Our principal business segments are based on our products and include: Senior Managed Care-Medicare Advantage, Senior Market Health Insurance, Specialty Health Insurance, Life Insurance and Annuity and Senior Administrative Services. We also report the activities of our holding company in a separate segment. Reclassifications have been made to conform prior year amounts to the current year presentation. See “Note 21-Business Segment Information” in our consolidated financial statements included in this Annual Report on Form 10-K for a description of our segments.
Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). The preparation of our financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the amounts of assets and liabilities and disclosures of assets and liabilities reported by us at the date of the financial statements and the revenues and expenses reported during the reporting period. As additional information becomes available or actual amounts become determinable, the recorded estimates may be revised and reflected in operating results. Actual results could differ from those estimates. Accounts that, in our judgment, are most critical to the preparation of our financial statements include policy related liabilities, deferred policy acquisition costs, intangible assets, valuation of certain investments and deferred income taxes. There have been no changes in our critical accounting policies during the current quarter.
Business combinations accounted for as a purchase result in the allocation of the purchase consideration to the fair values of the assets and liabilities acquired, including the present value of future profits, establishing such fair values as the new accounting basis. The present value of future profits is based on an estimate of the cash flows of the in-force business acquired, discounted to reflect the present value of those cash flows. The discount rate selected depends upon the general market conditions at the time of the acquisition and the inherent risk in the transaction. Purchase consideration in excess of the fair value of net assets acquired, including the present value of future profits and other identified intangibles, for a specific acquisition, is allocated to goodwill. Allocation of purchase price is performed in the period in which the purchase is consummated. Adjustments, if any, in subsequent periods relate to resolution of pre-acquisition contingencies and refinements made to estimates of fair value in connection with the preliminary allocation.
Amortization of present value of future profits is based upon the pattern of the projected cash flows of the in-force business acquired, over weighted average lives ranging from six to forty years. Other identified intangibles are amortized over their estimated lives.
We regularly evaluate the amortized cost of our investments compared to the fair value of those investments. Impairments of securities generally are recognized when a decline in fair value below the amortized cost basis is considered to be other-than-temporary. Generally, we consider a decline in fair value to be other-than-temporary when the fair value of an individual security is below amortized cost for an extended period and we do not believe that recovery in fair value is probable. Impairment losses for certain mortgage-backed and asset-backed securities are recognized when an adverse change in the amount or timing of estimated cash flows occurs, unless the adverse change is solely a result of changes in estimated market interest rates and we intend to hold the security until maturity. The cost basis for securities determined to be impaired are reduced to their fair value, with the excess of the cost basis over the fair value recognized as a realized investment loss.
We use the liability method to account for deferred income taxes. Under the liability method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabi­lities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date of a change in tax rates.
As a result of the increased reimbursement rates from the Centers for Medicare and Medicaid Services, the Federal agency that administers the Medicare Advantage program (“CMS”), Medicare Advantage plans are able to offer more attractive benefits including enhanced prescription drug coverage pursuant to Part D. Consequently, we believe that enrollment in Medicare Advantage programs is likely to increase in the coming years.
We entered the Medicare Advantage business in 2004 with the acquisition of Heritage Health Systems, Inc. which operates Medicare Advantage coordinated care plans in Southeastern Texas. Since 2005, Heritage has expanded its service area to include 8 counties in Texas, and has begun to offer an HMO product in three counties in Florida (Brevard, Broward and Miami-Dade) in 2006. In 2004, we began to offer Medicare Advantage PFFS plans in New York and Pennsylvania. As of January 2006, we are marketing PFFS plans in a total of 15 states.
Medicare Supplement insurance reimburses the policyholder for certain expenses that are not covered by standard Medicare coverage such as deductibles and co-pays. This coverage is designed for people who want the freedom to choose providers who participate in the standard Medicare program, as opposed to the more restrictive networks that exist in Medicare Advantage products. In the past ten years, we have become a successful provider of Medicare Supplement coverage as well as other products designed for the senior market. We believe that the market for Medicare Supplement products will continue to be attractive, especially because many seniors may lose similar coverage that had previously been offered to them as a retiree benefit by their former employers.
