You should read the following discussion and analysis of our financial condition and results of operations in conjunction with our audited financial statements and related notes included in this report. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those discussed below and elsewhere in this report, particularly in Items 1 and 1A of this report.
KMG America is a holding company incorporated under the laws of the Commonwealth of Virginia on January 21, 2004. We commenced our operations shortly before we completed our initial public offering of common stock on December 21, 2004, and our shares trade on the New York Stock Exchange under the symbol “KMA.” Concurrently with the completion of our initial public offering, we completed our acquisition of Kanawha and its subsidiaries, which are our primary operating subsidiaries and which underwrite and sell life and health insurance products.
Worksite insurance business. Our worksite insurance business is a provider of life and health insurance products to employers and their employees. Our predecessor's marketing and sales efforts were primarily in the southeastern United States, predominately in Florida, South Carolina and North Carolina. Since acquiring our predecessor, we have begun to implement our business strategy to market our products nationwide. The primary insurance products that we underwrite include: life insurance; short-term disability insurance; dental insurance; indemnity health insurance; critical illness insurance; and employer excess risk insurance. For the year ended December 31, 2006, our worksite insurance business produced premiums, commissions and fees, excluding
intercompany payments, of $83.8 million, which accounted for 58.0% of our premiums, commissions and fees, excluding intercompany payments in that period. Our business strategy is to operate our existing worksite insurance business efficiently while developing a new worksite marketing and distribution organization that targets larger employer groups nationwide with an expanded variety of life and health insurance products which have added a new set of employer-paid life insurance, disability and health products to our existing voluntary products. Since December 2004, we have opened sales offices hosting regional sales managers in Boston, Massachusetts and Irvine, California, a Los Angeles suburb and we have opened regional sales offices in Tampa, Florida; Chicago, Illinois; Morristown, New Jersey; Atlanta, Georgia; Dallas, Texas; Kansas City, Missouri; Cleveland, Ohio; Philadelphia, Pennsylvania; New Orleans, Louisiana; San Diego and San Francisco, California; Phoenix, Arizona; Denver, Colorado; and Minneapolis, Minnesota. We will base future expansion of our sales organization on developing market trends and our profit margins. The costs associated with any expansion of our sales organization will be recognized before we recognize revenues resulting from new sales activity. Consequently, we expect negative cash flow and operating losses in the short term.
Effective January 1, 2006, we ceased actively underwriting long-term care insurance policies. Significant factors that contributed to our decision to cease actively underwriting long-term care insurance policies include, among others: (1) sales for this business were significantly lower than originally projected; and (2) the lack of strategic fit between the underwriting and distribution of long-term care products and our current strategy of focusing on worksite marketing of life and health insurance products. We intend to retain and actively manage the existing block of in-force long-term care insurance policies (including the right to receive future premiums and the liability for future claims).
Third-party administration business. Our third-party administration business provides a wide range of insurance product administration, claims handling, eligibility administration, call center and support services. This business primarily administers the insurance plans offered by our worksite insurance business and senior market insurance business. Our third-party administration business also provides administrative and managed care services to third parties, such as employers with self-funded health care plans, other insurance carriers, reinsurers and managed care plans. For the year ended December 31, 2006, our third-party administration business produced commissions and fees, excluding intercompany payments, of $16.1 million, which accounted for 11.2% of our premiums, commissions and fees, excluding intercompany payments, in that period. Our primary business strategy for this business is to grow this business as it administers the increasing volume of policies and products that we anticipate will be sold by the worksite insurance business as we attempt to grow that business. In addition, as our national worksite marketing business develops, we intend to opportunistically market our third-party administration services to self-insured plans, stop loss insurers, pharmacy benefit organizations, managed care service providers, other insurance carriers and reinsurers nationwide. It is expected that any incremental costs associated with this expanded marketing will be modest and will be funded out of the operations of our third-party administration business.
We expect to realize earnings from our investment portfolio. Insurance companies in both the life and health and property and casualty insurance industries earn profits on the investment float, which reflects the investment income earned on the premiums paid to the insurer between the time of receipt and the time benefits are paid-out under the policy. Volatility in the capital markets, changes in interest rates and changes in economic conditions can all impact the amount of earnings that we will realize from our investment portfolio.
Described below are some of the significant recent events and trends affecting the life and health insurance industry and the possible effects they may have on our operations in the future.
The worksite insurance industry is increasingly focused on integration, coordination and simplification of products and services. Human resource departments often have limited resources with which to address the significant administrative complexity associated with many worksite insurance products. Our technology based administrative solutions and coordination of sales and service of voluntary group insurance products are designed to address these issues.
Some life and health insurance companies have suffered significant reductions in capital and will have to improve their capital adequacy ratios to support their business or divest a portion of their business. We expect these trends to have a positive impact on our competitive position in the industry as carriers become more disciplined with product pricing and/or exit markets or product lines in which we will compete.
We have observed that our earnings in the first and second quarters of our fiscal year are typically less than our earnings in the third and fourth quarters of our fiscal year. This seasonality is due, in part, to the fact that a majority of our outstanding long term care insurance policies have anniversary dates in the first half of the fiscal year, and policy reserve increases, (which are reflected as an expense on our statement of operations) are made as of the policy anniversary date. We expect that this seasonality effect will diminish as our long term care policies become a smaller portion of our total liabilities, although we anticipate this seasonality effect will occur again in 2007. Also contributing to the seasonality effect is that more of our voluntary benefit sales occur in the second half of our fiscal year, which increases our revenue for that period. This seasonality effect is due, in large part, to a significant number of employers offering their employees open enrollment for benefits purchases during the last half of the calendar year.
Pricing in the medical excess risk insurance market has proven to be cyclical, with periods of competitively lower pricing and periods of competitively higher pricing. Over the past two years, we have experienced a cycle where the market is offering this product line at competitively low prices. In order to compete in the market, we must consider offering our medical excess risk insurance product at lower prices, which may
reduce our profit margins. We have seen evidence of the excess risk insurance market firming over the past few quarters, which suggests a developing trend towards higher competitive pricing for this product line.
We consider the following accounting policies to be critical due to the amount of judgment and uncertainty inherent in the application of these policies. In calculating financial statement estimates, the use of different assumptions could produce materially different estimates. In addition, if factors such as those described in Item 1A of this report cause actual events to differ from the assumptions used in applying the accounting policies and calculating financial estimates, our business, results of operations, financial condition and liquidity could be materially adversely affected.
