We currently own and occupy our executive offices located at 9151 Grapevine Hwy, North Richland Hills, Texas 76180-5605 comprising in the aggregate approximately 250,000 square feet of office space. In addition, we lease office space at various locations.
The Company establishes liabilities for benefit claims that have been reported but not paid and claims that have been incurred but not reported under health and life insurance contracts. These claim liabilities are developed using actuarial principles and assumptions that consider a number of items, including historical and current claim payment patterns, product variations, the timely implementation of appropriate rate increases and seasonality. See discussion below, “Critical Accounting Policies and Estimates - Claim Liabilities” and Note F of Notes to Consolidated Financial Statements.
For segment reporting, the Company had previously reported the Student Insurance Division and Star HRG Division as one business unit referred to as “Group Insurance Division”. Effective October 1, 2004, the Company began reporting the results of the Group Insurance Division as two business units, the Student Insurance Division and Star HRG Division.
The Company’s 2004 results from continuing operations benefited from the strong performance of its SEA Division, which reported record operating income in 2004 of $260.7 million, compared to operating
income of $109.1 million in 2003. Results at the Company’s SEA Division in 2004 reflected a favorable loss ratio and increased renewal premium revenue, with which is associated a lower commission rate compared to the commission rate on first year premium revenue.
Results in 2004 at the Company’s SEA Division benefited from a significant decrease in loss ratio (from 61.7% in 2003 to 54.4% in 2004) associated with the SEA Division’s block of health insurance business. This decrease in the loss ratio was due in significant part to the reduction in the amount of $47.8 million during 2004 of claim liabilities established in 2003 in response to a rapid pay down in 2003 of an excess pending claims inventory. The actual claim payment experience during 2004 with respect to prior periods was lower than originally estimated when the claim liability was established in 2003. See discussion below under the caption “Critical Accounting Policies and Estimates - Claims Liabilities - Claims Liability Development Experience”. The decrease in loss ratio was also due in part to lower levels of incurred claims in 2004 compared to the prior year. The Company currently anticipates that loss ratios at the SEA Division will begin over time to trend upward to historical levels.
On October 8, 2004, the Company completed the acquisition, for a cash purchase price of $53.1 million, of substantially all of the operating assets of HealthMarket, Inc., a Norwalk, Connecticut-based provider of consumer driven health plans (CDHPs) to the small business (2 to 250 employees) marketplace. In the acquisition, UICI’s wholly owned insurance subsidiary, The MEGA Life and Health Insurance Company, acquired HealthMarket’s administrative platform and substantially all of HealthMarket’s CDHP technology, fixed assets and personnel. Subject to applicable regulatory approvals, UICI intends to market and sell HealthMarket’s Consumer Driven Health Plan products to the individual and small employer group markets through MEGA, Mid-West and Chesapeake.
The table below sets forth certain summary information about our operating results for each of the three most recent fiscal years:
Due to a 10% year over year increase in invested assets, investment income increased to $85.9 million in 2004 compared to $77.7 million in 2003.
The Company recognized gains on sale of investments of $6.7 million in 2004 compared to $39.7 million in 2003. The realized gains in 2003 resulted primarily from a $40.4 million (pre-tax) gain generated in the fourth quarter of 2003 on the sale of a substantial portion of the Company’s stake in AMLI Residential.
Underwriting costs, policy acquisition costs and insurance expenses increased by 12% to $632.1 million in 2004 from $563.6 million in 2003, reflecting the increase in premium revenue, offset by the establishment in 2003 of significant accruals associated with then-pending litigation.
The Company maintains for the benefit of its employees and independent agents various stock-based compensation plans, in connection with which it records non-cash variable stock-based compensation expense (benefit) in amounts that depend and fluctuate based upon the market performance of the Company’s common stock. In 2004, the Company recognized a non-cash stock based compensation expense in the amount of $(14.3) million, compared to non-cash stock based compensation benefit of $459,000 in 2003, principally due to the higher average price of UICI shares in 2004 compared to the average share price in 2003.
