The company currently leases from unaffiliated parties: (i) approximately 9,000 square feet of office space in Rye Brook, New York, under a lease expiring in October 2004; (ii) 2,500 square feet of office space, under a lease expiring in August 2003; 29,000 square feet of office space, under a lease expiring in February 2004; and 1,600 square feet of office space, under a lease expiring in June 2005, in Orlando, Florida; (iii)1,200 square feet of rental house space, under a lease expiring August 2001, 5,100 square feet of warehouse space, under a lease expiring June 2005; 32,000 square feet of office space, under a lease expiring in November 2007, with one renewal at the Company's option for a period of five years; and 8,200 square feet of office/warehouse space, under a lease expiring November 2007; 6,000 square feet of warehouse space, under a lease expiring November 2007 in Pensacola, Florida; (iv) 2,700 square feet in Richardson, Texas, under a lease expiring in March 2001; (v) 67,000 square feet in Raleigh, North Carolina, under a lease expiring January 2001; (vi) 22,000 square feet of office space and 6,000 square feet of warehouse space, both under a lease expiring November 2001 in Mississauga, Ontario; (vii) 14,300 square feet of office space in Clearwater, Florida, under a lease expiring December 2002; (viii) 11,500 square feet of office space in Weston, Florida, under a lease expiring June 2008. These leases represent the operating offices of American Progressive, American Pioneer Life, WorldNet Services Corp, American Exchange Life, Pennsylvania Life, PennCorp Life of Canada, AIAG, and CHCS respectively, and carry an aggregate annual rental of approximately $1.8 million. The company also leases a smaller office in Andalusia, Alabama, for an aggregate annual rental of approximately $17,000.
Forward-looking statements are based upon estimates and assumptions that are subject to significant business, economic and competitive uncertainties, many of which are beyond the Company's control and are subject to change. These uncertainties can affect actual results and could cause actual results to differ materially from those expressed in any forward-looking statements made by, or on behalf of the Company. Whether or not actual results differ materially from forward-looking statements may depend on numerous foreseeable and unforeseeable events or developments, some of which may be national in scope, such as general economic conditions and interest rates. Some of these events may be related to the insurance industry generally, such as pricing competition, regulatory developments and industry consolidation. Others may relate to Universal American specifically, such as credit, volatility and other risks associated with the Company's investment portfolio, and other factors. Universal American disclaims any obligation to update forward-looking information.
The Company owns nine insurance companies (collectively, the "Insurance Subsidiaries"): American Progressive Life & Health Insurance Company of New York ("American Progressive"), American Pioneer Life Insurance Company ("American Pioneer"), American Exchange Life Insurance Company ("American Exchange"), Constitution Life Insurance Company ("Constitution Life"), Marquette National Life Insurance Company ("Marquette"), Peninsular Life Insurance Company ("Peninsular Life"), Pennsylvania Life Insurance Company ("Pennsylvania Life"), PennCorp Life Insurance Company of Canada ("PennCorp Life of Canada") and Union Bankers Insurance Company ("Union Bankers"). Six of these companies, Pennsylvania Life, PennCorp Life of Canada, Peninsular, Union Bankers, Constitution and Marquette, as well as certain other related assets, were acquired on July 30, 1999. In addition to the Insurance Subsidiaries, Universal American owns three third party administrators: American Insurance Administration Group, Inc. ("AIAG"), which was purchased January 2, 2000, Capitated Health Care Services, Inc., ("CHCS"), which was purchased August 10, 2000 and WorldNet Services Corp. ("WorldNet") that process the Company's brokerage senior market policies, as well as business for unaffiliated insurance companies.
Currently, the Company manages its business, with primary emphasis on its distribution channels, through four operating segments, Senior Market Brokerage, Career Agency, Special Markets and Administrative Services and also maintains a Corporate segment.
SENIOR MARKET BROKERAGE - This distribution channel consists of a general agency system and insurance brokerage system that focus on the sale of products in the senior market segment, including Medicare Supplement, long term Care, Final Expense Life Insurance and annuities.
CAREER AGENCY SYSTEM - The Career Agency Segment was acquired in the 1999 Acquisition in July 1999 and comprises the operations of Pennsylvania Life and PennCorp Life of Canada. PennCorp Life of Canada operates exclusively in Canada, while Pennsylvania Life operates in both the U.S. ("Pennsylvania Life U.S.") and Canada. The Career Agency segment is comprised of a career agency field force, which distributes fixed benefit accident and sickness, life insurance and supplemental senior health insurance in the United States and Canada. The Career Agents are under exclusive contract with Pennsylvania Life and PennCorp Life of Canada.
