The following selected financial data as of and for the years ended December 31, 1996 through 2000 has been derived from the Company's consolidated financial statements. The following data should be read in conjunction with the Company's consolidated financial statements, the related notes thereto, and "Management's Discussion and Analysis of Financial Condition and Results of Operations."
During the second half of 1999, in an effort to combat the effects of rising claims cost trends on the Company's financial results, management announced a comprehensive plan to implement several corrective initiatives. Late in 1999 and into 2000, the Company implemented significant premium increases on new and existing small group business, made considerable changes in its product portfolio, and exited three unprofitable markets. To reduce claim costs, the Company introduced multi-tier drug programs, recontracted with its pharmacy benefit manager and implemented a number of projects to enhance claims cost management. The benefits from these initiatives began to materialize during the fourth quarter of 1999 and continued throughout 2000.
As a result, earnings improved $28.6 million from a net loss of $25.9 million or $1.58 per share in 1999 to net income of $2.7 million or $0.18 per share in 2000. Excluding the nonrecurring charge in 1999, as discussed in more detail in the following "Comparison of Results of Continuing Operations," earnings improved $14.9 million from a loss of $12.2 million or $0.74 per share in 1999 to net income of $2.7 million or $0.18 per share in 2000. The health segment loss ratio, excluding the nonrecurring charge in 1999, improved 3.2% from 1999 to 2000.
To serve the shifting consumer trend in the individual and small group markets, the Company is developing products with more limited plan designs, including higher copayments and deductibles. During 2000, the Company introduced a promising new health benefit plan concept with its newest product development, the Affordable Series, which features protection from major medical expenses at attractive rates. In addition, significant growth for the Company's MedOne product line for individuals and families is at the heart of management's strategic plan developed during 2000. The general regulatory environment for the MedOne products allows the Company expanded pricing and underwriting flexibility. At the end of 2000, MedOne membership rose to 34% of the Company's in-force business. At the end of 1999, MedOne membership represented 23% of the Company's business.
In an effort to combat the rising trend in pharmaceutical costs and utilization, the Company entered into a new agreement with its pharmacy benefit manager effective in early 2000. The new agreement provides significant cost and efficiency benefits to the Company. With the implementation of two-tier and three-tier drug copayment programs, the Company has also substantially reduced its drug claim cost trend.
Health insurance premiums decreased 7.9% to $907.7 million from $985.3 million reported for 1999. The Company acquired the majority of the fully insured group health business of Continental Assurance Company ("CNA") on January 1, 1999. Premiums on the CNA block of business declined approximately $70.0 million from 1999 to 2000, which accounted for the majority of the decrease in premium. The remainder of the decline in premiums from the prior year resulted from declining small group membership due to the exit from unprofitable markets. Partially offsetting the impact of the declining membership is the continued increase in premiums per member per month. The Company's average fully insured medical premium per member per month increased 7% to $136, compared to $127 for 1999. Premium revenues for the life segment decreased 13.8% in 2000 to $22.6 million from $26.2 million in 1999.
Other revenue, which primarily consists of administrative fee income from claim processing and other administrative services, decreased slightly to $20.1 million in 2000 from $22.4 million in 1999. The decrease resulted from a decline in administrative fee revenue from blocks of business acquired in prior years.
The expense ratio includes commissions, general and administrative expenses, premium taxes and assessments. As anticipated, the health segment expense ratio increased to 24.2% in 2000 from 23.0% in 1999. The increase largely reflects the change in the Company's product mix. MedOne business, which expanded significantly
Interest expense on the outstanding balance on the Company's line of credit agreement remained flat compared to 1999 at $3.6 million. Amortization of goodwill and other intangible assets declined from 1999 to 2000 to $3.8 million from $4.3 million.
The effective tax rate for 2000 was 56.4% compared with 33.5% for 1999. The change in the effective tax rate relates to the amortization of non-deductible goodwill and other permanent items in relation to pre-tax income. The Company had deferred tax assets recorded, net of valuation allowances, of $3.4 million related to state net operating loss carryforwards at December 31, 2000. State net operating loss carryforwards begin to expire in 2008. Management believes that the deferred tax assets will be realized primarily through future state taxable income.
