(3) Does not include restricted cash. See Note A of Notes to Consolidated Financial Statements.
(4) Excludes the unrealized gains (losses) on available for sale securities, which are reported in accumulated other comprehensive income as a separate component of stockholders' equity.
The following discussion of the Company's historical results of operations and of its liquidity and capital resources should be read in conjunction with the Selected Financial Data and the Consolidated Financial Statements of the Company and related notes thereto included herein.
interest income in the amount of $5.5 million in the second quarter of 1999; and (e) the recording of compensation expense in the amount of $5.3 million associated with stock option exercises in the third quarter of 1999. The application of the revised methodology for determining loan loss reserves and the carrying value of residual assets, the write-off of the UMMG minority interest purchase price, the adjustment to EFG's interest income and the recording of additional compensation expense reduced in the aggregate previously reported net income in the second and third quarters of 1999 by $51.7 million ($1.08 per share) and $38.3 million ($0.80 per share), respectively.
In addition, 1999 results from continuing operations were impacted by several significant adjustments taken in the fourth quarter, including (a) a $5.0 million accrual for professional fees, (b) a write off of previously capitalized software and system development costs in the amount of $2.3 million at the Company's Student Insurance Division, (c) a strengthening of insurance reserves associated with the Company's Special Risk operations in the amount of $3.5 million, and (d) a write off in the amount of $9.0 million to adjust Educational Finance Group, Inc.'s student loan balance.
Life premiums and other considerations. Life premiums and other considerations decreased to $46.4 million in 1999 from $49.3 million in 1998, a decrease of $2.9 million, or 6%. This decrease resulted from reduced premiums and other considerations from closed blocks of life and annuity business.
Other interest income. Other interest income increased to $65.1 million in 1999 from $31.6 million in 1998, an increase of $33.5 million. The increase was due to the additional interest income earned on student loans in 1999.
Operating Income. Income from continuing operations before federal income taxes ("operating income") increased to $50.9 million in 1999 from $47.3 million in 1998. Operating income (loss) for each of the Company's segments and divisions was as follows:
Other Key Factors. Other key factors include investment income not allocated to the other segments, interest expense from corporate borrowings, general expenses relating to corporate operations, amortization of goodwill, realized gains or losses on sale of investments and the AMLI operations. Operating income for other key factors decreased to $1.5 million from $12.2 million in 1998. The decrease is primarily due to an increase in amortization of goodwill (recorded in connection with Educational Finance Group, Inc.'s acquisition of AMS in July 1999), additional interest expense associated with a higher level of corporate borrowings outstanding during 1999, general corporate operations and a decrease in realized gains, which was partially offset by an increase in investment income on equity not allocated to the other segments. The amount of realized gains or losses on the sale of investments is a function of interest rates, market trends and the timing of sales. Losses are more likely during periods of increasing long-term interest rates.
In prior years, the Company discussed the nature and progress of its plans to become Year 2000 ready. In late 1999, the Company completed its remediation and testing of systems. As a result of those planning and implementation efforts, the Company experienced no significant disruptions in mission critical information technology and non-information technology systems and believes those systems successfully responded to the Year 2000 date change. The Company expensed approximately $10.3 million cumulatively, and $4.3 million during 1999, in connection with remediating its systems. The Company is not aware of any material problems resulting from Year 2000 issues, either with its products, its internal systems, or the products and services of third parties. The Company will continue to monitor its mission critical computer applications and those of its suppliers and vendors throughout the year 2000 to ensure that any latent Year 2000 matters that may arise are addressed promptly.
Investment income. Investment income decreased to $74.9 million in 1998 from $78 million in 1997, a decrease of $3.1 million, or 4%. The decrease was due to a decrease in investment yield.
Other interest income. Other interest income increased to $31.6 million in 1998 from $4 million in 1997, an increase of $27.6 million. The increase was due to the investment income earned on student loans in 1998.
Other fee income. Other fee income increased to $111.1 million in 1998 from $70.3 million in 1997, an increase of $40.8 million. The increase was due to the increase in revenue from Educational Finance Group and reporting a full year of operations of National Motor Club.