CORPORATE & ELIMINATIONS - This segment includes the corporate activities of the holding company, including interest on debt. This segment also includes the elimination of intersegment revenues and expenses that are reported gross in each of the operating segments. These eliminations affect the amounts reported on the individual financial statement line items, but do not change operating income before taxes. The significant items eliminated include intersegment revenue and expense relating to services performed by the Administrative Services segment for the Career Agency, Senior Market Brokerage and Special Market segments and interest on notes issued by the Corporate segment to the other operating segments.
For the purposes of assessing each segment's contribution to net income, management evaluates the results of these segments on a pre-tax, and realized gain (loss) basis. The following table reflects each segment's contribution to net income and a reconciliation to net income for these items.
Operating income from the Career Agency segment increased by $17.2 million, reflecting the impact of a full year's results in 2000 compared to five months in 1999. The results for 2000 trend consistently with 1999 on an annualized basis.
The operating results for the Special Markets segment improved by approximately 4% over 1999. This reflects the impact of a full year's results in 2000 from the companies acquired in 1999 compared to five months in 1999. However, underwriting results for the segment were negatively impacted by a deterioration of the loss ratios in the major medical line of business. Based, in part by the poor performance of this block of business, and in an effort to focus more on strategic lines, management decided to exit the major medical business during 2000 and as a result, wrote off $1.4 million of deferred acquisition costs relating to that line of business.
The increase in the operating loss from the Corporate & Eliminations segment reflects the inclusion of a full year of costs related to the acquisition financing in 2000, compared to five months for 1999.
The Senior Market Brokerage segment improved by $1.8 million, compared to 1998 as a result of internally generated growth combined with improvement in overall loss ratios.
Results for the Administrative Services segment for 1999 were consistent with 1998.
REVENUES. Net premiums for the year fell by approximately 3% for the segment compared to 1999 on an annualized basis. Canadian operations accounted for approximately 36% of the net premiums for both 2000 and 1999. During the year, the Company began to develop new products for the Career Agency sales force which are based on the Senior Market Brokerage products. Additionally, the Company was focused on the recruiting and training of new agents during the year. Management expects that the impact of these efforts will begin to be reflected in the Segment's results during the first half of 2001.
The table below details the gross premiums and policyholder fees before reinsurance for the major product lines in the Senior Market brokerage segment and the corresponding average amount of premium retained. The Company reinsures all of its senior market brokerage products to unaffiliated third party reinsurers under various quota share agreements. Medicare Supplement written premium is reinsured under quota share reinsurance agreements ranging between 50% and 75% based upon the geographic distribution. The Company has also acquired various blocks of Medicare Supplement premium, which are reinsured under quota share reinsurance agreements ranging from 75% to 100%. Under these reinsurance agreements, the Company reinsures the claims incurred and commissions on a pro rata basis and receives additional expense allowances for policy issue, administration and premium taxes.
REVENUES. Gross premium written increased $109.1 million, or 75% over 1999. This increase consists of an increase of $47.2 million, or 135%, on Medicare Supplement business written by the Insurance Subsidiaries, an increase of $50.9 million on Medicare Supplement premium acquired through acquisition, an increase of $7.9 million in other senior supplemental health premium and $3.1 million in senior life insurance premium.
1999 to $85.1 million in 2000. Medicare Supplement written premium grew as a result of the increase in number of general agents under contract and by the dis-enrollment of policyholders by various Health Maintenance Organizations ("HMO's"). In addition, premiums increased due to various rate increases implemented by the Company in 2000, offset by expected lapses.
Net premiums for the year increased by approximately $19.5 million, or 60%, compared to 1999. The net premiums did not increase in line with the gross premiums due to the amount of retained Medicare Supplement written premium decreasing from 34% in 1999 to 31% in 2000. This reduction in retained premium is a result of increased writing by American Pioneer that has 75% quota share reinsurance agreements in force. The retained Medicare Supplement acquired premium decreased from 13% in 1999 to 8% in 2000 as a result of the inclusion of a full year of the Medicare Supplement premium acquired in connection with the 1999 Acquisition, which premium was 100% reinsured under agreements that predated the acquisition. The other supplemental senior health insurance retained decreased from 60% in 1999 to 56% in 2000 as result of the increased writing of long-term care insurance that is reinsured pursuant to 50% quota share reinsurance agreements.