The Company reported a net loss of $25.9 million or $1.58 per share for 1999, compared to an after-tax loss from continuing operations of $3.0 million or $0.18 per share for 1998. Excluding nonrecurring charges and excluding interest on debt assumed by Newco/UWS, the Company reported a loss of $12.2 million or $0.74 per share for 1999, compared to income of $8.4 million or $0.51 per share for 1998. The decline in income from 1998 to 1999 was primarily the result of a higher loss ratio and lower investment gains, partially offset by a lower expense ratio and lower amortization of goodwill and other intangible assets.
Health insurance premium revenue increased 13.9% to $985.3 million from $865.2 million in 1998. The increase in premium revenue reflected both internal growth and business acquired from other insurance carriers. Premium revenue related to CNA acquired business for the year ended December 31, 1999 totaled $83.4 million. In addition, the Company's average fully insured medical premium per member per month was higher in 1999 at $127 compared to $123 for 1998. Life insurance premium revenues increased 6.9% in 1999 to $26.2 million from $24.5 million in 1998, which was the result of a 6.0% increase in life membership from 1998 to 1999.
Net investment income for 1999 decreased 21.9% to $18.9 million from $24.2 million for 1998. During 1999, the Company had $0.8 million in realized investment losses compared to realized investment gains in 1998 totaling $3.7 million. Average annual investment yields, excluding realized gains and losses, were also down to 6.7% for the year ended December 31, 1999, compared to 7.3% for the same period in the prior year.
The expense ratio includes commissions, administrative expenses, premium taxes and assessments, but excludes nonrecurring charges. The expense ratio for health products was 23.0% for 1999, an improvement from the prior year expense ratio of 23.9%. The administrative expense ratio decreased in 1999 as a result of successfully leveraging the Company's expenses over a larger premium base. The health commission expense ratio increased slightly from 1998 as a result of growth in new business.
Interest expense decreased to $3.6 million in 1999 from $4.3 million in 1998, excluding interest on the $70.0 million debt assumed by Newco/UWS in conjunction with the spin-off. In July 1998, the Company refinanced its debt replacing its subordinated notes with a bank line of credit at a lower interest rate, which accounted for the decrease in interest expense from 1998 to 1999.
Amortization of goodwill and other intangible assets declined significantly in 1999 to $4.3 million from $8.8 million in 1998. The decrease was caused by the write-off of the Company's distribution system intangible asset as previously discussed.
The effective tax rate for 1999 was 33.5% compared with 38.1% for 1998. The change in the effective tax rate related to the amortization of non-deductible goodwill and other permanent items in relation to pre-tax income.
Income from discontinued operations reflects the operating results of Newco/UWS through September 25, 1998, the distribution date of the spin-off. Reported results of discontinued operations in 1998 included direct costs of $4.9 million associated with the spin-off.
relevant factors. Based on the unpredictability of these factors, no assurance can be given as to how many, if any, shares may be repurchased in the future.
The Company maintains a revolving bank line of credit agreement ("Credit Agreement") with a maximum commitment of $40.0 million and a $10.0 million sublimit for swingline loans. At December 31, 2000, the outstanding balance of advances under the Credit Agreement was $35.2 million. The Credit Agreement contains customary covenants which, among other matters, require the Company to achieve certain minimum financial results and restrict the Company's ability to incur additional debt, pay future cash dividends, repurchase the Company's stock and dispose of assets outside the ordinary course of business. The Company was in compliance with all such covenants at December 31, 2000.
The Credit Agreement was amended in July and November of 2000 to increase the maximum allowable limit on the Company's stock repurchase program. The November amendment also reduced the Company's available line of credit from $45.0 million to $40.0 million, which was scheduled to occur during the first quarter of 2001, and amended certain debt covenants within the Credit Agreement.
The bond portfolio had an average quality rating of Aa3 at December 31, 2000 and 1999, as measured by Moody's Investor Service. Almost the entire portfolio was classified as available for sale. The Company had no investment mortgage loans, nonpublicly traded securities (except for principal only strips of U.S. government securities), real estate held for investment or financial derivatives. The amortized cost of the total investment portfolio exceeded market value by $6.1 and $16.1 million at December 31, 2000 and 1999, respectively. Management believes that cash flow from operations will be sufficient for its cash flow needs and that liquidation of its investment portfolio will not be necessary.
The primary market risk affecting the Company is interest rate risk. Assuming an immediate increase of 100 basis points in interest rates, the net hypothetical decline in fair value of shareholders' equity is estimated to be $6.6 million after-tax at December 31, 2000. This amount represents approximately 3.0% of the Company's shareholders' equity.
