On May 1, 1998, the Company intends to move its principal offices from 777 Main Street, Fort Worth, Texas, to 110 West 7th Street, Fort Worth, Texas. The lease for the new facility expires in April 2003. Westbridge Printing Services, Inc. ("WPS"), the Company's wholly-owned printing subsidiary which prints all policies, forms and brochures of the Insurance Subsidiaries, maintains its manufacturing facility at 7333 Jack Newell Boulevard North, Fort Worth, Texas, under a lease agreement which expires in October, 2005. The Company also has lease agreements for certain sales offices of its affiliated marketing agencies in Arizona, California and Texas. The Company believes that the newly leased facilities will meet its existing needs and that the leases can be renewed or replaced on reasonable terms if necessary.
(1) Includes operations of FLICA's parent, FHC, from June 1, 1996.
(2) Includes operations of NFIC and AICT from April 12, 1994.
During the second and third quarters of 1997, the Company's Insurance Subsidiaries experienced an increase in claims submissions on Medical Expense and Medicare Supplement products resulting in substantially increased loss ratios. In addition, a backlog of pending claims was paid during that period which also contributed to the second quarter's losses. Independent reviews of the Company's claim reserves were performed as of September 30, 1997. Additionally, an independent benefit analysis of claims was completed which indicated that significant rate increases, which are not expected to be fully implemented until at least September 1998, and further benefit modifications will be required to offset the current adverse claims experience. However, until such time as the necessary rate increases, and benefit modifications can be fully implemented, the Company expects that it will continue to incur operating losses. There can be no assurance that the full extent of such rate increase requests will be approved.
The Report of Independent Accountants included herein refers to certain of the foregoing events which are discussed in NOTE 2 to the Company's financial statements and which raise substantial doubt about the Company's ability to continue as a going concern. See
To the Board of Directors and Stockholders of Westbridge Capital Corp.
Cash and cash equivalents 1,030 1,013 Accrued investment income 2,453 1,889 Receivables from agents, net of $4,531 and $1,729 allowance for doubtful accounts 20,503 18,311 Deferred policy acquisition costs 19,165 83,871 Leasehold improvements and equipment, at cost (net of accumulated depreciation and amortization of $4,106 and $4,211) 1,141 1,311 Due from reinsurers 3,219 1,456 Commissions receivable 1,389 3,406 Deferred debt costs, net of accumulated amortization 4,046 2,816 Other assets 2,498 4,438 -------- --------
Stockholders' (Deficit) Equity: Common stock, ($.10 par value, 30,000,000 shares authorized; 6,195,439 and 6,039,994 shares issued) 620 604 Capital in excess of par value 30,843 29,226 Unrealized appreciation of investments carried at market value, net of tax 4,649 1,057 Retained (deficit) earnings (81,530) 17,186 --------- --------- (45,418) 48,073
Total Liabilities, Redeemable Preferred Stock and Stockholders' (Deficit) Equity $ 202,856 $ 220,716 ========= =========
One thousand shares of the Company's Series A Convertible Redeemable Exchangeable Preferred Stock ("Series A Preferred Stock") were converted into shares of Westbridge's common stock, par value $.10 per share ("Common Stock") during the year ended December 31, 1997. The converted shares of Series A Preferred Stock had an aggregate liquidation preference of $1,000,000 and were converted into 118,905 shares of Common Stock.
