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.
At December 31, 2002, consists of 33,896 shares, which are convertible, at the option of the holders thereof, into an aggregate of 6,944,941 shares of common stock at a conversion price of $4.88 per share of common stock.
ITEM 7 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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.
developments in health care reform and other regulatory issues, including the Health Insurance Portability and Accountability Act of 1996 (“HIPAA”) and increased privacy regulation, and changes in laws and regulations in key states where the Company operates;
Subsequent written or oral statements attributable to the Company or persons acting on its behalf are expressly qualified in their entirety by the cautionary statements in this Report and those in the Company’s reports previously filed with the SEC. Copies of these filings may be obtained by contacting the Company or the SEC.
Results of operations for Ascent are reported below for 2002, 2001 and 2000.
Overview. The Company’s pre-tax loss for 2002 was ($931,000) compared to a pre-tax loss of ($2.1) million for 2001 and ($12.9) million for 2000. The $1.2 million decrease in pre-tax loss for 2002 from 2001 was primarily the result of the $4.6 million improvement in insurance operating results in 2002 which was partially offset by a ($2.1) million decrease in fee and service results and an increase in interest expense on the note payable of $862,000.
Interest expense on the note payable issued in April 2001 of $11 million increased to $2.2 million in 2002 from $1.3 million in 2001 due to the longer period outstanding for 2002 and the increase in the note payable balance to $13.5 million as of December 31, 2002 for interest paid in kind. In addition, dividends on the redeemable convertible preferred stock increased during 2002 due to the payment of such dividends in kind. At December 31, 2002, total redeemable convertible preferred stock outstanding was $33.9 million. The redeemable preferred stock and note payable mature in March 2004 and April 2004, respectively. The Company must obtain additional financing to retire these obligations when due or restructure these facilities. Failure of the Company to successfully refinance these facilities could have a material adverse impact on the Company’s liquidity, capital resources and results of operations (see Liquidity, Capital Resources and Statutory Capital and Surplus.)
Premiums. The Insurance Subsidiaries’ premium revenue is derived principally from the following medical expense reimbursement products: comprehensive major medical, hospital/surgical major medical, supplemental specified disease and Medicare supplement. Comprehensive major medical products are generally designed to reimburse insureds for eligible expenses incurred for hospital confinement, surgical expenses, physician services, outpatient services and the cost of medicines. Hospital surgical major medical products are similar to comprehensive major medical products except that benefits are generally limited to hospital/surgical services and deductibles and coinsurance provisions are generally higher. Supplemental specified disease products include indemnity policies for hospital confinement and convalescent care for treatment of specified diseases and “event specific” policies, which provide fixed benefits or lump sum payments upon diagnoses of certain types of internal cancer or other catastrophic diseases. Prior to 1998, the Insurance Subsidiaries also underwrote Medicare supplement products and continue to receive renewal premiums from such policies.
Benefits and Claims. Benefits and claims are comprised of (1) claims paid, (2) changes in claim reserves for claims incurred (whether or not reported), and (3) changes in future policy benefit reserves (see Financial Condition - “Claims Reserves” and “Future Policy Benefit Reserves”). The 4.1 percentage point improvement in the ratio of consolidated benefits and claims to consolidated premiums in 2002 as compared to 2001 and the 10.4 percentage point improvement in 2001 as compared to 2000 is principally attributable to the new major medical product introduced in July 2000. As discussed above, this product was designed to produce a lower benefits and claims to premium ratio. Each year, the new major medical product comprises a greater percentage of total major medical premium revenue.
Commissions. For 2002, the commissions to premiums ratio decreased by 1.7 percentage points from 2001 as a result of the decrease in first year major medical premiums. Commission rates on first year premiums are significantly higher than those for renewal premiums. 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.
General and Administrative Expense. General and administrative expenses decreased by $2.1 million in 2002 as compared to 2001, principally due to the decline in first year premiums and new policy issue cost. General and administrative expenses decreased $2.9 million in 2001 as compared to 2000 due to non-recurring expenses incurred in 2000 related to the implementation of the Company’s new policy administration and claims data processing systems and efficiencies realized in 2001 from such systems.