Recently, there has been increased competition from other Medicare Supplement carriers, as well as from Medicare Advantage plans, which has affected our production of Medicare Supplement business.
We also experienced higher than expected lapsation in our Medicare Supplement business. We believe that there are a number of factors contributing to the lapsation, including competitive pressure from other Medicare Supplement companies and Medicare Advantage products, as well as the departure of certain of our sales managers. This excess lapsation required us to accelerate the amortization of the deferred acquisition cost and present value of future profits assets associated with the business that lapsed. We cannot give assurances that lapsation of our Medicare Supplement business will decline from the 2005 level, requiring faster amortization of the deferred costs.
Effective January 1, 2006, private insurers were permitted to sponsor insured stand-alone prescription drug benefit plans (“PDP’s”) pursuant to Part D, which was established by the MMA. A portion of the premium for this insurance is paid by the Federal government, and the balance, if any, is paid by the individuals who enroll. The Federal government will also provide additional subsidies in the form of premium support and coverage of the cost-sharing elements of the plan to certain low income Medicare beneficiaries. We have been approved to offer these programs in 32 of the 34 regions that have been established for this program.
During the third quarter of 2005, we commenced a new reinsurance arrangement with PharmaCare Captive Re, Ltd. Under the terms of the agreement, we provide an insured drug benefit for the employees of the State of Connecticut. The agreement is renewable annually by the State of Connecticut. The risk is reinsured to PharmaCare’s reinsurance subsidiary under a 100% quota share contract. We receive an underwriting fee of two percent of premium. Annualized premium for this program is approximately $260 million. As a result of this arrangement, both direct and ceded premium increased by approximately $132 million for the year, with no impact on net premium.
On May 28, 2004, we acquired Heritage, a privately owned managed care company that operates Medicare Advantage plans in Houston and Beaumont Texas, for $98 million in cash plus transaction costs of $1.6 million. The acquisition was financed with $66.5 million of net proceeds derived from the amendment of our credit facility and $33.1 million of cash on hand. As of the date of acquisition, Heritage had approximately 16,000 Medicare members and annualized revenues of approximately $140 million. Operating results generated by Heritage prior to the date of acquisition are not included in our consolidated financial statements.
Effective July 1, 2003, we entered into an agreement with Swiss Re and its newly acquired subsidiary, Guarantee Reserve Life Insurance Company (“Guarantee Reserve”), to acquire Guarantee Reserve’s marketing organization, including all rights to do business with its field force. The primary product sold by this marketing organization is low face amount whole life insurance, primarily for seniors. Beginning July 1, 2003, the Guarantee Reserve field force continued to write this business in Guarantee Reserve, with us administering all new business and assuming 50% of the risk through a quota share reinsurance arrangement. New business has been written by our subsidiaries with 50% of the risk ceded to Swiss Re beginning in the second quarter of 2004 as the products were approved for sale in each state.
On March 31, 2003, we acquired all of the outstanding common stock of Pyramid Life Insurance Company (“Pyramid Life”). Pyramid Life specializes in selling health and life insurance products to the senior market, including Medicare Supplement, long term care, life insurance, and annuities. With this acquisition, we acquired a $120 million block of in-force business, as well as a career sales force that is skilled in selling senior market insurance products. As of the date of acquisition, Pyramid Life marketed its products in 30 states through a career agency sales force of over 1,000 agents operating out of 39 Senior Solutions® Sales Centers. Operating results generated by Pyramid Life prior to the date of acquisition are not included in our consolidated financial statements.
Our Senior Market Health Insurance segment results improved by $7.7 million, or 28%, to $35.4 million in 2004 compared to 2003, primarily as a result of the Pyramid Life business being included for a full year in 2004 compared to nine months in 2003 and increased retention of the Medicare Supplement
business. We have increased our retention to 100% for all Medicare Supplement business sold beginning January 1, 2004.
Results for our Life Insurance and Annuity segment improved by $1.4 million, or 12%, to $13.4 million in 2004 compared to 2003, primarily as a result of an increase in business and more favorable morbidity.