Expenses. Our expenses primarily consist of policyholder benefits, insurance commissions, premium taxes, licenses, fees, amortization of deferred acquisition costs, or DAC, and value of business acquired, or VOBA, and general insurance operating expenses.
Loss recognition testing of our policy benefit reserves is performed annually. This testing involves a comparison of our actual net liability position (all liabilities less DAC and VOBA) to the present value of future net cash flows calculated using then-current assumptions. These assumptions are based on our best estimate of future experience. To the extent a premium deficiency exists, it would be recognized immediately by a charge to the statement of operations and a corresponding reduction in DAC or VOBA. Any additional deficiency would be recognized as a premium deficiency reserve. Historically, loss recognition testing has not resulted in an adjustment to DAC or reserves. These adjustments would occur only if economic, mortality and/or morbidity conditions significantly deviated from the underlying assumptions.
Deferred Acquisition Costs. The costs of acquiring new business that vary with and are primarily related to the production of new business have been deferred to the extent that these costs are deemed recoverable from future premiums or gross profits and are amortized into income as discussed below. Acquisition costs primarily consist of commissions, policy issuance expenses and some direct marketing expenses.
A premium deficiency is recognized immediately by a charge to the statement of operations as a reduction of DAC to the extent that future policy premiums, including anticipated interest income, are not adequate to recover all DAC and related claims, benefits and expenses. If the premium deficiency is greater than unamortized DAC, a liability will be accrued for the excess deficiency.
Value of Business Acquired. VOBA is the value assigned to the insurance in force of acquired insurance companies or blocks of business at the date of acquisition. The amortization of VOBA is recognized using amortization schedules established at the time of the acquisitions based upon expected patterns of premiums, mortality, policy lapses, and morbidity as adjusted to take into account variances between expected and actual costs. VOBA is amortized over the expected life of the underlying business reinsured (or acquired).
Under our assumptions as of December 31, 2006, we estimate that the amortization of VOBA, for the next five years will be as follows:
If actual lapse and mortality experience is higher or lower than assumed for the table above, then actual amortization will be faster or slower, respectively, than indicated in the table.
Changes in individual security values are monitored on a monthly basis in order to identify potential problem credits. In addition, pursuant to our impairment testing process, each month the portfolio holdings are reviewed with additional screening for securities whose market price is equal to 80% or less of their original purchase price. Management then makes an assessment as to which of these securities are other than temporarily impaired. Assessment factors include, but are not limited to, the financial condition and rating of the issuer, any collateral held and the length of time the market value of the security has been below cost. Each month the watch list is distributed to our investment committee and the outside investment managers, and discussions are held as needed in order to make any impairment decisions. Each quarter any security deemed to have been other than temporarily impaired is written down to its then current market value, with the amount of the write-down reflected in the statement of operations for that quarter. Previously impaired issues are also monitored monthly, with additional write-downs taken quarterly if necessary.
individuals. The level of operating earnings reported in any period during the reporting period for our senior market insurance business generally depended on growth in underwritten business, business mix, risk concentration, the ability to adjust premium rates, persistency of business in force, benefit payouts and administrative expenses incurred. Revenues were generated primarily from new and renewal premiums. As a result of our decision to cease actively underwriting long-term care insurance after December 31, 2005, operating earnings from this business segment will be dependent on our ability to adjust premium rates, persistency of business in force, benefit payouts and administrative expenses incurred. Revenues will be generated primarily from renewal premiums.
Direct Premiums: Direct premiums represent premiums on insurance products written and issued by us.
Insurance taxes, licenses and fees: Insurance taxes, licenses and fees are primarily comprised of employment taxes, premium taxes and various filing fees required by the jurisdictions in which we do business.
Net premiums: Net premiums represent the sum of direct premiums and assumed premiums, less ceded premiums.
New premiums: New premiums represent premiums collected within the first twelve months following the initial policy date.
Policyholder benefits: Policyholder benefits consist of the policy benefit claims paid to policyholders and the increase or decrease in benefit reserves. The primary factors affecting policyholder benefits are premium growth, claims experience and reserve assumptions including persistency, morbidity, mortality and interest rates.
The following represents a summary of our and our predecessor’s statement of operations and asset composition by reportable segment. Except as noted, the financial statement information of the Predecessor set forth below is reported on a historical basis without GAAP purchase accounting adjustments reflecting the acquisition of the predecessor.
The result of the reallocation of reserves between business segments was to strengthen reserves by $37.5 million in the senior market insurance business segment. This was offset by a reduction in reserves of $31.2 million in the acquired business segment and $6.3 million in the worksite segment. No material effect to overall policy reserves or to earnings results from the reallocation. Subsequent reserve adequacy testing of policy reserves by segment indicates that the resulting alignment of reserves is sufficient in each segment.
This reallocation of reserves between business segments does impact the comparability of the current reported policyholder benefits and the resulting reported benefit ratios by segment.
(1) KMG America at December 31, 2004, adjusted for purchase accounting adjustments to reflect the Kanawha acquisition.
Revenues. Total revenues for the year ended December 31, 2006, increased $27.7 million, or 18.1%, to $181.1 million from total revenues of $153.4 million in 2005. The primary factors causing the fluctuations are explained below under the captions “Premiums,” “Net Investment Income” “Commission and Fee Income” “Realized Investment Gains and Losses” and “Other Income”.
Premiums. The following table presents the distribution of premiums by type and business segment.
Senior market net new premiums decreased $0.5 million, or 62.5%, to $0.3 million for the year ended December 31, 2006, from $0.8 million for the year ended December 31, 2005 due to decreased sales volumes as the Company effective December 31, 2005, ceased actively underwriting new long term care policies. Sales in 2006 result from business submitted prior to December 31, 2005 and issued in 2006, as well as the exercise of guaranteed purchase options on in force policies. Net renewal premiums decreased $ 0.2 million, or 0.5% to $41.2 million for the year ended December 31, 2006, from $41.4 million for the year ended December 31, 2005. This business represents the insurance in force created by prior year sales.
Acquired business premiums decreased $1.4 million, or 34.1%, to $2.7 million for the year ended December 31, 2006 from $4.1 million for the year ended December 31, 2005. We have not acquired any blocks of business in this segment since 1999 and the decline is a result of policy lapses.
