The preliminary purchase price paid by Centris for the VASA group was the estimated statutory book value of the Insurance Companies as of December 31, 1998, plus or minus certain adjustments or $42,681,784. Financing for the transaction was provided by Centris' principal lender, Fleet National Bank, which increased its Credit Agreement with Centris from $35,000,000 to $75,000,000. Centris pledged the stock of the Insurance Companies as additional security for the increased loan and has committed to pay down the loan balance to $50,000,000 by June 30, 1999. In accordance with the terms of the stock purchase agreement, an audit of the Insurance Companies as of December 31, 1998 was performed, and Centris has determined that the final purchase price for the acquired group is $36,613,134. Centris has made a claim with Eureko for a refund of the difference between the preliminary purchase price and the final purchase price and is waiting for payment from Eureko. The stock purchase agreement provides a mechanism for resolving any disputes with respect to the amount of the final purchase price.
In early September, 1997, the Company acquired INTERRA, an Indiana based company which manages and underwrites catastrophic accident and health risks nationally and internationally. INTERRA brings fee income and underwriting opportunities for the Company's risk assumption businesses in one of the fastest growing sectors of the industry--international accident and health insurance and reinsurance. INTERRA underwrites on behalf of an unaffiliated life insurance company and for its affiliate, Seaboard Life. Previously it had written business for USF RE. INTERRA also provides catastrophic claims management services to the Company and its subsidiaries. INTERRA's results are included in the medical lines segment.
The Company continues to actively pursue accretive acquisition opportunities in complementary business lines.
Medical lines includes (i) medical stop-loss and provider excess coverages underwritten by USBenefits Insurance Services, Inc. ("USBenefits") on behalf of The Continental Insurance Company ("Continental"), one of the CNA Insurance Companies, (ii) catastrophic accident and health risks underwritten and managed nationally and internationally by INTERRA, Inc. ("INTERRA"), and (iii) reinsurance of 50% of such business by USF RE through December 31, 1998, at which time USF RE terminated its reinsurance of the medical lines business on a run-off basis. Effective January 1, 1999, Seaboard Life and VNAIC became reinsurers of the medical lines business with net retained liability under all medical stop-loss and provider excess contracts limited to 25%. In addition, USBenefits is the underwriting manager and marketing organization for medical lines coverages issued on behalf of Continental. Medical stop-loss coverage is a form of excess insurance that protects employers that self-fund their employee healthcare plans by capping their exposure from the risk of loss. Provider excess coverage limits the financial risks healthcare providers face from medical plans that prepay the providers fixed sums per plan participant (capitated fees) or provide specified rates for services. Medical lines products are marketed through a network of unaffiliated third party administrators, insurance agents, brokers and consultants.
Substantially all commissions and fees and premiums earned from continuing operations for 1998, 1997 and 1996, respectively, arise from USBenefits' and USF RE's relationship with Continental and its affiliate.
Specialty Lines insurance underwriting is conducted by the Company's subsidiary, USF Insurance Company ("USFIC") which is presently rated "A" (Excellent) by A.M. Best Company, a rating that it currently shares with USF RE, under an Intercompany Pooling Agreement that has been terminated effective as of January 1, 1999. A.M. Best Company has placed USFIC's and USF RE's rating under review pending final resolution of the announced sale of USF RE. There can be no assurance that USFIC will continue to be rated by A.M. Best Company following the disposition of USF RE or that if USFIC continues to be rated, that it will retain its current rating of "A".
Increases in premiums earned and commissions and fees in 1998 as compared to 1997 were attributable to modest growth in the medical lines segment. In 1998, the Company was more selective in its' underwriting of medical stop loss as rating actions adopted in late 1997 took effect. These actions, which resulted in a 2% decrease in medical stop loss premium volume, included a focus on larger groups where there is more predictability and better opportunities to write profitable business, increased selectivity in those areas of the country where managed care is not firmly established and a reduction in the amount of business written through producers whose book of business has been less profitable. Provider excess premium volume, which represents 12% of the medical lines book, advanced 35% in 1998 over 1997 through a combination of increased group size and increased penetration into this market. Revenue changes between 1997 and 1996 primarily reflect additional medical stop-loss business from the 1997 acquisition of Global Excess Re combined with increased production of provider excess.
Returns on invested assets are an integral element of results from operations. Underwriting cash flows, which consist of premiums collected over losses and expenses paid, and investment cash flows, which consist of income from existing investments and proceeds from sales and maturities of investments, provide the funds used to build the investment portfolio. The portfolio is managed based upon Company guidelines which incorporate a variety of factors including the relationship of invested assets to liabilities, total return, business needs, regulatory requirements and tax considerations. Increases in net investment income result from higher levels of invested assets and the increasingly higher concentration of these assets in higher yielding fixed income securities as
Insurance expenses are comprised of losses and loss adjustment expenses incurred and policy acquisition expenses. Insurance and reinsurance companies establish reserves for losses incurred, but not yet paid, in order to match such losses with the related premiums earned. The process of establishing loss reserves is subject to uncertainties that are a normal, recurring aspect of the insurance business which requires the use of informed judgments and estimates. Loss and loss adjustment expense reserve development is reviewed on a regular basis, incorporating analysis of current trends, market changes in the Company's business segments and historical experience to analyze the Company's actuarial assumptions. As additional experience and other data becomes available, the Company's actuarial estimates may be revised. Such revisions may impact earnings. Policy acquisition expenses vary on the basis of market conditions and mix of business. See segment disclosures contained herein for additional discussion of insurance expenses.
