The executive offices of the Company are in Rye Brook, New York. Marketing and professional staff for our U.S. insurance subsidiaries occupy space in Orlando, Florida. Our Canadian operations are located in Mississauga, Ontario, Canada. Our Administrative Services operations occupy office space in Pensacola and Weston Florida. The Company leases all of the approximately 175,000 square feet of office space that it occupies, Management considers its office facilities suitable and adequate for the current level of operations.
In addition to the above, Pennsylvania Life is the named lessee on approximately 40 properties occupied by Career Agents for use as field offices. Rent for these field offices is reimbursed by the agents.
- ---------- (1) After provision for Series C Preferred Stock dividends of $180 and $434 for the years ended December 31, 1999 and 1998, respectively.
(3) Includes the results of AIAG since its acquisition on January 6, 2000, and CHCS since its acquisition on August 10, 2000.
(10) The ratio of deferred policy acquisition costs to equity represents deferred policy acquisition costs divided by shareholders' equity.
(11) The debt to total capital ratio is calculated as the ratio of the total outstanding bank debt plus trust preferred securities to the sum of total shareholders' equity, excluding accumulated other comprehensive income, plus total outstanding bank debt plus trust preferred securities.
(13) Includes capital and surplus of Penncorp Life (Canada) of C$59,724 as of December 31, 2002, C$32,314 as of December 31, 2001, C$30,421 as of December 31, 2000 and C$31,531 as of December 31, 1999, as reported to the Office of the Superintendent of Financial Institutions Canada, converted at the related exchange rates of C$0.6377 per U.S. $1.00 as of December 31, 2002, C$0.6261 per U.S. $1.00 as of December 31, 2001, C$0.6671 per U.S. $1.00 as of December 31, 2000, and C$0.6900 per U.S. $1.00 as of December 31, 1999.
The following analysis of our consolidated results of operations and financial condition should be read in conjunction with the consolidated financial statements and related consolidated footnotes included elsewhere.
Our principal business segments are: Career Agency, Senior Market Brokerage and Administrative Services. We also report the corporate activities of our holding company in a separate segment. During 2002 we modified the way we report segment information by combining our previously defined Senior Market Brokerage and Special Markets segments into one segment, Senior Market Brokerage. Our decision to combine the two segments was based on the significant reduction in the insurance in force in the Special Markets segment as a result of our exit from the major medical line of business. Reclassifications have been made to conform prior year amounts to the current year presentation. A description of these segments follows:
ADMINISTRATIVE SERVICES -- CHCS Services, Inc. acts as a third party administrator and service provider for both affiliated and unaffiliated insurance companies, primarily with respect to senior market insurance products and non-insurance products. The services that we perform include policy underwriting and issuance, telephone and face-to-face verification, policyholder services, claims adjudication, case management, care assessment and referral to health care facilities.
Intersegment revenues and expenses are reported on a gross basis in each of the operating segments. These intersegment revenue and expenses affect the amounts reported on the individual financial statement line items, but are eliminated in consolidation and do not change operating income before taxes. The significant items eliminated include intersegment revenue and expense relating to services performed by the Administrative Services segment for the Career Agency and Senior Market Brokerage segments and interest on notes issued by the Corporate segment to the other operating segments.
The determination of gross profits is an inherently uncertain process, and relies on assumptions including the persistency of the policies issued as well as anticipated benefits, commissions and expenses. It is possible that the actual profits from the business will vary materially from the assumptions used in the determination and amortization of deferred acquisition costs. Deferred policy acquisition costs are written off to the extent that it is determined that future policy premiums and investment income or gross profits would not be adequate to cover related losses and expenses.
Fair value of investments is based upon quoted market prices, where available, or on values obtained from independent pricing services. For certain mortgage and asset-backed securities, the determination of fair value is based primarily upon the amount and timing of expected future cash flows of the security. Estimates of these cash flows are based upon current economic conditions, past credit loss experience and other circumstances.
