United Wisconsin Services, Inc. (the Company) is a leading provider of managed health care services and employee benefit products. The Company's three primary product lines are (i) Health Maintenance Organization (HMO) products, including Compcare Health Services Insurance Corporation (Compcare), Valley Health Plan, Inc. (Valley), Unity Health Plans Insurance Corporation (Unity) and certain point-of-service (POS) and other related products managed by Compcare and Valley; (ii) small group managed care and life products sold through American Medical Security Holdings, Inc. (AMS), formerly American Medical Security Group, Inc., and (iii) specialty managed care products and services, including dental, life, disability and workers' compensation products, managed care consulting, electronic claim submission, pharmaceutical management and managed mental health services. These three product groups represented the following percentages of the Company's premium and other revenue and the following amounts of income (loss) before income tax expense for the periods noted.
YEARS ENDED DECEMBER 31, ------------------------------ 1996 1995 1994 ---- ---- ----- (AS A PERCENTAGE OF THE TOTAL) PREMIUM AND OTHER REVENUE HMO products 37.6% 40.3% 39.3% AMS products 52.5 49.7 50.3 Specialty managed care products and services 11.1 10.8 10.8 Intercompany eliminations (1.2) (0.8) (0.4) ----- ----- ----- Total 100.0% 100.0% 100.0% ----- ----- ----- ----- ----- -----
(IN MILLIONS OF DOLLARS) INCOME (LOSS) BEFORE INCOME TAX EXPENSE HMO products $ 7.1 $ 2.4 $ 8.1 AMS products (2.9) (7.6) 34.6 Specialty managed care products and services 21.0 19.0 10.4 Holding company expenses (8.2) (4.4) (3.8) ----- ----- ----- Total $17.0 $ 9.4 $49.3 ----- ----- ----- ----- ----- -----
Reclassifications have been made to the product line amounts shown above for 1994 and 1995 to conform with the 1996 presentation. The life products sold by AMS are now included in the AMS products category; previously, they were included with specialty products and services. This reclassification was made in conjunction with the AMS merger (AMS Merger), as discussed further below.
The Company's revenues are derived primarily from premiums, while medical benefits constitute the majority of expenses. Profitability is directly affected by many factors including premium rate adequacy, estimates of medical benefits, health care utilization, effective administration of benefit payments, operating efficiency, investment returns and federal and state laws and regulations.
PREMIUM AND OTHER REVENUE -- HMO premiums in 1996 increased 4.9% to $421.2 million from $401.6 million in 1995. HMO premiums in 1995 increased 36.9% from $293.4 million in 1994. The increase in HMO premiums for 1995 was due primarily to the acquisition of HMO-W, Incorporated and the business of U-Care HMO, Inc. (U-Care), both effective October 1, 1994, which accounted for $76.3 million of the 1995 increase. Upon acquisition, the business of U-Care was transferred to Unity (formerly HMO of Wisconsin Insurance Corporation),
an insurance subsidiary of HMO-W, Incorporated, via a bulk reinsurance transaction. Average HMO medical premium per member in 1996 increased 2.9% from 1995. Average HMO medical premium per member in 1995 increased 4.6% from 1994. The average number of HMO medical members in 1996 increased 1.6% to 259,506 from 255,471 in 1995. The average number of HMO medical members in 1995 increased 33.0% from 192,017 in 1994, due primarily to the HMO acquisitions in the fourth quarter of 1994.
Premiums on AMS products in 1996 increased 18.2% to $585.2 million from $495.3 million in 1995, which followed a 31.7% increase from $376.0 million in 1994. The increase in AMS premiums for 1996 was due primarily to the acquisition of the 88% of AMS that the Company did not already own. See Note 2 of Notes to the Consolidated Financial Statements. Prior to the merger of the Company and AMS effective December 3, 1996, the Company retained 50% of the premium revenue and 50% of the profit (loss) on small group managed care and life business sold by AMS. Following the AMS Merger, the Company retained 100% of the premium revenue and 100% of the profit (loss) on small group managed care and life business sold by AMS. This additional 50% of premium revenue for the month of December 1996 accounted for $43.7 million or 48.6% of the premium revenue increase in 1996. The increase in AMS premiums for 1995 was due primarily to substantial growth in the average number of insured medical contracts outstanding. The average number of small group insured medical contracts outstanding increased 6.1% in 1996 to 313,613 from 295,457 in 1995. The average number of small group insured medical contracts during 1995 increased 31.1% from 225,417 in 1994. Average insured medical premium per contract increased 4.9% during 1996 and 1.4% during 1995, compared with the respective prior year average premium amounts. In general, targeted premium rate increases were offset by a shift to products with lower benefit levels and contract growth in lower cost geographic areas. See "Expense Ratios - Medical Loss Ratio" for a further discussion of pricing actions on small group products.
