The Company owns its home office building, located at 17800 Royalton Road, Strongsville, Ohio. The building, which consists of 121,625 square feet of gross floor area, was occupied in late 1990 by the Company and all its subsidiaries. Central, the principal operating subsidiary, entered into a 15 year triple net lease agreement with the Company for 100% of the space. All operations are conducted in this building.
Liquidity is the ability of an enterprise to generate adequate amounts of cash to meet its financial commitments. The major needs for cash are to enable Central to pay claims and expenses as they come due. Central's primary sources of cash are premiums and investment income. Central's payments consist of current claim payments to insureds, managed care expenses, operating expenses such as salaries, employee benefits, commissions, taxes, etc., and shareholder dividends payable to the Company. The Company has, in the past, relied on the dividend from Central to enable it to pay dividends to shareholders. By statute, the state regulatory authorities set minimum liquidity standards to protect both policyholders and shareholders and limit the dividends payable by Central to the Company. See Item 5.
The majority of the Company's assets are in investments which were $90,723,418, after a net unrealized holding loss of $247,637 (see below), or 76% of the total assets at December 31, 1996. Fixed maturities are the primary investment of the Company and were $79,501,862 or 88% of total investments at December 31, 1996. Other investments consist of short-term securities and policy loans. The Company is carrying fixed maturities of $11,892,925 at amortized cost (held to maturity) and fixed maturities of $67,608,937 at estimated fair value (available for sale) at December 31, 1996. The Company does not hold any so-called
Central, the major operating subsidiary, suffered a large decrease in its statutory capital and surplus to $16,595,497 at December 31, 1996 from $27,477,972 at December 31, 1995. The decrease was primarily due to the $9,321,633 statutory loss, after tax benefits of $2,810,830, as further explained in the "results of operations" section. This decrease has caused Central to fall under the regulatory action level (RAL) imposed by the Ohio Department of Insurance under the recently adopted Risk-Based Capital (RBC) requirements on insurance enterprises (see note 4 to the consolidated financial statements). Central's adjusted capital, under the RBC standards, at December 31, 1996, was $17,137,515 and the RAL was $18,508,044 at December 31, 1996. Central is required to, and did, submit a RBC financial plan to the Ohio Department of Insurance reflecting certain projections and steps to be taken to return the adjusted capital to the required levels. In 1996 Central increased reserves in excess of $11.5 million and did end the year with a positive cash flow while continuing to meet all necessary expenditures for claims, commissions, expenses, etc. for 1996. The Company is also exploring opportunities to raise capital to contribute to Central.
The only long-term debt the Company had at December 31, 1996, was $8,503,776, which is the principal amount payable under a loan secured by a mortgage on the Company's home office building. The Company entered into the loan agreement in 1990 for $9 million for a term of 10 years bearing interest at 9 1/2% per annum with a 30 year amortization period payment schedule. At the same time, the Company also entered into a 15 year lease agreement with Central for 100% of the space. The Company will use the monthly rental payments to pay, among other expenses, the required mortgage loan payments. In 1995, the Company started a search for a new computer system for claims and administration which includes, among other things, billing, rating and commission functions. The increase in the Company's business, new state mandates and new products have created the need for this new system. A system of this nature is expected to cost between $8 million and $9 million, including software, hardware and implementation, over an estimated four year period. The Company estimates these costs could be recovered over a 4 to 5 year period, through a combination of payroll cost savings, expense controls and new production capacity. The Company has not entered into any contract or commitment for the purchase of such a computer system, although such an acquisition is planned for 1997. In light of the Company's growth over the last several years, the Company has considered expansion of its headquarters building. However, it has determined to take no actions currently, in light of its financial results in 1996.
certificates in force increased about 10% to 113,720 in 1995 from 102,959 in 1994. Certificates issued for new group policies were 44,398 in 1995, up 42%, from 31,270 in 1994. The increase came primarily from a new product, the Professional Multi-Option (PMO), which was introduced in late 1994 and targets small businesses with 2 to 25 lives. Total lapses (net of additions/decreases) in 1995 were 33,637, down slightly from 33,847 in 1994. Overall, the lapse ratio was in line with the Company's expectations and was lower than the industry average for small group business.
Not included in premiums, for generally accepted accounting principles (GAAP) purposes, were annuity considerations in the amounts of $3,498,442 and $3,492,402 for 1995 and 1994.
Inflation rates impact the Company's financial condition and operating results in several areas. Changes in inflation rates impact the market value of the investment portfolio and yields on new investments.
Inflation has had an impact on claim costs and overall operating costs and although it has been lower in the last few years, hospital and medical costs have still increased at a higher rate than general inflation. While to a certain extent these increased costs are offset by interest rates (investment income), hospital charges increased, while the rate of income from investments has not increased proportionately. The Company will continue to establish premium rates in accordance with trends in hospital and medical costs along with concentrating on various cost containment programs.