Net Investment Income. Net investment income increased $2.2 million, or 7.9%, to $29.9 million in the year ended December 31, 2006, from $27.7 million in the year ended December 31, 2005. Net investment income is primarily affected by changes in levels of invested assets and interest rates. The increase in investment income in 2006 occurred primarily as a result of investing in longer term securities in combination with higher interest rates in 2006. Cash and invested assets on an amortized cost basis increased $7.3 million, or 1.3%, to $590.9 million as of December 31, 2006, from $583.6 million as of December 31, 2005. Generally, an increase in invested assets is due to retention of premiums to establish policy reserves for the payment of future policyholder benefits.
Commission and Fee Income. Commission and fee income increased $1.9 million, or 13.0%, to $16.5 million for the year ended December 31, 2006, from $14.6 million for the year ended December 31, 2005. Most of the commission and fee income was from administrative fees relating to third-party administration. The increase was due to an increase in business in force resulting from increased sales of our administrative services.
Gain on extinguishment of debt. In the fourth quarter of 2006 the Company realized a $1.0 million gain on the payoff of its subordinated promissory note to the former owners of Kanawha.
Benefits and Expenses. Total benefits and expenses increased $23.2 million, or 15.8 %, to $170.0 million in the year ended December 31, 2006, from $146.8 million in the year ended December 31, 2005. The primary factors causing this increase are explained below under the captions “Policyholder Benefits”, “Insurance Commissions”, “General Insurance Expenses”, “Insurance Taxes, Licenses and Fees” and “Amortization of DAC and VOBA.”
Worksite marketing policyholder benefits increased $12.1 million, or 27.8%, to $55.7 million for the year ended December 31, 2006, from $43.6 million for the year ended December 31, 2005. This produced a benefits to premium ratios of 66.4% for the year ended December 31, 2006, compared to 72.0% for the year ended December 31, 2005. The 2006 ratio is impacted by the $6.3 million conversion adjustment to PGAAP seriatim reserve factors from the aggregate method which was completed as of June 30, 2006 , and resulted in decreased benefits coupled with an increase in new premiums with more favorable benefit ratios. The 2006 benefits to premium ratio excluding the reserve conversion impact would be 73.9%. The unfavorable benefit experience in the worksite segment is driven by a few factors. The Company increased loss reserves on its stop loss cases by $2.0 million in the fourth quarter of 2006 related to the continued transition from formula reserving to actual claims experience as claims associated with cases written in 2005 and early 2006 continue to exceed pricing expectations. The Company had also recognized additional loss reserves of $0.9 million in the third quarter of 2006. Volatility, both favorable and unfavorable, is not uncommon in small, growing books of business. Cases giving rise to these excess claims have since been re- priced or did not renew.
Acquired business policyholder benefits decreased $29.9 million to $(24.5) million for the year ended December 31, 2006, from $5.4 million for the year ended December 31, 2005. This produced benefits to premium ratios of (913.5)% for the year ended December 31, 2006, compared to 130.5% for the year ended December 31, 2005. The 2006 ratio is impacted by the $31.2 million conversion adjustment to PGAAP seriatim reserve factors from the aggregate method which was completed as of June 30, 2006, and resulted in decreased benefits. Also, coupled with this is the fact that these benefits to premium ratios are impacted by large portions of the acquired business that are no longer premium paying with substantial reserves and investment income on reserves. The 2006 benefits to premium ratio excluding the reserve conversion impact would be 248.9%.
General Insurance Expenses. General insurance expenses increased $3.5 million, or 8.4%, to $45.4 million in the year ended December 31, 2006, from $41.9 million in the year ended December 31, 2005. The increased expenses in the year ended December 31, 2006, are primarily attributable to increases in salaries and related benefits due to the additional staff associated with our continuing expansion to a national insurance company, including the addition of management and marketing personnel. Also, there was the recognition of employee and director stock option and common stock expense of $1.4 million as a result of the adoption of SFAS123(R) - Share Based Compensation. Fourth quarter 2006 expenses include a one-time pretax benefit of $1.0 million related to the discount associated with retiring and replacing the Company's $15 million subordinated note with bank debt.
Insurance Taxes, Licenses and Fees. Insurance taxes, licenses and fees increased $0.6 million, or 12.8%, to $5.3 million in the year ended December 31, 2006 from $4.7 million in the year ended December 31, 2005. The increase is driven by employment taxes related to additional staffing and additional premium taxes due to the increased premiums primarily as a result of new business in the worksite segment.
Amortization of DAC and VOBA. First year commissions and general insurance expenses associated with the acquisition of new business are deferred and amortized over the premium-paying period of the related policies. The total deferrals of policy acquisition costs were $15.6 million and $15.0 million for the years ended December 31, 2006 and 2005, respectively. The increase in deferrals was primarily due to the increase in net new premiums and the associated increase in commissions and expenses in the worksite segment somewhat offset by the decrease in net new long-term care premiums in the senior segment.
The amortization of deferred acquisition costs (“DAC”) and the value of business acquired (“VOBA”) increased $0.6 million, or 17.1%, to $4.1 million for the year ended December 31, 2006, from $3.5 million for the year ended December 31, 2005. The DAC balance at December 31, 2006 has increased by $14.5 million, or 103.6%, over the balance at December 31, 2005. This is due to the fact that our predecessor’s DAC balance was eliminated at December 31, 2004, when the acquisition was completed. Therefore, as of December 31, 2005 there was only one year of deferrals compared to two years of deferrals as of December 31, 2006. The increase in the DAC balance accounts for the related increase in amortization expense.
sales decreased $1.7 million, or 53.1%, to $1.5 million in the year ended December 31, 2005, from $3.2 million in the year ended December 31, 2004. A sales decline that began in mid-2003, resulting from the discontinuance of an older product and the introduction of a new product with significantly higher premiums, continued into 2005. In addition, decisions were made to no longer actively underwrite long term care insurance policies after December 31, 2005 and to close our primary long term care distribution office in October, 2005. We intend to retain and actively manage the existing in force block of long term care. Net renewal premiums increased $0.9 million, or 2.2%, due to the increased amount of insurance in force created by prior year sales. This increase is reflected in both the direct renewal premiums and the ceded renewal premiums.