INVESTMENT INCOME -- Investment income in 1996 increased 9.6% to $30.6 million from $27.9 million in 1995. Investment income in 1995 increased 26.3% from $22.1 million in 1994. These increases were due primarily to an increased level of invested assets due to growth in premiums and recent capital raising activities. In July 1994, the Company issued 1,000,000 new shares of its common stock (Common Stock) in a public offering and in February 1995 issued another 484,500 new shares of Common Stock to the public. The net proceeds of $26.1 million from the 1994 stock offering and $16.6 million from the 1995 stock offering contributed to the increased level of invested assets. Offsetting these increases, UWIC expended $30.0 million in January 1995 to redeem its outstanding preferred stock.
Average invested assets in 1996 increased 9.0% to $523.1 million from $479.9 million in 1995. Average invested assets in 1995 increased 20.2% from $399.4 million in 1994. Average annual investment yields, excluding net realized gains, were 5.9%, 5.7% and 5.5% for 1996, 1995 and 1994, respectively.
of the small group managed care business and supporting capital from UWIC to UWLIC was completed in anticipation of the Company's acquisition of the remaining interest in AMS through the AMS Merger. See "Liquidity and Capital Resources". The source of funds for these capital contributions was a dividend from subsidiaries in December 1995, which was substantially collected from UWIC. During 1995, gains were realized as appreciated equity securities were sold in the process of rebalancing the portfolio to its targeted equity exposure. Prior to the AMS Merger, the Company held funds on behalf of an insurance subsidiary of AMS, an affiliated reinsurer. Investment income and realized gains attributable to those funds are included in their respective captions on the statements of income and are offset by amounts reported as a component of interest and profit sharing on joint ventures on the Company's statements of income.
The increase in medical costs in 1995 and 1996 has affected other companies operating in the small group marketplace. The small group managed care products utilize a variety of provider reimbursement arrangements, many of which are based on, but do not necessarily control, provider prices. A number of steps have been and are continuing to be taken in an effort to improve the profitability of the small group managed care business, including (i) implementation of increased renewal price quotes, (ii) modification of the design of certain small group managed care products to adjust to the changed market conditions, inflation patterns and utilization trends, (iii) a tightening of underwriting practices by type of risk and state, (iv) review and modification of provider contracting arrangements, including direct contracting with providers to better control health care costs, (v) review and modification of claims processing practices and procedures, and (vi) review of profitability by market and state.
COMMISSION EXPENSE RATIO -- The commission ratio for AMS medical products decreased to 11.4% in 1996 from 12.1% in 1995 and 12.8% in 1994. Over time, renewal business has gradually represented a larger proportion
of the total AMS medical business. Since renewal commissions are typically lower than commissions on new sales, this has contributed to the decrease in the AMS medical commission ratio. The commission ratio on AMS Life products reflected a similar trend, decreasing to 19.3% in 1996 from 19.9% in 1995 and 21.4% in 1994. The commission ratio for HMO products has remained relatively steady at 0.5% for 1996, 1995 and 1994. AMS products are sold exclusively through independent agents who are compensated through commissions, while the Company's HMO products are primarily sold directly by the Company's sales force. The costs of the Company's sales force are included in administrative expenses and are, therefore, not reflected in the commission expense ratio.
Premium taxes and other assessments for 1996 increased to $14.1 million, from $12.9 million in 1995 and $9.1 million in 1994. These increases were due primarily to premium taxes on the increased volume of business sold by AMS outside Wisconsin. Premium taxes and other assessments also include expenses related to Wisconsin's Health Insurance Risk Sharing Plan (HIRSP), a state program that provides health insurance to individuals who cannot obtain commercial health coverage. HIRSP is subsidized by health insurance carriers doing business in the State of Wisconsin. Expenses related to HIRSP fluctuate based on assessments from the state and totaled $1.7 million, $3.3 million and $1.5 million in 1996, 1995 and 1994, respectively.
As discussed further in Note 2 of Notes to Consolidated Financial Statements, the Company borrowed $70 million from Blue Cross & Blue Shield United of Wisconsin (BCBSUW) to fund a portion of the AMS Merger. Interest expense related to this note totaled $0.6 million in 1996. In conjunction with the AMS Merger, the Company also recorded $150.0 million of goodwill and other intangibles and $22.2 million of related deferred taxes. Amortization expense for the month of December 1996 of $0.6 million related to these intangibles, along with the $0.6 million of debt service costs are included in pre-tax income for AMS products.