Other expenses (consisting primarily of direct expenses incurred by the Company in connection with providing ancillary services and membership marketing and administrative services provided to the membership associations that make available to their members the Company’s health insurance products) decreased by 18%, to $59.8 million in 2004 from $73.4 million in 2003. The decrease is attributed to the decrease in enrollment of new association memberships relative to existing memberships; the direct expenses related to new ancillary services are higher than the costs of maintaining these ancillary services for existing business.
The Company’s business segments for financial reporting purposes include (a) the Insurance segment, which includes the businesses of the Company’s Self-Employed Agency Division, the Student Insurance Division, the Star HRG Division, the Life Insurance Division and Other Insurance; and (b) Other Key Factors, which includes investment income not allocated to the Insurance segment, realized gains or losses on sale of investments, interest expense on corporate debt, general expenses relating to corporate operations, minority interest, variable stock-based compensation and operations that do not constitute reportable operating segments (including the Company’s investment in Healthaxis, Inc. until sold on September 30, 2003).
For purposes of segment reporting, the Company had previously reported the results of its Student Insurance Division and Star HRG Division as one business unit referred to as its “Group Insurance Division.” Effective October 1, 2004, the Company began separately reporting the results of the Student Insurance Division and Star HRG Division.
Operating income (loss) for each of the Company’s business segments and divisions in 2004 and 2003 was as follows:
The health loss ratio represents benefits, claims and settlement expenses related to health insurance policies stated as a percentage of earned health premiums. The health expense ratio represents underwriting, policy acquisition costs and insurance expenses related to health insurance policies stated as a percentage of earned health premiums.
Submitted annualized premium volume in any period is the aggregate annualized premium amount associated with health insurance applications submitted by the Company’s agents in such period for underwriting by the Company.
Student Insurance Division. Set forth below is certain summary financial and operating data for the Company’s Student Insurance Division for each of the three most recent fiscal years:
Earned premium revenue at the Student Insurance unit increased to $297.0 million in 2004 from $239.6 million in 2003 (a 24% increase). The Company’s Student Insurance unit has completed its 2004-2005
Earned premium revenue at Star HRG increased to $145.7 million in 2004 from $114.4 million in 2003 (a 27% increase).
Allocations of investment income and certain general expenses are based on a number of assumptions and estimates, and the business division’s reported operating results would change if different methods were applied.
Other Insurance. During 2003, through a newly formed company, ZON Re USA LLC (an 82.5%-owned subsidiary), we began to underwrite, administer and issue accidental death, accidental death and dismemberment (AD&D), accident medical and accident disability insurance products, both on a primary and on a reinsurance basis. In 2004, ZON Re generated revenues and operating income of $14.4 million and $1.4 million, respectively.
Other Key Factors. The Other Key Factors segment includes investment income not allocated to the Insurance segment, realized gains or losses on sale of investments, interest expense on corporate debt, general
expenses relating to corporate operations, minority interest, variable stock-based compensation and operations that do not constitute reportable operating segments (including the Company’s investment in Healthaxis, Inc. until sold on September 30, 2003).
Results from discontinued operations in 2003 included losses (net of tax) from AMS in the amount of $(64.2) million (which included a $(61.2) million expense reflecting the estimated loss on disposal recorded in the third quarter of 2004) and the costs associated with the close down of the Company’s former Senior Market Division.
UICI reported revenues and income from continuing operations in 2003 of $1.813 billion and $87.3 million ($1.82 per diluted share), respectively, compared to 2002 revenues and income from continuing operations of $1.376 billion and $51.1 million ($1.05 per diluted share), respectively.
($(0.11) per diluted share), which was reflected as a cumulative effect of a change in accounting principle in accordance with Financial Accounting Standards Board (“FASB”) Statement No. 142, Goodwill and Other Intangible Assets.