Our Senior Administrative Services segment income improved by $2.1 million, or 19%, compared to 2003. This improvement was primarily a result of the growth in premiums managed.
The loss from our Corporate segment increased by $1.8 million, or 16%, compared to the 2003. The increase was due to higher interest cost as a result of an increase in the amount of the debt outstanding during the year, relating to the amendment of our credit facility in connection with our acquisition of Heritage, offset in part, by a reduction in the weighted average interest rates, as compared to the same period of 2003.
Our Senior Managed Care - Medicare Advantage segment includes the operations of Heritage and our other initiatives in Medicare managed care, including our Medicare Advantage private fee-for-service plans and special needs plan. Heritage generates its revenues and profits from three sources. First, Heritage owns an interest in SelectCare of Texas (“SCOT”), a health plan that offers coverage to Medicare beneficiaries in Houston and Beaumont, Texas, under a contract with CMS. Next, Heritage operates three separate Management Service Organizations (“MSO’s”) that manage the business of SelectCare and two affiliated Independent Physician Associations (“IPA’s”). Lastly, Heritage participates in the profits derived from these IPA’s.
Starting in June 2004, American Progressive, an insurance subsidiary of Universal American, began enrolling members in its private fee-for-service (“PFFS”) product, a Medicare Advantage program that allows its members to have more flexibility in the delivery of their health care services than other Medicare Advantage plans. In addition to premium received from CMS, we receive modest premium payments from the members. Beginning September 1, 2005, we have expanded our PFFS product offering to Medicare eligibles in 258 counties in seven new states. As part of this expansion Pyramid Life, an insurance subsidiary of Universal American, began enrolling members in its PFFS product. As of January 1, 2006, we expanded the PFFS product to an additional 152 counties in six states.
Intra-segment revenues are reported on a gross basis in each of the above components of the Medicare Advantage segment. These intra-segment revenues are eliminated in the consolidation for the segment totals. The eliminations include premiums received by the IPA’s from the Health Plan amounting to $117.7 million for 2005 and $59.1 million for the seven months since the acquisition of Heritage in 2004 and management fees received by the MSO’s from the Health Plan and the IPA’s amounting to $35.2 million for 2005 and $15.6 million for the seven months since the acquisition of Heritage in 2004.
Heritage operates a health plan through SCOT, a provider sponsored organization (“PSO”). SCOT offers Medicare Advantage coordinated care plans operating in Southeastern Texas, including Beaumont and Houston, and receives its premiums primarily from CMS. SCOT makes capitated risk payments to IPA’s or other medical groups in the Houston and Beaumont regions, two of which are affiliated IPA’s. In addition, SCOT retains the risk for certain other types of care, primarily out of area emergency and transplants. As of December 31, 2005, SCOT had 24,834 members enrolled. As of December 31, 2005, SCOK had 98 members enrolled in its special needs plan. During 2005, the health plans had revenues of $217.3 million and reported a medical loss ratio of 82.3%. For the seven months since the acquisition of Heritage in 2004, the health plans had revenues of $90.5 million and reported a medical loss ratio of 83.3%.
Heritage owns three MSO’s that provide comprehensive management services to SCOT and its affiliated IPA’s as part of long-term management agreements. Services provided include strategic planning, provider network services, marketing, finance and accounting, enrollment, claims processing, information systems, utilization review, credentialing and quality management. For 2005, these MSO’s earned $3.8 million of income on $36.0 million of fees collected. For the seven months since the acquisition of Heritage in 2004, these MSO’s earned $1.1 million of income on $15.8 million of fees collected.
Revenues. Net premiums for the Senior Market Health Insurance segment increased by $35.2 million, or 10%, compared to 2004, due to increased retention of our Medicare Supplement business, rate increases and new sales.