During 2002, Pyramid Life agents produced more than $25 million of annualized new sales. We believe this acquisition will add further scale and efficiencies to our operations in the rapidly expanding senior market. Following a transition period, we plan to take advantage of our cost-effective and efficient service center to administer the business; however, we will preserve the marketing identity and quality service that has defined Pyramid Life.
In the third quarter of 2001, we completed a secondary equity offering in which we sold 5.7 million shares of our common stock with proceeds to the Company of $26.0 million, net of expenses. In addition, 2.2 million shares were sold by some of our shareholders as part of the offering. The primary reason for the offering was to enhance the capital of our insurance subsidiaries to support our growth and to improve our risk based capital ratios. Out of the proceeds of the offering, $9.3 million was contributed to the capital and surplus of our insurance subsidiaries, $5.5 million was used to reduce intercompany obligations and the balance was held for general corporate purposes.
In July 1999, we acquired six insurance companies, including the subsidiaries that comprise our career agency segment, and other assets from PennCorp Financial Group. This acquisition enhanced our prospects for future growth by expanding our geographic reach and through the addition of a career agency marketing channel to supplement our senior market brokerage agency marketing channel.
Beginning in 1998, many HMO's realized that their Medicare programs were unprofitable and, therefore, decided to terminate these programs. As a result, millions of seniors were involuntarily dis-enrolled from these programs. This development contributed to our increased new sales of Medicare supplement products in 2001 and 2000. Under applicable legislation, such dis-enrollees had the right to acquire Medicare supplement insurance without medical underwriting or pre-existing condition limitations. As we expected, during 2002 new sales of our Medicare products have slowed since the HMO's are not dis-enrolling members as much as they were in prior years. To offset this impact, we have continued to expand geographically, and we have stepped up recruiting effort to augment our production. Additionally, we have increased our retention on new Medicare supplement business. As a result, we believe that we will continue to grow our net premiums.
(3) Tax on realized capital gains (losses) is based on a 35.0% effective tax rate for all periods.
Our senior market brokerage segment improved results by more than 9%, increasing pre-tax operating income by $1.2 million. This improvement is primarily the result of improved loss ratios for our Medicare supplement/select business. However, this was partially offset by an increase in claims relating to a block of home health care policies that we stopped selling in 2000.
Pre-tax operating income from our administrative services segment improved by $1.0 million or 15% in 2002 compared to 2001. The increase is due primarily to the growth in the Medicare supplement business being serviced by our administrative services company.
The decrease in the pre-tax operating loss from our corporate segment is due primarily to the reduction in interest cost. This reduction was due to a combination of a declining balance of debt outstanding as a result of principal repayments and reductions in the weighted average interest rates for the year, compared to 2001.
Our senior market brokerage segment improved results by more than 33%, increasing pre-tax operating income by $3.4 million. In the fourth quarter of 2000, we wrote off $1.4 million of deferred acquisition costs as a result of our decision to exit the major medical line of business. Adjusted for this item, pre-tax operating income for the segment increased by $2.0 million. This improvement is the result of continued internally generated growth of business in this segment, primarily in the Medicare supplement line.
Pre-tax operating income from our administrative services segment improved by $2.8 million or 72% in 2001 compared to 2000. The increase is due primarily to the growth in the Medicare supplement business being serviced by our administrative services company.
Net investment income increased by approximately 2% over 2001. The increase is due to an increase in the segment's invested assets, offset by a decrease in the overall yield. Other income decreased by $1.1 million, due primarily to a decrease in the sale of non-insurance products.
The increase in deferred acquisition costs was approximately $3.1 million more in 2002 than the increase in 2001. This is directly related to the increase in the new business, including annuities, generated by the segment during 2002.
REVENUES. New production of our Senior Market products amounted to $98.2 million in 2002. This represents a 10% decrease compared to $109.5 million in 2001. As we anticipated, new sales of our Medicare products have slowed since Health Maintenance Organizations ("HMOs") are not dis-enrolling members as much as in prior years. We have continued to expand geographically and have increased our recruiting efforts to further augment our production. Additionally, $17.6 million of fixed annuities were sold during 2002, compared to $7.1 million in 2001, that are not reported as premiums for GAAP.