WESTBRIDGE CAPITAL CORP. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT) (in thousands, except share data)
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND OTHER MATTERS
Principles of Consolidation. The consolidated financial statements include the accounts of Westbridge Capital Corp. ("the Company"), and its wholly-owned subsidiaries, National Foundation Life Insurance Company ("NFL"), Freedom Life Insurance Company of America ("FLICA"), National Financial Insurance Company ("NFIC"), American Insurance Company of Texas ("AICT"), Freedom Holding Company ("FHC"), Foundation Financial Services, Inc. ("FFS"), Westbridge Marketing Corporation ("WMC"), Westbridge Financial Corp. ("Westbridge Financial"), Westbridge Printing Services, Inc. ("WPS"), Precision Dialing Services, Inc. ("PDS"), Westbridge National Life Insurance Company ("WNL"), Flex-Plan Systems, Inc. ("FPS"), Westbridge Funding Corporation ("WFC") (formerly known as National Legal Services Company, Inc.), LifeStyles Marketing Group, Inc. ("LifeStyles Marketing"), Senior Benefits, LLC ("Senior Benefits") and American Senior Security Plans, LLC ("ASSP"). The consolidated financial statements also include the accounts of the Company's 80%-owned subsidiary Health Care-One Marketing Group, Inc. ("HCO Marketing") as well as the Company's 50%-owned subsidiary, Health Care-One Insurance Agency, Inc. ("Health Care-One"). The Company's decision to consolidate the accounts of Health Care-One is based on the extent to which the Company exercises control over Health Care-One. The Company has agreed to provide 100% of the financing required to support the marketing efforts of Health Care-One and also has significant input in its management. All significant intercompany accounts and transactions have been eliminated.
Accounting Principles and Regulatory Matters. The consolidated financial statements have been prepared in accordance with generally accepted accounting principles ("GAAP"). These principles differ from statutory accounting principles, which must be used by NFL, FLICA, NFIC and AICT (together, the "Insurance Subsidiaries") when reporting to state insurance departments. The Insurance Subsidiaries are subject to oversight by the state insurance departments of Delaware, Mississippi, Texas and other states in which they are authorized to conduct business. These regulators perform periodic examinations of the Insurance Subsidiaries' statutory financial statements and, as a result, may propose adjustment to such statements.
Cash Equivalents. Cash equivalents consist of highly liquid instruments with maturities at the time of acquisition of three months or less. Cash equivalents are stated at cost, which approximates market.
Concentrations of Credit Risk. Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents, investments and receivables from agents. The Company maintains cash and investments with various major financial institutions. The Company performs periodic evaluations of the relative credit standing of these financial institutions. Concentrations of credit risk with respect to receivables from agents are limited due to the large number of agents and their dispersion across many geographic areas. The Company establishes an allowance for doubtful accounts based upon factors surrounding the credit risk of specific agents, historical trends and other information. The Company's historical experience in collection of these receivables falls within the recorded allowances. Due to these factors, no additional credit risk beyond the amounts provided for collection losses is believed inherent in the Company's receivables from agents.
Leasehold Improvements and Equipment. Leasehold improvements and equipment are stated at cost less accumulated depreciation and amortization. Depreciation of equipment is computed using the straight-line method over the estimated useful lives (three to seven years) of the assets. Leasehold improvements are amortized over the estimated useful lives of the related assets or the period of the lease, whichever is shorter. Maintenance and repairs are expensed as incurred, and renewals and betterments which materially extend the useful life of the underlying assets are capitalized.
Recognition of Revenue. Life insurance and accident and health premiums are recognized as revenue when received. Benefits and expenses are associated with related premiums so as to result in a proper matching of revenues with expenses. Fee and service income and investment income are recognized when earned.
Earnings Per Share. In February 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share," (the "Statement") that revises the standards for computing earnings per share previously found in APB Opinion No. 15, "Earnings Per Share." The Statement established two measures of earnings per share: "basic earnings per share" and "diluted earnings per share." Basic earnings per share is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were converted or exercised. The Statement requires dual presentation of basic and diluted earnings per share on the face of the income statement for all entities with potential dilutive securities outstanding. Diluted weighted average shares exclude all convertible securities for loss periods.
The Statement also requires a reconciliation of the numerator and denominator of the basic earnings per share computation to the numerator and denominator of the diluted earnings per share computation. The Statement is effective for interim and annual periods ending after December 15, 1997. The Company adopted SFAS No. 128 for the year ended December 31, 1997 and has restated the earnings per share computations for 1996 and 1995 to conform to this pronouncement.