Investment policy is determined by the applicable 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. The Company’s entire fixed maturity portfolio is classified as “available for sale” and carried at market value.
Mortgage-backed securities comprised 33.4% of the Company’s fixed maturity portfolio at December 31, 2002 as compared to 11.9% at December 31, 2001. Mortgage-backed securities are subject to risks associated with variable pre-payments. This may result in these securities having a different actual cash flow and maturity than expected at the time of purchase. Securities that have an amortized cost greater than par and are backed by mortgages that prepay faster than expected will incur a reduction in yield or a loss. Those securities with an amortized cost lower than par that prepay faster than expected will generate an increase in yield or a gain. In addition, the Company may incur reinvestment risks if market yields are lower than the book yields earned on the securities. Prepayments occurring slower than expected have the opposite impact. The Company may incur disinvestment risks if market yields are higher than the book yields earned on the securities and the Company is forced to sell the securities. The degree to which a security is susceptible to either gains or losses is influenced by 1) the difference between its amortized cost and par, 2) the relative sensitivity of the underlying mortgages backing the assets to prepayment in a changing interest rate environment and 3) the repayment priority of the securities in the overall securitization structure. There are negligible default risks in the mortgage-backed securities portfolio as a whole as the vast majority of the assets are either guaranteed by U.S. government-sponsored entities or are supported in the securitization structure by junior securities enabling the assets to achieve high investment grade status.
Average gross annual yield on fixed maturities 6.6 % 7.0 % 7.2 %
Excludes interest on receivables from agents of $1.5 million, $2.0 million and $1.9 million for the years ended December 31, 2002, 2001 and 2000, respectively.
The following table indicates by rating the composition of the Company’s fixed maturity securities portfolio, excluding short-term investments, at December 31:
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, 2002, 81.7%, 16.6% and 1.7% of the market value of the Company’s fixed maturity securities were rated NAIC 1, NAIC 2, and NAIC 3 and below, respectively.
The scheduled contractual maturities of the Company’s fixed maturity securities, excluding short-term investments, at December 31 are shown in the table below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalties.
Agent Receivables. In the ordinary course of business, a subsidiary of Ascent advances commissions on policies written by its general agencies and their agents. Net agent receivables were $6.3 million and $7.4 million at December 31, 2002 and 2001, respectively. Such subsidiary is reimbursed for these advances from the commissions earned over the respective policy’s life. In the event that policies lapse prior to the time the subsidiary has been fully reimbursed, the general agency or the individual agents, as the case may be, are responsible for reimbursing the outstanding balance of the commission advance. A reserve for uncollectible agent’s balances is routinely established based upon historical experience and projected commission earnings. As of December 31, 2002 and 2001, the allowance for uncollectible commission advances was $4.6 million and $4.0 million, respectively.
Deferred Policy Acquisition Costs. Policy acquisition costs consisting of commissions and other policy issue costs, which vary with and are primarily related to the production of new business, are deferred and amortized over periods not to exceed the estimated premium-paying periods of the related policies. Projected future levels of premium revenue are estimated using assumptions as to interest, mortality, morbidity and withdrawals consistent with those used in calculating liabilities for future policy benefits. Deferred policy acquisition costs totaled $25.4 million and $25.6 million at December 31, 2002 and 2001, respectively.
A premium deficiency exists if the present value of future net cash flows plus future policy benefit and claims 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. The Company routinely evaluates the recoverability of deferred acquisition costs in accordance with GAAP. As a result of losses from major medical products issued prior to July 2000, 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 Company’s fresh start date of March 31, 1999. Accordingly, deferred policy acquisition costs were reduced by $1.5 million at December 31, 2000. At December 31, 2002 and 2001, there were no premium deficiencies.