Net premiums for 2002 increased to $141.2 million, an increase of 37% compared to 2001. Net premiums grew more than gross premium as a result of our decision to reinsure less premium and retain more risk. The net amount of premium retained increased from 27% in 2001 to 31% in 2002 due to the increase in retention on new Medicare supplement/select premiums written from 25% to 50%, effective January 2002.
Net investment income decreased by 5% compared to 2002, primarily as a result of a decline in investment yields.
The ratio of commissions to gross premiums increased to 17.5% in 2002 from 17.4% in 2001. Other operating costs as a percentage of gross premiums was 13.1% in 2002, consistent with 2001. Commission and expense allowances received from reinsurers as a percentage of the premiums ceded decreased to 28.9% in 2002 from 30.2% in 2001, primarily due to the reduction in new business ceded as a result of our decision to increase our retention on new business.
Net investment income decreased by 4% compared to 2002, primarily as a result of a decline in invested assets and decreasing investment yields.
The ratio of commissions to gross premiums increased to 17.4% in 2001 from 16.1% in 2000 as a result of the increase in new business sold. Other operating costs as a percentage of gross premiums decreased to 13.1% in 2001 from 14.1% in 2000. Commission and expense allowances received from reinsurers as a percentage of the premiums ceded were relatively flat at 30.2% in 2001 compared to 29.6% in 2000.
Included in unaffiliated revenue are fees received from a reinsurer of 100% of certain business of our insurance subsidiaries, which amounted to $6.9 million and $7.8 million in 2002 and 2001. These fees, together with the affiliated revenue, were eliminated in consolidation.
Service fee revenue increased by $9.9 million, or 30%, in 2002 as compared to 2001. In 2002, approximately 44% of the total fees earned were from non-affiliated companies compared to 52% in 2001. The relative decrease in the non-affiliated fees is the result of continued growth of business from our Senior Market Brokerage segment. Affiliated fee revenue increased $7.7 million compared to 2001 primarily as the result of the increase in Medicare supplement business in force at our insurance subsidiaries. Unaffiliated fee revenues increased by approximately $2.3 million. This is primarily due to an increase in fees for underwriting of long term care policies for our third party clients, including the underwriting support work we performed for the consortium that is offering long term care to employees of the Federal Government and their families.
General expenses for the segment increased by $9.8 million, or 40%, compared to 2001. The increase is due primarily to the increase in business and costs incurred to bring new clients on line. Additionally, during the second quarter of 2002, we completed the closing of our Clearwater office and consolidated those functions into our Pensacola operations. The total cost of the transition was approximately $0.3 million, however most of this was offset by efficiencies and cost savings as a result of the transition.
The amortization of PVFP relates primarily to the acquisition of CHCS Services, Inc., formerly American Insurance Administration Group, Inc. ("AIAG") in 2000. Approximately $7.7 million of PVFP was established when AIAG was acquired in January, 2000. It is being amortized in proportion to the expected profits from the contracts in force on the date of acquisition. During 2002, approximately $1.5 million was amortized compared to $2.1 million in 2001. As of December 31, 2002, $1.3 million, or 17%, of the original amount
remains unamortized. It is anticipated that $0.4 million will be amortized in 2003. During 2001 amortization of goodwill was approximately $0.1 million. There was no amortization of goodwill during 2002 as a result of the adoption of SFAS 142.
Service fee income increased by $8.7 million, or 36%, in 2001 as compared to 2000. Fees for our administration of Medicare supplemental business increased by $4.6 million, or 46%, in 2001 compared to 2000, primarily as a result of the increase in Medicare business issued by our Senior Market Brokerage segment. Fees for our administration of long term care business increased $4.3 million in 2001 compared to 2000. This increase is due primarily to the inclusion of a full year of operations of CHCS in 2001 compared to only five months in 2000. During 2001 our Administrative Services segment generated 48% of its revenues from the administration of business on behalf of affiliates and 52% from unaffiliated third party clients. During 2000, our Administrative Services segment generated $24.1 million in service fee income with 42% of its revenues from the administration of business on behalf of affiliates and 58% from unaffiliated third party clients.