Recently Issued Accounting Pronouncements. In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income," ("SFAS 130"). This pronouncement, effective for calendar year 1998 financial statements, requires comprehensive income and its components to be reported either in a separate financial statement, combined and included with the statement of income or included in a statement of changes in stockholders' equity. Comprehensive income equals the total of net income and all other non-owner changes in equity. For the Company, comprehensive income will equal its reported consolidated net income plus the change in the unrealized appreciation of marketable securities from the previously reported period. Currently, this unrealized appreciation of marketable securities, net of tax, is reported in the Company's Consolidated Balance Sheets as a separate component of stockholders' equity. Accordingly, the adoption of SFAS 130 in 1998 will require the Company to modify its presentation of the information already disclosed in the Consolidated Financial Statements.
In December 1997, the Accounting Standards Executive Committee issued Statement of Position ("SOP") 97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments," which provides guidance on accounting for insurance-related assessments. The Company is required to adopt SOP 97-3 effective January 1, 1999. Previously issued financial statements should not be restated unless the SOP is adopted prior to the effective date and during an interim period. The adoption of SOP 97-3 is not expected to have a material impact on the Company's results of operations, liquidity or financial position.
Reclassifications. Certain reclassifications have been made to 1996 and 1995 amounts in order to conform to 1997 financial statement presentation.
During the second and third quarters of 1997, the Company's Insurance Subsidiaries experienced an increase in claims submissions on Medical Expense and Medicare Supplement products resulting in substantially increased loss ratios. In addition, a backlog of pending claims was paid during that period which also contributed to the second quarter's losses. Independent reviews of the Company's claim reserves were performed as of September 30, 1997. Additionally, an independent benefit analysis of claims was completed which indicated that additional rate increases, which are not expected to be fully implemented until at least September 1998, and further benefit modifications will be required to offset the current adverse claims experience. However, until such time as the necessary rate increases and benefit modifications can be fully implemented, the Company expects that it will continue to incur operating losses. There can be no assurance that the full extent of such rate increase requests will be approved.
The accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern. As such, the consolidated financial statements do not include any adjustments relating to the recoverability and classification of liabilities that might be necessary should the Company be unable to continue as a going concern.
Fixed maturities $ 8,268 $ 6,607 $ 6,542 Mortgage loans on real estate 42 62 71 Short-term investments and certificates of deposit 891 513 250 Interest on receivables from agents 1,633 1,201 400 Other 426 584 424 ------- ------- ------- 11,260 8,967 7,687 Less: Investment expenses 237 231 266 ======= ======= ======= Net investment income $11,023 $ 8,736 $ 7,421 ======= ======= =======
The amortized cost and estimated market value of investments in available-for-sale fixed maturities as of December 31, 1997, are shown below, in thousands, summarized by year to maturity. Mortgage-backed securities are listed separately. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
A summary of unrealized appreciation reflected directly in stockholders' equity at December 31, 1997 and 1996, on investments in fixed maturities available-for-sale, is as follows:
Year Ended December 31, -------------------- 1997 1996 -------- -------- (in thousands)
Investment securities on deposit with insurance regulators in accordance with statutory requirements at December 31, 1997 and 1996 had a par value totaling $26.5 million and $21.9 million, respectively.
As of December 31, 1997, the Company had restricted access to $1.8 million of invested cash in connection with the processing of premium collections through the Automated Clearing House (ACH) banking system.
In September 1987, NFL consummated an agency contract with LifeStyles Agency of Arlington, Texas ("LifeStyles Marketing") granting its agency force the exclusive right, subject to territorial production requirements, to sell NFL's Medical Expense products developed in 1987 and 1988. During the second quarter of 1988, the Company agreed with the owners of LifeStyles Marketing to restructure the insurance agency as a joint venture. Under the terms of the definitive agreement consummated in November 1988, WMC, a wholly-owned subsidiary of the Company, held a 51%-voting interest in the entity, LifeStyles Marketing. Effective January 1, 1997, WMC acquired the remaining 49% of LMG.