Deferred Tax Asset. The Company’s net deferred tax asset before valuation allowance at December 31, 2002 and 2001 was $16.0 million and $17.8 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 losses from major medical products issued prior to July 2000, 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 ($0.9) million in 2002 and ($2.1) million in 2001 and has now reported cumulative pre-tax losses since the fresh start date of ($12.8) million. Accordingly, the Company has reported no income tax benefit for 2002 and 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.
Management considers many factors when setting reserves including: (1) historical trends; (2) current legal interpretations of coverage and liability; (3) loss payments and pending levels of unpaid claims; and (4) product mix. Based on these considerations, management believes that adequate provision has been made for the Company’s claim reserves. Actual claims paid may deviate, perhaps substantially, from such reserves.
Future Policy Benefit Reserves. Policy benefit reserves are established by each of the Insurance Subsidiaries for their benefit payments that have not been incurred, but, are estimated to be incurred in the future. Policy benefit reserves totaled $60.7 million at December 31, 2002 as compared to $61.6 million at December 31, 2001. The policy benefit reserves are calculated according to the net level premium reserve method and are equal to the discounted present value of the applicable Insurance Subsidiary’s expected future policyholder benefits minus the discounted present value of its expected future net premiums. These present value determinations are based upon assumed fixed investment yields, the age of the insured(s) at the time of policy issuance, expected morbidity and persistency rates, and expected future policyholder benefits. Except for purposes of reporting to insurance regulatory authorities and for tax filing, the Insurance Subsidiaries’ claim reserves and policy benefit reserves are determined in accordance with GAAP.
Policy benefit reserve requirements are also interrelated with product pricing and profitability. Each of the applicable Insurance Subsidiaries must price their respective products at a level sufficient to fund their policyholder benefits and still remain profitable. Because such claim and policyholder benefits represent the single largest category of its operating expenses, inaccuracies in the assumptions used to estimate the amount of such benefits can result in the Insurance Subsidiaries failing to price their respective products appropriately and to generate sufficient premiums to fund the payment thereof. The sharp increase in claim loss ratios experienced by certain Insurance Subsidiaries during 2000 was indicative of inadequate pricing for major medical products marketed prior to July 2000.
Statutory Accounting Practices. The 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 under GAAP. In particular, SAP interest rate assumptions for investment results are fixed by statute and are generally lower than those used for GAAP. Another significant difference is that under SAP, unlike GAAP, the Insurance Subsidiaries are 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 Insurance Subsidiaries 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 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”).
General. The primary sources of cash for the Company’s consolidated operations are premiums and fees from insurance policies, sales and maturity of invested assets and investment income while the primary uses of cash are payments of insurance policy benefits, claims and commissions, and general operating expenses. Net cash used in operations totaled $5.0 million, $6.6 million and $4.9 million for the years ended December 31, 2002, 2001 and 2000, respectively. The variance in cash used by operations from year to year is principally due to the variance in the cash basis ratio of benefits and claims to premiums.
The statutory losses incurred during recent years resulted from (1) significant losses on major medical products marketed prior to July 2000 (see “Operating Results”) and (2) costs associated with increased new business production which must be expensed under statutory accounting (for GAAP, such costs are deferred and amortized as related premiums are recorded). Claims experience adverse to management’s current estimates might require capital contributions to the Insurance Subsidiaries in excess of those currently projected for 2003. Additional financing might be required by Ascent in order to make any such “excess” contributions. As a result, adverse claims experience could have a material adverse effect 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.
Ascent’s redeemable convertible preferred stock is 100% owned by Special Situations Holdings, Inc. - Westbridge, which is the Company’s largest common stockholder and is also an affiliate of CSFB. Dividends may be paid in cash or by issuance of additional shares of preferred stock, at the Company’s option. During 2002, Ascent paid preferred stock dividends through the issuance of 3,261, 2,930 and 2,575 additional shares of preferred stock in 2002, 2001 and 2000, respectively. The preferred stock is mandatorily redeemable in cash in March 2004.