Gains on sale of investments. The Company recognized gains on sale of investments of $4.9 million in 1998 compared to $4.0 million in 1997. The amount of realized gains or losses on the sale of investments is a function of interest rates, market trends and the timing of sales.
Benefits, claims, and settlement expenses. Benefits, claims, and settlement expenses increased to $586.0 million in 1998 from $449.7 million in 1997, an increase of $136.3 million, or 30%. The increase was primarily due to the growth in premium volume and a higher loss ratio in the SEA Division.
Underwriting, acquisition and insurance expenses. Underwriting, acquisition and insurance expenses increased to $270.9 million in 1998 from $249.8 million in 1997, an increase of $21.1 million, or 8%. The increase was primarily due to increased premium volume in 1998 compared to 1997.
Other expenses. Other expenses increased to $114.4 million in 1998 from $81.4 million in 1997, an increase of $33 million, or 41%. The increase was primarily due to the increased costs associated with the operations of Educational Finance Group and reporting a full year of operations of National Motor Club.
Depreciation and amortization. Depreciation and amortization increased to $15.9 million in 1998 from $10 million in 1997, an increase of $5.9 million. The increase is primarily due to increased amortization costs associated with goodwill recorded in connection with the acquisitions of Educational Finance Group and National Motor Club.
Interest expense. Interest expense on corporate borrowings increased to $3.1 million in 1998 from $2.9 million in 1997, an increase of $200,000. Interest expense on student loan obligations was $19.2 million in 1998 and $-0- in 1997.
The losses on the managed care products resulted primarily from losses from a specific PPO insurance product. The Company discontinued the marketing of this PPO product in the first quarter of 1998. The losses on the managed care products were due to higher loss ratios and a slower than anticipated implementation of rate increases on the managed care products. The Company also encouraged current in-force policyholders to raise their deductibles and co-payment amounts.
The Company implemented a substantial rate increase on its PPO policies beginning in April 1998 which was completed in October 1998. A new round of rate increases was also imposed in October 1998. The marketing organizations were successful in directing a larger portion of new sales to the Company's traditional indemnity
products, with respect to which the Company did not experience similar pricing problems and higher claims volumes.
The claim reserving method employed by the previous administrator of a portion of SEA's insurance business was not comparable to the traditional reserving methods employed by the Company for its other self employed health insurance. While both reserving methods are acceptable for statutory and GAAP reporting, the Company's method is the more conservative of the two methods. The decision to conform the two methods at a time when a continuing evaluation of rates and rate changes was critical in managing the block to profitability. Conforming the two methods resulted in an increase in the claim reserves of $12 million in March 1998.
In 1998, EFG significantly changed its business as it evolved from a marketing company to an originator, holder, and servicer of student loans. Student loans increased to $670.4 million at December 31, 1998 from $11.3 million at December 31, 1997. With this change, EFG also established funding sources for the student loans. The first funding facility was entered into in March 1998 and subsequently increased to $750 million.
Insurdata. Insurdata generated operating income of $3.3 million in 1998 compared to operating income of $2.6 million in 1997. The operating income in 1998 was reduced by approximately $740,000 of expenses incurred in preparation for an initial public offering of equity securities, which offering was not consummated. Revenue generated by Insurdata increased to $41.2 million in 1998 from $25.1 million in 1997, an increase of 64%. Insurdata revenue from other divisions of the Company were $21.1 million and $10.4 million in 1998 and 1997, respectively.
Other Key Factors. Other key factors include investment income not allocated to the other segments, interest expense, general expenses relating to corporate operations, amortization of goodwill, realized gains or losses on sale of investments and the AMLI operations. Operating income for other key factors decreased to $12.2 million in 1998 from $21.0 million in 1997. The decrease in 1998 is mainly attributed to an increase in amortization of goodwill of $3.4 million and a decrease of $4.4 million in investment income on equity. The decrease in investment income on equity is attributed to a decrease in investment yield.