This report and other documents or oral presentations prepared or delivered by and on behalf of the Company contain or may contain forward-looking statements. Such statements are based upon management's current expectations and are subject to risks and uncertainties that could cause the Company's actual results to differ materially from those contemplated in the statements. Readers are cautioned not to place undue reliance on the forward-looking statements. When used in written documents or oral presentations, the terms "anticipate," "believe," "estimate," "expect," "objective," "plan," "possible," "potential," "project" and similar expressions are intended to identify forward-looking statements. In addition to the assumptions and other factors referred to specifically in connection with such statements, factors that could cause the Company's actual results to differ materially from those contemplated in any forward-looking statements include, among others, the following:
- - Increasing health care costs resulting from the aging of the population, advances in medical technology, increased utilization of medical services and drugs, health care inflation (particularly technology-driven procedures and pharmacy costs), possible epidemics and natural disasters and other factors affecting the delivery and cost of health care that are beyond the Company's control.
- - Federal and state health care reform laws adopted in recent years, currently proposed (such as the "Patients' Bill of Rights") or that may be proposed in the future, which affect or may affect the Company's operations, products, profitability or business prospects. Reform laws adopted in recent years generally limit the ability of insurers and health plans to use risk selection as a method of controlling costs for small group business.
- - The effectiveness of the Company's strategy to expand sales of its MedOne products for individuals and families, to focus its small group health product sales in core markets and to grow its ancillary products, including its life, dental and self-funded benefit administration business.
We have audited the accompanying consolidated balance sheets of American Medical Security Group, Inc. and its subsidiaries, (the "Company") as of December 31, 2000 and 1999, and the related consolidated statements of operations, changes in shareholders' equity and comprehensive income (loss) and cash flows for each of the three years in the period ended December 31, 2000. Our audits also included the financial statement schedules listed in the Index at Item 14(a). These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2000 and 1999, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.
The Company's investments are classified in three categories. Investments that the Company has the positive intent and ability to hold to maturity are classified as held-to-maturity securities and are reported at amortized cost. Assets which are invested for the purpose of supporting the Company's nonqualified executive retirement plan are classified as trading securities and reported at fair value, with unrealized gains and losses included in earnings as net investment income. All other investments are classified as available-for-sale securities and are reported at fair value based on quoted market prices, with unrealized gains and losses excluded from earnings and reported as a separate component of shareholders' equity as accumulated other comprehensive income or loss, net of income tax effects. Realized gains and losses from the sale of available-for-sale debt and equity securities are calculated using the specific identification method.
The Company limits the maximum net loss that can arise from certain lines of business by reinsuring (ceding) a portion of these risks with other insurance organizations (reinsurers) on an excess of loss or quota share basis. The Company's retention limit per covered life is $500,000 per policy year for medical claims and $50,000 for life claims. The Company is contingently liable on reinsurance ceded in the event that the reinsurers do not meet their contractual obligations.
The Company has deferred compensation payable to employees of $3,388,000 and $3,597,000 at December 31, 2000 and 1999, respectively.
Options to purchase 3,460,130 shares of common stock were outstanding at the end of 2000 and all but 1,429,960 were excluded from the computation of diluted earnings per share because the option's exercise price was greater than the average market price of common shares and, therefore, the effect would be antidilutive. There was no effect of dilutive securities for 1999 and 1998 because employee stock options were antidilutive during such periods.
Unrealized gains (losses) are computed as the difference between estimated fair value and amortized cost for fixed maturities and equity securities classified as available for sale. A summary of the net change in unrealized gains (losses), which is included in accumulated other comprehensive income (loss), is as follows:
The Company recognized depreciation expense on property and equipment of $4,656,000, $4,544,000, and $5,450,000 in 2000, 1999 and 1998, respectively.
The Company maintains a revolving bank line of credit agreement ("Credit Agreement") with a maximum commitment of $40,000,000 and a $10,000,000 sublimit for swingline loans. At December 31, 2000, the outstanding balance of advances under the Credit Agreement was $35,158,000. Interest is charged on the outstanding balance based upon an indexed floating rate of interest. The swingline loans may be used for short-term borrowings and are required to be repaid no later than 30 days after they are made. All swingline loans bear interest at the floating rate. The Credit Agreement contains customary covenants which, among other matters, require the Company to achieve certain minimum financial results and restrict the Company's ability to incur additional debt, pay future cash dividends and dispose of assets outside the ordinary course of business.