Net Investment Income. Net investment income increased $2.5 million, or 9.9%, to $27.7 million in the year ended December 31, 2005, from $25.2 million in the year ended December 31, 2004. Net investment income for 2004 was negatively impacted by a non-recurring $1.6 million incentive payment to one of Kanawha’s outside investment managers at the conclusion of the contract period. Excluding this item, net investment income increased $0.9 million in the year ended December 31, 2005. Net investment income is primarily affected by changes in levels of invested assets and interest rates. The increase in investment income in 2005 occurred as a result of an increase in total cash and investments of approximately $58.0 million that occurred in conjunction with the completion of our initial public offering on December 21, 2004. These proceeds were held in short term investments or cash equivalents for the majority of 2005, which produced lower effective yields for that portion of the portfolio. Invested assets increased by $82.2 million or 17.8%, to $543.3 million as of December 31, 2005, from $461.1 million as of December 31, 2004, reflecting the investment of cash generated by 2004 asset sales and our initial public offering. Generally, increases in cash and invested assets are due to retention of premiums to establish policy reserves for the payment of future policyholder benefits.
In conjunction with the application of GAAP purchase accounting requirements, assets attributed to the worksite insurance business, the senior insurance business and the acquired business all increased at December 31, 2004. For 2005, total assets attributed to the worksite insurance business have not experienced any significant fluctuations. Total assets attributed to the senior market insurance business have increased significantly due to the accumulation of long-term care insurance premiums retained to establish policy reserves for the payment of future policyholder benefits. Assets attributed to the third-party administration business consist primarily of operating cash and receivables with respect to administrative claims payments awaiting settlement. These assets are subject to significant variations due to timing of payments made, and there is no investment income attributed to them. Assets attributed to the acquired business have declined since 1999 as a result of policy lapses and the fact that no blocks of business have been acquired since 1999. Assets attributed to the corporate and other segment are subject to significant fluctuations because changes in unrealized gains are all allocated to the corporate and other segment.
Commission and Fee Income. Commission and fee income increased $1.1 million, or 8.1%, to $14.6 million for the year ended December 31, 2005, from $13.5 million for the year ended December 31, 2004. Most of the commission and fee income was from administrative fees relating to third-party administration. The increase was due to an increase in business in force resulting from increased sales of our administrative services.
Realized Investment Gains and Losses. Realized investment gains and losses occur as a result of the sale or impairment of investments. The net realized investment gain in the year ended December 31, 2005 decreased by $9.0 million to $0.4 million from $9.4 million in the year ended December 31, 2004. The net gain realized on fixed maturity securities in the year ended December 31, 2005, totaled $0.1million compared to a net gain realized on fixed maturity securities of $7.1 million in the year ended December 31, 2004. In 2004, our predecessor’s investment committee elected to take advantage of favorable market conditions for fixed maturity securities by
Benefits and Expenses. Total benefits and expenses increased $2.5 million, or 1.7%, to $146.8 million in the year ended December 31, 2005, from $144.3 million in the year ended December 31, 2004. The primary factors causing this increase are explained below under the captions “Policyholder Benefits”, “Insurance Commissions”, “General Insurance Expenses”, “Insurance Taxes, Licenses and Fees” and “Amortization of DAC and VOBA.”
Policyholder Benefits. Policyholder benefits decreased $5.9 million, or 6.5 %, to $84.3 million in the year ended December 31, 2005, from $90.2 million in the year ended December 31, 2004. This produced a benefits to premium ratio of 78.9% in 2005 compared to 87.7% in 2004. The benefits to premium ratio declined primarily as a result of the GAAP purchase accounting adjustments described in the next three paragraphs.
The amortization of DAC and VOBA decreased $6.0 million, or 63.2%, to $3.5 million for the year ended December 31, 2005, from $9.5 million for the year ended December 31, 2004. In accordance with GAAP purchase accounting requirements, our predecessor’s DAC and VOBA were eliminated, and a new VOBA was established for the value of the in-force business as of December 31, 2004. This adjustment resulted in decreased DAC and VOBA balances, which cause smaller amortization charges going forward.
Provision for Income Taxes. Total income taxes may differ from the amount computed by applying the federal corporate tax rate of 35% due to tax-advantaged investments and net operating loss carry forwards available. The effective income tax rates for the years ended December 31, 2005, and 2004 were 32.2% and 36.5%, respectively. The variations in these rates is due to the fact that a portion of our consolidated income for the year ended December 31, 2005 resulted from a subsidiary that has net operating loss carry forwards available. Due to the uncertainty of using these net operating losses, a valuation allowance had been established offsetting the deferred tax asset; therefore, the tax on the net income from this subsidiary has been offset by the release of the associated valuation allowance, which reduces the effective tax rate for the consolidated company.
The following table shows the carrying value of our investments by type of security as of the dates indicated.
Of the fixed maturity securities shown above, 77.3% and 77.6% (based on total carrying value), were invested in securities rated “A” or better as of December 31, 2006, and 2005, respectively.
Unrealized losses were reviewed for other than temporary impairment in conjunction with our investment policies. Impairment charges of $0.0 million and $0.2 million were taken in 2006 and 2005, respectively.
length of time and the extent to which the market value of the security has been below amortized cost;
when the issuer is experiencing significant financial difficulties, a review of all securities of the issuer, including its known subsidiaries and affiliates;
conditions of the industry sector or subsector in which the issuer operates;
growth in the underlying business, with the majority of the reserve growth being accumulated from long-term care renewal premiums received as well as the conversion to PGAAP seriatim reserves (refer to Note 16 - Business Segments, of the Notes to Consolidated Financial Statements included in this report, which is incorporated herein by reference for further explanation).
Policyholder dividends are recognized over the term of the related policies. Participating business represents approximately 30% and 30%, respectively, of the Company’s total ordinary life insurance in force at December 31, 2006, and 2005. Dividends paid to policyholders in 2006, 2005, and 2004 were approximately $1.5 million, $2.1 million and $2.2 million, respectively. Participating premiums as a percentage of direct life premiums were 39% in 2006, 46% in 2005, and 51% in 2004.
Reinsurance recoverables increased by $10.8 million, or 13.8 %, to $89.1 million as of December 31, 2006, from $78.3 million as of December 31, 2005. The increase in the recoverable balance is attributable to underlying business growth, specifically the growth in long-term care and excess risk business reinsured.