Revenues generated by United CreditServ (consisting of interest, credit card and other fees) increased to $123.2 million in 1998 from $50.3 million in 1997, an increase of 145%. The increase was primarily due to growth in new sales from the ACE program started in 1997. Of the accounts added during 1998 under the new program, 67% were added during the last four months of the year. Operating income for United CreditServ increased to $43.5 million in 1998 from $18.1 million in 1997, primarily attributable to increased credit card volumes. United CreditServ's net managed credit card receivables increased to $233.4 million in 1998 from $95.5 million in 1997. A substantial portion of the increased receivables was financed through a securitization of $60 million of AFCA receivables in December 1998 and an increase in time deposits to $98.9 million at December 31, 1998 from $7.6 million at December 31, 1997.
On February 25, 2000, UCNB agreed to the issuance of a Consent Order by the U.S. Office of the Comptroller of the Currency (the "OCC"). Under the terms of the Consent Order, UCNB is prohibited from accessing the brokered deposit market and from soliciting or accepting deposits over the Internet. At March 31, 2000, UCNB had $296.0 million of certificates of brokered deposits outstanding, the majority of which are scheduled to mature over the next six months. At March 31, 2000, UCNB had approximately $160.0 million in cash, cash equivalents and short term U.S. Treasury securities.
The Consent Order requires UCNB, until further notice from the OCC, to cease all activities with ACE and AFCA (its only marketing organizations). The Consent Order further required UCNB, until further notice from the OCC, to cease all transactions with affiliated parties (including UICI but excluding Specialized Card Services, Inc., the servicer of UCNB's credit card accounts), and to conduct an immediate review of all agreements with all third parties to assess whether such agreements are on terms fair and reasonable to UCNB. UCNB has engaged PricewaterhouseCoopers LLP to independently review the terms of all agreements between UCNB and Specialized Card Services, Inc. (an indirect wholly owned subsidiary of UICI and the servicer of UCNB's credit card accounts). On March 27, 2000, UCNB submitted to the OCC its review of third party agreements and PricewaterhouseCoopers LLP's review of agreements between UCNB and Specialized Card Services, Inc.
UCNB is further prohibited under the terms of the Consent Order from introducing new products or services, without accompanying policies and procedures reviewed and approved by the OCC providing for, among
While revenues at Educational Finance Group, Inc. increased from $57.2 million in 1998 to $104.6 million in 1999, during 1999 EFG incurred an operating loss in the amount of $19.9 million, compared to an operating loss of $1.3 million in 1998. The significant operating loss was attributable primarily to increases in interest expense from higher borrowings and interest rates and sustained operating losses at EFG Technologies Inc. and Education Loan Administrators Group. EFG's AMS unit also incurred an operating loss in 1999, due to the timing of the acquisition and the recording of revenues in the tuition installment plan business of AMS, which revenues are recorded primarily in May through August. The AMS acquisition was completed on July 26, 1999.
The Company believes it has taken steps to restore EFG to profitability. In January 2000, UICI named William A. Hastings (formerly President and Chief Executive Officer of AMS) to serve as President and Chief Executive Officer of EFG, and Mr. Hastings and his management team have been charged with assessing all aspects of EFG's operations and lines of business.
During 1999 the Company held a 100% interest in Insurdata Incorporated ("Insurdata"), a provider of Internet-enabled, integrated proprietary software applications that address the workflow and processing inefficiencies embedded in the healthcare insurance industry. On January 7, 2000, Insurdata merged with and into HealthAxis.com, Inc. ("HealthAxis.com"), a web-based retailer of health insurance products and related consumer services. Following the merger, the Company held approximately 44%, and HealthAxis, Inc. (formerly Provident American Corporation) ("HAI") held approximately 28.1%, of the issued and outstanding capital stock of HealthAxis.com, the surviving corporation in the merger. On March 14, 2000, the Company sold in a private sale to an institutional purchaser 2,000,000 shares of HealthAxis.com common stock, and, giving effect to such sale, the Company holds 39% of the issued and outstanding shares of common stock of HealthAxis.com.
In May 1999, the Company entered into a $100 million unsecured credit facility with a group of commercial banks. Amounts outstanding under the credit facility initially bore interest at an annual rate of LIBOR plus 75 basis points (0.75%). At December 31, 1999, the Company had fully drawn on the credit facility, of which $50 million was used to repay $50 million of debt outstanding under the Company's prior bank facility and $50 million was used to fund the UMMG and AMS acquisitions (completed in May 1999 and July 1999, respectively) and current operations. Effective December 31, 1999, the interest rate on amounts outstanding under the credit facility was increased to LIBOR plus 100 basis points (1.00%).