The Credit Agreement was amended in July and November of 2000 to increase the maximum allowable limit on the Company's stock repurchase program. The November amendment also reduced the Company's available line of credit from $45,000,000 to $40,000,000, which was scheduled to occur during the first quarter of 2001, and amended certain debt covenants within the Credit Agreement. In addition, the Company is required to maintain a minimum cash deposit of $1,500,000 in an account at the lender's institution as collateral for the loan.
Future annual principal amounts due for all notes are $1,200,000 for 2001, $1,358,000 for 2002, $11,200,000 for 2003, $12,500,000 for 2004, and $15,000,000 for 2005. During 2000, 1999 and 1998, interest paid totaled $4,005,000, $3,547,000 and $6,971,000, respectively.
The federal deferred benefit arising from the deductibility of state deferred tax is included as a component of other federal deferred taxes. The net deferred tax assets are included in other assets in the accompanying balance sheets.
On February 7, 2000, a $5.4 million verdict was entered against the Company in a lawsuit which alleged breach of contract involving commission amounts due to a former agent. On April 18, 2000, the Company filed a notice of appeal with an Ohio Appeals Court requesting reversal of the decision. The Appeals Court heard oral arguments on October 5, 2000, and the parties are awaiting a decision. Management expects the verdict to be reversed or substantially reduced following appeal. As a result, the Company's accrual related to this case is not material.
The Company is involved in various legal and regulatory actions occurring in the normal course of its business. In the opinion of management, adequate provision has been made for losses that may result from the above-mentioned and other legal and regulatory actions; accordingly, the outcome of these matters is not expected to have a material adverse effect on the consolidated financial statements.
State insurance laws and regulations prescribe accounting practices for determining statutory net income and equity for insurance companies. These regulations require, among other matters, the filing of financial statements prepared in accordance with statutory accounting practices prescribed or permitted for insurance companies. The combined statutory surplus of the Company's insurance subsidiaries, United Wisconsin Life Insurance Company and American Medical Security Insurance Company of Georgia, at December 31, 2000 and 1999, was $153,912,000 and $155,937,000, respectively.
State insurance regulations also require the maintenance of a minimum compulsory surplus based on a percentage of premiums written. At December 31, 2000, the Company's insurance subsidiaries were in compliance with these compulsory regulatory requirements.
During 2000, the Company adopted a nonqualified executive retirement plan (the "Nonqualified Plan") to provide key management with the opportunity to accumulate deferred compensation which cannot be accumulated under the Retirement Savings Plan due to compensation limitations imposed by the Internal Revenue Service. The Nonqualified Plan is funded through a rabbi trust and has contribution and investment options similar to those of the Retirement Savings Plan. The Company recognized expense associated with the Nonqualified Plan of $77,000 during 2000.
On November 17, 1998, the Company and a key executive entered into a deferred stock agreement. Under the agreement the Company has an obligation to issue 73,506 shares of AMSG common stock provided the executive remains continuously employed with AMSG through November 17, 2002. The Company incurred expense of $225,000 in 2000 and 1999 and $28,000 in 1998 related to this agreement.
The Company also has a Director Stock Option Plan which permits the grant of NQSOs. The plan allows for the granting of up to 75,000 shares of which 14,000 shares are available for grant, as of December 31, 2000.
(a) Effective on the date of Distribution, certain AMSG stock options held by Newco/UWS employees were converted to Newco/UWS stock options. (b) Immediately following the Distribution, the number of options was increased and exercise prices were decreased (the "modification") to preserve the economic value of those options that existed just prior to the Distribution for the holders of certain AMSG stock options.
Selected quarterly financial data for the years ended December 31, 2000 and 1999 are as follows:
Note: The sum of the four quarters may not equal the earnings (loss) per common share for the year due to the change in the number of shares outstanding during the year.
The Company has two reportable segments: 1) health insurance products and 2) life insurance products. The Company's health insurance products consist of the following coverages related to small group PPO products: MedOne and small group medical, self-funded medical, dental and short-term disability. Life products consist primarily of group term life insurance. The "All Other" segment includes operations not directly related to the business segments and unallocated corporate items (i.e., corporate investment income, interest expense on corporate debt, amortization of goodwill and intangibles and unallocated overhead expenses). The Company's All Other segment also includes data for its HMO subsidiary. The reportable segments are managed separately because they differ in the nature of the products offered and in profit margins.