Net investment income increased by approximately 21% over 1999 as a result of the increase in the average invested assets for the comparable periods. Average invested assets increased as a result of earnings for the year.
The ratio of commissions to gross premiums remained flat at 16.9% and 16.5% in 2000 and 1999, respectively. Other operating costs as a percentage of gross premiums decreased to 13.1% in 2000 from 14.5% in 1999. Commission and expense allowances received from reinsurers as a percentage of the premiums ceded were flat at 29.2% in 2000 compared to 28.9% in 1999.
REVENUES. Gross premium earned before reinsurance increased $53.8 million, or 58%, over 1998. This consists of an increase of $20.9 million on Medicare Supplement business written by the Insurance Subsidiaries, an increase of $28.8 million on Medicare Supplement premium acquired through acquisition, an increase of $4.9 million in supplemental senior health premium and a reduction of $0.7 million in senior life insurance premium.
This increase in Medicare Supplement gross premium written by the Insurance Subsidiaries was the result of the rapid growth of the senior market product portfolio from 1997 to 1999. This growth was a result of the increase in Medicare Supplement issued premium generated by the increase in the number of general agents under contract and by the dis-enrollment of policyholders by various HMO's.
The increase of $4.9 million in other supplemental senior health gross premiums is the result of increased sales of long term care products and an increase of $2.0 million due to the inclusion of long term care premiums acquired in the 1999 Acquisition for the five months in 1999.
Net premiums for the year increased by approximately $10.8 million, or 50%, compared to 1998. Included in the 1999 amount were $1.9 million of net premiums acquired in the 1999 Acquisition. The remaining increase was less than the increase in gross premiums discussed above due to the amount of retained Medicare Supplement written premium decreasing from 41% in 1998 to 34% in 1999. This decrease is the result of increased writing by American Pioneer, which has 75% quota share reinsurance agreements in force. The retained Medicare Supplement acquired premium decreased from 20% in 1998 to 13% in 1999 as a result of the inclusion of the Medicare Supplement premium acquired in connection with the 1999 Acquisition, which premium was 100% reinsured under agreements that predated the acquisition.
BENEFITS, CLAIMS AND OTHER DEDUCTIONS. Policyholder benefits, including the change in reserves, increased by approximately $7.1 million, or 43%, from 1998, compared to the increase in net premiums of 50% noted above. The policyholder benefits did not increase as much as net premiums due to a decrease in loss ratios on the acquired block of Medicare Supplement premium from approximately
Interest credited to policyholders decreased by approximately $0.6 million, or 10%, as a result of the decrease in the effective interest rate credited to the policies in 1999 compared to 1998 and the expected lapses of the policies in force.
The ratio of commissions to gross premiums decreased to 16.5% in 1999 from 21.1% in 1998, as a result of the implementation of rate increases on the acquired Medicare Supplement business. Other operating costs as a percentage of gross premiums increased to 14.5% in 1999 from 13.9% in 1998 as a result of the increase in the production of new sales in 1999 over the 1998 amount and the inclusion of the expenses incurred on the business acquired in the 1999 Acquisition. Commission and expense allowances received from reinsurers as a percentage of the premiums ceded were flat at 29.2% in 1999 compared to 28.9% in 1998.
BENEFITS, CLAIMS AND OTHER DEDUCTIONS. Policyholder benefits increased by $12.6 million in 2000 compared to 1999. Approximately $9.8 million relates to the impact of a full year's results from the acquired companies in 2000 compared to five months in 1999. Approximately $2.0 million results from deterioration in the loss ratios for the health business of the segment. The remaining increase relates to adverse mortality in 2000 compared to 1999.
The increase in the net amortization of deferred acquisition costs relates primarily to the Company's decision to exit the major medical line of business. As a result of this decision, the Company wrote off approximately $1.4 million of deferred acquisition costs in 2000. The Company believes that it will be able to cancel, by the end of 2002, approximately $27.0 million of the $31.0 million of annualized premium in force for this line of business.
Commissions and general expenses, net of allowances increased by $2.5 million, or 28%, during 2000. An increase of approximately $3.3 million was due to the inclusion of a full year's results of the acquired companies in 2000 compared to five months in 1999. Offsetting this increase is a decrease in operating expenses relating to the existing blocks of business.