The Company must obtain additional financing to retire the redeemable preferred stock and note payable when due in early 2004 or restructure these facilities. Failure of the Company to successfully refinance these facilities could have a material adverse impact on the Company’s liquidity, capital resources and results of operation.
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, 2002 are net agent receivables of $6.3 million and a cash collateral 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, 2002, there were no events of default under the Credit or Guaranty Agreements.
On January 31, 2003, pursuant to the terms of the Credit Agreement, AFI liquidated the $2.6 million cash collateral account pledged to LaSalle. Approximately $640,000 of the funds were used to reduce the outstanding loan balance under the Credit Agreement to $2.4 million as of January 31, 2003. Pursuant to an agreement with LaSalle, AFI paid a dividend of $1.6 million to Ascent on January 31, 2003. The proceeds of this dividend were used to fully pay off AMI’s term loan facility. In addition, AMI’s assets and capital stock were pledged as collateral under the Credit Agreement.
Consolidated Statements of Cash Flows for the Years Ended December 31, 2002, 2001 and 2000
We have audited the accompanying consolidated balance sheet of Ascent Assurance, Inc., as of December 31, 2002, and the related consolidated statements of operations, comprehensive income, stockholders’ equity, and cash flows for the year ended December 31, 2002. Our audit also included the financial statement schedules as of December 31, 2002 and for the year then ended listed in the Index at Item 15 (a)(2). These financial statements and schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedules based on our audit.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Ascent Assurance, Inc., at December 31, 2002, and the consolidated results of its operations and its cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.
Loss applicable to common stockholders $ (4,194 ) $ (5,051 ) $ (21,518 )
Basic and diluted net loss per common share $ (0.64 ) $ (0.78 ) $ (3.31 )
Capital In Excess of Par value Accumulated Other Comprehensive Income (Loss) Retained(Deficit)Earnings
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 to the 2002 financial statement presentation.
Investments. The Company’s fixed maturity portfolio is classified as available-for-sale and is carried at estimated market value. Equity securities (common and non-redeemable preferred stocks), which are included in other investments, are also carried at estimated market value. Changes in aggregate unrealized appreciation or depreciation on fixed maturity and equity securities are reported directly in stockholders’ equity, net of applicable deferred income taxes and, accordingly, will have no effect on current operations.
Deferred Policy Acquisition Costs (“DPAC”). Policy acquisition costs consisting of commissions and other policy issue costs, which vary with and are primarily related to the production of new business, are deferred and amortized over periods not to exceed the estimated premium-paying periods of the related policies. Also included in DPAC is the cost of insurance purchased on acquired business. The amortization of these costs is based on actuarially estimated future premium revenues, and the amortization rate is adjusted periodically to reflect actual experience. Projected future levels of premium revenue are estimated using assumptions as to interest, mortality, morbidity and withdrawals consistent with those used in calculating liabilities for future policy benefits.
Property and Equipment. Property and equipment is stated on the basis of cost and consists primarily of furniture, fixtures, leasehold improvements and software. Depreciation is computed principally by the straight-line method for financial reporting purposes using estimated useful lives of 2-10 years.
Recognition of Revenue. Premium revenues from insurance contracts are recognized when due from policyholders. Fee and service income is recognized when earned, the services have been provided, and collectibility is reasonably assured.
Use of Estimates. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The Company’s significant accounting estimates relate to investments, agent receivables, deferred policy acquisition costs, deferred tax assets, claim reserves, future policy benefit reserves, reinsurance and statutory accounting practices. Important factors known to management that could cause actual results to differ materially from those estimates or contemplated include, but are not limited to:
the ability of the Company to renew its existing revolving credit facility for the financing of commission advances to agents which expires in January 2004;
the Company’s ability to meet minimum regulatory capital requirements for its Insurance Subsidiaries;
the impact of changing health care trends on the Insurance Subsidiaries' ability to accurately estimate claim and settlement expense reserves;
Recently Issued Accounting Pronouncements. In 1998, the NAIC adopted the Codification of Statutory Accounting Principles guidance that 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 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 not 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 this statement to materially impact the Company’s results of operations and financial position.