The Company had, prior to 1996 recognized 100% of the cumulative losses of LifeStyles Marketing. During 1996, those cumulative losses were fully recovered through earnings.
In November 1993, the Company acquired a 50% ownership interest in Senior Benefits. In June 1996, the Company acquired the remaining 50% ownership interest in Senior Benefits. Senior Benefits' revenue and expenses were $5.3 million and $4.9 million during 1997, $1.6 million and $1.4 million during 1996 and $1.0 million and $1.1 million during 1995, respectively. Senior Benefits primarily markets Medicare Supplement products for non-affiliated insurance carriers although it previously sold Medicare Supplement products for NFL. Of the revenues received, $674,000 were derived from NFL in the form of commission income on insurance products sold during 1997 ($770,000 in 1996 and $982,000 in 1995.) Through December 31, 1997, the Company had loaned Senior Benefits approximately $0.5 million in the form of working capital advances. These advances will be repaid in the future through positive cash flows generated from renewal commissions, from advanced commissions from non-affiliated insurance carriers, and if and when profits are recognized from continuing operations.
In 1995, the Company formed Health Care-One, which markets insurance products for non-affiliated insurance carriers. The Company owns 50% of Health Care-One. The Company is providing financing to Health Care-One during the start-up phase of operations. Health Care-One's revenue and expenses were $5.1 million and $4.8 million and $4.4 million and $4.1 million in 1997 and 1996, respectively. Health Care-One's operations were not significant in 1995. Through December 31, 1997 and 1996, the Company had loaned Health Care-One approximately $0.8 million and $1.2 million in the form of first-year commission advances. These advances will be repaid in the future through positive cash flows generated from renewal commissions, from advanced commissions from non-affiliated insurance carriers, and if and when profits are recognized from continuing operations. The minority interest in pre-tax income subject to profit-sharing and recognized by the Company is $107,000 and $44,000 at December 31, 1997 and 1996, respectively.
On February 28, 1995, the Company issued $20.0 million aggregate principal amount of its 11% Senior Subordinated Notes due 2002 (the "Senior Subordinated Notes") in an underwritten public offering. The Senior Subordinated Notes were issued at par, less an underwriting discount of 4%.
The Company may redeem the Senior Subordinated Notes at any time on or after March 1, 1998, upon 30-days written notice, at par plus accrued interest. Following the death of any holder of the Senior Subordinated Notes and the request for repayment, the Company will repay such holder's Senior Subordinated Notes at par plus accrued interest. The Company is not obligated to redeem more than $50,000 in principal amount per holder per calendar year or in aggregate for all holders more than $250,000 in principal amount per calendar year. The Senior Subordinated Notes contain certain covenants which limit the Company's ability to (i) incur certain types of indebtedness, (ii) pay dividends or make distributions to holders of the Company's equity securities, or (iii) consolidate, merge, or transfer all or substantially all of the Company's assets. The Senior Subordinated Notes also contain covenants which require the Company to maintain (i) a minimum amount of liquid assets, (ii) a minimum consolidated net worth, and (iii) a minimum fixed charge ratio.
On December 22, 1995, the Company issued a $1.0 million principal amount 10% Senior Note due 2002 (the "Senior Note") to the Chairman of the Board of Directors, a related party. The Senior Note was issued at par. In connection with the Senior Note issuance, the Company also issued a Common Stock purchase Warrant for 135,501 shares of Common Stock at an exercise price of $7.38 per share.
Interest on the Convertible Notes is payable semi-annually on May 1 and November 1 of each year, commencing November 1, 1997. Since November 1997, the Company has suspended the scheduled interest payments on these Convertible Notes. At December 31, 1997, approximately $3.5 million has been accrued on such Convertible Notes. See further discussion herein regarding covenant defaults.