The increase in deferred acquisition costs was $1.8 million less for 2005, than the increase for 2004. We experienced higher than expected lapsation in our Medicare Supplement business beginning in the third quarter of 2005. We believe that there are a number of factors contributing to the lapsation, including competitive pressure from other Medicare Supplement companies and Medicare Advantage products, as well as the departure of certain of our sales managers. This excess lapsation required us to accelerate the amortization of the deferred acquisition cost and present value of future profits assets associated with the business that lapsed. The excess lapsation of our Medicare supplement in force resulted in the acceleration of approximately $4.6 million in the amortization of deferred acquisition costs. Excluding the effect of the excess lapsation, the increase in deferred acquisition costs was $2.7 million more for 2005, than for 2004, primarily as a result of higher retained premium and the effect of prospective unlocking resulting from higher than anticipated rate increases and better than anticipated persistency (excluding the lapses incurred from the departure of the sales managers discussed above). As a percentage of premium, the increase in deferred acquisition costs, excluding the effect of the excess lapsation, was 9.1% for 2005 compared to 9.3% for 2004.
The ratio of commissions to gross premiums decreased to 14.3% for 2005, from 15.0% for 2004, as a result of lower overall commission rates associated with the continued growth of our in force renewal premium. Other operating costs as a percentage of gross premiums were 13.5% for 2005, compared to 12.7% for 2004. The increase relates primarily to the $4.8 million of expenses related to the implementation of our Part D program. Commission and expense allowances received from reinsurers as a percentage of the premiums ceded decreased to 20.6% for 2005 from 22.4% for 2004, primarily due to the reduction in new business ceded and the effects of normal lower commission allowances on our aging base of ceded renewal business.
Our Senior Market Health Insurance segment results improved by $7.7 million, or 28%, to $35.4 million in 2004 compared to 2003, primarily as a result of the inclusion of the results of operations of the Pyramid Life business for a full year in 2004 compared to only nine months in 2003 and increased retention of the Medicare Supplement business. We have increased our retention to 100% for all Medicare Supplement business sold as of January 1, 2004.
Revenues. Net premiums for the Senior Market Health Insurance segment increased by $87.3 million, or 33%, compared to 2003. Approximately $28.2 million, or 11%, relates to additional premiums from the Pyramid Life business as a result of the inclusion of the results of operations of the Pyramid Life business for a full year in 2004 compared to only nine months in 2003. $59.1 million, or 22%, is due to growth and increased retention of the Medicare Supplement business
Net investment income increased by approximately $0.8 million, or 25%, compared to 2003. The increase is due primarily to growth in invested assets due to growth in business.
Benefits, Claims and Expenses. Policyholder benefits, including the change in reserves, increased by $61.5 million, or 33%, during 2004 compared to 2003, primarily as a result of the increased retention of the Medicare Supplement business noted above, the effect of a full year of the Pyramid Life operations and a modest increase in loss ratios. Overall loss ratios for the segment increased to 69.2% in 2004 compared to 68.8% in 2003, which accounted for $1.3 million of the increase in benefits. The additional quarter of the Pyramid Life business contributed $19.6 million and the growth and increased retention rate added the balance of $40.6 million to the increase.
The amortization of intangibles relates primarily to intangibles relating to the acquisition of Pyramid Life.
Commissions and general expenses increased by $30.3 million, or 38%, in 2004 compared to 2003. $7.8 million of this increase is due to the inclusion of an additional quarter of the results of operations of the Pyramid Life business and the balance of $22.5 million is due to higher net commission expense due to the growth and increased retention of the Medicare Supplement business. The following table details the components of commission and other operating expenses:
Benefits, Claims and Expenses. Policyholder benefits incurred increased by $5.3 million, or 6%, compared to 2004, primarily as a result of higher loss ratios for our U.S. fixed benefit accident and sickness line, our Canadian business and our long term care line. Overall loss ratios for the segment increased to 69.2% for 2005 compared to 65.7% for 2004.
Commissions and general expenses decreased by $4.0 million, or 7%, in 2005 compared to 2004, primarily as a result of an increase in reinsurance allowances of $2.6 million due to the underwriting fees earned on the new reinsurance arrangement with PharmaCare Re. Commissions for our U.S. fixed benefit accident and sickness line decreased by $2.3 million and commissions for our long term care line decreased by $0.9 million as a result of the decline in premiums for those lines. Commissions for our Canadian business increased by $1.7 million, consistent with the increased sales.