Commissions and general expenses, net of allowances increased by $2.6 million or 41% during 1999. An increase of approximately $3.5 million was due to the addition of the acquired companies in 1999. Offsetting this increase is a decrease in operating expenses for the existing blocks of business, related to the decrease in premium noted above.
Administrative service revenue increased by $14.8 million, or 160%, in 2000 as compared to 1999. Fees from AIAG, acquired in January 2000 and CHCS, acquired in August 2000 added $10.3 million and $2.2 million, respectively, to the segment in 2000. Affiliated revenues at WorldNet increased by $2.7 million as a result of the increase in premiums serviced by WorldNet on behalf of the affiliated insurance subsidiaries.
Currently, the Administrative Services segment administers more than $330.0 million of annualized in-force premium. Approximately $304.0 million of annualized premium in-force is administered on behalf of affiliates. This combined with fees for telephone support and managed care and claims services on behalf of the affiliated insurance subsidiaries generated $18.1 million of affiliated revenue for the year ended December 31, 2000. The remaining $6.0 million was generated from services provided to unrelated companies.
Operating expenses for the segment increased by $0.5 million in 1999 as compared to 1998. The increase relates to the costs associated with the increase in business administered for the affiliated insurance subsidiaries.
The above results reflect the elimination of revenues and expenses associated with services performed by the Administrative Services segment for affiliates of $18.1 million, $7.3 million and $6.5 million, respectively for 2000, 1999 and 1998 and the elimination of interest income and expense on bonds issued by the Corporate segment to an affiliate of $0.7 million, $0.7 million and $0.6 million, respectively for 2000, 1999 and 1998.
The increase in the interest cost and the amortization of capitalized loan fees reflects the impact of a full year's costs compared to five months in 1999. The stock-based compensation expense decreased due to termination of options as the result of employees leaving the company prior to vesting.
In January 2000, the Company announced that it had approved a plan to consolidate the Raleigh location acquired in the 1999 Acquisition into its locations in Toronto (Canada), Pensacola (Florida) and Orlando (Florida) in order to improve operating efficiencies and capabilities. The plan to consolidate this location was being formed at the date of the acquisition and was approved by the Board of Directors.
The Company requires cash to pay the operating expenses necessary to function as an insurance holding company (which under applicable Insurance Department regulations must bear its own expenses), and to meet the cost involved in being a publicly owned company. In addition, it requires cash to meet Universal American's obligations under the loan agreement discussed below and the debentures outstanding with American Progressive.
In connection with an agreement entered into 1996 whereby American Pioneer became a direct subsidiary of Universal American, rather than an indirect subsidiary owned through American Progressive, Universal American has $7.9 million in debentures outstanding to its subsidiary, American Progressive. The debentures pay interest quarterly at 8.50% and are due between September 2002 and May 2003. During the year ended December 31, 2000 the Company paid $0.7 million in interest on these debentures to American Progressive, which was eliminated in consolidation.
American Progressive, American Pioneer, American Exchange, Constitution Life, Marquette, Peninsular Life, PennCorp Life of Canada, Pennsylvania Life and Union Bankers (collectively, the "Insurance Subsidiaries") are required to maintain minimum amounts of capital and surplus as determined
by statutory accounting. Each of the Insurance Subsidiaries' statutory capital and surplus exceeds its respective minimum requirement. However, substantially more than such minimum amounts are needed to meet statutory and administrative requirements of adequate capital and surplus to support the current level of the Insurance Subsidiaries' operations. At December 31, 2000 the statutory capital and surplus, including asset valuation reserves, of the U.S. Insurance Subsidiaries totaled $86.5 million.
Cash generated by the Insurance Subsidiaries will be made available to Universal American, the ultimate parent, principally through periodic payments of principal and interest on surplus debentures. Currently, the surplus notes between Universal American and American Exchange total $70 million, which calls for interest at the LIBOR rate plus 375 basis points. The Company anticipates that the surplus note will be primarily serviced by dividends from Pennsylvania Life, a wholly owned subsidiary of American Exchange, and by tax-sharing payments among the insurance companies which are wholly owned by American Exchange filing a consolidated Federal income tax return. During the year-end December 31, 2000, Pennsylvania Life and Union Bankers paid dividends amounting to $2.9 million and $2.0 million, respectively. In addition, the insurance companies included in the tax allocation agreement with American Exchange, paid $4.8 million of taxes to American Exchange. During the year ended December 31, 2000, American Exchange paid $7.0 million in interest to Universal American. No principal payments were made during 2000.