On May 1, 1997, Westbridge contributed approximately $7 million of the net proceeds from the sale of the Convertible Notes to recapture a block of insurance policies that had previously been reinsured consisting of approximately $9.0 million in total recapture costs less approximately $2.0 million in unearned premium reserves due to NFL and FLICA. See NOTE 16 EXTRAORDINARY ITEM. As of December 31, 1997, Westbridge had contributed approximately $38.3 million of additional proceeds to the Insurance Subsidiaries to enhance statutory capital and surplus. The Company has used approximately $6.7 million in net proceeds to settle certain intercompany balances with its Insurance Subsidiaries and for other general corporate purposes. Subsequent to December 31, 1997, Westbridge contributed an additional $1.0 million and used $1.8 million of the net proceeds to collateralize a $1.5 million standby letter of credit ("LOC") for the purpose of potential future capital contributions to NFIC. This collateralized LOC expires after a one-year term and future draws upon this LOC are subject to certain provisions regarding NFIC's statutory capital and surplus levels.
WFC's obligations under the Credit Agreement have been guaranteed by Westbridge under the Guaranty Agreement, and the Company has pledged all of the issued and outstanding shares of the capital stock of WFC, NFL and NFIC as collateral for that guaranty. As of December 31, 1997, the Company had placed $2.5 million of cash in a cash collateral account in connection with this Credit Agreement. The maintenance of this cash collateral account allows WFC to borrow against the Credit Agreement and purchase agent advance receivables at face value.
As described herein, since November 1997, the Company has suspended its scheduled interest payments on the Senior Subordinated Notes and the Convertible Notes. The failure to make the scheduled interest payments constituted payment defaults under the Indentures relating to such Notes and became events of default thereunder on November 17, 1997. In addition, the failure to make such interest payments also resulted in an event of default under the Credit Agreement (as defined herein). Other covenant defaults are also existing under the Credit Agreement and the Indenture relating to the Senior Subordinated Notes. As a result of the foregoing events of defaults, the holders of such indebtedness may declare the outstanding principal amount thereof, together with accrued and unpaid interest thereon, to be due and payable immediately. If such indebtedness were to be accelerated, the Company does not have the ability to repay the indebtedness under the outstanding Convertible Notes, the Senior Subordinated Notes and the Credit Agreement. The Company is currently in ongoing discussions with its creditors regarding its transactional alternatives to resolve these matters which may include, without limitation, a refinancing, recapitalization or other corporate reorganization involving a significant reduction in, or exchange of equity for, outstanding indebtedness.
Deferred Debt Costs. In connection with the Company's financing activities, the Company defers the costs incurred in connection with the issuance of debt and amortizes such costs on a straight-line basis over the related term of each underlying debt issue.
The following table provides a reconciliation of the beginning and ending claim reserve balances, on a gross-of-reinsurance basis, for 1997, 1996 and 1995, to the amounts reported in the Company's balance sheet:
Included in reinsurance recoverables on claims reserves is approximately $1.9 million and $1.5 million relating to paid claims as of December 31, 1997 and 1996, respectively.
On April 12, 1994, the Company issued 20,000 shares of Series A Cumulative Convertible Redeemable Exchangeable Preferred Stock (the "Series A Preferred Stock"), at a price of $1,000 per share. The Series A Preferred Stock was issued in a private placement and was subsequently registered with the Securities and Exchange Commission under a registration statement which was declared effective in October 1994. The following summarizes the significant terms of the Series A Preferred Stock:
Cumulative annual dividend rate of 8.25%, subject to increase to 9.25% upon non-compliance by the Company with certain restrictions.
At December 31, 1994, the Series A Preferred Stock was convertible by the holders thereof into the 2,285,720 shares of the Company's Common Stock at a conversion price of $8.75 per share. As a result of the Common Stock offering in 1995, the conversion price was adjusted to $8.41 per share. One thousand shares of the Company's Series A Preferred Stock were converted into shares of Westbridge's common stock, par value $.10 per share ("Common Stock") during the year ended December 31, 1997. The converted shares of Series A Preferred Stock had an aggregate liquidation preference of $1,000,000 and were converted into 118,905 shares of Common Stock.