Under indemnity reinsurance transactions in which we are the ceding insurer, we remain liable for policy claims if the assuming company fails to meet its obligations. In the event one or more assuming companies were to default on its obligations, it could have an adverse effect on our business, results of operations and financial condition. To limit this risk, we have implemented procedures to evaluate the financial condition of reinsurers and to
The credit agreement requires the Company to comply with certain covenants, including, among others, maintaining a maximum ratio of consolidated indebtedness to total capitalization, a minimum available dividend amount for Kanawha and a minimum A.M. Best financial strength rating of B++ for Kanawha. The Company must also comply with limitations on certain payments, additional debt obligations, dispositions of assets and its lines of business. The credit agreement also restricts the Company from creating or allowing certain liens on its assets and from making certain investments.
While our primary focus is organic growth of our existing businesses by expanding our product and marketing capabilities, we do evaluate opportunities to grow through strategic alliances and acquisitions of blocks of business and/or companies that are compatible with our core businesses. If such opportunities arise we may make significant capital expenditures or acquisitions in 2007 or subsequent years. However, our primary focus is on significantly expanding outlays relating to marketing and sales activities over the next several years including outlays required to continue to build a national sales organization, which is a key component of our strategy. These outlays will include expenses such as salaries and cash incentive compensation, employee benefits, occupancy and information technology expenses of additional sales personnel, advertising and marketing costs, consulting and recruiting. The execution of our business plan will require additional outlays associated with the development of a national insurance company including home office expenses for executive management and additional financial,
actuarial and underwriting personnel, infrastructure development and back-office expenses, as well as costs associated with our being a public company.
Cash Flows for the Years Ended December 31, 2006, 2005 and 2004. In the table shown above, increases in net cash provided by operating activities generally result from collected premiums while decreases in net cash flow provided by investing activities generally are a result of the investment of collected premiums. Policy and contract liabilities increase when premiums collected are retained to establish policy reserves. The portions of these liabilities that are reinsured by reinsurance companies are reflected in reinsurance balances recoverable.
Other changes in cash flows for the years ended December 31, 2006, 2005, and 2004 are as follows:
2006: We held approximately $32.6 million in cash and cash equivalents at December 31, 2005, primarily consisting of investments in short term commercial paper. We invested a significant portion of this in longer term securities during 2006, resulting in the net cash outflow from investing activities of $24.9 million for the year ended December 31, 2006. This produced a corresponding increase in invested assets.
Excluding the offset to other comprehensive income for the adoption of SFAS158, other assets increased by $4.7 million in 2006, primarily as a result of claims reimbursements due from self funded Administrative Services Only (“ASO”) clients increasing $3.4 million. These claims are not actually disbursed until receipt of these funds, so there is nothing at risk with these assets, and fluctuations from day to day are typical. The balance of the increase in other assets can be attributed to an increase in uncollected premiums of $1.3 million due primarily to the timing of reinsurance settlements.
Accounts payable and accrued expenses increased by $1.3 million in 2005, primarily due to a $1.6 million increase in reinsurance settlements due to the acquired business.
Federal income tax recoverable increased by $0.9 million in 2005 as a result of losses incurred in Kanawha that will be carried back to prior years. The deferred tax asset increased by $5.8 million and the deferred tax liability increased by $6.6 million. The combination of the three items results in a net decrease in tax liabilities of $0.1 million, inclusive of a decrease of $2.7 million related to the decrease in fair market value of invested assets.
The liability for benefits for employees and agents decreased by $2.1 million in 2004 as the result of payments for accrued pension plan contributions of $3.1 million. The remaining increase is attributable to additional pension plan liability accruals of $1.2 million established to fund future payments under the pension plan.
In 2004, our predecessor had realized gains of $9.4 million primarily due to its decision to sell its convertible bond portfolio and the majority of its equity securities.
We have obligations and commitments to third parties as a result of our operations. These obligations and commitments, as of December 31, 2006, are detailed in the following table:
The development of these anticipated payments by period entailed the use of actuarial projections of expected future benefits and expected future net premiums from current in force business.
Consolidated Statements of Shareholders’ Equity for KMG America Corporation for the period January 21, 2004 (inception) through December 31, 2004, and for the years ended December 31, 2005 and 2006, and for the Predecessor for the year ended December 31, 2004
REPORT OF MANAGEMENT ON THE CONSOLIDATED FINANCIAL STATEMENTS AND MANAGEMENT’S ASSESSMENT OF INTERNAL CONTROL OVER FINANCIAL REPORTING
The management of KMG America Corporation (“KMG”) is responsible for the preparation, integrity and fair presentation of Consolidated Financial Statements of KMG and for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13(a) - 15(f). The accompanying Consolidated Financial Statements, including Notes to Financial Statements, have been prepared by management in accordance with U.S. generally accepted accounting principles (GAAP), and reflect management’s estimates and judgments, the use of which are inherent in the preparation of financial statements. In the opinion of management, the accompanying Consolidated Financial Statements present fairly KMG’s financial position and results of operations, giving due consideration to materiality.
KMG management conducted an evaluation of the effectiveness of KMG's internal control over financial reporting as of December 31, 2006. In making this evaluation, it used the framework set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework. Based on the evaluation under the framework in Internal Control - Integrated Framework, our management concluded, that as of December 31, 2006, KMG's internal control over financial reporting was effective.
We have audited management’s assessment, included in the accompanying Report of Management on the Consolidated Financial Statements and Management’s Assessment of Internal Control over Financial Reporting, that KMG America Corporation maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). KMG America Corporation’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.
In our opinion, management’s assessment that KMG America Corporation maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, KMG America Corporation, maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on the COSO criteria.
We have audited the accompanying consolidated balance sheets of KMG America Corporation as of December 31, 2006 and 2005, and the related consolidated statements of operations, shareholders’ equity and cash flow of KMG America Corporation for the years ended December 31, 2006 and 2005 and the period January 21, 2004 (inception) through December 31, 2004, and the consolidated statements of operations, shareholders’ equity and cash flow of the Predecessor, as defined in Note 1, for the year ended December 31, 2004. Our audits also included the financial statement schedule listed in the Index at Item 15. These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
Equity securities available for sale, at fair value (cost of $101,945 and $286,809 for 2006 and 2005, respectively)
Common Stock: par value $0.01 per share, 75,000,000 shares authorized and 22,211,589 and 22,125,998 shares issued and outstanding at December 31, 2006 and 2005, respectively
KMG America is a holding company incorporated under the laws of the Commonwealth of Virginia on January 21, 2004. KMG America commenced operations shortly before it completed its initial public offering of common stock on December 21, 2004, and its shares trade on the New York Stock Exchange under the symbol “KMA.” Concurrently with the completion of its initial public offering, KMG America completed its acquisition of Kanawha and its subsidiaries, which are KMG America’s primary operating subsidiaries and which underwrite and sell life and health insurance products.