Amortization of goodwill and other intangibles recorded on the consolidated statements of income totaled $1.5 million in 1996, including amounts related to the AMS Merger discussed above plus $0.8 million related to other acquisitions, compared with $0.7 million and $0.2 million of amortization expense in 1995 and 1994, respectively.
In 1995, the Company granted an executive officer of the Company an option to purchase 7,113 shares of common stock of AMS owned by the Company which upon completion of the AMS Merger, were converted into options to purchase shares of the Common Stock. Upon conversion, the Company recorded compensation expense of $2.1 million. This non-recurring charge was included as an expense of the parent company and was not reported in pre-tax income for AMS products.
Consolidated net income in 1996 increased 60.1% to $10.2 million from $6.4 million in 1995. Consolidated net income in 1995 decreased 80.5% from $32.8 million in 1994. The lower earnings in 1995 were due primarily to the increase in health care costs for small group managed care products and to a lesser extent for HMO products. Earnings per share increased to $0.79 in 1996, compared with $0.50 in 1995 and $2.81 in 1994.
Pre-tax income for HMO products in 1996 nearly tripled to $7.1 million from $2.4 million in 1995, due primarily to an improved medical loss ratio. Pre-tax income for HMO products in 1995 decreased 70.4% from $8.1 million in 1994, due primarily to an increase in the medical loss ratio. See "Expense Ratios - Medical Loss Ratio."
The Company's sources of cash flow consist primarily of premium revenue and investment income. The primary uses of cash include medical and other benefits, commissions and administrative expense payments. Positive cash flows are invested pending future payments of medical and other benefits and other operating expenses. The Company's investment policies are designed to maximize yield, preserve principal and provide liquidity to meet anticipated payment obligations.
the first eleven months of 1996. Due to periodic cash flow requirements of certain subsidiaries, the Company made borrowings under its bank line of credit ranging up to $14.4 million during 1996 to meet short-term cash needs, and $1.2 million was outstanding on this line of credit at December 31, 1996.
In November 1994, the Company purchased all of the assets of U-Care and certain assets from University Health Care, Inc. (UHC), an affiliate of U-Care, for cash approximating $3.8 million, and purchased all of the outstanding common stock of HMO-W, Incorporated for cash approximating $7.6 million. Effective October 1, 1994, the Company contributed the assets acquired in the U-Care transaction to Unity, a wholly owned subsidiary of HMO-W, Incorporated. Both acquisitions were effective October 1, 1994, and on a combined basis, they added members of 79,000, 71,000 and 63,000 to the Company's HMO membership as of December 31, 1996, 1995 and 1994, respectively.
At December 31, 1995 the Company owned 11.9% of the common stock of AMS, which was recorded at cost of $1.3 million at December 31, 1995 and is included in other assets on the consolidated balance sheet. Effective December 3, 1996, the Company acquired the remaining 88.1% interest in AMS that it did not already own. The acquisition was accomplished through the merger of AMS with and into the Company pursuant to the terms of an Agreement and Plan of Merger dated July 31, 1996, by and between AMS, BCBSUW, the Company and the two principal AMS shareholders. UWS is the surviving corporation in the merger. The aggregate consideration for the merger was cash of $71.8 million, including expenses, and $98.7 million representing the market value of 3,694,280 newly issued shares of Common Stock and options to purchase Common Stock. Most of the cash came from $70.0 million borrowed from BCBSUW, which, after the merger, owns approximately 38% of Common Stock. See Note 6 of Notes to Consolidated Financial Statements for the terms of the note payable to BCBSUW.
expenses, totaled $16.6 million. The net proceeds of the July 1994 and February 1995 offerings are being used by the Company for general corporate purposes, including supporting the growth of its businesses, and for possible entry into additional geographic areas and related lines of business through strategic acquisitions.
In January 1995, UWIC expended $30.0 million to redeem its outstanding preferred stock in accordance with the terms of the preferred stock. The Company also expended $2.0 million in January 1995 to redeem its Series A redeemable preferred stock, which was previously used as the employer's matching contribution under the Company's saving plan for employees of the Company and BCBSUW. Effective January 1, 1995, the Company purchased Aon Corporation's 50% equity ownership in United Heartland for $0.5 million, and United Heartland is now a wholly owned subsidiary of the Company.
In December 1995, UWIC borrowed $65.0 million from BCBSUW under a Surplus Note Agreement, which was guaranteed by the Company. The Surplus Note provided UWIC with regulatory capital needed to replace capital paid to the Company in the form of a dividend in December 1995. The dividend and Surplus Note were part of a capital restructuring plan designed to transfer capital from UWIC to UWLIC to support UWLIC's retention of the AMS medical business beginning in 1996. The entire $65.0 million was repaid to BCBSUW in 1996.
