As a result of the sale of all of its insurance operations and the adoption of the Plan of Liquidation, the Company occupied only a small portion of the leasable space in the office building. The Company subleased portions of the building to third party tenants pursuant to various short-term leases and received $14,000 and $175,000 in 2000 and 1999, respectively, from these subleases. In August 2000, the Company and its co-owner sold the office building. The Company reported a gain of approximately $9,000 on the sale transaction and also collected approximately $56,000 in penalties from the buyer as a result of the buyer's delays in closing on the transaction.
A review of the significant factors which affected the Company's net assets in liquidation at December 31, 2001 and the changes in its net assets in liquidation for the year then ended is presented below. Information relating to 2000 and 1999 is also presented for comparative purposes. This analysis should be read in conjunction with the Consolidated Financial Statements and the related Notes appearing elsewhere in this Form 10-K.
As discussed in Item 1 of this Form 10-K, the Company's Board of Directors may consider other alternatives to liquidating the Company, if such alternatives are deemed by the Board to be in the best interest of the Company and its shareholders. In August 2001, the Board solicited proposals for interest in acquiring control of the Company and received proposals from several investor groups that had expressed such an interest. Following a review of the proposals which were received, the Company selected one group to whom it granted an option to acquire a 51% interest in the Company. In accordance with the terms of the Option Agreement, which was entered into on February 13, 2002, the option is exercisable within 15 business days following the completion by the Company of a tender offer to its preferred shareholders. The tender offer, if accepted by all of the preferred shareholders, will result in the payment to those shareholders of substantially all of the Company's remaining net assets. If the option is exercised, the investor group intends to merge or otherwise combine certain existing and start-up businesses into the Company. The Board of Directors considered a transaction of this type in lieu of the Plan of Liquidation because it has the potential to produce future value for the common shareholders while protecting the rights of the preferred shareholders. As indicated above, the common shareholders are not expected to receive any distribution under the Plan of Liquidation. If the option is exercised, the liquidation of the Company would be discontinued. However, since there is no assurance at this time that the option will be exercised, the Company continues to proceed with the Plan of Liquidation. For additional information regarding the terms of the Option Agreement, see Note 17 of the Notes to Consolidated Financial Statements appearing elsewhere in this Form 10-K.
As a result of the approval of the Plan of Liquidation, the Company adopted a liquidation basis of accounting in its financial statements for periods subsequent to March 24, 1998. Under liquidation accounting rules, assets are stated at their estimated net realizable values and liabilities are stated at their anticipated settlement amounts. Prior to March 25, 1998, the Company reported the results of its operations and its asset and liability amounts using accounting principles applicable to going concern entities. If the option discussed above is exercised, and the Company resumes business operations, it would again adopt accounting principles applicable to going concern entities.
Since the sale of the credit insurance business and the adoption of the Plan of Liquidation, the Company's revenues, benefits and expenses have consisted principally of (i) fee revenues from the sale of the Company's customer accounts (see discussion below regarding the discontinuation of these fee revenues), (ii) investment income on the remaining invested assets and (iii) corporate expenses, primarily salaries, professional fees and, pension expense and home office rent and related costs. A discussion of the material factors which affected the Company's changes in net assets in liquidation for the years ended December 31, 2001, 2000 and 1999 is presented below.
During 2000, the estimated liquidation value of the preferred stock decreased by $938,000. The 456,061 shares of preferred stock outstanding at December 31, 2000 had an estimated liquidation value of $3,320,000, or $7.28 per share on that date.
The Company's unfunded pension liability increased by $388,000 in 1999 principally because of the Company's decision in early 2000 to terminate the plan. This decision resulted in the use of an interest rate in computing the December 31, 1999 plan liabilities which was intended to approximate the rate which would be in effect when the plan actually terminated. For continuing plans, different assumptions regarding interest rates are generally utilized.
ESTIMATED NET EXPENSES AND OTHER CHANGES IN NET ASSETS DURING LIQUIDATION PERIOD
If the option discussed above is not exercised by the investor group, the Board of Directors intends to continue with the liquidation of the Company. The option to acquire control of the Company is not exercisable by the investor group until after the Company completes a tender offer to its preferred shareholders. The Company believes that most of the preferred shareholders will elect to surrender their shares in the tender offer. Therefore, if the investor group does not exercise its option, the Company would use the assets remaining in the Company (comprised of cash which had been allocated to the preferred shares not tendered plus a cash reserve) to cover its operating expenses during the remainder of the liquidation period, to pay any remaining liabilities and to make a final distribution to the preferred shareholders who did not previously tender their shares.