The primary insurance products that the Company underwrites include: group and individual life insurance; group long term disability; group and individual short term disability; group and individual dental insurance; group and individual indemnity health insurance; group critical illness insurance and employer group excess risk insurance. The Company ceased actively underwriting new long-term care insurance policies after December 31, 2005. The Company intends to retain and actively manage the Company's existing block of in force long-term care policies. The Company's third-party administration and medical management businesses include a wide array of services with the primary emphasis on the offering of administrative service-only products.
The accompanying consolidated financial statements include the accounts of the Company and the Predecessor after elimination of all significant intercompany balances and transactions. The Company also submits financial statements to insurance industry regulatory authorities. Those financial statements are prepared on the basis of statutory accounting practices (“SAP”) and are significantly different from financial statements prepared in accordance with GAAP (see Note 10).
The Company includes with cash and cash equivalents its holdings of highly liquid investments with maturities of three months or less from the date of acquisition.
Mortgage loans on real estate are stated at unpaid balances, net of allowances for unrecoverable amounts. Valuation allowances for mortgage loans are established when the Company determines it is probable that it will be unable to collect all amounts (both principal and interest) due according to the contractual terms of the loan agreement. Such allowances are based on the present value of expected future cash flows discounted at the loan’s effective interest rate or, if foreclosure is probable, on the estimated fair value of the underlying real estate.
Company-occupied real estate, primarily buildings, is carried at cost less accumulated depreciation and are depreciated principally by the straight-line method over estimated useful lives generally ranging from 15 to 30 years. Equipment is stated at cost, less accumulated depreciation, and depreciated principally by the straight-line method over their estimated useful lives, generally 3 to 5 years.
The amortization of value of business acquired is recognized using amortization schedules established at the time of the acquisitions based upon expected annual premium. Certain of these amortization schedules include actual to expected adjustments to reflect actual experience as it emerges. The value of business acquired is amortized over the premium-paying period of the policies.
Benefits related to traditional life and accident and health insurance products are recognized when incurred in a manner designed to match them with related premiums and spread income recognition over expected policy lives. For annuity and interest sensitive products including universal life products, benefits include interest credited to policyholders’ accounts, which is recognized as it accrues.
The Company had adopted the disclosure-only requirements of SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS 123”), as amended by FASB Statement No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure (“SFAS 148”) through December 31, 2005. As permitted by the provisions of this Statement, the Predecessor accounted for stock-based compensation using the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and Related Interpretations ("APB No. 25"). Accordingly, the Company recognized no compensation expense for stock option awards to employees or directors when the option exercise price was not less than the market value of the stock at the date of award.
SFAS 123(R) requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. The Company has used a Black-Scholes option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in the Company’s Consolidated Statement of Operations.
Stock-based compensation expense recognized during the period is based on the value of the portion of share-based payment awards that is ultimately expected to vest during the period. Stock-based compensation expense recognized in the Company’s Consolidated Statement of Operations as of December 31, 2006 included compensation expense for share-based payment awards granted prior to, but not yet vested as of December 31, 2005 based on the grant date fair value estimated in accordance with the pro forma provisions of SFAS 123 and compensation expense for the share-based payment awards granted subsequent to January 1, 2006 based on the grant date fair value estimated in accordance with the provisions of SFAS 123(R). As stock-based compensation expense recognized in the Consolidated Statement of Operations for the year ended December 31, 2006 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. In the Company’s pro forma information required under SFAS 123 for the periods prior to 2006, the Company accounted for forfeitures as they occurred.
In June 2006, the Financial Accounting Standards Board (“FASB”), issued Interpretation (“FIN”) No.48, “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement 109.” FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return, and provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company is currently assessing the impact of FIN 48 on its financial statements.
Aggregate amortized cost, aggregate fair value and gross unrealized gains and losses of investments in fixed maturity and equity securities are summarized in the following table.
Proceeds from the sales of investments in fixed maturity securities during the years ending December 31, 2006, 2005 and 2004 were $47.1 million, $61.6 million and $99.2 million, respectively. Gross gains of $0.0 million and gross losses of $0.6 million were realized in 2006 on those sales. Gross gains of $0.8 million and gross losses of $0.6 million were realized in 2005 on those sales. Gross gains of $7.9 million and gross losses of $0.7 million were realized in 2004 on those sales.
Proceeds from the sale of investments in equity securities during the years ended December 31, 2006, 2005 and 2004, were $1.4 million, $0.0 million and $2.7 million, respectively. Gross gains of $1.3 million and gross
Gross gains of $2.6 million and gross losses of $0.0 million were realized in 2004 on those sales.
At December 31, 2006, fixed maturity securities and short-term investments with an amortized cost of $4.7 million and fair value of $4.8 million were on deposit with state insurance departments to satisfy regulatory requirements. At December 31, 2006, the Company held bonds with an amortized cost of $102.6 million and fair value of $102.2 million in trust accounts for our reinsurance assumed treaties with Equitable Life, Metropolitan Life, and Security Benefit Life (part of reinsurance assumed reserves in Note 8, which is incorporated herein by reference).
At December 31, 2006, the Company held certain fixed income investments with unrealized losses. Information regarding these investments is as follows:
At December 31, 2006 the Company held $0.1 million in residential mortgage loans with interest overdue more than 90 days.