From time to time, the Company makes capital contributions to its subsidiaries to assist them in maintaining appropriate levels of capital and surplus for regulatory and rating purposes. Insurance subsidiaries are required to maintain certain levels of statutory capital and surplus. In Wisconsin, where a large percentage of the Company's premium is written, these levels are based upon the amount and type of premiums written and are calculated separately for each subsidiary. As of December 31, 1996, statutory capital and surplus for each of these insurance subsidiaries exceeded required levels.
The quarterly consolidated results of operations of the Company are summarized in Note 17 to Notes to Consolidated Financial Statements.
The Company is continually updating its information systems capabilities, and has evaluated all significant computer software applications for compatibility with the year 2000. With the system changes implemented to date and other planned changes, the Company anticipates that its computer software applications will be compatible with the year 2000. Expenditures specifically related to software modifications for year 2000 compatibility are not expected to be material.
looking statements include, among others, the following possibilities: (1) the steps being taken to improve the profitability of the small group managed care business and to reduce the administrative expense ratio for small group managed care products do not have the effect that the Company expects; (2) competitive pressure in the health care industry increases significantly; and (3) general economic conditions, either nationally or in the states in which the Company does business are less favorable than expected.
Consolidated Statements of Shareholders' Equity for the years ended December 31, 1996, 1995 and 1994........................... 34
Consolidated Statements of Cash Flows for the years ended December 31, 1996, 1995 and 1994 ................................ 35
We have audited the accompanying consolidated balance sheets of United Wisconsin Services, Inc. (the Company) as of December 31, 1996 and 1995, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1996. Our audits also included the financial statement schedules listed in the index at item 14(a). 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 audits.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 1996 and 1995, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. 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.
Stocks, at market 59,685 71,582 -------- -------- Total investments 467,123 543,347
Liabilities: Medical and other benefits payable $240,338 $245,118 Advance premiums 51,514 41,456 Due to affiliates 74,005 71,508 Funds held on behalf of affiliated reinsurers -- 60,041 Payables and accrued expenses 50,879 30,300 Other liabilities 49,941 15,557 Debt 55,788 44,898 -------- -------- Total liabilities 522,465 508,878
Redeemable preferred stock: Series A Adjustable Rate Nonconvertible, $1,000 stated value, 25,000 shares authorized, none issued or outstanding -- --
UNITED WISCONSIN SERVICES, INC. CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
The accompanying notes are in integral part of the Consolidated Financial Statements.
BASIS OF PRESENTATION - The consolidated financial statements include the accounts of United Wisconsin Services, Inc. (the Company) and all of its majority-owned subsidiaries. The Company is affiliated with Blue Cross & Blue Shield United of Wisconsin (BCBSUW).
The remainder of the Company's bonds are classified as available for sale. Bonds available for sale are stated at market value and changes in market value are reported as unrealized gains (losses) on investments in shareholders' equity, net of applicable deferred taxes. In 1995, unrealized gains(losses) are also net of amounts attributable to funds held on behalf of an affiliated reinsurer. See Note 3.
Market values for bonds are principally a function of current interest rates. The Company provides for potential losses on bonds upon early indication that a decline in the market value of a particular bond may be other than temporary. Premium and discount amortization on mortgage-backed securities is adjusted to reflect anticipated prepayment patterns.
Stocks are stated at market value and changes in market value are reported as unrealized gains (losses) on investments in shareholders' equity, net of applicable deferred taxes. In 1995, unrealized gains (losses) are also net of amounts attributable to funds held on behalf of an affiliated reinsurer. Investment income is recognized when earned. Realized gains and losses are calculated using the first-in, first-out method.
RECEIVABLES - Receivables are stated at net realizable value, net of allowances of $284,000 and $274,000 at December 31, 1996 and 1995, respectively, based upon historical collection trends and management's judgment of the ultimate collectibility of the accounts. These collection trends are monitored and any adjustments required are reflected in earnings currently.
GOODWILL AND OTHER INTANGIBLES - Goodwill and other intangibles represent the excess of cost over the fair market value of tangible assets acquired in business combinations accounted for by the purchase method of accounting. These intangible assets are being amortized on a straight-line basis over a period of 40 years or less.
DEFERRED ACQUISITION COSTS - Certain costs of acquiring new insurance policies have been deferred. Deferred acquisition costs are included in other assets and are being amortized over the estimated premium-paying periods of the related policies.