Liquidity is also affected by unscheduled benefit payments including death benefits, benefits under accident & health policies and interest-sensitive policy surrenders and withdrawals. The amount of surrenders and withdrawals is affected by a variety of factors such as credited interest rates for similar products, general economic conditions and events in the industry that affect policyholders' confidence. Although the contractual terms of substantially all of the Company's in force life insurance policies and annuities give the holders the right to surrender the policies and annuities, the Company imposes
The net yields on the Company's cash and invested assets increased slightly from 6.79% in 1999 to 6.88% in 2000. A significant portion of these securities are held to support the liabilities for policyholder account balances, which liabilities are subject to periodic adjustments to their credited interest rates. The credited interest rates of the interest-sensitive policyholder account balances are determined by management based upon factors such as portfolio rates of return and prevailing market rates and typically follow the pattern of yields on the assets supporting these liabilities.
The Company's investment policy is to balance the portfolio duration to achieve investment returns consistent with the preservation of capital and maintenance of liquidity adequate to meet payment of policy benefits and claims. The Company invests in assets permitted under the insurance laws of the various states in which it operates. Such laws generally prescribe the nature, quality of and limitations on various types of investments that may be made. The Company currently engages the services of three investment advisors under the direction of the management of the Insurance Subsidiaries and in accordance with guidelines adopted by their respective Boards of Directors. Conning Asset Management and Asset Allocation and Management Company manage the Company's fixed maturity portfolio in the United States and Elliot and Page manages the Canadian fixed maturity portfolio. The Company's policy is not to invest in derivative programs or other hybrid securities, except for GNMA's, FNMA's and investment grade corporate collateralized mortgage obligations. It invests primarily in fixed maturity securities of the U.S. Government and its agencies and in corporate fixed maturity securities with investment grade ratings of "Baa3" (Moody's), "BBB-" (Standard & Poor's) or higher. However, the Company does own some investments that are rated "BB" or below (together 2.9% and 1.1% of total fixed maturities as of December 31, 2000 and 1999, respectively). Fixed maturities with a carrying value of $0.7 million were non-income producing for the year ended December 31, 2000. During the years ended December 31, 2000 and 1999 the Company wrote down the value of certain fixed maturity securities by $0.5 million and $0.6 million, respectively, which represents management's estimate of other than temporary declines in value and was included in net realized gains (losses) on investments in the accompanying consolidated statement of operations.
The Company files a consolidated return for federal income tax purposes, in which American Exchange and the Acquired Companies are not currently permitted to be included. At December 31, 2000, the Company (exclusive of American Exchange and the Acquired Companies) had net operating tax loss carryforwards of approximately $9.4 million that expire in the years 2005 to 2019. At December 31, 2000, the Company also had an Alternative Minimum Tax (AMT) credit carryforward for Federal income
tax purposes of approximately $0.4 million that can be carried forward indefinitely. As a result of the change in ownership of the Company in July 1999, use of most of the loss carryforwards of the Company are subject to annual limitations.
American Exchange and the other U. S. Acquired Companies file a separate consolidated federal income tax return. At December 31, 2000, these companies had net operating loss carryforwards, most of which were incurred prior to their acquisition by the Company, of approximately $46.7 million that expire in the years 2007 to 2013. As a result of the change in ownership of the Company in July 1999 and the 1999 Acquisition, use of most of the loss carryforwards are subject to annual limitations.
At December 31, 2000 and 1999, the Company carried valuation allowances of $10.4 million and $11.3 million, respectively, with respect to its tax loss carryforwards (deferred tax assets). The Company determines a valuation allowance based upon an analysis of projected taxable income and through its ability to implement prudent and feasible tax planning strategies. The tax planning strategies include the expense reductions anticipated from the Company's recent reorganization and from the income generated by its administration companies WorldNet, AIAG and CHCS. As a result of the increased profitability of the Administrative Services segment, valuation allowances on certain of the non-life tax loss carryforwards were considered not necessary at December 31, 2000. The amount of the valuation allowance released was $1.3 million and was recorded as a benefit in the deferred income tax expense. This decrease was partially offset by the establishment of a valuation allowance for the purchased net operating losses of CHCS, which are subject to limitation on their use. Management believes it is more likely than not that the Company will realize the recorded net deferred tax assets.