Under FAS No. 142, goodwill and intangible assets with indefinite useful lives are not amortized. Effective December 31, 2004, historical goodwill of the Predecessor was eliminated as a part of the application of GAAP purchase accounting requirements. The fair value of net assets of the Predecessor was greater than the acquisition purchase price, therefore no goodwill was recorded, effective December 31, 2004. Certain other intangibles were recorded as a result of the acquisition effective December 31, 2004. The weighted-average useful life, gross carrying
In connection with the Kanawha acquisition, the Company recorded the value of business acquired for the value of the Predecessor’s in force business. The interest rate assumption used to amortize the value of business acquired was approximately 6.0% at December 31, 2006. Information about deferred policy acquisition costs and value of business acquired are summarized below:
The interest rate used in 2004 to amortize value of business acquired was approximately 7.0%. Periodically, the Company performs tests to determine whether the value of business acquired remains recoverable from future premiums on the acquired business. No write-offs were incurred in 2004, 2005 or 2006 from impairments as a result of such recoverability tests. The interest rate assumption used to amortize the value of business acquired was reset upon the closing of the Kanawha acquisition and the rate was approximately 6.0% at December 31, 2004. Under the Company’s assumptions, as of December 31, 2006, the Company estimated that the amortization of value of business acquired for the next five years will be as follows:
Insurance reserves for individual life insurance, individual accident and health insurance, group life insurance and group accident and health insurance are computed using the net level premium method, including
assumptions based on our experience, modified as necessary to reflect anticipated trends and to include provisions for possible unfavorable deviations. Reserve interest assumptions are graded and range from 3.0% to 8.5% for historical GAAP purposes and for current Purchase GAAP the interest assumptions range from 5.75% to 6.60% The weighted average assumed investment yield for all life and accident and health policy reserves was 6.07% in 2006, 6.04% in 2005 and 6.84% in 2004. Benefit reserves for limited-payment policies take into account, where necessary, any deferred profits to be recognized in income over the policy term. Policy benefit claims are charged to expense in the period that the claims are incurred.
Interest crediting rates for investment products ranged from 3.5% to 5.0% in 2006, 2005, 2004, respectively.
During the quarter ended June 30, 2006, the Company implemented the use of seriatim PGAAP reserve factors. While the implementation of seriatim PGAAP factors did not change total reserves of the Company, it did result in a reallocation of reserves among the worksite insurance, senior market insurance and acquired business segments. This reallocation has been reflected in the second quarter results of the affected segments.
The result of the reallocation of reserves between business segments was to strengthen reserves by $37.5 million in the senior market insurance business segment. This was offset by a reduction in reserves of $31.2 million in the acquired business segment and $6.3 million in the worksite segment. No material effect to overall policy reserves or to earnings resulted from the reallocation. Subsequent reserve adequacy testing of policy reserves by segment indicates that the resulting alignment of reserves is sufficient in each segment.
The Company and its subsidiaries have filed separate federal income tax returns as required by regulations regarding the consolidation for tax purposes of life insurance and non-life insurance companies. The Company and its subsidiaries have incurred net operating losses which will expire between 2024 and 2026. Under SFAS No. 109, management must provide a valuation allowance for any deferred tax amounts that it does not believe will be realized. Management believes that there is more likely than not that these net operating losses will be realized; therefore, no valuation allowance has been established. The valuation allowance decreased by $0.2 million and $1.6 million in 2006 and 2005, respectively. The Company paid income taxes of $0.0 million and $0.0 million, during the years ended December 31, 2006 and 2005, respectively.
Statutory accounting practices (“SAP”) prescribed or permitted by regulatory authorities for the Company differ from GAAP. Shareholders’ equity and net loss, as determined in accordance with statutory accounting practices, for Kanawha are summarized as follows:
Risk-Based Capital (“RBC”) requirements promulgated by the NAIC require life insurers to maintain minimum capitalization levels that are determined based on formulas incorporating credit risk pertaining to its
The following table provides a reconciliation of the beginning and ending balances of unpaid accident and health claim liabilities, net of reinsurance recoverables, for years ended December 31:
The Company adopted the Predecessor’s defined benefit retirement plan, defined contribution plan, and deferred compensation plan. These plans were amended during 2006. These changes are discussed in detail below.
The Company’s defined benefit retirement plan complies with two principal standards: the Employee Retirement Income Security Act of 1974, as amended (“ERISA”), which, in conjunction with the Internal Revenue Code, determines legal minimum and maximum deductible funding requirements; and Statement of Financial Accounting Standards No.158, “Employers Accounting for Defined Benefit Pension and Other Postretirement Plans - An Amendment of FASB Statements No. 87,88,106, and 132R (“SFAS No. 158”) which was issued in September 2006 and effective for the Company as of December 31, 2006. The measurement date for the Company’s defined benefit plan is December 31.
Plan benefits are based on years of service and compensation during the last five years of service. The Company’s funding policy is to make the minimum annual contributions required by applicable regulations, including amortization of unfunded prior service costs over the maximum period allowed by ERISA.
On January 31, 2006, the Company adopted two amendments to the defined benefit retirement plan that froze participation in the plan and froze accrual of any additional benefits under the plan. As of March 31, 2006, no new participants were allowed to enter the plan. Effective as of September 30, 2006, no additional benefits accrue under the plan with respect to service after that date. As a result, final average earnings will be determined as of September 30, 2006, for all future benefit payments, and will not be adjusted for future changes in employee compensation.
The key assumptions used to determine Net Periodic Benefit Cost for years ended December 31:
The pension plan asset allocation at December 31, 2006, and 2005 by asset category is as follows:
The Predecessor granted options for a total of 371.8 shares of the Predecessor’s common stock. Stock options for 191 shares were granted in 1985 and the exercise price was 100% of the estimated fair market value of the common stock on the date of the grant, $16,534 per share. These options were fully vested at the closing of the Company’s acquisition of the Predecessor. In 1998, options for the remaining 180.8 shares were granted with an exercise price of $16,536 per share, and an estimated fair market value at the grant date of $45,688 per share.
These options generally vested 30% in 1998 and 10% annually thereafter. Amortization of deferred stock option compensation expense of approximately $0.2 million was recognized in 2004.
Pro forma information regarding net income and net income per share is required by SFAS 123, as amended by SFAS 148, and has been determined as if the Predecessor had accounted for its employee stock options under the fair value method of SFAS 123 as of its effective date. The fair value for these options was estimated at the date of grant using a Black-Scholes option-pricing model with the following weighted-average assumptions:
Deduct: Total stock-based employee compensation determined under fair value based method for all awards, net of related tax effects
Pro forma information regarding net income and net income per share is required by SFAS 123, as amended by SFAS 148, and has been determined as if the Company had accounted for its employee stock options under the fair value method of SFAS 123 as of its effective date. The fair value for these options was estimated at the date of grant using a Black-Scholes option-pricing model with the following weighted-average assumptions:
The activity related to the stock options is set forth below:
The following table sets forth share-based compensation and the related tax benefit:
As of December 31, 2006, there was $3,474,667 of total unrecognized compensation cost related to nonvested share-based compensation arrangements.