The Company is also a defendant in several small lawsuits which must be settled or resolved in court prior to the final distribution to shareholders. While management believes the plaintiffs' claims in these cases are without merit, the ultimate outcome of these matters cannot be determined at this time. Furthermore, the Company may be entitled to all or a portion of the assets in a contingency fund established by the Company and the purchaser of its credit insurance business based on the claims experience of the in force credit insurance business from October 1, 1997 to September 30, 2002. However, based on the claims experience to date, as provided by the purchaser, it does not appear likely that the Company will receive any portion of the contingency fund.
A discussion of the important elements affecting the Company's net assets in liquidation and its total invested assets at December 31, 2001 and 2000 is presented below.
Since adopting the Plan of Liquidation, the Company has made no commitments for capital expenditures and, if the company proceeds with the liquidation process, it does not intend to make any such commitments in the future. However, if the Company is acquired pursuant to the Option Agreement discussed above, the Company's plans regarding capital expenditures and related commitments could change.
During the year ended December 31, 2001, the Company's cash and invested assets decreased from $3,479,000 to $2,745,000, primarily because of a $521,000 excess of expenses over revenues (most of which were cash items) and the payment of $386,000 in preferred shareholder dividends. The Company also benefited from the collection of a $284,000 receivable during 2001. For the year ended December 31, 2000, the Company's cash and invested assets declined by $389,000 to $3,479,000 at the end of the year. That reduction was primarily attributable to the $966,000 payment to the Company's pension plan, in order to fully fund the plan, the payment of $391,000 in preferred stock dividends and an excess of expenses paid over revenues collected. These decreases were partially offset by a $1,150,000 increase in invested assets resulting from the sale of the Company's 50% interest in its home office building. The sale of the home office building also resulted in the payoff of a $1,176,000 mortgage granted to the co-owner of the building. The mortgage proceeds along with the proceeds from the building sale were invested in short-term securities.
Historically, the Company's subsidiaries met most of their cash requirements from funds generated from operations, while the Company generally relied on those subsidiaries to provide it with sufficient cash funds to maintain an adequate liquidity position. As a result of the Company's decision to sell its remaining operations, liquidate all of its net assets and distribute cash to its shareholders, the Company's principal sources of cash funds are investment income and proceeds from the sales of non liquid assets. If the Company continues with the Plan of Liquidation, these funds must be used to settle all remaining liabilities as they become due, to pay expenses until the Company is dissolved and to pay dividends on the preferred stock until a final distribution is made to the preferred shareholders. Alternatively, if the Company is acquired in connection with the Option Agreement discussed above, substantially all of the Company's remaining liquid assets will be available to complete the tender offer to the preferred shareholders. The adequacy of the Company's liquidity position during the remainder of the liquidation period will be principally dependent on its ability to sell its remaining non liquid assets and the timing of such sales, as well as on the level of expenses the Company must incur during the liquidation period. The Company's liquidity has been particularly affected by the fact that virtually all of its assets are held by its insurance subsidiary, since dividends and other distributions to the Company from that subsidiary must be approved by the Delaware Insurance Department. As discussed previously, the planned sale of the subsidiary will eliminate significant liquidity restrictions for the Company.
The terms of the Company's 8.5% redeemable preferred stock require the Company to make annual payments to a sinking fund. The first such payment was due in July 1998. The preferred stock terms also provide that any purchase of preferred shares by the Company will reduce the sinking fund requirements by the redemption value of the shares acquired. As a result of the Company's purchases of preferred stock prior to 1998, no sinking fund payment was due in 1998, and the required payment due for 1999 was reduced from $550,000 to $414,610. The purchase of 18,000 preferred shares in 1999, 7,400 shares in 2000 and 3,447 shares in 2001 further reduced the 1999 sinking fund deficiency to $126,140. On July 1, 2000, an additional $550,000 sinking fund payment became due but was not paid. On July 1, 2001, another $550,000 sinking fund payment became due but was also not paid. Consequently, at December 31, 2001, the total sinking fund deficiency was $1,226,140.