Net investment income decreased by approximately $0.6 million, or 2%, compared to 2003. The decrease is due primarily to a combination of lower yields and a decrease in invested assets, due to the dividend paid by Penncorp Life (Canada) to our parent holding company in early 2004.
Benefits, Claims and Expenses. Policyholder benefits, including the change in reserves, decreased by $0.3 million, or less than 1%, during 2004 compared to 2003, primarily as a result of improved loss ratios. Overall loss ratios for the segment declined to 65.5% in 2004 compared to 67.2% in 2003. During 2004 we recorded a non-recurring reduction in reserves in the amount of U.S. $1.3 million (C$1.8 million) which was identified during a review in connection with a conversion of the actuarial system used to determine reserves on our Canadian policies. Additionally, during 2004, we increased reserves on the runoff block of Florida home healthcare business by $1.4 million as a result of an actuarial study performed on this block.
Commissions and general expenses decreased by $1.2 million, or 2%, in 2004 compared to 2003. Approximately $0.6 million of the decrease relates to reductions in general expenses and the balance relates to lower commission expense as a result of the reduction in new business sold.
Net investment income increased by approximately $2.1 million, or 6%, compared to the 2004, primarily as a result of the increase in policyholder account balances as a result of the additional deposits received as noted above, offset by a decline in yields on the portfolio.
Revenues. Net premiums for the segment increased by $13.9 million, or 39%, compared to 2003. Approximately, $7.1 million of the increase relates to the net business produced by the former Guarantee Reserve field force acquired in mid 2003. Approximately $2.5 million of the increase relates to additional premiums from the Pyramid Life business as a result of inclusion of the results of operations of the Pyramid business for a full year in 2004 compared to only nine months in 2003. The balance relates to increased sales of our senior life product and an increase in policy fees on our interest sensitive life and annuity business as a result of the growth in the level of deposits for those products. Ceded premiums increased by approximately $2.3 million as a result of the Guarantee Reserve business. During 2003, prior to receiving approval to write the business through the insurance subsidiaries of Universal American, 50% of the business was assumed from Swiss Re. As we received the regulatory approvals, we wrote the business through our insurance subsidiaries and ceded 50% back to Swiss Re. The balance of the increase in the ceded premiums relates to the increase in our senior life business.
Our agents sold $72.0 million of fixed annuities during 2004 and $120.7 million in 2003. Annuity deposits are not considered premiums for reporting in accordance with generally accepted accounting principles. The reduction in annuity sales was the result of lower interest crediting rates on policy account balances and a decrease in minimum guaranteed crediting rates on our policies from the rates existing in 2003.
Net investment income increased by approximately $3.5 million, or 11%, compared to 2003. Approximately $4.9 million relates to the increase in policyholder account balances as a result of the additional deposits received as noted above. This was offset by a decline in yields on the portfolio.
Benefits, Claims and Expenses. Policyholder benefits, including the change in reserves, increased by $8.4 million, or 32%, during 2004 compared to 2003, consistent with the increase in premiums. Claims benefits incurred for the segment declined in 2004 compared to 2003, as a result of more favorable mortality. Interest credited increased by $3.7 million, due to the increase in policyholder account balances as a result of continued annuity sales, offset by a reduction in credited rates. In addition, during the fourth quarter of 2004, we recorded approximately $0.3 million in additional benefits on certain replacement annuity policies that we determined contained inappropriate disclosure information to the insured. There is no additional liability to these policyholders.
The increase in deferred acquisition costs was approximately $5.7 million more in 2004, compared to the increase in 2003. This is directly related to the increase in commissions and other acquisition costs related to the new life and annuity business produced during the year. The amortization of intangible assets relates to the present value of the future profits of the life business acquired with Pyramid Life. Commissions and general expenses increased by $9.5 million, or 30%, in 2004 compared to 2003, consistent with the increase in premium.
(1) In addition to segment income, we also evaluate the results of our Senior Administrative Services segment based on earnings before interest, taxes, depreciation and amortization (“EBITDA”). EBITDA is a common alternative measure of performance used by investors, financial analysts and rating agencies. It is also a measure that is included in the fixed charge ratio required by the covenants for our outstanding bank debt. Accordingly, these groups use EBITDA, along with other measures, to estimate the value of a company and evaluate the Company’s ability to meet its debt service requirements. While we consider EBITDA to be an important measure of comparative operating performance, it should not be construed as an alternative to segment income or cash flows from operating activities (as determined in accordance with generally accepted accounting principles).