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 No. 145 rescinds SFAS No. 4, which required all gains and losses from extinguishment of debt to be aggregated and, if material, classified as an extraordinary item, net of related income tax effect. As a result, the criteria in Opinion 30 will now be used to classify those gains and losses. The provisions of this Statement related to the rescission of SFAS No. 4 shall be applied in fiscal years beginning after May 15, 2002. SFAS No. 145 amends SFAS No. 13 to require that certain lease modifications that have economic effects similar to sale-leaseback transactions be accounted for in the same manner as sales-leaseback transactions. The provisions of this Statement related to SFAS No. 13 shall be effective for transactions occurring after May 15, 2002. The Company does not expect the adoption of the statement to materially impact the Company’s results of operations and financial position.
In December 2002, the FASB issued SFAS No. 148, “Accounting and Stock-Based Compensation - Transition and Disclosure an amendment of FASB Statement No. 123". This statement amends FASB Statement No. 123, “Accounting for Stock-Based Compensation”, to provide alternative transition for an entity that voluntarily changes to the fair value based method of accounting for stock-based employee compensation. It also amends the disclosure provisions of that Statement to require prominent disclosure about the effects on reported net income of an entity’s accounting policy decisions with respect to stock-based employee compensation. Finally, this statement amends APB Opinion No. 28, “Interim Financial Reporting”, to require disclosure about those effects in interim financial information. SFAS No. 148 is effective for financial statements for fiscal years ending after December 15, 2002. The Company has complied with the requirements of SFAS No. 148 in the preparation of this statement (See Note 11 of the Notes To The Consolidated Financial Statements).
A summary of unrealized appreciation (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:
Included in fixed maturities at December 31, 2002 and 2001, are high-yield, unrated or less than investment grade corporate debt securities comprising approximately 1.7% and 0.4% of fixed maturities at December 31, 2002 and 2001, respectively.
Future policy benefits for Accident and Health insurance products have been calculated using assumptions (which generally contemplate the risk of adverse deviation) for withdrawals, interest, mortality and morbidity appropriate at the time the policies were issued. The more material assumptions are as follows:
Issues through 1980 are based on industry experience; 1981 through 2002 issues are based on industry experience and applicable Insurance Subsidiary experience, where available. Policies acquired in acquisitions are based on recent experience of the blocks acquired.
Based on industry tables published in 1974 by Tillinghast, Nelson and Warren, Inc. and the 1985 NAIC cancer tables, as well as other population statistics and morbidity studies.
The following table provides a reconciliation of the beginning and ending claim reserve balances, on a gross-of-reinsurance basis, for 2002, 2001 and 2000, to the amounts reported in the Company’s consolidated balance sheets:
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 Insurance Subsidiaries 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.
The Credit Agreement expires January 5, 2004 at which time the outstanding principal and interest will be due and payable. Under the terms of the Credit Agreement, agent advances made within six months of the expiration date (after July 5, 2003) are not eligible for financing. Failure of the Company to obtain additional renewals of the Credit Agreement beyond January 2004 could have a material adverse impact on Ascent’s liquidity and capital resources. Lack of adequate financing would impair the Company’s ability to pay competitive commission advances and reduce new business sales needed to replace the normal lapsing of existing policies. Therefore, failure by Ascent to maintain new business sales at current levels would result in declining premium revenue and could have a material adverse impact on Ascent’s results of operations.
On January 31, 2003, pursuant to the terms of the Credit Agreement, AFI liquidated the $2.6 million cash collateral account pledged to LaSalle. Approximately $640,000 of the funds were used to reduce the outstanding loan balance under the Credit Agreement to $2.4 million as of January 31, 2003. Pursuant to an agreement with LaSalle, AFI paid a dividend of $1.6 million to Ascent in January 31, 2003. The proceeds of this dividend were used to fully pay off AMI’s term loan facility on January 31, 2003. In addition, AMI’s assets and capital stock were pledged as collateral under the Credit Agreement.