If the Company proceeds with the Plan of Liquidation, it intends to liquidate its assets, pay all of its liabilities, distribute any remaining cash to its shareholders and ultimately dissolve within the next year. Under those circumstances, the effects of inflation on the Company are not material. If the Company is acquired pursuant to the Option Agreement, the effects of inflation on the Company may change.
The consolidated financial statements for the years ended December 31, 2001 and 2000 have been audited by Stambaugh Ness, PC, independent auditors. Such audits were conducted in accordance with auditing standards generally accepted in the United States of America, and included a review and evaluation of our internal accounting control structure, tests of the accounting records and other auditing procedures which the auditors considered necessary to express their informed professional opinion on the consolidated financial statements.
The Board of Directors monitors the financial and accounting operations of the Company. The Board meets periodically with representatives of its independent auditing firm to discuss the scope of the audit and related reports. The Company's independent auditors have at all times full and free access to the Board of Directors, without management present, to discuss any matter that they believe should be brought to the attention of the Board.
Our audits were made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The schedules listed in the index of financial statement schedules at Item 14(a) are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic financial statements. The amounts included in these schedules have been subjected to the auditing procedures applied in the audit of the basic consolidated financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.
CONSUMERS FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2001, 2000 AND1999
Fixed maturities includes bonds, notes and certificates of deposit maturing after one year. Management determines the appropriate classification of bonds and notes at the time of purchase and reevaluates such designation as of each financial statement date. All bonds and notes are classified as available-for-sale. Available-for-sale securities are carried at fair value, with the unrealized appreciation and depreciation, net of income taxes, if applicable, reported as a separate component of the changes in net assets in liquidation. All certificates of deposits maturing after one year are deemed to be held to maturity. Mortgage loans on real estate are carried at the unpaid principal balance. Short-term investments are carried at cost.
Prior to the conversion of the Company's remaining indemnity reinsurance agreements to assumption reinsurance, unearned premiums for credit life and disability insurance contracts were computed based upon the original and remaining term of the related policies as follows: decreasing term credit life on the Rule of 78's method, level term credit life using the Pro Rata method and credit disability using a 65% - 35% weighted average of the Rule of 78's and Pro Rata methods. At December 31, 2001, the Company had no liability for unearned premiums.
The Company and its subsidiary provide income taxes, for financial reporting purposes, on the basis of the liability method.
(a) Bonds eligible for amortization are reported at amortized value, whereas in the accompanying financial statements, only bonds which are classified as held-to-maturity securities are stated at amortized cost, and available-for-sale securities are carried at fair value. Other securities are carried at values prescribed by the National Association of Insurance Commissioners' Accounting Practices and Procedures manual.
(b) The statutory liabilities for the interest maintenance reserve and asset valuation reserve, designed to lessen the impact on surplus of market fluctuations of securities and mortgage loans, have not been provided in the financial statements.
(c) Certain assets are reported as assets in the statements of net assets in liquidation rather than being charged directly to surplus and excluded from the statutory balance sheets.
Insurance laws require Consumers Life to deposit certain amounts with various state insurance departments in order to maintain its licenses. The approximate carrying amount of such deposits at December 31, 2001 and 2000 was $1.4 million.
Investments, which are valued for financial statement purposes as described in Note 1, consist of the following at December 31, 2001:
At December 31, 2001 and 2000, the Company held only one mortgage loan, a first mortgage lien secured by income-producing real estate located in central Pennsylvania. This loan, which had a principal balance of $13,278 and $50,212 at the end of 2001 and 2000, respectively, exceeded 10% of the Company's net assets in liquidation at December 31, 2001 and 2000.
At December 31, 2000, future policy benefits and unearned premiums related to reinsurance ceded are classified as Reinsurance Recoverable and Prepaid Reinsurance Premiums, respectively, as follows:
The sale of the credit insurance business of Consumers Life was completed pursuant to an indemnity reinsurance agreement with American Republic. The reinsurance transactions through which Consumers Life and its former subsidiaries sold their individual life insurance business included the use of both indemnity and assumption agreements. Consumers Life remained contingently liable for insurance risks ceded under indemnity agreements, while such risks were legally transferred to the reinsurer when assumption agreements were utilized.
Net periodic pension cost for the years ended December 31, 2000 and 1999 is computed below:
Rates used in determining pension expense for the years ended December 31, 2000 and 1999 were as follows:
Rental expense in 2001, 2000 and 1999 was approximately $23,000, $57,000 and $138,000, respectively.