Approximately $2.1 million of the PVFP was amortized during 2001 and $2.8 million of the PVFP was amortized during 2000. The remaining amortization related to the goodwill established in connection with the acquisition of CHCS.
Our current credit facility consists of a term loan and a $10 million revolving loan facility. The loans call for interest at LIBOR for one, two, three or six months plus 350 basis points (4.84% beginning January 31, 2003). Principal payments are due on a quarterly basis over a seven-year period that commenced on July 31, 2000. The final maturity date of the facility is July 31, 2006. We pay a commitment fee of 50 basis points on the unutilized portion of the revolving facility, which is currently $7.0 million. The term loan is secured by a first priority security interest in 100% of the outstanding common stock of American Exchange, American Progressive, and WorldNet Services and 65% of the outstanding common stock of UAFC (Canada) Inc. (the parent of Penncorp Life (Canada)) and a subordinate interest in 100% of the outstanding common stock of American Pioneer. As of December 31, 2002, $47.8 million was outstanding under the term loan and $3.0 million was outstanding under the revolving loan facility. We incurred the revolving indebtedness in connection with our acquisition of CHCS in August 2000. During January 2003, we made a regularly scheduled principal repayment that further reduced the outstanding balance of the term loan to $45.0 million. During 2002, we paid $2.6 million in interest and repaid $10.7 million in principal on the term loan. For 2001, we paid $5.2 million in interest and repaid
We are obligated under certain lease arrangements for its executive and administrative offices in New York, Florida, Texas, and Ontario, Canada. Rent expense for the three years ended December 2002, 2001 and 2000 was $1.7 million, $1.8 million, and $2.9 million, respectively. The minimum rental commitments, subject to escalation clauses, at December 31, 2002 under non-cancelable operating leases (in thousands) are as follows:
In December 2002, the Company formed Universal American Statutory Trust I, a Connecticut statutory business trust (the "Trust"), which issued, through a private placement, $15.0 million, thirty year floating rate trust preferred securities (the "Capital Securities"). The Trust will have the right to call the Capital Securities at par after five years from the date of issuance. The proceeds from the sale of the Capital Securities, together with proceeds from the sale by the Trust of its common securities to the Company, were invested in floating rate junior subordinated deferrable interest debentures of the Company due 2032 (the "Junior Subordinated Debt"). The proceeds were used to support the growth of the Company's insurance subsidiaries and a portion retained at the parent company in anticipation of funding the acquisition of Pyramid Life.
The Capital Securities represent an undivided beneficial interest in the Trust's assets, which consist solely of the Junior Subordinated Debt. Holders of Capital Securities generally have no voting rights. The Company owns all of the common securities of the Trust. Holders of both the Capital Securities and the Junior Subordinated Debt are entitled to receive cumulative cash distributions accruing from December 4, 2002, the date of issuance, and payable quarterly in arrears commencing March 4, 2003 at a floating rate equal to the three-month LIBOR plus 4.0% (currently 5.4%) of the stated liquidation amount of $1,000 per Capital Security. The floating rate resets quarterly and is limited to a maximum of 12.5% through December 4, 2007. The Capital Securities are subject to mandatory redemption upon repayment of the Junior Subordinated Debt at maturity or upon earlier redemption. The Junior Subordinated Debt is unsecured and ranks junior and subordinate in right of payment to all present and
The Capital Securities have not been and will not be registered under the Securities Act of 1933, as amended (the "Securities Act"), and will only be offered and sold under an applicable exemption from registration requirements under the Securities Act.
In March 2003, a second subsidiary trust of the Company issued $10.0 million of floating rate trust preferred securities under terms similar to the above securities at a rate of 5.29%. The proceeds will be used to pay down a portion of the term loan and for general corporate purposes.