DEPRECIATION - Property and equipment used in operations are depreciated using the straight-line method over the estimated useful lives of the respective assets. Depreciation expense was $2,421,000, $1,018,000 and $695,000 in 1996, 1995 and 1994, respectively. For federal income tax purposes, certain assets are depreciated using accelerated methods.
AMERICAN MEDICAL SECURITY GROUP, INC. - At December 31, 1995, the Company owned 15,000 shares of preferred stock and 12% of the common stock of American Medical Security Group, Inc., which are recorded at cost of $16,330,000 and are included in other assets. The preferred stock was purchased in October 1995 at a cost of $15,000,000. The Company also had a joint venture agreement with American Medical Security Group, Inc. and its subsidiaries (AMSG) and was a party to related reinsurance agreements.
The aggregate consideration for the merger was cash of $71,800,000, including expenses, and $98,719,000 representing the market value of 3,694,280 newly issued shares of the Company's common stock and options to purchase the Company's common stock. Most of the cash came from $70,000,000 borrowed from BCBSUW, which, after the merger, owns approximately 38% of the Company's common stock. See Note 6. The merger agreement provides that $8,000,000 of the cash consideration be deposited in escrow to indemnify the Company for breaches of certain representations, warranties, covenants and other agreements contained in the merger agreement. A bank has been named as escrow agent and is authorized to disburse the funds in accordance with an escrow agreement by and among the Company, a designated agent for the former shareholders of AMSG, and the escrow agent.
In conjunction with the merger, $150,018,000 of goodwill and other intangibles and $22,173,000 of related deferred tax liabilities were recorded in the consolidated balance sheet and are being amortized over 3 to 40 years using the straight-line method. Upon merger, the U&C Real Estate Partnership (the Partnership), a partnership between the Company and AMSG, became wholly owned by the Company and is consolidated.
Upon merger, the AMSG preferred stock owned by the Company was cancelled and the AMSG stock options were converted into options to purchase 305,696 shares of the Company's common stock at $4.66 per share. The Company also granted options to purchase 1,000,000 shares of the Company's common stock at $32.83 per share to two of the previous shareholders of AMSG.
Gross investment income 33,496 28,237 22,808 Investment expenses (1,350) (763) (664) Other interest income (expense) (1,532) 458 (32) ------- ------- ------- $30,614 $27,932 $22,112 ------- ------- ------- ------- ------- -------
Years Ended December 31, ------------------------------ 1996 1995 1994 ------- ------- ------- (In thousands)
Bonds available for sale: Gross realized gains 4,561 4,065 1,239 Gross realized losses (4,334) (2,450) (1,027) ------- ------- ------- $12,996 $12,915 $ 1,649 ------- ------- ------- ------- ------- -------
December 31, ------------------------------ 1996 1995 1994 ------- -------- -------- (In thousands)
Stocks: Gross unrealized gains $ 9,638 $12,267 $ 2,340 Gross unrealized losses (928) (2,258) (1,861) Deferred income tax expense (3,236) (3,557) (170) Net unrealized (gains) losses attributable to funds held on behalf of an affiliated reinsurer, net of deferred income taxes -- (1,732) 117 Bonds available for sale: Gross unrealized gains 3,996 10,794 253 Gross unrealized losses (2,714) (442) (17,616) Deferred income tax (expense) benefit, net of valuation allowance (487) (3,745) -- Net unrealized (gains) losses attributable to funds held on behalf of an affiliated reinsurer, net of deferred income taxes -- (1,779) 3,464 ------- ------- --------
The amortized cost and estimated market values of bonds are as follows:
Gross Gross Estimated Amortized unrealized unrealized market cost gains losses values --------- ---------- ---------- --------- (In thousands)
At December 31, 1995: Available for sale: U.S. Treasury securities $148,686 $ 4,048 $ - $152,734 State and municipal securities 17,668 148 (1) 17,815 Foreign government securities 18,530 435 (20) 18,945 Corporate securities 158,343 4,314 (167) 162,490 Government agency mortgage-backed securities 108,336 1,849 (254) 109,931 --------- ---------- ---------- --------- 451,563 10,794 (442) 461,915
Held to maturity: U.S. Treasury securities 9,850 295 (7) 10,138 --------- ---------- ---------- --------- $461,413 $ 11,089 $ (449) $472,053 --------- ---------- ---------- --------- --------- ---------- ---------- ---------
The amortized cost and estimated market values of bonds at December 31, 1996, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations.