Revenues. UICI’s revenues increased to $1.813 billion in 2003 from $1.376 billion in 2002, an increase of $437.5 million, or 32%. The Company’s revenues were particularly impacted by the following factors:
The Company generated a significant increase in health premium revenue (to $1.547 billion in 2003 from $1.161 billion in 2002, an increase of $385.9 million, or 33%) which resulted from new business as well as increased renewal business derived from new health business originally written in 2001 and 2002.
Life premiums and other considerations decreased by 5% to $30.0 million in 2003 from $31.5 million in 2002. This decrease resulted primarily from reduced premiums and other considerations from closed blocks of life and annuity business and the termination of sales (in May 2003) of the Company’s life policies through its former College Fund Life Division.
Other income (consisting primarily of income derived by the SEA Division from ancillary services and membership marketing and administrative services provided to the membership associations that make available to their members the Company’s health insurance products) increased by 10% to $118.6 million in 2003 from $107.5 million in 2002. Other income is directly related to sales of health insurance by the SEA Division and, as a result, the Company benefited from strong renewal income from health business originally written 2001 and 2002.
Results at the SEA Division in 2003 included a $(25.0) million charge associated with the reassessment of loss accruals established for certain pending litigation. See Note L of Notes to Consolidated Financial Information.
Operating margin (operating income as a percentage of earned premium revenue) remained relatively constant (9.1% in 2003 and 9.2% in 2002).
Student Insurance Division. Operating losses at the Student Insurance Division in 2003 were attributable to unfavorable claim experience. In the third quarter of 2003, the Company recorded a $(13.1) million ($(8.5) million net of tax, or $(0.18) per diluted share) charge, substantially all of which was attributable to unfavorable claims experience. Because Student Insurance policies are issued on a single school year basis and the 2003-2004 school year commenced in August 2003, the Student Insurance Division was limited in its ability to reprice its overall book of business until August 2004.
Star HRG Division. Operating income at the Star HRG Division decreased in 2003 to $1.9 million from $7.6 million in 2002. This decrease in operating income was due mostly to unfavorable claims experience.
Life Insurance Division. The operating losses at the Company’s Life Insurance Division in 2003 were primarily attributable to a claim accrual increase associated with the Company’s former workers compensation business, a charge associated with the final resolution of litigation arising out of the closedown in 2001 of the
Other Insurance. In the third quarter of 2003, the Company established a subsidiary (ZON Re USA, LLC) to underwrite, administer and issue accidental death, accidental death and dismemberment (AD&D), accident medical and accident disability insurance products, both on a primary and on a reinsurance basis. At December 31, 2003, the results of the start up operation were not material to the consolidated results of operations of the Company.
Other Key Factors. The Other Key Factors category includes investment income not allocated to the Insurance segment, realized gains or losses on sale of investments, interest expense on corporate debt, general expenses relating to corporate operations, minority interest, variable stock-based compensation and operations that do not constitute reportable operating segments (including the Company’s investment in Healthaxis, Inc. until sold on September 30, 2003)
For the year ended December 31, 2003 and 2002, AMS reported earnings (losses) (net of tax) in the amount of $(64.2) million and $5.3 million, respectively. Reflecting the anticipated sale of AMS, the
In 2003, the Company reported losses associated with the former Senior Market Division in the amount of $(9.2) million (net of tax), compared to losses in the amount of $(5.0) million (net of tax) in 2002. The losses in 2003 were primarily attributable to a loss of $(5.5) million (net of tax) recognized in the second quarter of 2003 upon sale of the Company’s interest in the agency through which the Company formerly marketed and distributed insurance products to the senior market, a write off of impaired assets, operating losses incurred at the Senior Market Division through the close-down date and costs associated with the wind down and closing of the operations.