The Company may redeem any and all shares of Series A Preferred Stock outstanding on or after April 12, 1997.
During 1995, the Company recorded purchase accounting adjustments to the allocation of the purchase price of NFIC and AICT as these adjustments fell within the allocation period following the acquisition, in accordance with Statement of Financial Accounting Standard No. 38 "Accounting for Preacquisition Contingencies of Purchased Enterprises."
Recognition of Premium Deficiency. During the second and third quarters of 1997, the Company's Insurance Subsidiaries experienced an increase in claims submissions on Medical Expense and Medicare Supplement products resulting in substantially increased loss ratios. In addition, policy persistency declined in connection with the implementation of certain rate increases together with intensified competitor solicitation of the Company's policyholders. These events affected the future profit margins available to absorb DPAC.
As a result of these adverse changes, the Company undertook a revaluation of the recoverability of DPAC in the fourth quarter of 1997. Based on the results of this review and the impact of future projected premium revenues and the discontinuance of certain lines of business, the Company determined that a premium deficiency for certain lines of business existed at December 31, 1997. A premium deficiency occurs when the projected present value of future premiums associated with these policies will not be adequate to cover the projected present value of future payments for benefits and related amortization of DPAC. GAAP requires the immediate recognition of a premium deficiency by charging the unamortized DPAC to expense. In this connection, the Company recorded a non-cash charge to expense of approximately $65.0 million for the quarter and year ended December 31, 1997. This adjustment has no impact on the Company's cash position at December 31, 1997 and does not impact the statutory capital and surplus of the Insurance Subsidiaries.
The (benefit from) provision for U.S. federal income taxes charged to continuing operations was as follows:
Provision has not been made for state and foreign income tax expense since such expense is minimal. In addition, as described in NOTE 16 - EXTRAORDINARY ITEM, the Company recognized an extraordinary loss of approximately $1.0 million for the year ended December 31, 1997. This amount has been reflected in the accompanying financial statements, net of approximately $519,000 in deferred taxes.
Deferred Tax Assets: Deferred policy acquisition costs $ 3,662 $ - Policy reserves 3,514 7,196 Net operating loss carryforwards 24,640 8,296 Tax credit carryforwards 11 11 Other deferred tax assets 429 263 Valuation allowance (28,728) (4,878) -------- -------- Total deferred tax asset $ 3,528 $ 10,888 ======== ======== Net deferred tax liability $ - $ 10,299 ======== ========
NFIC and AICT, Texas domestic companies, may make dividend payments from surplus profits or earned surplus arising from its business. The Texas Insurance Code defines earned surplus as unassigned surplus not including any unrealized gains. Texas life insurance companies may generally pay ordinary dividends or make distributions of cash or other property within any twelve month period with a fair market value equal to or less than the greater of 10% of surplus as regards policyholders as of the preceding December 31 or the net gain from operations for the twelve month period ending on the preceding December 31. Any dividend exceeding the applicable threshold is considered extraordinary and requires prior approval of the Texas Insurance Commissioner. During 1998, NFIC's and AICT's earned surplus is negative, and as such, each company is precluded from paying dividends without the prior approval of the Texas Insurance Commissioner.
FLICA, a Mississippi domestic company, may make dividend payments only from its actual net surplus computed as required by law in its statutory annual statement. Mississippi life insurance companies may generally pay ordinary dividends or make distributions of cash or other property within any twelve month period with a fair market value not exceeding the lesser of 10% of surplus as regards policyholders as of the preceding December 31 or the net gain from operations for the twelve month period ending on the preceding December 31. Any dividend exceeding the applicable threshold amount requires prior approval of the Mississippi Insurance Commissioner. During 1998, FLICA is precluded from paying dividends to NFL without prior regulatory approval as it recorded a net loss from operations for the year ending December 31, 1997.