Giving effect to the restructuring, at March 13, 2000, UICI and its consolidated subsidiaries had approximately $159.5 million of long and short term indebtedness outstanding (other than indebtedness under student loan funding facilities), bearing interest at a weighted average annual rate of 8.18%.
In addition, the fourth quarter 1999 results from continuing operations were impacted by several significant adjustments, including (a) a $5.0 million accrual for professional fees, (b) a write off of previously capitalized software and system development costs in the amount of $2.3 million at the Company's Student Insurance Division, (c) a strengthening of insurance reserves associated with the Company's Special Risk operations in the amount of $3.5 million, and (d) a write off in the amount of $9.0 million to adjust Educational Finance Group, Inc.'s student loan balance.
The following table presents the information for each of the Company's fiscal quarters in 1999 and 1998 as originally reported and as restated to reflect adjustments described above. This information is unaudited and has been prepared on the same basis as the audited Consolidated Financial Statements of the Company included herein and, in management's opinion, reflects all adjustments necessary for a fair presentation of the information for the periods presented. The operating results for any quarter are not necessarily indicative of results for any future period.
Historically, the Company's primary sources of cash have been premium revenues from policies issued, investment income, fees and other income, deposits to fund the credit card receivables, and borrowings to fund student loans. The primary uses of cash have been payments for benefits, claims and commissions under those policies, operating expenses and the funding of credit card receivables and student loans. Net cash used in operations totaled approximately $58.3 million in 1999. Net cash provided from operations totaled $140.5 million and $145.6 in 1998 and 1997, respectively. The Company's insurance subsidiaries invest a substantial portion of these funds, pending payment of the subsidiaries' pro rata share of future benefits and claims.
UICI is a holding company, the principal assets of which are its investments in its separate operating subsidiaries, including its regulated insurance subsidiaries. The holding company's ability to fund its cash requirements is largely dependent upon its ability to access cash, by means of dividends or other means, from its subsidiaries. Dividends paid by the Company's domestic insurance subsidiaries in any year are restricted by the laws of the state of such subsidiaries' domicile. Inability to access cash from its subsidiaries could have a material adverse effect upon the Company's liquidity and capital resources.
In connection with the Company's designation of United CreditServ as a discontinued operation, the Company has recorded in 1999 a loss in the amount of $130.0 million, which represents its current estimate of ultimate loss upon disposal for financial reporting purposes. As part of its plan to exit from the credit card business on or before December 31, 2000 and in accordance with the terms of the Consent Order issued by the OCC, the Company also expects that UCNB will enter into a capital plan designed to meet Federal bank regulatory requirements. Based on current projections, the Company believes that its exit from the credit card business will require the holding company to generate additional cash in the amount of approximately $92.0 million to fund future operating losses of the credit card business, including approximately $25.0 million which will be required to be contributed as additional capital to UCNB pursuant to the capital plan. In addition, through December 31, 2000 the holding company will have additional cash requirements in the amount of approximately $32.0 million, of which $25.0 million represents a mandatory principal payment owing on its bank credit facility in July 2000.
There can be no assurance that the cash requirements at the holding company level will not exceed current estimates, or that the holding company will be able to raise sufficient cash to fund cash requirements on a timely basis.
The Company securitized $60.0 million, $30.0 million and $29.0 million of credit card receivables in 1998, 1997 and 1996, respectively. The Company did not securitize any credit card receivables in 1999. The Company purchased participating interests in such securitizations in the aggregate principal amount of $6.0 million, $3.0 million and $2.9 million in 1998, 1997 and 1996, respectively. On December 30, 1999, the Company sold for cash at par $10.0 million principal amount of such participating interests to Ronald L. Jensen (the Company's Chairman). See Note L of Notes to Consolidated Financial Statements.
As of December 31, 1999 (giving effect to all capital contributions made subsequent to December 31, 1999), UCNB had a total risk-based capital ratio of 13.10%, a Tier 1 risk-based capital ratio of 11.40% and a leverage ratio of 6.79%. The Board of Directors of UCNB has established a policy of maintaining a Tier I leverage ratio of 8%, a Tier I risk-based capital ratio of 10% and a total risk-based capital ratio of not less than 12%.