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. The Company must obtain additional financing to retire the preferred stock when due or restructure the terms of the preferred stock.
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 flow 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 flow 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 with respect to policies issued subsequent to 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 federal taxes were paid in 2002 and 2001. Federal taxes recovered in 2000 were $1.2 million. The Company and its wholly-owned subsidiaries file a consolidated federal income tax return. Prior to 2002, FLICA filed a separate federal income tax return. Prior to 2000, NFIC and AICT filed a separate consolidated tax return.
Total provision for income taxes $ - $ - $ 6,003
As of December 31, 2002, 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. 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, 2002 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, 2002, 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 that would approximate $0.9 million have not been provided on such amount.
At both December 31, 2002 and 2001, NFL had approximately $7.8 million in its shareholders surplus account from which it could make distributions to the Company without incurring any federal tax liability. The amount of dividends that may be paid by NFL to the Company is limited by statutory regulations.
At December 31, 2002, the Company and its wholly-owned subsidiaries have aggregate net operating loss carryforwards, net of bankruptcy related tax attribute reductions, of approximately $55.4 million for regular tax and $55.3 million for alternative minimum tax purposes, which will expire in 2003 through 2017.
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, 2002, aggregate statutory capital and surplus for NFL, FLICA, NFIC and AICT was approximately $6.3 million, $7.2 million, $1.7 million and $2.3 million, respectively. Although NFIC’s capital and surplus is less than $5.0 million at December 31, 2002, 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.
The weighted average fair value of options granted during 2002, 2001 and 2000 was $0.47, $1.26 and $1.57. 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 2002, 2001 and 2000, respectively: dividend yield of 0% for all years; expected volatility of 1.214, 1.218 and 1.839; risk-free interest rate of 4.32% for 2002, 4.65% for 2001 and 6.57% for 2000; expected life of 3 years for 2002 and 5 years for 2001 and 2000.
Because the Company's employee stock options have characteristics significantly different from those of traded options, and because change in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.
Compensation cost recognized in the income statement for stock-based employee and consultants (including marketing agents) compensation awards was approximately $55,000 in 2002, $400,000 in 2001 and $300,000 in 2000.
Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects (273)
The Company’s future minimum lease payments for non-cancelable operating leases, relating primarily to office facilities and data processing equipment having a remaining term in excess of one year, at December 31, 2002 aggregated $4.6 million. The amounts due by year are as follows: 2003 - $1.2 million; 2004 - $1.1 million; 2005 - $1.0 million; 2006 - $0.4 million; 2007 - $0.4 million; and thereafter - $ 0.5 million. The Company’s principal office lease for which lease payments totaled approximately $500,000 in 2002 expires in April 2003. The Company expects to enter into a new principal office lease with comparable terms and conditions. Aggregate rental expense included in the consolidated financial statements for all operating leases approximated $1.8 million, $2.0 million and $2.1 million in 2002, 2001 and 2000, respectively.
In the normal course of their business operations, the Insurance Subsidiaries, continue to be involved in various claims, lawsuits (alleging actual as well as substantial exemplary damages) and regulatory matters. In the opinion of management, the disposition of these or any other legal matters will not have a material adverse effect on the Company’s business, consolidated financial position or results of operations.
Diluted $ (0.27 ) $ (0.23 ) $ (0.08 ) $ (0.20 )
Loss applicable to common shareholders $(4,194 ) $(5,051 ) $(21,518 )
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (in thousands, except share data)
Net Cash (Used For) Provided by Operating Activities (2,342 ) (4,256 ) 3,650
Total $ 25,385 $60,660 $30,899 $111,048 $ 7,722 $ 78,299 $ 9,465 $44,445 $112,513
Deferred tax valuation allowance $ 17,841 $ (667 ) $ (1,176 ) $ 15,998
Deferred tax valuation allowance $ 18,263 $ 776 $ (1,198 ) $ 17,841