The net premium assumption was revised from two-year preliminary term to net level in order to produce a more appropriate accrual for the liability of the ROP benefits in relation to the premiums. The interest rate assumption was reduced from 5% to 4.5% to reflect current investment yields. Since the ROP rider is primarily attached to attained-age rated health insurance products that are subject to periodic rate adjustment, the Company has determined as part of its ongoing review of the ROP estimation technique to increase its ROP liability to cover reasonably foreseeable changes to the future gross premium. Based on Company experience, the revised reserve factors incorporate an assumption of a 10% average annual increase in future gross premiums on such products. The estimation technique was also refined to use historical premiums and anticipated future premium increases in the calculation of future benefits rather than calculating the liability only from the current gross premium. Finally, a claim offset for actual benefits paid through the reporting date is applied to the ROP liability for all policies on a contract-by-contract basis. In the original simplified estimation technique, the intent was to balance the offsetting effects of applying the two-year preliminary term factors to the current gross premiums, since the historical premium information was not available. Changes to the technique were made in 2003 when sufficient historical premium information was available to refine the estimation calculation. Substantially all of the effect of this change in estimating the liability for future ROP benefits was attributable to the refinement of adding the assumption of a 10% average annual increase in the level of future gross premiums for attained-age rated health insurance products.
The ROP liabilities in the amount of $86.0 million and $83.4 million at December 31, 2004 and 2003, respectively, are reflected in future policy and contract benefits on the Company’s consolidated balance sheet.
Due to the anticipation of a future increase in the level of favorable development associated with the growth in business, the SEA Division undertook an analysis of the liability estimation process. The Company believes that the developmental method is the standard methodology within the health insurance industry and therefore re-evaluated the key assumptions utilized under this method. As the Company gained more
Several refinements in the claims liability calculation, all of which were treated as changes in accounting estimates, resulted in a further reduction of the claims liability, and corresponding increase in operating income, in the amount of $5.4 million during the first quarter of 2003. This reduction in the claims liability was attributable primarily to the effects of a change in estimate of the liability for excess pending claims. This change was necessary to maintain consistency with the historical data underlying the calculation of the new completion factors used in the claim development calculation. These completion factors are based on more recent experience with claims payments than the previous factors. This more recent experience has a greater number of pending claims. As a result, the new completion factors have built in a higher level of liabilities for pending claims. The release of a portion of the excess pending claims liability reflects the additional pending claims included in the completion factors.
On a consolidated level, the Company’s primary sources of liquidity have been premium revenues from policies issued, investment income, fees and other income, proceeds from corporate borrowings and borrowings to fund student loans. The primary uses of cash have been payments for benefits, claims and commissions under those policies, operating expenses, cash dividends to shareholders, stock repurchases and the funding of student loans. During 2004, the Company generated net cash from operations on a consolidated basis in the amount of $243.9 million, compared to $291.2 million in 2003 and $266.0 million in 2002.
All indebtedness issued under the secured student loan credit facility is reflected as student loan indebtedness on the Company’s consolidated balance sheet; all such student loans and accrued investment income pledged to secure such facility are reflected as student loan assets and accrued investment income, respectively, on the Company’s consolidated balance sheet; and all such cash, cash equivalents and qualified investments specifically pledged under the student loan credit facility are reflected as restricted cash on the Company’s consolidated balance sheet. The SPE Notes represent obligations solely of the SPE and not of the
The SPE Notes were issued by the SPE in three tranches ($50.0 million of Series 2001A-1 Notes and $50.0 million of Series 2001A-2 Notes issued on April 27, 2001, and $50.0 million of Series 2002A Notes issued on April 10, 2002). The Series 2001A-1 Notes and Series 2001A-2 Notes have a final stated maturity of July 1, 2036; the Series 2002A Notes have a final stated maturity of July 1, 2037. However, the SPE Notes are subject to mandatory redemption in whole or in part (a) on the first interest payment date which is at least 45 days after February 1, 2006, from any monies then remaining on deposit in the acquisition fund not used to purchase additional student loans and (b) on the first interest payment date which is at least 45 days after July 1, 2005, from any monies then remaining on deposit in the acquisition fund received as a recovery of the principal amount of any student loan securing payment of the SPE Notes, including scheduled, delinquent and advance payments, payouts or prepayments. After July 1, 2005, the SPE Notes are also subject to mandatory redemption in whole or in part on each interest payment date from any monies received as a recovery of the principal amount of any student loan securing payment of the SPE Notes, including scheduled, delinquent and advance payments, payouts or prepayments.