The Federal Deposit Insurance Corporation Improvement Act of 1991("FDICIA") expanded the powers of federal bank regulatory authorities to take corrective action with respect to banks that do not meet minimum capital requirements. For these purposes, FDICIA established five capital tiers: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. Under regulations adopted by the OCC, an institution is generally considered to be "well capitalized" if it has a total risk-based capital ratio of 10% or greater, a Tier 1 risk-based capital ratio of 6% or greater, and a leverage ratio of 5% or greater; "adequately capitalized" if it has a total risk-based capital ratio of 8% or greater, a Tier 1 risk-based capital ratio of 4% or greater and, generally, a leverage ratio of 4% or greater; and "undercapitalized" if it does not meet any of the "adequately capitalized" tests. An institution is deemed to be "significantly undercapitalized" if it has a total risk-based capital ratio under 3% and "critically undercapitalized" if it has a ratio of tangible equity (as defined in the regulations) to total assets that is equal to or less than 2%. An "adequately capitalized" institution is permitted to accept brokered deposits only if it receives a waiver from the FDIC and pays interest on deposits at a rate that is not more than 75 basis points higher than the prevailing rate in its market. Undercapitalized institutions cannot accept brokered deposits, are subject to growth limitations and must submit a capital restoration plan. "Significantly undercapitalized" institutions may be subject to a number of additional requirements and restrictions. "Critically undercapitalized" institutions are subject to appointment of a receiver or conservator.
A liquidity and capital assurances agreement, dated May 15, 1998, between UICI and UCNB provides that, upon demand by UCNB, UICI will purchase certificates of deposit issued by UCNB to assure sufficient liquidity to meet UCNB's funding demands and will contribute capital to UCNB sufficient for UCNB to comply with its stated policy of maintaining a total (Tier I and Tier II) risk-based capital ratio of at least 12%.
In accordance with the terms of the Consent Order, on March 29, 2000, UCNB submitted to the OCC for its review and approval a capital plan (the "Proposed Capital Plan"). The Proposed Capital Plan contemplates the orderly disposition of United CreditServ's ownership interest in UCNB or the liquidation of UCNB, the payment of all of UCNB's insured deposits and satisfaction of all other UCNB liabilities, and the maintenance of minimum capital ratios. The Proposed Capital Plan provides that United CreditServ will dispose of its interest in UCNB or UCNB will dispose of all of its assets on or before December 31, 2000 (the "Plan Period"). To support its implementation, the Proposed Capital Plan further contemplates that (a) UICI, United CreditServ and UICI's principal shareholder will provide financial support to UCNB and deliver collateral to UCNB to secure its obligations to provide such financial support and (b) UCNB will be able to access the brokered deposit market on a limited basis. Under the Proposed Capital
EFG's student loan portfolio increased from $670 million at December 31, 1998 to $1.326 billion at December 31, 1999. This growth was funded utilizing the proceeds from EFG's student loan credit facility (which had a balance outstanding of $398 million at December 31, 1999) and the issuance of long term notes.
On June 11, 1999, a special purpose financing subsidiary of EFG sold, in a private placement transaction, $319.5 million principal amount of Auction Rate Student Loan-Backed Notes at an initial interest rate of 5.038%. The interest rate on the notes is reset monthly through an auction process. The notes were sold in two equal tranches and mature in November 2022. The notes received a "AAA" credit rating from Standard & Poor's and Fitch IBCA and an "Aaa" rating from Moody's Investor Services.
Effective August 6, 1999, EFG completed a $650 million single seller asset-backed commercial paper conduit through its special purpose entity, EFG Funding, LLC. Approximately $515 million of commercial paper was issued under the facility in a private placement transaction. The commercial paper bears annual interest at rates ranging from 5.05% to 5.69%. Commercial paper is issued under the conduit from time to time with maturities from one to 270 days. Liquidity support is provided by a separate banking facility. The commercial paper received ratings of A1/P1/F1 from Standard & Poor's, Moody's, and Fitch, respectively.