Segment income for our Senior Administrative Services segment decreased by $3.6 million, or 28%, to $9.4 million compared to 2004, primarily as a result of the $5.9 million of expenses incurred in this segment relating to our implementation of Part D, offset in part by growth in premiums managed.
life insurance business. Unaffiliated service fee revenue increased by $2.0 million compared to 2004, due primarily to an increase of $1.9 million, or 30%, for services for long term care products. General expenses for the segment increased by $6.1 million, or 14%, due to the Part D implementation costs, as well as an increase in business.
Service fee revenue increased by $8.2 million, or 17%, compared to 2003. Affiliated service fee revenue increased by $9.5 million compared to 2003 as a result of the increase in Medicare Supplement business in force at our insurance subsidiaries, including Pyramid, for which CHCS Services began providing service effective January 1, 2004, and fees from the administration of the life insurance products sold by the Guarantee Reserve marketing organization that was acquired in July 2003. Unaffiliated service fee revenue decreased by approximately $1.4 million primarily due to the reduction in the fees from the underwriting work we performed for the consortium that is offering long term care to employees of the Federal government and their families. The initial enrollment period for this program, for which we performed underwriting, began in the third quarter of 2002 and ended during the first quarter of 2003. General expenses for the segment increased by $6.0 million, or 16%, due primarily to the increase in business.
The loss from our Corporate segment increased by $1.4 million, or 12%, in 2005 compared to 2004. The increase was due primarily to higher interest cost as a result of an increase in the amount of the debt outstanding during the year, relating to the amendment of our credit facility in connection with our acquisition of Heritage, and an increase in the weighted average interest rates, as compared to 2004. Our combined outstanding debt was $170.8 million at December 31, 2005 compared to $176.1 million at December 31, 2004. The weighted average interest rate on our loan payable increased to 5.5% for 2005 from 4.1% for 2004. The weighted average interest rate on our other long term debt increased to 7.2% for 2005 from 6.3% for 2004. See “Liquidity and Capital Resources” for additional information regarding our loan payable and other long term debt. The increase in interest cost was offset partially by interest income earned on the proceeds from our equity offering in June 2005.
Additionally, certain of the companies acquired in July 1999 had post-retirement benefit plans in place prior to their acquisition and Universal American maintained the liability for the expected cost of such plans. In October 2000, participants were notified of the termination of the plans in accordance with
their terms. The liability has been reduced as, and to the extent that, it becomes certain that we will incur no liabilities for the plans as a result of the termination. During the fourth quarter of 2005, $1.8 million of the liability was released, compared to a release of $0.6 million in 2004.
The loss from our Corporate segment increased by $1.8 million, or 16%, compared to the 2003. The increase was due to higher interest cost as a result of an increase in the amount of the debt outstanding during the year, relating to the amendment of our credit facility in connection with our acquisition of Heritage, offset in part, by a reduction in the weighted average interest rates, as compared to the same period of 2003. Our combined outstanding debt was $176.1 million at December 31, 2004 compared to $113.2 million at December 31, 2003. The weighted average interest rate on our loan payable decreased to 4.1% for 2004 from 4.5% for 2003. The weighted average interest rate on our other long term debt increased slightly to 6.3% for 2004 from 5.9% for 2003. See “Liquidity and Capital Resources” for additional information regarding our loan payable and other long term debt. In 2003, we reported a $1.8 million charge relating to the early extinguishment of debt that was incurred during the first quarter of 2003 that did not recur in 2004. Other parent company expenses increased as a result of additional expenses from an increase in corporate governance related activities, as well as management bonuses. Additionally, during the fourth quarter of 2004, $0.6 million of the retiree plan termination liability was released compared to a release of $0.4 million in 2003.
future. However, there can be no assurance as to our actual future cash flows or to the continued availability of dividends from our insurance company subsidiaries.