Set forth below is a summary statement of cash flows for UICI at the holding company level for each of the three most recent years:
2004 includes $25.0 million dividend from a non-insurance subsidiary related to the sale of the remaining uninsured student loans retained by the Company at the sale of AMS.
Includes borrowings from and/or repayments on loans from subsidiaries in the amount of $3.9 million, $8.3 million and $2.8 million in 2004, 2003 and 2002, respectively, and proceeds from subsidiaries related to agent stock plans in the amount of $19.7 million, $10.5 million and $8.5 million in 2004, 2003 and 2002, respectively.
On March 31, 2004, the Company completed the sale of all of the remaining uninsured student loan assets formerly held by the Company’s former Academic Management Services Corp. subsidiary. These assets had been retained by the Company at the November 18, 2003 sale of Academic Management Services Corp and reflected as held-for-sale assets on the Company’s consolidated balance sheet. The sale of the uninsured student loans generated gross cash proceeds in the amount of approximately $25.0 million.
On November 18, 2003, the Company sold its AMS unit, generating net cash proceeds to UICI of approximately $27.8 million (which amount is reflected as “Proceeds from sale of AMS” in the table above). At closing, UICI also received uninsured student loan assets formerly held by AMS’ special
purpose financing subsidiaries with a face amount of approximately $44.3 million (including accrued interest). In 2004, the Company completed the sale of the portfolio of uninsured loans.
At August 15, 2002, all remaining options initially granted to agents and employees in August 1998 under the UICI 1998 employee and agent stock option plans vested and became exercisable. All such options were exercisable at an option price of $15.00 per UICI share and remained exercisable during the period ended on January 13, 2003. During the year ended December 31, 2002 and the interim period that commenced on January 1, 2003 and ended January 13, 2003, the Company at the holding company level derived cash proceeds in the amount of $10.7 million and $8.9 million, respectively, from the exercise of stock options granted under the 1998 plans (which amounts are reflected as “Proceeds from stock option activities” in the table above). See Note M of Notes to Consolidated Financial Statements.
The Company and Mr. Jensen (the Company’s Chairman) were formerly defendants in litigation concerning the distribution of the cash proceeds from the sale and liquidation of SunTech Processing Systems, LLC (“STP”) assets in February 1998 (the “Sun Litigation”). Effective April 2, 2002, the Company and Mr. Jensen entered into an Assignment and Release Agreement, which, among other things, transferred UICI’s financial and other rights and obligations in STP to Mr. Jensen and effectively terminated the Company’s active participation in, and limited the Company’s financial exposure associated with, the Sun Litigation. In accordance with the terms of the Assignment and Release Agreement, on April 2, 2002 Mr. Jensen made a total payment to UICI of $15.6 million (which amounts are reflected as “Proceeds from Sun Litigation agreement” in the table above) and granted to UICI various indemnities against possible losses which UICI might incur resulting from the Sun Litigation. See Note K of Notes to Consolidated Financial Statements.
During 2004, 2003 and 2002, the Company’s principal uses of cash and liquidity at the holding company were as follows:
On August 18, 2004, the Company’s Board of Directors adopted a policy of issuing a regular semi-annual cash dividend on shares of its common stock. In accordance with the new dividend policy, on August 18, 2004, the Company’s Board of Directors declared a regular semi-annual cash dividend of $0.25 on each share of Common Stock ($11.5 million in the aggregate), which dividend was paid on September 15, 2004.
“Contribution to AMS” in the table above). See Note Q of Notes to Consolidated Financial Statements.