On December 21, 2004, the Company entered into a $15.0 million five-year subordinated promissory note to fund a portion of the purchase price for the Kanawha acquisition. Interest on the promissory note accrued at 5% per annum and was added to the principal balance on December 31 of each year.
On December 21, 2006, the Company entered into a credit agreement with Wachovia, which provides a $15.0 million unsecured revolving credit facility from which we borrowed $14.0 million to repay the five-year subordinated promissory note we issued to fund a portion of the purchase price for the Kanawha acquisition. The remaining $1.0 million available under the credit facility may be used to finance the Company’s working capital, liquidity needs and general working requirements and those of its subsidiaries. Amounts outstanding under the credit agreement will bear interest at a rate calculated according to, at the Company’s option, a base rate or the LIBOR rate plus an applicable percentage. The applicable percentage is based on the A.M. Best financial strength rating of Kanawha, and ranges from 0.25% to 0.35% for base rate loans and from 1.25% to 1.35% for LIBOR rate loans. In the case of LIBOR rate loans, interest on amounts outstanding is payable at the end of the interest period, which can be one, two, three or six months, as selected by the Company in its notice of borrowing. Wachovia’s obligation to fund the credit agreement terminates, and all principal outstanding under the credit agreement is due and payable, no later than December 31, 2007. As of December 31, 2006, the $14.0 million outstanding under the credit agreement was a LIBOR rate plus applicable percentage loan with an initial interest rate of 6.60%.
On February 18, 2005, a complaint was filed by plaintiffs ReliaStar Life Insurance Company and ReliaStar Life Insurance Company of New York (“ReliaStar”), both indirect wholly-owned subsidiaries of ING America U.S., in the Fourth Judicial District Court in Hennepin County, Minnesota, against KMG America, Kanawha, Kenneth U. Kuk, Paul Kraemer, Paul Moore and Thomas J. Gibb. Messrs. Kuk, Kraemer, Moore and Gibb are officers of KMG America and former employees of the plaintiffs. The complaint alleges misappropriation of trade secrets, conversion, tortious interference contract by KMG America, Kanawha and Messrs. Kuk, Kraemer, and Moore. The complaint seeks injunctive relief and unspecified monetary damages. On August 24, 2005, the plaintiffs amended their complaint to add Scott H. DeLong III and Thomas D. Sass as defendants. Messrs. DeLong and Sass are officers of KMG America and former employees of the plaintiffs. The plaintiffs’ amended complaint adds claims alleging unfair competition, interference with contractual relationships, civil conspiracy, fraudulent misrepresentations and civil theft. On August 9, 2005, a hearing was held before the court to consider plaintiffs’ motion for a temporary injunction and on August 26, 2005, the court issued a ruling denying plaintiffs’ motion. The plaintiffs filed a notice of appeal of the court’s ruling with the Minnesota Court of Appeals. On September 5, 2006, the Minnesota Court of Appeals issued a ruling affirming the district court’s denial of plaintiffs' motion for a temporary injunction. On December 21, 2006, the defendants filed a motion for summary judgment with the district court and a hearing on the motion was held on January 19, 2007. We expect a ruling from the Court in the second quarter of 2007. The Company believes plaintiffs’ allegations are without merit and intends to defend the action vigorously. While the outcome of legal actions cannot be predicted with certainty, management believes the outcome of this matter will not have a material adverse effect on the Company’s consolidated financial position or results of operations. The Company has been advised by the insurance carrier for its primary directors and officers insurance policy that the insurance carrier will, subject to the terms, conditions and limitations of the insurance policy, reimburse the Company for a significant portion of future defense costs and potential damages, losses and liabilities resulting from this litigation. The Company also has received partial reimbursement under the insurance policy for defense costs incurred to date. As a result, the Company expects that the ongoing defense cost reimbursements and reimbursements of any damages, losses or liabilities under the directors and officers insurance policy should reduce the risk that future defense costs and any damages, losses or liabilities may have a material adverse effect on the Company’s future consolidated financial position or results of operations.
The Company is assessed amounts by state guaranty funds to cover losses to policyholders of insolvent or rehabilitated insurance companies. Those mandatory assessments may be partially recovered through a reduction in future premium taxes in certain states. The Company recognizes its obligation for guaranty fund assessments and records an estimated accrual for any potential assessment. There were no such accruals as of December 31, 2005, and 2006.
Investment Securities: The carrying amount for fixed maturity and equity securities classified as available-for-sale is fair value, which is based on quoted market prices, where available. For fixed maturity and equity securities that are not actively traded, fair values are estimated using values obtained from independent pricing services.
Policy Loans: The carrying amounts reported in the accompanying balance sheets for these financial instruments approximate their fair values.
The Company has five reportable segments that are differentiated by their respective methods of distribution and the nature of the related products: worksite insurance business, senior market insurance business, third party administration business, acquired business and corporate and other. Management makes decisions regarding the Company’s business based on these segment classifications.
The senior market insurance business consists primarily of the Company’s in-force block of long-term care insurance policies that the Company actively manages, including the right to receive renewal premiums and liability for future claims. The Company ceased actively underwriting long-term care insurance policies after December 31, 2005.
This segment also includes marketing allowances, commissions and related expenses pertaining to product sales for other insurance carriers, which are currently not material. In addition, this segment includes certain unallocated expenses, primarily costs associated with being a public company, deferred compensation, incentive compensation and stock based compensation, and other non-allocated items such as the costs associated with the litigation with ReliaStar.
The following represents a summary of the Company’s and Predecessor’s statement of operations and asset composition by reportable segment. Except as noted, the financial statement information of the Predecessor set forth below is reported on a historical basis without GAAP purchase accounting adjustments reflecting the Company’s acquisition of the Predecessor.
(2) Aggregate total assets for the Predecessor as of December 31, 2004 is not reported because the Predecessor had been acquired by KMG America at that date and the Predecessor’s assets had been consolidated into the KMG America balance sheet at that date.
The following is a summary of the unaudited quarterly results of operations for the years ended December 31, 2006 and 2005:
*Balance sheet amounts at December 31, 2004 are those of KMG America. Statement of operations for the year ended December 31, 2004 are those of the Predecessor.