Bonds available for sale: Due in one year or less $ 2,899 $ 2,910 Due after one through five years 127,446 128,237 Due after five through ten years 121,958 122,227 Due after ten years 45,552 46,022 --------- --------- 297,855 299,396 Government agency mortgage-backed securities 95,478 95,219 --------- --------- $393,333 $394,615 --------- --------- --------- ---------
Activity in the liability for medical and other benefits payable is as follows: Years Ended December 31, -------------------------------------- 1996 1995 1994 --------- --------- --------- (In thousands)
Incurred related to: Current year 526,776 434,846 286,806 Prior years (13,970) 6,255 (5,199) --------- --------- --------- Total incurred 512,806 441,101 281,607
SURPLUS NOTE - On December 15, 1995, a subsidiary of the Company borrowed $65,000,000 from BCBSUW under a Surplus Note Agreement (Surplus Note), which was guaranteed by the Company. The Surplus Note provided the subsidiary with regulatory capital needed to replace capital paid to the Company in the form of a dividend in December, 1995. The entire $65,000,000 was repaid to BCBSUW in 1996. Interest expense on the Surplus Note totaled $1,228,000 and $196,000 in 1996 and 1995, respectively, and is reflected as an offset to investment income on the consolidated statements of income.
The Company and several subsidiaries have a bank line of credit, guaranteed by BCBSUW, which permits aggregate borrowings to $20,000,000. Intercompany guarantees exist which obligate the companies to reimburse BCBSUW should the bank enforce the guarantee for their borrowing. Periodic borrowings have been made on this line of credit. The outstanding line of credit balance was $1,200,000 and $550,000 at December 31, 1996 and 1995, respectively, and is included in other liabilities.
Beginning in 1996, a subsidiary of the Company has a bank line of credit which permits borrowings to $2,000,000. No borrowings have been made on this line of credit in 1996.
For the next five years, required principal amounts to be paid for the maturity of the Notes are $44,888,000 in the year 2000. The Notes decreased by $10,000 and $62,000 in 1996 and 1995, respectively, due to the right of repayment upon the death of holders. Interest expense on the Notes totaled $3,479,000, $3,483,000 and $3,487,000 in 1996, 1995 and 1994, respectively. At December 31, 1996 and 1995, the fair value of the Notes approximated $44,888,000 and $44,898,000, respectively.
Certain subsidiaries of the Company provide health, life and other insurance benefits to the employees of BCBSUW. Premium revenue received from BCBSUW totaled $4,370,000, $4,568,000 and $3,812,000 in 1996, 1995 and 1994, respectively.
The Company has loans and advances receivable from employees, agents and joint venture partners of $2,639,000 at December 31, 1996.
The Company leases office space from the two former primary shareholders of AMSG. This agreement requires annual lease payments of $767,000 in 1997 through 1999, and $576,000 in 2000. Lease expense of $64,000 was recorded in 1996.
Eleven months ended Years ended November 30, December 31, ------------- ------------------ 1996 1995 1994 ------------- -------- -------- (In thousands)
Premium revenue $997,818 $990,077 $751,860 Medical and other benefits 800,224 777,440 500,394 Commission expenses 117,394 122,970 98,962 Administrative expenses 97,756 95,855 72,833 Premium taxes and other assessments 20,392 18,977 14,101
REINSURANCE WITH RELATED PARTIES - AMSG JOINT VENTURE - Prior to the merger of the Company and AMSG on December 3, 1996, the Company ceded to AMSG, on a quota share basis, approximately 50% of the premium revenue on small group health care and life business sold by AMSG. As a result, the Company retained 50% of the premium revenue and 50% of the profit (loss) on the products sold by AMSG. The Company holds funds on behalf of American Medical Security Holdings, Inc. (AMSH) equivalent to the medical and other benefits payable and the undistributed net profit. The Company credits investment income on the funds retained for AMSH at the Company's average portfolio rate.
Eleven months ended Years ended November 30, December 31, ------------- -------- -------- 1996 1995 1994 ------------- -------- -------- (In thousands)
Premium revenue $497,941 $494,107 $374,875 Medical and other benefits 397,877 388,310 250,034 Commission expenses 58,698 61,485 49,481 Administrative expenses 47,555 47,310 35,875 Premium taxes and other assessments 10,191 9,485 7,048 Interest and profit sharing on joint ventures (8,669) (12,436) (6,123)
OTHER REINSURANCE - The Company also cedes insurance to other related and unrelated insurance carriers on an excess of loss or quota share basis. In addition, the Company assumes insurance risk from certain federal and state insurance programs. The impact of this reinsurance activity is not significant to the consolidated financial statements.