On January 17, 2002, UICI completed the purchase, for a cash purchase price of $8.0 million (which amount is included in “Acquisitions” in the table above), of a 50% interest in an agency specializing in the sale of long-term care and Medicare supplement insurance products. In the second quarter of 2003, the Company completed the sale of its 50% interest in this agency for a nominal price.
Set forth below is a summary of the Company’s contractual obligations (on a consolidated basis) at December 31, 2004:
The Company has historically funded its College Fund Life Division student loan commitments with the proceeds of indebtedness issued by a bankruptcy-remote special purpose entity (the “SPE Notes”). At December 31, 2004, $29.7 million of cash, cash equivalents and other qualified investments was available to fund the purchase by the bankruptcy-remote special purpose entity from the Company of additional student loans generated under the Company’s College First Alternative Loan program. The indenture governing the terms of the SPE Notes provides, however, that the proceeds of such SPE Notes may be used to fund student loan commitments only until February 1, 2006, after which any monies then remaining on deposit in the acquisition fund created by the indenture not used to purchase additional student loans must be used to redeem the SPE Notes. See discussion above under the caption “Liquidity and Capital Resources - Consolidated” and Note H of Notes to Consolidated Financial Statements.
At each of December 31, 2004 and 2003, the Company had $5.0 million and $7.1 million, respectively, of letters of credit outstanding relating to its insurance operations.
General. The Company’s Investment Committee monitors the investment portfolio of the Company and its subsidiaries. The Investment Committee receives investment management services from external professionals and from the Company’s in-house investment management team. The internal investment management team monitors the performance of the external managers as well as directly managing approximately 20% of the investment portfolio.
Investments are reviewed quarterly (or more frequently if certain indicators arise) to determine if they have suffered an impairment of value that is considered other than temporary. Managements’ review considers
Included in the fixed maturity portfolio is an allocation of corporate bonds. The Company invests in primarily short term and medium term investment grade corporate bonds. The Company’s investment policy limits individual concentration risk of investment grade bonds to 3% of assets and non investment grade bonds to 2% of assets. As of 12/31/04, the largest concentration in any one investment grade corporate bond was $16.0 million which represented less than 1% of total invested assets. The largest concentration in any one non investment grade corporate bonds was $3.7 million, which represented less than 0.5% of total invested assets.
The Company regularly monitors its investment portfolio to attempt to minimize its concentration of credit risk in any single issuer. Set forth in the table below is a schedule of all investments representing greater than 1% of the Company’s aggregate investment portfolio at December 31, 2004 and 2003, excluding investments in U.S. Government securities:
The Company believes that its recorded claim liabilities are reasonable and adequate to satisfy its ultimate claims liability. Each of the Company’s major operating units has an actuarial staff that has primary responsibility for assessing the claim liabilities. Corporate has an oversight process in place to provide final review of the establishment of the claim liabilities. The Company uses its own experience as appropriate and relies on industry loss experience as necessary in areas where the Company’s data is limited. Our estimate of claim liabilities represents management’s best estimate of the Company’s liability as of December 31, 2004. Assuming a hypothetical 1% difference in the loss ratio (i.e., benefits, claims and settlement expenses stated as a percentage of earned premiums) for the year ended December 31, 2004, net income would increase or decrease by approximately $12.0 million and diluted net earnings per common share would increase or decrease by approximately $0.25 per share.
Effective January 1, 2003, the Company implemented a new incurred date coding definition to establish incurred dates under the developmental method in the SEA Division. Under this new incurred date coding definition, a break in service of more than six months will result in the establishment of a new incurred date for subsequent services. In addition, under this new incurred date coding definition, claim payments continuing more than thirty-six months without a six month break in service will result in the establishment of a new incurred date. This change in the incurred date definition assumption resulted in a reduction in the estimated claim liabilities, and a corresponding increase in operating income, at the SEA Division in the amount of $12.3 million during the first quarter of 2003.