Generally, all states require insurance companies to maintain statutory capital and surplus which is reasonable in relation to their existing liabilities and adequate to their financial needs. Delaware, Texas and Mississippi also maintain discretionary powers relative to the declaration and payment of dividends based upon an insurance company's financial position. In light of the significant statutory losses incurred during the year ended December 31, 1997, Westbridge does not expect to receive any dividends from its Insurance Subsidiaries for the foreseeable future.
The Model Act provides four levels of regulatory attention, varying with the ratio of the insurance company's total adjusted capital (defined as the total of its statutory capital and surplus, asset valuation reserve and certain other adjustments) to its risk-based capital ("RBC"). If a company's total adjusted capital is less than 100 percent but greater than or equal to 75 percent of its RBC, or if a negative trend (as defined by the regulators) has occurred and total adjusted capital is less than 125 percent of RBC (the "Company Action Level"), the company must submit a comprehensive plan aimed at improving its capital position to the regulatory authority proposing corrective actions. If a company's total adjusted capital is less than 75 percent but greater than or equal to 50 percent of its RBC (the "Regulatory Action Level"), the regulatory authority will perform a special examination of the company and issue an order specifying the corrective actions that must be followed. If a company's total adjusted capital is less than 50 percent but greater than or equal to 35 percent of its RBC (the "Authorized Control Level"), the regulatory authority may take any action it deems necessary, including placing the company under regulatory control. If a company's total adjusted capital is less than 35 percent of its RBC (the "Mandatory Control Level"), the regulatory authority must place the company under its control. The NAIC's requirements are effective on a state by state basis if, and when, they are adopted by the regulators in the respective states. The Insurance Departments of the States of Delaware and Mississippi have each adopted the NAIC's Model Act. At December 31, 1997, total adjusted capital for NFL, a Delaware domiciled company, and FLICA, a Mississippi domiciled company, exceeded the respective Company Action Levels.
The Texas Department of Insurance ("TDI") has adopted its own RBC requirements, the stated purpose of which is to require a minimum level of capital and surplus to absorb the financial, underwriting and investment risks assumed by an insurer. Texas' RBC requirements differ from those adopted by the NAIC in two principal respects: (i) they use different elements to determine minimum RBC levels in their calculation formulas and (ii) they do not stipulate "Action Levels" (like those adopted by the NAIC) where corrective actions are required. However, the Commissioner of the TDI does have the power to take similar corrective actions if a company does not maintain the required minimum level of statutory capital and surplus. NFIC and AICT are domiciled in Texas and must comply with Texas RBC requirements. At December 31, 1997, AICT's RBC exceeded the minimum level prescribed by the TDI; however, NFIC's RBC was below the minimum level prescribed by the TDI. As a result of the statutory losses sustained by the Insurance Subsidiaries during 1997, certain intercompany and large cash transactions are subject to the approval of the domiciliary states.
The estimated market value of each option grant is estimated on the date of grant using the Black-Scholes options pricing model with the following weighted average assumptions used for grants during the years ended December 31, 1996 and 1995:
A third employee stock option plan, was adopted as of March 26, 1992 (as amended, the "1992 Plan"). The 1992 Plan provides for the granting, to eligible employees of the Company or its subsidiaries, of stock options to purchase up to a total of 300,000 shares of the Company's Common Stock. Options granted under the 1992 Plan are treated as "non-qualified stock options" for purposes of the Code and the option price per share shall not be less than 90% of the estimated market value of the Company's Common Stock on the date of grant. All options outstanding are exercisable within seven years from the date the option was granted, except that no option is exercisable until at least one year after its grant.
On April 19, 1996, the Company adopted a Restricted Stock Plan (the "1996 Plan"). This 1996 Plan provides for the granting of up to 1,000,000 shares of Common Stock subject to certain restrictions and adjustments. The restricted shares are subject to vesting requirements ("the restriction period") ranging from twelve months for non-employee directors to sixty months for employees or other authorized grantees. During the restriction period, the grantee may not sell, assign, transfer, pledge, encumber or otherwise dispose of or hypothecate such an award. Upon satisfaction of the vesting schedule and any other applicable restrictions, terms or conditions, the grantee will be entitled to receive the shares. The total compensation expense recognized in the Company's statement of operations for the year ending December 31, 1997 was $611,000.