From March 1994 until August 2000, the Company owned a 50% interest in its home office building, which it sold in August 2000. The Company leased the portion of the building it did not own at a rate of $17,000 per month until July 1999 when its lease expired. The building lease was classified as an operating lease. The Company also subleased a portion of the unused space in the building to third party tenants until April 2000. Income from these subleases totaled $14,000 in 2000 and $175,000 in 1999. The Company has no other significant lease commitments.
In November 1997, the Company and a third party reinsurer were sued by a former general agency with whom the Company had a partnership agreement. The partnership agreement provided that the agency would market universal life insurance business for the Company, pursuant to specific criteria established by the Company, and would also be entitled to a share of the profits, if any, which arose from the business produced. The claimant was seeking monetary damages to compensate it for the Company's alleged failure to share profits and for other alleged losses resulting from the Company's rejection of policy applications involving unacceptable risks. The Company filed two counterclaims against this agency seeking damages for losses the Company sustained as a result of the agency's alleged breach of the partnership agreement and to recover an unpaid loan made to the agency. In December 2000, the trial for the Company's claim for recovery of the unpaid loan took place, and, in January 2001, the court awarded a $90,000 judgment in favor of the Company. In August 2001, the parties settled this matter through mediation. As a result of this settlement, the Company agreed to pay the agency $210,000 in cash and to mark as satisfied the $90,000 judgment the Company had previously been awarded. The $90,000 receivable had been fully reserved in the Company's financial statements.
During 1999, a dispute arose between the Company and the purchaser of its credit insurance business relating to the payment of investment income on the assets which were transferred to the purchaser. Subsequent to the closing of the transaction, the purchaser claimed that the Company owed it approximately $1,400,000 for investment earnings on the amount transferred. In October 1999, the purchaser informed the Company that it would begin withholding from the Company the fee revenue payments which were contractually due to the Company from the sale of the credit insurance accounts. At September 30, 2000, fee revenues totaling $421,000 had been withheld by the purchaser. In October 2000,
the parties settled this dispute. Pursuant to the terms of the settlement agreement, the purchaser paid the Company $250,000 in settlement of all prior amounts withheld and in lieu of any future fee revenue payments. In addition, the Company agreed to permit the purchaser to withdraw $500,000 from a contingency fund established by the parties at the time of the sale. The total balance in the fund at the time of withdrawal was approximately $1,500,000. Although the Company may be entitled to receive all or a portion of the contingency fund in late 2002 (based on the claims experience of the in force block of business sold to the purchaser), the Company agreed to the partial withdrawal following its review of the claims experience to date, which showed that it is unlikely the Company will ultimately receive any portion of the fund.
The Redeemable Convertible Preferred Stock (the Preferred Stock) has a liquidation preference of $10.00 per share and is convertible at any time, unless previously redeemed, into shares of common stock at the rate of 1.482 shares of common stock for each share of Preferred Stock (equivalent to a conversion price of $6.75 per share). The Preferred Stock is redeemable at the option of the Company at a redemption price of $10.00 per share.
Annual dividends at the rate of $.85 per share are cumulative from the date of original issue and are payable quarterly on the first day of January, April, July and October. At December 31, 2001, the Company was not in arrears with respect to payment of dividends on the Preferred Stock. Except in certain limited instances, the holders of the Preferred Stock have no voting rights.
The terms of the Preferred Stock require the Company to make annual payments to a sinking fund. The first such payment was due in July 1998. The Preferred Stock terms also provide that any purchase of preferred shares by the Company will reduce the sinking fund requirements by the redemption value of the shares purchased. As a result of the Company's purchases of Preferred Stock prior to 1998, no sinking fund payment was due in 1998, and the required payment for 1999 was reduced from $550,000 to $414,610. The purchase of 18,000 preferred shares in 1999, 7,400 shares in 2000 and 3,447 shares in 2001 further reduced the 1999 sinking fund deficiency to $126,140. On July 1, 2000, an additional $550,000 sinking fund payment became due but was not paid. On July 1, 2001, another $550,000 sinking fund payment became due but was also not paid. Consequently, at December 31, 2001, the total sinking fund deficiency was $1,226,140.