In connection with the acquisition of Heritage on May 28, 2004, the Company amended the Credit Agreement by increasing the facility to $120 million from $80 million (the “Amended Credit Agreement”), including an increase in the term loan portion to $105 million from $36.4 million (the balance outstanding at May 28, 2004) and maintaining the $15 million revolving loan facility. None of the revolving loan facility was drawn as of December 31, 2005. Under the Amended Credit Agreement, the spread over LIBOR was reduced to 225 basis points from 275 basis points. Effective January 1, 2006, the interest rate on the term loan was 6.6%. Principal repayments are scheduled at $5.3 million per year over a five-year period with a final payment of $80.1 million due upon maturity on March 31, 2009.
The obligations of the Company under the Amended Credit Facility are guaranteed by our subsidiaries, CHCS Services Inc., WorldNet Services Corp., Quincy Coverage Corporation, Universal American Financial Services, Inc., Heritage, HHS-HPN Network, Inc., Heritage Health Systems of Texas, Inc., PSO Management of Texas, LLC, HHS Texas Management, Inc. and HHS Texas Management LP (collectively the “Guarantors”) and secured by substantially all of the assets of each of the Guarantors. In addition, as security for the performance by the Company of its obligations under the Amended Credit Facility, the Company, CHCS Services Inc., WorldNet Services Corp., Heritage and HHS Texas Management, Inc., have each pledged and assigned substantially all of their respective securities (but not more than 65% of the issued and outstanding shares of voting stock of any foreign subsidiary), all of their respective limited liability company and partnership interests, all of their respective rights, title and interest under any service or management contract entered into between or among any of their respective subsidiaries and all proceeds of any and all of the foregoing.
The following table shows the schedule of principal payments (in thousands) remaining on our Amended Credit Agreement, with the final payment in March 2009:
We are obligated under certain lease arrangements for our executive and administrative offices in New York, Florida, Indiana, Texas, and Ontario, Canada. Rent expense was $4.2 million for the year ended December 31, 2005, $3.0 million for 2004 and $2.4 million for 2003. Annual minimum rental commitments, subject to escalation, under non-cancelable operating leases (in thousands) are as follows:
In addition to the above, Pennsylvania Life and Penncorp Life (Canada) are the named lessees on 69 properties occupied by Career Agents for use as field offices. The Career Agents reimburse Pennsylvania Life and Penncorp Life (Canada) the actual rent for these field offices. The total annual rent paid by the Company and reimbursed by the Career Agents for these field offices during 2005 was approximately $1.7 million.
We anticipate funding the obligations of the parent company and the capital required to grow our business from the four distinct and uncorrelated sources of cash flow within the organization as follows:
· the expected cash flows of our senior administrative services company;
· the expected cash flows of our senior managed care company (acquired in the acquisition of Heritage);
In addition, we have access to the $15.0 million available under the revolving portion of our credit facility. Finally, we have the ability, from time to time, to access the capital markets for additional capital.
Insurance Subsidiaries-Surplus Note, Dividends and Capital Contributions.Cash generated by our insurance company subsidiaries will be made available to our holding company, principally through periodic payments of principal and interest on the surplus note owed to our holding company by our subsidiary, American Exchange Life. As of December 31, 2005, the principal amount of the surplus note was $40.1 million. The note bears interest to our parent holding company at LIBOR plus 325 basis points. We anticipate 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 that are wholly owned by American Exchange and file a consolidated Federal income tax return. American Exchange made principal payments totaling $8.4 million during the year ended December 31, 2005 and payments totaling $11.6 million during the year ended December 31, 2004. No principal payments were made during 2003. American Exchange paid interest on the surplus note of $2.6 million during the year ended December 31, 2005, $2.4 million in 2004, and $2.8 million in 2003.
During the year ended December 31, 2003, no dividends were declared or paid by the U.S. insurance company subsidiaries to American Exchange. During 2003, American Exchange received capital contributions from its parent totaling $35.5 million. American Exchange made capital contributions of $27.0 million to Pennsylvania Life, primarily relating to the acquisition of Pyramid Life, $2.5 million to American Pioneer, $3.5 million to American Progressive and $2.5 million to Union Bankers. Pennsylvania Life contributed $1.0 million to Pyramid Life in 2003.