Information regarding the Company's restricted stock plan is summarized as follows:
Restricted stock outstanding at beginning of year 7,000 - Restricted stock awards during the year: Non-employee directors 12,000 7,000 Employees 455,000 - Agents 11,800 - Restricted stock vested during the year: Non-employee directors (7,000) - Employees (60,000) - Agents - - Restricted stock forfeitures during the year: Non-employee directors - - Employees (194,000) - Agents (300) - -------- -------- Restricted stock outstanding at end of year 224,500 7,000 ======== ========
At December 31, 1997, options for 20,000 shares were exercisable under the stock options plans at a price of $1.88 and options for 99,000 shares were exercisable at a price ranging from $5.18 to $8.25. Also, at December 31, 1997, 1996 and 1995, options for 154,000, 10,000 and 6,000 shares, respectively, remained available for future grant under the plans.
In September 1986, the Company established a retirement savings plan for its employees. The plan permits all employees who have been with the Company for at least one year to make contributions by salary reduction pursuant to section 401(k) of the Internal Revenue Code. The plan allows employees to defer up to 3% of their salary with partially matching discretionary Company contributions determined by the Company's Board of Directors. Employee contributions are invested in any of five investment funds at the discretion of the employee. Company contributions are in the form of the Company's Common Stock. The Company's contributions to the plan in 1997, 1996 and 1995 approximated $106,000, $102,000, and $79,000, respectively.
The Insurance Subsidiaries cede insurance to other insurers and reinsurers on both life and accident and health business. Reinsurance agreements are used to limit maximum losses and provide greater diversity of risk. The Company remains liable to policyholders to the extent the reinsuring companies are unable to meet their treaty obligations. Total accident and health premiums of $3.6 million, $4.1 million, and $2.8 million, were paid to reinsurers in 1997, 1996, and 1995, respectively. Face amounts of life insurance in force approximated $53.1 million, $87.0 million and $43.4 million at December 31, 1997, 1996 and 1995, respectively. No life insurance was reinsured as of December 31, 1997, 1996 and 1995, respectively.
The Company, through NFL and FLICA, entered into a 90% Coinsurance Funds Withheld Reinsurance Agreement (the "Agreement") with a reinsurer effective July 1, 1996 on the inforce Critical Care and Specified Disease business. The Agreement provided an initial ceding commission of $10.5 million, of which $8.4 million was received in cash. This ceding commission allowance was to be repaid, inclusive of interest at 12.5%, as statutory profits emerged from the reinsured block of business. For the year ended December 31, 1996, the repayment was $1.9 million. The ceding allowance payable for the year ended December 31, 1996 was $8.6 million. The Company exercised its option to terminate and recapture this Agreement on April 1, 1997 consisting of approximately $9.0 million in total recapture costs calculated at an interest rate of 15% less approximately $2.0 million in unearned premium reserves due to NFL and FLICA. See NOTE 16 EXTRAORDINARY ITEM.
The Company's Insurance Subsidiaries are subject to extensive governmental regulation and supervision at both federal and state levels. Such regulation includes premium rate levels, premium rate increases, policy forms, minimum loss ratios, dividend payments, claims settlement, licensing of insurers and their agents, capital adequacy, transfer of control, and amount and type of investments. Additionally, there are numerous health care reform proposals and regulatory initiatives under consideration which if enacted could have significant impact on the Company's revenues and results of operations.
A reconciliation of the statutory capital and surplus reported by the Insurance Subsidiaries under regulatory practices to stockholders' (deficit) equity as reported herein by the Company on a consolidated GAAP basis is as follows:
(2) From early extinguishment of debt, net of income tax benefit of $210.