Set forth below is a summary of claim liabilities by business unit at each of December 31, 2004, 2003 and 2002:
The above table shows incurred losses developed at the SEA Division in amounts less than originally anticipated due to better-than-expected experience on the health business in the SEA Division in 2004, 2003, and 2002.
The favorable claims liability development experience at the SEA Division in 2004 reflects the effect of $47.8 million in claim liabilities established during 2003 in response to a rapid pay down during 2003 of an excess pending claims inventory. In particular, during 2003 the Company observed a change in the distribution of paid claims by incurred date; more paid claims were assigned to recent incurred dates than had been the case on paid claims in prior years. Assignment of paid claims with more recent incurred dates typically results in an understatement of the claim development liability, resulting in the need for augmented claim liabilities. The Company believes that the deviation from historical experience in incurred date assignment was a natural consequence of the effort required to reduce a claims backlog, which the Company was experiencing at the SEA Division during the course of 2003. However, as the actual claims experience developed in 2004, these augmented claim liabilities in the amount of $47.8 million proved to be redundant. These claim liabilities were released during 2004 and, as a result, will not influence the level of claim liability redundancies in future periods.
The total favorable claims liability development experience for 2003 in the amount of $54.0 million represented 14.9% of total claim liabilities established for the SEA Division at December 31, 2002. The favorable experience in the SEA Division for 2003 included the effect of the $17.7 million decrease in claims liability due to the refinements made effective January 1, 2003 to the claims liability calculation ($12.3 million) and changes in estimate ($5.4 million). See the discussion above under the caption “2003 Change in Claims and Future Benefit Liability Estimates - Self-Employed Agency Division.” Excluding the impact of these refinements and changes in estimate, the favorable experience in 2003 in the claims liability was $36.3 million, or 10.0% of the total claim liabilities established for the SEA Division at December 31, 2002.
The favorable claims liability development experience at the Star HRG Division in 2004 includes the effects of claims in 2004 developing more favorably than indicated by the loss trends in 2003 used to determine the claim liability at December 31, 2003. The Star HRG Division also experienced favorable development for 2003. Since the Star HRG business was new to the Company (acquired in 2002), an expected loss ratio was used to set the claims liability at December 31, 2002.
fair value and assessing investment impairment. The same influences tend to increase the risk of potentially impaired assets.
The Company records deferred tax assets to reflect the impact of temporary differences between the financial statement carrying amounts and tax bases of assets. The Company establishes a valuation allowance when management believes, based on the weight of the available evidence, that it is more likely than not that some portion of the deferred tax asset will not be realized. Realization of the net deferred tax asset is dependent on generating sufficient future taxable income. However, the amount of the deferred tax asset considered realizable, however, could be reduced in the near term if estimates of future taxable income during the carryforward period are reduced.
During 2003, the Company realized $59.3 million of net capital losses for federal tax purposes. The capital losses were generated in 2003 from the sale of AMS, Healthaxis and SeniorsFirst LLC and were partially offset by the gain from the sale of a substantial portion of the Company’s equity stake in AMLI Residential. To the extent not utilized to offset capital gains generated in prior years, the net capital losses generated in 2003 will be carried forward to future years, with the ability to utilize the remaining capital losses in 2004 through 2008. During 2003, the Company determined that it was more likely than not that it would not be able to realize its deferred tax assets related to a portion of the capital loss carryforwards generated in 2003. Accordingly, the Company established a valuation allowance of $19.8 million associated with the carryforwards at December 31, 2003.
As of December 31, 2004, the balance of the valuation allowance was $17.0 million, reflecting a reduction of $2.8 million from the valuation allowance at December 31, 2003. The reduction in the valuation allowance was attributable primarily to realization of tax capital gains during 2004.
Dividends paid by domestic insurance companies out of earned surplus in any year are limited by the law of the state of domicile. See Item 5 - Market for Registrant’s Common Stock and Related Stockholder Matters and Note J of Notes to the Consolidated Financial Statements.