Dividend payments by our U.S. insurance companies to our holding company or to intermediate subsidiaries are limited by, or subject to the approval of the insurance regulatory authorities of each insurance company’s state of domicile. Such dividend requirements and approval processes vary significantly from state to state. Pennsylvania Life is able to pay ordinary dividends of up to $9.8 million to American Exchange during 2006, without prior approval.
Liquidity is also affected by unscheduled benefit payments including benefits under accident and health insurance policies, death benefits and interest-sensitive policy surrenders and withdrawals.
Our accident and health insurance policies generally provide for fixed-benefit amounts and, in the case of Medicare Supplement policies, for supplemental payments to Medicare provider rates. Some of
The net yields on our cash and invested assets decreased to 5.0% for the year ended December 31, 2005, from 4.9% for 2004 and 5.3% for 2003. A 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 us 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.
Our domestic insurance subsidiaries are required to maintain minimum amounts of statutory capital and surplus as required by regulatory authorities. However, substantially more than the statutory minimum amounts are needed to meet statutory and administrative requirements of adequate capital and surplus to support the current level of our insurance subsidiaries’ operations. Each of our insurance subsidiaries’ statutory capital and surplus exceeds its respective minimum statutory requirement at levels we believe are sufficient to support their current levels of operation. Additionally, the National Association of Insurance Commissioners (“NAIC”) imposes regulatory risk-based capital (“RBC”) requirements on life insurance enterprises. At December 31, 2005, all of our insurance subsidiaries maintained ratios of total adjusted capital to RBC in excess of the “authorized control level”. The combined statutory capital and surplus, including asset valuation reserve, of our U.S. insurance subsidiaries totaled $158.4 million at December 31, 2005 and $127.9 million at December 31, 2004. For the year ended December 31, 2005, our U.S. insurance subsidiaries generated a statutory net loss of $1.8 million. Our U.S. insurance companies generated statutory net income of $5.4 million for the year ended December 31, 2004 and $0.6 million for the year ended December 31, 2003.
statutory capital and surplus of each of our health plan affiliates exceeds its minimum requirement and its RBC is in excess of the “authorized control level”. The statutory capital and surplus for our health plan affiliates was $23.0 million at December 31, 2005 and $9.9 million at December 31, 2004. Statutory net income for our health plan affiliates was $9.6 million for the year ended December 31, 2005 and $5.5 million for the year ended December 31, 2004.
As of December 31, 2005, approximately 99% of our fixed maturity investments had investment grade ratings from Standard & Poor’s Corporation or Moody’s Investor Service. There were no non-income producing fixed maturities as of December 31, 2005. During the years ended December 31, 2005 and 2004, we did not write down the value of any fixed maturity securities. We wrote down the value of certain fixed maturity securities, considered to have been subject to an other-than-temporary decline in value, by $1.3 million during 2003. In each case, these write-downs represent our estimate of other than temporary declines in value and were included in net realized gains on investments in our consolidated statements of operations.
We file a consolidated return for Federal income tax purposes that includes all of the non-life insurance company subsidiaries, including Heritage. American Progressive was included in the consolidated return through March 31, 2002 and American Pioneer was included through June 30, 2002. American Exchange and its subsidiaries and Penncorp Life (Canada) are not currently included. American Exchange and its subsidiaries, including American Progressive since April 1, 2002 and American Pioneer since July 1, 2002, filed a separate consolidated Federal return. Penncorp Life (Canada) files a separate return with the Canada Revenue Agency.
during 2005 and 2006 from an insurance company that has a PSA will be treated as a distribution from its PSA account. However, the distribution will not be subject to Federal income tax. As of December 31, 2005, we had $20.2 million of PSA balances and have accrued $7.1 million in deferred tax liabilities corresponding to those balances. The Jobs Creation Tax Act of 2004 provides the mechanism to eliminate this potential tax without the imposition of any tax payment. Although, we have received the pre-approval of the Insurance Departments of the respective companies for the transactions required to trigger the elimination of the potential tax, such distributions had not been made as of December 31, 2005.