Years Ended December 31, --------------------------- 1996 1995 1994 ------- ------- ------- (In thousands) Current: Federal $ 5,072 $ 3,684 $13,123 State 1,932 360 1,326 ------- ------- ------- 7,004 4,044 14,449 Deferred: Federal 740 (1,144) 2,207 State (898) 81 (93) ------- ------- ------- (158) (1,063) 2,114 ------- ------- ------- $ 6,846 $ 2,981 $16,563 ------- ------- ------- ------- ------- -------
Significant components of the Company's federal and state deferred tax liabilities and assets are as follows:
December 31, 1996 December 31, 1995 ----------------- ----------------- Federal State Federal State ------- ------- ------- ------- (In thousands) Deferred tax liabilities: Claims based receivables $ (574) $ (130) $(1,055) $ (238) Intangibles (19,137) (4,319) -- -- Pension accrual (1,835) (347) (1,303) (248) Unrealized gains on investments (4,637) (454) (7,998) (376) Other - net (6,683) (534) (4,451) (653) ------- ------- ------- ------- (32,866) (5,784) (14,807) (1,515) Deferred tax assets: Unrealized losses on investments 1,321 47 1,048 24 Unrealized gains on investments attributable to affiliated reinsurer -- -- 1,890 -- Post-retirement benefits other than pensions 1,294 278 1,223 264 Advance premium discounting 2,653 228 1,336 173 Basis in minority-owned subsidiaries 2,131 485 -- -- Deferred compensation 2,888 581 -- -- Medical and other benefits payable discounting 2,511 74 2,009 94 Other - net 11,477 3,461 5,291 1,436 ------- ------- ------- ------- 24,275 5,154 12,797 1,991 Valuation allowance -- (636) -- (294) ------- ------- ------- ------- 24,275 4,518 12,797 1,697 ------- ------- ------- ------- Net deferred tax assets (liabilities) $(8,591) $(1,266) $(2,010) $ 182 ------- ------- ------- ------- ------- ------- ------- -------
The federal deferred benefit arising from the deductibility of state deferred tax is included as a component of other federal deferred taxes. The net deferred tax liabilities are included in other liabilities.
During 1996, BCBSUW entered into an agreement with another service bureau to obtain electronic data processing services. The processing of services under the agreement is expected to commence on July 1, 1998. The agreement has a term of five years, with options to extend for two additional one-year renewal periods.
LITIGATION - The Company is involved in various legal actions occurring in the normal course of its business.
On January 26, 1990, a subsidiary of the Company issued $30,000,000 of preferred stock in a private placement transaction with an institutional investor. The preferred stock was redeemed on January 25, 1995 for $30,000,000.
In 1992, the Board of Directors designated 25,000 shares of the Company's authorized but unissued preferred stock as Series A Adjustable Rate Nonconvertible Preferred Stock to be used as the employers' matching contribution under the 401(k) plan covering salaried and nonunion hourly employees of the Company and BCBSUW. At the date of issue and at December 31, 1994, the fair market value per share of the Series A Preferred Stock was approximately equal to the stated value. The shares were redeemable at the option of the Company.
On January 3, 1995, the Company redeemed all of the outstanding shares of Series A Preferred Stock and discontinued its use as the employer's matching contribution to the 401(k) plan.
STATUTORY FINANCIAL INFORMATION - Insurance companies are subject to regulation by the Office of the Commissioner of Insurance of the State of Wisconsin and certain other state insurance regulators. These regulations require, among other matters, the filing of financial statements prepared in accordance with statutory accounting practices prescribed or permitted for insurance companies. The combined statutory surplus of insurance subsidiaries at December 31, 1996 and 1995 was $268,250,000 and $203,551,000, respectively. The combined statutory net income of insurance subsidiaries was $11,847,000, $8,437,000 and $37,181,000 in 1996, 1995 and 1994, respectively.
State insurance regulations also require the maintenance of a minimum compulsory surplus based on a percentage of premiums written. At December 31, 1996, the Company's insurance subsidiaries were in compliance with these compulsory regulatory requirements.
RESTRICTIONS ON DIVIDENDS FROM SUBSIDIARIES - Dividends paid by the insurance subsidiaries to the Company are limited by state insurance regulations. The insurance regulator in the state of domicile may disapprove any dividend which, together with other dividends paid by an insurance company in the prior twelve months, exceeds the regulatory maximum as computed for the insurance company based on its statutory surplus and net income.
The pension plans' assets are comprised primarily of common stocks, bonds and other marketable securities.
YEARS ENDED DECEMBER 31, -------- -------- -------- 1996 1995 1994 -------- -------- -------- (In thousands)
After giving effect to all administrative expense allocations between the Company and BCBSUW, the pension credit was $1,288,000, $435,000 and $663,000 in 1996, 1995 and 1994, respectively.
