax basis of the Company's assets and liabilities. The sources of these differences and the estimated tax effect of each are as follows: December 31, --------------------------- 2001 2000 ----------- ----------- (in thousands) Deferred Tax Assets: Unrealized loss on investments $ - $ 1,198 Policy reserves 4,116 6,792 Net operating loss carryforwards 17,939 13,538 Other deferred tax assets 1,800 3,055 ----------- ----------- Total deferred tax asset $ 23,855 $ 24,583 ----------- -----------
Deferred Tax Liabilities: Deferred policy acquisition costs $ 2,533 $ 1,361 Other deferred tax liabilities 3,481 4,959 ----------- ----------- Total deferred tax liability $ 6,014 $ 6,320 ----------- -----------
As of December 31, 2001, the Company has reported cumulative pre-tax losses since the fresh start date of March 31, 1999. Realization of the Company's deferred tax asset is dependent upon the return of the Company's operations to profitability. Pre-tax losses during 2001 were principally attributable to adverse claims experience for certain major medical products. Management believes that such product losses can be significantly reduced through aggressive rate increase management. However, projections of future profitability are significantly discounted when evaluating the recoverability of deferred tax assets and do not overcome the negative evidence of cumulative losses. Accordingly, the Company increased its deferred tax asset valuation allowance by $10.4 million to $18.3 million to fully reserve the remaining net deferred tax assets as of December 31, 2000. As a result of limitations arising from the action of sections 108 and 382 of the Internal Revenue Code, the Company's net operating loss carryforwards and valuation allowance as of December 31, 1999 were reduced by $9.1 million. Changes in the valuation allowance applicable to the net deferred tax asset for the three years ended December 31, 2001 are as follows:
Under the provisions of pre-1984 life insurance tax regulations, NFL was taxed on the lesser of taxable investment income or income from operations, plus one-half of any excess of income from operations over taxable investment income. One-half of the excess (if any) of the income from operations over taxable investment income, an amount which was not currently subject to taxation, plus special deductions allowed in computing the income from operations, were placed in a special memorandum tax account known as the policyholders' surplus account. The aggregate accumulation in the account at December 31, 2001, approximated $2.5 million. Federal income taxes will become payable on this account at the then current tax rate when and to the extent that the account exceeds a specific maximum, or when and if distributions to stockholders, other than stock dividends and other limited exceptions, are made in excess of the accumulated previously taxed income. The Company does not anticipate any transactions that would cause any part of the amount to become taxable and, accordingly, deferred taxes which would approximate $0.9 million have not been provided on such amount.
Under the applicable laws of the states in which insurance companies are licensed, the companies are required to maintain minimum amounts of capital and surplus. Effective September 28, 2000, NFL and FLICA redomesticated from the states of Delaware and Mississippi, respectively, to the state of Texas. As a result, NFL, FLICA, NFIC and AICT are Texas domestic companies and are subject to regulation under Texas insurance laws. Under the Texas Insurance Code, the insurance subsidiaries are required to maintain aggregate capital and surplus of $1.4 million. The following states where the companies are licensed require greater amounts of capital and surplus: California $1.5 million of capital and $2.5 million of surplus, Washington $4.8 million of aggregate capital and surplus and Nebraska and Tennessee $1 million of capital and $1 million of surplus. Accordingly, the minimum aggregate statutory capital and surplus which NFL and NFIC must each maintain is $5.0 million. FLICA must maintain a minimum of $4.8 million and AICT must maintain $2.0 million. At December 31, 2001, aggregate statutory capital and surplus for NFL, FLICA, NFIC and AICT was approximately $6.5 million, $8.8 million, $1.6 million and $1.8 million, respectively. Although NFIC's capital and surplus is less than $5.0 million at December 31, 2001, NFIC voluntarily ceased writing new business effective December 15, 1997. Moreover, NFIC's capital and surplus exceeds the minimum requirements of its state of domicile, Texas. AICT is wholly owned by NFIC. Accordingly, statutory capital and surplus of NFIC includes the statutory capital and surplus of AICT.