General and administrative (G&A) expenses related to continuing operations remained at 11% of revenues in 1998 and 1997, reflecting the Company's continuous focus on managing its expense as it incorporates acquired companies into its business mix. Higher levels of general and administrative expenses in 1997 as compared to 1996 reflect the acquisitions of Global Excess Holdings, Inc. and INTERRA which were completed in the 1997 period.
During 1998, the Company made the decision to exit the property/casualty reinsurance market by offering its wholly owned subsidiary, USF RE INSURANCE COMPANY ("USF RE"), for sale. Accordingly, the Company discontinued its property/casualty segment and has segregated 1998 results between income from continuing operations and discontinued operations. The Company, through USF RE, entered the property/casualty reinsurance market in 1987. Since that time the property/casualty segment experienced significant growth. In recent years, however, it has become increasingly difficult to compete in the property/casualty reinsurance arena as other market participants grow ever larger and the business has begun to
program opportunities as well as the exclusive use of managing general agents to produce business. Part of this strategy is to also act as a policy issuing carrier earning non risk exposed fee income to balance the risks assumed on the balance of the business.
As a result of these changes, the specialty lines segment produced pre tax income of $581,000 in 1998. In 1999 USFIC will expand its focus to include writing specialty risks for medically related lines of business where it can leverage existing relationships and opportunities through USBenefits and INTERRA.
See "Note 1" to the Company's Consolidated Financial Statements appearing elsewhere in this Form 10-K for information regarding significant accounting policies.
The healthcare marketplace has long been subject to the effects of increases in costs of services. Inflation can also negatively impact insurance and reinsurance operations by causing higher claims settlements than may have originally been estimated, while not necessarily allowing an immediate increase in premiums to a level
Application of the National Association of Insurance Commissioners ("NAIC") risk-based capital ("RBC") requirements for property and casualty and life insurance entities indicates that the Company's insurance company subsidiaries substantially exceed the capital level required under the RBC requirements.
As the year 2000 approaches, the Company recognizes the need to ensure that its operations will not be adversely affected by year 2000 computer software and hardware issues. Such issues pertain to date sensitive software and hardware which could incorrectly recognize a two digit date field. This could result in a system miscalculation or failure and lead to a disruption of operations, including, among other things, a temporary inability to process transactions, send invoices, make claims or other payments or engage in similar activities.
The evaluation phase of the plan, which was completed in December 1997, included an analysis of the Company's software and hardware systems, identification of hardware which needed to be upgraded or replaced, identification of software enhancements required to address year 2000 issues and identification of those customers, business partners, vendors and service providers that could have an impact on the Company's operations in the event that their systems were not year 2000 compliant. The Company's significant operational and financial software systems are provided by third party vendors who the Company has confirmed have also been focusing on addressing year 2000 issues. During 1998, the Company has implemented and tested year 2000 compliant systems for its corporate financial reporting system, its treaty reinsurance business, its facultative
The Company has solicited its trading partners including agents and brokers, suppliers, financial institutions and others who could directly or indirectly affect the Company's operations as to their year 2000 compliance efforts. Presently, these trading partners are in various stages of completion of their own year 2000 remediation efforts. The third party vendors providing the Company's significant operational and financial software systems have represented to the Company that the software now in use is Year 2000 Compliant. The Company will continue to monitor the Year 2000 readiness of its own systems, as well as the readiness of its customers, business partners, vendors and service providers on an ongoing basis. It is presently not possible to quantify the aggregate cost to the Company with respect to external year 2000 issues, if any, although the Company does not expect such matters to have a material adverse effect on its operations.
As the Company continues to monitor the status of external year 2000 issues, it expects to develop contingency plans for issues that may arise. In support of this objective, the Company has developed a worst case scenario relating to Year 2000 issues. This scenario indicates that Year 2000 risks relate to the Company's relationships with its trading partners where issues such as telephone availability, fax services and telecommunications including internet service usage could cause the Company to revise its business practices in the event of the non availability of such common services. The Company is presently developing alternative methods to conducting its business in the event that a worst case scenario or element thereof was to occur. This scenario considers it unlikely that all external trading relationships would become useless simultaneously. Therefore, the Company's contingency plan is based upon alternatives to the specific loss of up to two of the identified worst case items described. The Company intends to continue testing elements of its contingency plan throughout 1999.
The Company has also taken steps to ensure that it will have adequate insurance coverages for any year 2000 losses that it may incur by monitoring its coverages to ensure that there are no year 2000 restrictions or limitations on its policies, renewing its D&O and E&O coverages early without any limitations pertaining to year 2000, and by obtaining multi-year contracts that will extend beyond the year 2000 to ensure that its coverages are not restricted or canceled during 1999. In addition, it is the Company's intention to renew all of its other principal coverages to ensure that such coverages also do not contain year 2000 restrictions.
The Company's vendor provided software systems were scheduled for replacement between 1996 and 1998 as the legacy systems previously operated could no longer support the Company's growing business. Year 2000 compliance was a consideration in each system replacement made by the Company. Specific remediation costs for hardware and software year 2000 issues have been less that $100,000. Such cost of the year 2000 remediation plan is not considered material to the Company's financial position.
The Company's consolidated financial statements and notes thereto, and supplementary data are filed as a part of this Annual Report on Form 10-K as indicated in the Index to Financial Statements and Financial Statement Schedules appearing on page of this report.