POST-RETIREMENT BENEFITS - The Company and all of its subsidiaries, except certain recent acquisitions, participate with BCBSUW in two post-retirement welfare benefit plans; one plan covers salaried employees and one plan covers hourly employees. Both plans provide health, life and certain other employee benefits for retired employees and their eligible dependents. The salaried plan also provides for dental and vision benefits. Salaried employees become eligible for these benefits if they retire from the Company at a minimum age of 55 years with 10 years of service. Hourly employees are eligible if they retire at a minimum age of 60 years with 15 years of service. Retirees are required to pay a portion of the cost of their coverage, which varies based upon date of retirement and the retiree's status, age and length of service at retirement. The plans are currently unfunded.
The Company has amended its post-retirement welfare benefit plans for nonunion employees, which limits the Company's financial contribution in future periods. The amendment is effective January 1, 1997. The resulting reduction in the accumulated post-retirement benefit obligation is included in the funded status of the post-retirement welfare benefit plans at December 31, 1996 and 1995, and was also considered in the calculation of post-retirement benefit cost for 1996.
DECEMBER 31, ------------------ 1996 1995 -------- -------- Accumulated post-retirement (In thousands) benefit obligation: Retirees $ 247 $ 224 Fully eligible active plan participants 248 261 Other active plan participants 1,797 1,476 -------- -------- 2,292 1,961
The net periodic post-retirement benefit cost is comprised of the following:
YEARS ENDED DECEMBER 31, ----------------------------- 1996 1995 1994 -------- -------- --------- (In thousands)
Service cost $ 164 $ 216 $ 202 Interest cost 156 189 176 Net amortization and deferrals (90) (27) (21) -------- -------- --------- Net periodic post-retirement benefit cost $ 230 $ 378 $ 357 -------- -------- --------- -------- -------- ---------
After giving effect to all administrative expense allocations between the Company and BCBSUW, the net periodic post-retirement benefit cost was $224,000, $351,000 and $319,000 in 1996, 1995 and 1994, respectively.
401(k) PLANS - The Company and all of its subsidiaries, except certain recent acquisitions, participate with BCBSUW in two 401(k) plans; one plan covers salaried and nonunion hourly employees and one plan covers union hourly employees. Employees are eligible to participate if they work at least 1,000 hours per year and have been employed with the Company or BCBSUW for at least one year. Employees may contribute a percentage of their earnings on a pre-tax basis with up to 5% matched by a 50% employer contribution.
PROFIT SHARING AND BONUS PROGRAMS - The Company and all of its subsidiaries, except certain recent acquisitions, participate with BCBSUW in a Profit Sharing Plan for substantially all employees. The plan provides additional compensation to each employee, calculated as a percentage of the employee's regular earnings. The profit sharing percentage is determined based upon BCBSUW's combined net income, affiliate profitability measurements and customer satisfaction levels. Profit sharing expense, after giving effect to all administrative expense allocations between the Company and BCBSUW, was $1,501,000, $810,000 and $1,968,000 in 1996, 1995 and 1994, respectively.
In January 1992, 82,500 SARs were granted at $9.67 per share. In 1995, 7,500 of these SARs were forfeited. In 1996, 7,500 of these SARs were exercised. Accrued benefits related to the SAR Plan, after giving effect to all administrative expense allocations between the Company and BCBSUW represented an expense of $176,000 in 1996, a credit of $635,000 in 1995 and an expense of $506,000 in 1994.
NQSOs have been granted to directors of the Company under this plan, and are exercisable in whole or in part and at such times as specified in the grant. The rights of grantees vest over a three year period after the date of the grant. The options lapse if not exercised within twelve years of the grant date, or within two years of termination as a director.
YEARS ENDED DECEMBER 31, ----------------------------- 1996 1995 ------------ ------------ Total number of NQSOs: Outstanding at beginning of year 394,404 188,497 Granted 1,863,259 225,519 Forfeited (13,204) (19,612) ------------ ------------ Outstanding at end of year 2,244,459 394,404 ------------ ------------ ------------ ------------
NQSOS BY EXERCISE PRICE RANGE: Range of exercise prices $4.66 -- Weighted average exercise price $4.66 -- Weighted average remaining contractual life 5.93 -- Exercisable at end of year 305,696 -- Weighted average exercise price of options exercisable at end of year $4.66 --
Range of exercise prices $28.00-$35.00 $28.00-$35.00 Weighted average exercise price $32.29 $28.55 Weighted average remaining contractual life 5.52 10.47 Exercisable at end of year 1,065,966 39,312 Weighted average exercise price of options exercisable at end of year $32.56 $28.33
YEARS ENDED DECEMBER 31, -------------------------- 1996 1995 ------ ------ (In thousands, except per share data)