As a result of losses from the GPPO comprehensive major medical product, FLICA required significant capital contributions during 2000 and 2001 to comply with minimum statutory capital and surplus requirements. In April 2001, Ascent obtained debt financing of $11 million from an affiliate of its largest stockholder. The proceeds of this loan were used to fund an $11 million capital contribution to FLICA. Adverse claims experience for the GPPO product in excess of management's current expectations or adverse claims experience for other insurance products could have a material adverse impact on the Insurance Subsidiaries' ability to meet minimum statutory capital and surplus requirements and maintain new business production at current levels and therefore have a material adverse impact on Ascent's liquidity and capital resources and results of operations.
In 1998, NFIC and AICT entered into a voluntary consent order, pursuant to Article 1.32 of the Texas Insurance Code, providing for the continued monitoring of the operations of NFIC and AICT by the Texas Department of Insurance in response to losses sustained in 1997 and 1998 as well as the projected inability to meet RBC requirements. Both NFIC and AICT ceased the sale and underwriting of new business in 1998. At December 31, 2001, AICT's RBC exceeded Company Action Level RBC; however, NFIC's RBC only exceeded Authorized Control Level RBC. Both NFIC and AICT are in compliance with the terms of the voluntary consent order.
1999 Stock Option Plan On March 24, 1999, the Company's Board of Directors adopted the 1999 Stock Option Plan (the "1999 Plan") in order to further and promote the interest of the Company, its subsidiaries and its shareholders by enabling the Company and its subsidiaries to attract, retain and motivate employees, non-employee directors and consultants (including marketing agents) or those who will become employees, non-employee directors and consultants (including marketing agents), and to align the interests of those individuals and the Company's shareholders (see Note 14). Pursuant to the 1999 Plan, 1,251,685 shares of common stock are reserved for issuance to employees and directors and 387,119 shares are reserved for issuance to the Company's marketing agents. The maximum term of an award under the 1999 Plan is 10 years.
Year Ended December 31, ------------------------------------------------ 2001 2000 1999 -------------- -------------- --------------
Outstanding at January 1 944,600 1,096,750 - Granted 155,750 42,950 1,106,750 Exercised - - - Forfeit / Cancelled (14,500) (195,100) (10,000) -------------- -------------- -------------- Outstanding at December 31 1,085,850 944,600 1,096,750 ============== ============== ==============
The weighted average option exercise price was $2.63, $2.82 and $2.88 for options outstanding at December 31, 2001, 2000 and 1999, respectively. For options granted, weighted average exercise price was $1.49, $1.63 and $2.85 for 2001, 2000 and 1999. For options forfeited, the weighted average exercise price was $2.77, $2.74 and $2.85, respectively.
The weighted average fair value of options granted during 2001, 2000 and 1999 was $1.26, $1.57 and $2.85. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following significant weighted-average assumptions used for grants in 2001, 2000 and 1999, respectively: dividend yield of 0% for all years; expected volatility of 1.218, 1.839 and 1.142; risk free interest rate of 4.65% for 2001, 6.57% for 2000 and 1999; expected life of 5 years for all years.
To the holders of Senior Notes other than Credit Suisse First Boston Corporation ("CSFB"), cash payments totaling approximately $15.2 million, which equaled the total Allowed 11% Senior Note Claims (as defined in the Plan) held by creditors other than CSFB, were distributed subject to completion of the exchange of securities as contemplated by the Plan. In order to provide the Company with sufficient funds to make the cash distribution to the holders of the Allowed 11% Senior Notes under the Plan, an affiliate of CSFB (the "CSFB Affiliate") purchased all of the shares of the New Preferred Stock which were not otherwise distributed under the Plan.
Pursuant to the Plan and the purchase of New Preferred Stock, 6,500,000 shares of New Common Stock and 23,257 shares of New Preferred Stock were issued, subject to the completion of the exchange requirements as contemplated by the Plan, on the Effective Date as follows:
To holders of Old Preferred Stock as of December 10, 1998, 260,000 shares, or 4%, of the New Common Stock issued on the Effective Date and Warrants ("New Warrants") to purchase an additional 277,505 shares, or 2%, of the New Common Stock issued on the Effective Date, on a fully diluted basis.