At December 31, 2001 and 2000, the redemption value of the Preferred Stock exceeded the net assets available to redeem these shares by $1,989,000 and $1,241,000, respectively. Accordingly, the carrying amount for the Preferred Stock has been reduced to reflect the net assets available. At December 31, 2001 and 2000, 670,539 and 675,646 shares of common stock, respectively, were reserved for the conversion of the Preferred Stock.
There are currently no significant amounts of retained earnings in excess of statutory surplus upon which neither current nor deferred income taxes have been provided.
As discussed in Note 4, following the sale of its credit insurance business, the Company began liquidating its remaining assets and paying or providing for its liabilities. If the Company proceeds with the Plan of Liquidation, the Company intends to eventually distribute all of its remaining cash to its preferred shareholders pursuant to the Plan of Liquidation. The Company's revenues, benefits and expenses now consist principally of investment income on remaining assets and corporate expenses. If the Company is acquired as a result of the proposed transaction described in Note 17, any new businesses which are merged into or otherwise combined with the Company will be reported as new business segments in the Company's financial statements.
As discussed in Note 17, in February 2002, Black Diamond Insurance Group, Inc. filed a Form A with the Delaware Insurance Department in connection with its planned acquisition of Consumers Life. The Company expects that regulatory approval of this transaction will be received within 60 days.
In August 2000, Consumers Life signed a Consent Order issued by the Delaware Insurance Department in which the Department claimed that Consumers Life had violated certain provisions of the Delaware Holding Company statutes in
In August 2000, Consumers Life surrendered its certificate of authority to write insurance business in the state of Idaho because it did not meet that state's statutory deposit requirements. Since Consumers Life is no longer writing any insurance business, the surrender of the Idaho license has had no material adverse effect on the Company. However, the loss of this license will reduce the consideration the Company will receive when Consumers Life is sold (see Note 17).
The NAIC has established certain minimum capitalization requirements based on risk-based capital (RBC) formulas. The formulas are designed to identify companies which are undercapitalized and require specific regulatory action based on requirements relating to insurance, business, asset and interest rate risks. At December 31, 2001, Consumers Life has more than sufficient capital to meet the NAIC's RBC requirements.
On January 31, 2002, the Company entered into a Stock Purchase Agreement to sell all of the stock of Consumers Life to Black Diamond Insurance Group, Inc., a Delaware corporation. At the closing of this transaction, the Company will receive cash equal to the fair value of the net assets of Consumers Life plus $10,000 for each of the subsidiary's 25 state insurance licenses. The sale transaction must be approved by the Delaware Insurance Department. In that regard, on February 21, 2002, the purchasers filed a Form A with the Delaware Department seeking approval of the change in control.
On February 13, 2002, the Company entered into an option agreement (the Option Agreement) with CFC Partners, Ltd., an unrelated investor group based in New York (CFC Partners). The execution of the Option Agreement with CFC Partners followed a review by the Board of Directors of various proposals to acquire a controlling interest in the Company. The Option Agreement permits CFC Partners to acquire a 51% interest in the Company's common stock through the issuance of 2,700,000 authorized but unissued shares. The option price of $108,000 was deposited into an escrow account in March 2002. The option is exercisable within 15 business days following the completion by the Company of a tender offer to its preferred shareholders, in which those shareholders will be given an opportunity to receive a cash payment in exchange for their shares. The tender offer, if accepted by all of the preferred shareholders, will result in the payment to those shareholders of substantially all of the Company's remaining net assets. Under Pennsylvania laws, the newly issued common shares will have no voting rights until CFC Partners obtains the required approval from the common shareholders.
Pursuant to the terms of the Option Agreement, if another offer to acquire the Company is received prior to the exercise of the option by CFC Partners, and the Board of Directors believes that it is in the best interest of the Company's shareholders to accept such offer, the Company may terminate the Option Agreement by paying $50,000 to CFC Partners and returning the escrow deposit. The Option Agreement also provides that if CFC partners does not exercise the option, it will forfeit $25,000 of the escrow deposit. If the option is not exercised, the Board of Directors intends to continue with the Plan of Liquidation.
The sale of Consumers Life, as discussed above, is essential to completing the Company's tender offer to the preferred shareholders because virtually all of the Company's cash funds are held by Consumers Life and cannot be withdrawn under Delaware insurance laws until the subsidiary is either sold or liquidated.