On December 16, 2004, the Financial Accounting Standards Board (“FASB”) issued Statement 123R, Share-Based Payment, which requires all companies to recognize compensation cost for all share-based payments to employees at fair value. The Statement is effective for public companies (except small business issuers, as defined in SEC Regulation S-B) for interim or annual periods beginning after June 15, 2005. The FASB also concluded that retroactive application of the requirements of Statement 123 (not Statement 123R) to the beginning of the fiscal year that includes the effective date would be permitted, but not required. The Company therefore will be required to apply Statement 123R beginning July 1, 2005 and could choose to apply Statement 123 retroactively from January 1, 2005 to June 30, 2005. The cumulative effect of adoption, if any, would be measured and recognized on July 1, 2005. The Company believes the adoption of this pronouncement will not have a material effect upon the financial condition or results of operations.
more of its licenses. From time to time the Company is subject to inquiries related to its activities and practices in states in which it operates. The Company has been subject to regulatory penalties, assessments and restitution orders in a number of states. Furthermore, federal and state laws and regulations continue to evolve. The costs of compliance may cause the Company to change its operations significantly, or adversely impact the health care provider networks with which the Company does business, which may adversely affect its business and results of operations.
As is the case with many of our competitors in the self-employed market, a substantial portion of our health insurance products are issued to members of various independent membership associations that act as the master policyholder for such products. The two principal membership associations in the self-employed market that make available to their members our health insurance products are the National Association for the Self-Employed and the Alliance for Affordable Services. The associations provide their membership access to a number of benefits and products, including health insurance underwritten by us. Subject to applicable state law, individuals generally may not obtain insurance under an association’s master policy unless they are also members of the association. The agreements with these associations requiring the associations to continue as the master policyholder for our policies and to make our products available to their respective members are terminable by us and the associations upon not less than one year’s advance notice to the other party.
While we believe that we are providing association group coverage in full compliance with applicable law, changes in our relationship with the membership associations and/or changes in the laws and regulations governing so-called “association group” insurance (particularly changes that would subject the issuance of policies to prior premium rate approval and/or require the issuance of policies on a “guaranteed issue” basis) could have a material adverse impact on our financial condition, results of operations and/or business.
Company’s principal insurance subsidiaries are currently rated by A.M. Best Company, Fitch and Standard & Poor’s. In evaluating a company, independent rating agencies review such factors as the company’s capital adequacy; profitability, leverage and liquidity, book of business; quality and estimated market value of assets; adequacy of policy liabilities; experience and competency of management; and operating profile. If the Company’s insurance subsidiaries are not able to maintain their current rating by A.M. Best Company, Fitch and/or Standard & Poor’s, the Company’s results of operations could be materially adversely affected, particularly with respect to the Company’s Star HRG and Student Insurance businesses. Decreases in operating performance and other financial measures may result in a downward adjustment of the rating of the insurance subsidiaries assigned by A.M. Best Company, Fitch or Standard & Poor’s. In addition, other factors beyond the Company’s control such as general downward economic cycles and changes implemented by the rating agencies, including changes in the criteria for the underwriting or the capital adequacy model may result in a decrease in the rating. A downward adjustment in rating by A.M. Best Company, Fitch and/or Standard & Poor’s of the Company’s insurance subsidiaries could cause the Company’s agents or potential customers to look at the Company with less favor, which could have a material adverse effect on the Company’s results of operations.
UICI is a holding company, the principal assets of which are its investments in its separate operating subsidiaries, including its regulated insurance subsidiaries. The holding company’s ability to fund its cash requirements is largely dependent upon its ability to access cash, by means of dividends or other means, from its subsidiaries. The Company’s insurance subsidiaries are subject to regulations that limit their ability to transfer funds to the Company. If the Company is unable to obtain funds from its insurance subsidiaries, it will experience reduced cash flow, which could affect the Company’s ability to pay its obligations to creditors as they become due.
The audited consolidated financial statements of the Company and other information required by this Item 8 are included in this Form 10-K beginning on page.