To holders of Old Common Stock as of December 10, 1998, 130,000 shares or 2%, of the New Common Stock issued on the Effective Date and New Warrants to purchase an additional 693,761 shares, or 5%, of the New Common Stock issued on the Effective Date, on a fully diluted basis. Fractional shares of New Common Stock were not issued in connection with the Plan. As a result of this provision, certain holders of Old Common Stock received no distribution of New Common Stock or New Warrants under the Plan.
Prior to the Effective Date of the Plan, the Company had the following securities outstanding:
Senior Notes During the first quarter of 1995, the Company issued $20.0 million aggregate principal amount of its Senior Notes, due 2002, in an underwritten public offering. The Senior Notes were issued at par, less an underwriting discount of 4%. Contractual interest on the Senior Notes was payable in monthly installments. In November 1997, the Company suspended the scheduled monthly interest payments on these Senior Notes.
As more fully described above, in order to provide the Company with sufficient funds to make the cash distributions to the holders of the Allowed 11% Senior Notes under the Plan, the Company entered into a Stock Purchase Agreement with CSFB, a significant noteholder, pursuant to which CSFB, subject to the conditions contained therein, purchased all of the shares of the New Preferred Stock which were not otherwise distributed under the Plan.
Convertible Notes During the second quarter of 1997, the Company completed the sale of $70.0 million aggregate principal amount of its Convertible Notes, due 2004, in an underwritten public offering. Contractual interest on the Convertible Notes was payable in semi-annual installments on May 1 and November 1 of each year, commencing November 1, 1997. In November 1997, the Company suspended the scheduled interest payments on these Convertible Notes. At the Petition Date, approximately $7.3 million of unpaid interest was accrued. The Company did not accrue interest on its Convertible Notes after the Petition Date as it was unlikely such interest would be paid under the Plan. The amount of contractual interest that would have otherwise been accrued from the Petition Date to December 31, 1998 totaled $2.7 million, and such contractual interest would have continued to accrue at $14,583 per day from January 1, 1999 until the Effective Date.
As of the Effective Date, shares of Old Preferred Stock were canceled, extinguished and retired. Holders of Old Preferred Stock received their pro rata share of 4% of the New Common Stock issued on the Effective Date and New Warrants to purchase their pro rata share of up to 2% of the number of shares of New Common Stock issued and outstanding on the Effective Date, on a fully diluted basis.
Assets: Cash $ 897 $ 1,407 Short-term investments 299 1,682 Fixed maturities, at market value - 1,193 Equity securities, at market value 21 Investment in consolidated subsidiaries 48,622 37,168 Accrued investment income - 29 Receivables from affiliates 655 - Other assets 403 52 ----------- ----------- Total Assets $ 50,897 $ 41,531 =========== =========== Liabilities: Note payable $ 11,987 $ - Payable to subsidiaries 3,175 7,155 Other liabilities 2,278 2,596 ----------- ----------- Total Liabilities 17,440 9,751 ----------- -----------
Stockholders' Equity: Common stock 65 65 Capital in excess of par value 28,017 27,620 Accumulated other comprehensive loss, net of tax (121) (2,324) Retained Deficit (25,139) (21,286) ----------- -----------
Net investment income $ 209 Realized gains on investments 12 Intercompany interest income on surplus certificates 20 Interest on advances to subsidiaries 110 ---------- ----------
General and administrative expenses (112) Taxes, licenses and fees 24 Interest expense 507 ---------- ----------
Other comprehensive income (loss) on investment in Subsidiaries: Unrealized holding loss arising during period, net of tax (1,628) Reclassification adjustment of gain on sales of investments included in net income, net of tax (19) ------------- Comprehensive loss $ (1,778) =============
Cash Flows From Operating Activities: Net income $ 208 Adjustments to reconcile net income to cash used for operating activities: Equity in undistributed net (income) loss of subsidiaries (276) Accrued investment income 42 Decrease (increase) in other assets 3,063 (Decrease) increase in other liabilities (13,102) Other, net 9,589 ------------ Net Cash Used For Operating Activities (476) ------------