On October 7, 1999 EFG completed a $344 million financing of three classes of notes. The $229 million Class A-1 notes were structured as three-month LIBOR floating rate notes and were priced with a spread of 42 basis points with the interest rate to be reset quarterly. The Class A-1 notes have an expected average life of 3.5 years with legal final maturity in April 2009. The $57.5 million Class A-2 and $57.5 million Class A-3 notes were structured as auction rate notes with an initial interest rate of 6.38%. The interest rate (6.38% at December 31, 1999) on these notes is reset quarterly pursuant to auctions conducted by Lehman Brothers and BancAmerica Securities. Legal final maturity of the A-2 and A-3 notes is July 2000. Lehman Brothers and Banc of America Securities were the initial purchasers of all three classes of notes. All three classes of notes received AAA/Aaa/AAA ratings from Standard & Poor's, Moody's and Fitch IBCA respectively.
In 1998, the Company borrowed $12.0 million on a revolving credit note extended by AEGON USA. The funds were used to fund the student loan credit facility. The Company had no outstanding balance on its revolving
During 1997, the Company acquired four companies and certain assets for $88.3 million in cash. Total fair value of assets acquired were $112.1 million and total fair value of liabilities assumed were $23.8 million.
Effective January 1, 1997, the Company acquired the agency force and certain assets of United Group Association, Inc., for a price equal to the net book value of the tangible assets acquired and assumed certain agent commitments of $3.9 million. The tangible assets acquired consist primarily of agent debit balances, a building, and related furniture and fixtures having a net book value of $13.1 million, which approximates fair market value of the tangible assets.
The state of domicile of each of the Company's domestic insurance subsidiaries imposes minimum risk-based capital requirements that were developed by the NAIC. The formulas for determining the amount of risk-based capital specify various weighting factors that are applied to financial balances and premium levels based on the perceived degree of risk. Regulatory compliance is determined by a ratio of a company's regulatory total adjusted capital, as defined, to its authorized control level risk-based capital, as defined. Companies' specific trigger points or ratios are classified within certain levels, each of which requires specified corrective action. At December 31, 1999, the risk-based capital ratio of each of the Company's domestic insurance subsidiaries significantly exceeded the ratios for which regulatory corrective action would be required.
Dividends paid by domestic insurance companies out of earned surplus in any year are limited by the law of the state of domicile. See "Item 5. Market for Registrant's Common Stock and Related Stockholder Matters" and Note K to Notes to the Consolidated Financial Statements.
Fixed maturity securities. Fixed maturity securities accounted for 82.9% of the Company's total investments at December 31, 1999. Fixed maturity securities consisted of the following:
Inflation historically has had a significant impact on the health insurance business. In recent years, inflation in the costs of medical care covered by such insurance has exceeded the general rate of inflation. Under major hospital insurance coverage, established ceilings for covered expenses limit the impact of inflation on the amount of claims paid. Under catastrophic hospital expense plans and preferred provider contracts, covered expenses are generally limited only by a maximum lifetime benefit and a maximum lifetime benefit per accident or sickness. Thus, inflation may have a significantly greater impact on the amount of claims paid under catastrophic hospital expense and preferred provider plans as compared to claims under major hospital coverage. As a result, trends in health care costs must be monitored and rates adjusted accordingly. Under the health insurance policies issued in the self-employed market, the primary insurer generally has the right to increase rates upon 30-60 days written notice and subject to regulatory approval in most cases.
The Company is assessed amounts by state guaranty funds to cover losses of policyholders of insolvent or rehabilitated insurance companies, by state insurance oversight agencies to cover the operating expenses of such agencies and by other similar legislative entities. These mandatory assessments may be partially recovered through a reduction in future premium taxes in certain states. Effective January 1, 1999, the Company adopted provisions of AICPA Statement of Position 97-3 ("SOP 97-3"), under which these assessments are accrued in the period in which they have been incurred. The effects of initially adopting SOP 97-3 were not material to the financial condition or results of operations of the Company.
In June 1998, the Financial Accounting Standards Board issued Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, which is required to be adopted in years beginning after June 15, 2000. Because of the Company's minimal use of derivatives, management does not anticipate that the adoption of the new Statement will have a significant effect on earnings or the financial position of the Company.