On August 13, 2001, the over-allotment option provided in the underwriting agreement was exercised and, as a result, the Company issued an additional 720,000 shares of common stock at a price of $5.00 per share, less the underwriters' discounts and commissions of $0.3187 per share, generating additional net proceeds of $3.4 million. In connection with the over-allotment option, certain shareholders sold an additional 30,000 shares at $5.00 per share, less the underwriters' discounts and commissions of $0.3187 per share.
The net proceeds to the Company of the total offering, including the over-allotment, was $26.0 million, net of total expenses of $2.6 million.
In connection with an agreement entered into in 1996 under which American Pioneer became a direct subsidiary of our holding company rather than an indirect subsidiary owned through American Progressive, our holding company issued $7.9 million in debentures to American Progressive. A portion of the proceeds from our equity offering in July 2001 was used to pay down $5.5 million of the debentures. A scheduled redemption of $0.4 million was made in December 2002, leaving a balance at December 31,
Liquidity for our administrative service company is measured by its ability to pay operating expenses. The primary source of liquidity is fees collected from clients. We believe that the sources of cash for our administrative service company exceed scheduled uses of cash and results in amounts available to dividend to our parent holding company. We measure the ability of the administrative service company to pay dividends based on its earnings before interest, taxes, depreciation and amortization ("EBITDA"). EBITDA for our administrative services segment was $10.5 million for the year ended December 31, 2002, $9.7 million for the year ended December 31, 2001 and $7.2 million for the year ended December 31, 2000.
Cash generated by our insurance company subsidiaries will be made available to our holding company, principally through periodic payments of principal and interest on surplus notes. As of December 31, 2002, the principal amount of surplus notes owed to our holding company from our American Exchange subsidiary was $60.0 million. The notes pay interest to our parent holding company at LIBOR plus 375 basis points. We anticipate that the surplus notes will be primarily serviced by dividends from Pennsylvania Life, a wholly owned subsidiary of American Exchange, and by tax-sharing payments among the insurance companies that are wholly owned by American Exchange and file a consolidated Federal income tax return. During 2002, the surplus note was reduced by $10.0 million in the form of a capital contribution to American Exchange by our holding company. No principal payments were made during 2001 or 2000. During 2002, American Exchange paid $3.8 million in interest on the surplus notes to our parent holding company, $5.7 million in 2001 and $7.2 million in 2000.
Our insurance subsidiaries are required to maintain minimum amounts of capital and surplus as determined by statutory accounting practices. As of December 31, 2002, each insurance company subsidiary's statutory capital and surplus exceeded its respective minimum requirement. However, substantially more than these minimum amounts are needed to meet statutory and administrative requirements of adequate capital and surplus to support the current level of our insurance subsidiaries' operations. As of December 31, 2002 the statutory capital and surplus, including asset valuation reserves, of our U.S. domiciled insurance subsidiaries totaled $106.5 million.
Dividend payments by our insurance companies to our parent holding company or to intermediate subsidiaries are limited by, or subject to the approval of the insurance regulatory authorities of each insurance company's state of domicile. Such dividend requirements and approval processes vary significantly from state to state. The maximum amount of dividends which can be paid to American Exchange from Pennsylvania Life (to assist in servicing the surplus note held by American Exchange) without the prior approval of the Pennsylvania Department of Insurance is restricted to the greater of 10% of the Pennsylvania Life's surplus as regards policyholders as of the preceding December 31 or the net gain from operations during the preceding year, but such dividends can be paid only out of unassigned surplus. Thus, future earnings of Pennsylvania Life would be available for dividends without prior approval, subject to the restrictions noted above. Based upon the current dividend regulations of Pennsylvania, Pennsylvania Life would be able to pay ordinary dividends of up to $10.6 million to American Exchange (its direct parent) without the prior approval from Pennsylvania Department of Insurance in 2003. Additionally, it is anticipated that Penncorp Life (Canada) would be able to pay ordinary dividends of up to $6.6 million to Universal American in 2003. We do not expect that our remaining regulated insurance subsidiaries will be able to pay ordinary dividends in 2003.
As of December 31, 2002, our insurance company subsidiaries held cash and cash equivalents totaling $23.5 million, as well as fixed maturity securities that could readily be converted to cash with carrying values (and fair values) of $954.5 million. The fair values of these holdings totaled more than $978.0 million as of December 31, 2002.
Our U.S. insurance company subsidiaries, other than Peninsular Life Insurance Company, are taxed as life insurance companies as provided in the Internal Revenue Code. The Omnibus Budget Reconciliation Act of 1990 amended the Internal Revenue Code to require a portion of the expenses incurred in selling insurance products to be capitalized and amortized over a period of years, as opposed to an immediate deduction in the year incurred. Instead of measuring actual selling expenses, the amount capitalized for tax purposes is based on a percentage of premiums. In general, the capitalized amounts are subject to amortization over a ten-year period. Since this change only affects the timing of the deductions, it does not, assuming stability of rates, affect the provisions for taxes reflected in our financial statements prepared in accordance with GAAP. However, by deferring deductions, the change does have the effect of increasing the current tax expense, thereby reducing statutory surplus. Because of our insurance company subsidiaries' net operating loss carryforwards, there was no material increase in our current income tax provision for any of the three years in the period ended December 31, 2002 due to this provision.
In June 2001, the FASB issued SFAS No. 141, "Business Combinations" ("SFAS 141"). SFAS 141 eliminates the pooling-of-interests method of accounting for business combinations, requiring all business combinations to be accounted for under the purchase method. Accordingly, net assets acquired are recorded at fair value with any excess of cost over net assets assigned to goodwill. SFAS 141 also requires that certain intangible assets acquired in a business combination be recognized apart from goodwill. The provisions of SFAS 141 apply to all business combinations initiated after June 30, 2001. Adoption of SFAS 141 did not have a material impact on the Company's consolidated financial condition or results of operations.
In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). Under SFAS 142, effective January 1, 2002 amortization of goodwill is precluded; however, its recoverability must be periodically (at least annually) reviewed and tested for impairment. Goodwill must be tested at the reporting unit level for impairment in the year of adoption, including an initial test performed within six months of adoption. If the initial test indicates a potential impairment, then a more detailed analysis to determine the extent of impairment must be completed within twelve months of adoption. During the first quarter of 2002, the Company completed the review and analysis of its goodwill asset in accordance with the provisions of SFAS 142. The result of these analyses indicated that each
Effective January 1, 2001, the Company adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"), as amended by SFAS Nos. 137 and 138. The standard requires, among other things, that all derivatives be carried on the balance sheet at fair value. The standard also specifies hedge accounting criteria under which a derivative can qualify for special accounting. In order to receive special accounting, the derivative instrument must qualify as a hedge of either the fair value or the variability of the cash flow of a qualified asset or liability, or forecasted transaction. Special accounting for qualifying hedges provides for matching the timing of gain or loss recognition on the hedging instrument with the recognition of the corresponding changes in value of the hedged item. The Company does not currently have any derivative instruments and therefore adoption of SFAS 133 did not have a material impact on the Company's consolidated financial condition or results of operations.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections" ("SFAS 145"). SFAS 145 requires any gain or loss on extinguishments of debt to be presented as a component of continuing operations (unless specific criteria are met) whereas SFAS No. 4 required that such gains and losses be classified as an extraordinary item in determining net income. The Company will adopt these provisions on January 1, 2003, as required. The other provisions of SFAS No. 145 were not relevant to the Company.
the intrinsic value approach under Accounting Principles Board ("APB") Opinion No. 25. Accordingly, the Company did not recognize compensation expense upon the issuance of its stock options because the option terms were fixed and the exercise price equaled the market price of the underlying common stock on the grant date. The Company complied with the disclosure provisions of SFAS 148 by providing pro forma disclosures of net income and related per share data giving consideration to the fair value method provisions of SFAS 123.