In October 1995, the Financial Accounting Standards Board (FASB) has issued Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation", which was effective for the Company for the year ended December 31, 1996. The Statement prescribes accounting and reporting standards for all stock-based compensation plans, including employee stock options, restricted stock and stock appreciation rights. SFAS No. 123 allows for either the adoption of the "fair value" method of accounting for stock-based compensation or the continued use of APB No. 25, "Accounting for Stock Issued to Employees." The Company has elected to continue to comply with APB No. 25. The Company has not granted any new stock options subsequent to January 1, 1995, therefore, the pro forma disclosures required by SFAS No. 123 are not applicable.
We have audited the consolidated financial statements of Central Reserve Life Corporation and subsidiaries as listed on the accompanying index on page 13. In connection with our audits of the consolidated financial statements, we have also audited the financial statement schedules as listed in the accompanying index on page 13. These consolidated financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to report on these consolidated financial statements and financial statement schedules based on our audits.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Central Reserve Life Corporation and subsidiaries as of December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1996, in conformity with generally accepted accounting principles. Also, in our opinion, the financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in note 4 to the consolidated financial statements, the Ohio Department of Insurance (the Department) imposes risk-based capital requirements on insurance enterprises, including the Company. At December 31, 1996, the Company's total adjusted capital is at the Regulatory Action Level based on the risk-based capital calculation required by the Department. The Company filed a comprehensive financial plan with the Department on March 5, 1997, outlining its plans for attaining the required levels of regulatory capital. The Department has sixty days to notify the Company if its comprehensive financial plan is unsatisfactory. Failure to meet the capital requirements and interim capital targets included in the Company's plan could expose the Company to regulatory sanctions that may include restrictions on operations and growth, mandatory asset dispositions, and placing the Company under regulatory control. These matters raise substantial doubt about the ability of the Company to continue as a going concern. The ability of the Company to continue as a going concern is dependent on many factors, one of which is regulatory action, including ultimate acceptance of the Company's comprehensive plan. Management's plans in regard to these matters are described in note 4 to the consolidated financial statements. The accompanying consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
The following is a description of certain risks facing life and accident and health insurers and how Central mitigates those risks:
Legal/Regulatory Risk is the risk that, changes in the legal or regulatory environment in which an insurer operates, will create additional expenses not anticipated by the insurer in pricing its products. That is, regulatory initiatives designed to reduce insurer profits or otherwise affecting the industry in which the insurer operates, new legal theories or insurance company insolvencies through guaranty fund assessments, may create costs for the insurer beyond those recorded in the financial statements. Central attempts to mitigate this risk by offering a wide range of products and by operating in 35 states, thus reducing its exposure to any single product or non-Federal jurisdiction, and also by employing underwriting practices which identify and minimize the adverse impact of this risk.
The Health Insurance Portability and Accountability Act of 1996, which provides for changes in the health insurance market is scheduled to become effective in July 1997. It guarantees the availability and renewability of health insurance coverage for certain employees and individuals, and limits the use of preexisting condition restrictions. The Act creates federal standards for insurers, health maintenance organizations (HMOs), and employer plans, including those who self-insure. It permits, however, substantial state flexibility for compliance with the requirements on insurers.
In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and revenues and expenses for the reporting period. Actual results could differ significantly from those estimates.
The following is the breakdown of net investment income by category of investments for the years ending December 31:
The amortized cost and estimated fair value of securities held to maturity and available for sale as of December 31, 1995 are as follows. The estimated fair value is based on quoted market prices, where available, or on values obtained from independent pricing services.
The proceeds, gross realized gains and gross realized losses from the sale (excluding calls, maturities and pay downs) of fixed maturities available for sale during each year were as follows:
Shareholders' capital and surplus and net income (loss) as determined in accordance with statutory accounting practices for Central differ from GAAP. Following is a reconciliation showing those differences.
Central has filed annual financial statements with the Ohio Department of Insurance (ODI) prepared on the basis of accounting practices prescribed or permitted by such regulatory authorities. Prescribed statutory accounting practices include a variety of publications of the National Association of Insurance Commissioners, as well as state laws, regulations and general and administrative rules. Permitted statutory accounting practices encompass all accounting practices not prescribed. Central's statutory accounting practices are all prescribed by the ODI.
business risks (management, regulatory action, and contingencies). The amount determined under such formulas is called the Authorized Control Level RBC (ACL).
On March 5, 1997, Central filed its RBC financial plan with the Ohio Department of Insurance (ODI) outlining plans for attaining the levels of RBC required to raise the Company's RBC above the Company Action Level. The RBC financial plan identifies the conditions that contributed to the Regulatory Action Level, including underpricing of a new product, PMO, sold primarily in 1995, and state mandated benefits and guaranteed issue. The RBC financial plan also contains corrective actions taken by Central beginning April 1, 1996, including an increase of PMO premium rates, changes in certain policy benefits and the renegotiating of certain provider contracts to produce further cost savings. The PMO plan represented approximately 40% of Central's premiums collected in 1996. Since the PMO plan is monthly business, the rate action taken on April 1, 1996 will not be completed until the end of March 1997. In addition to these corrective actions, the Company has engaged an investment banking firm to assist the Company in its efforts to raise additional capital for Central. Raising of additional capital will be necessary to raise Central's RBC above the Company Action Level within the short term. The ODI has sixty days to notify Central if the RBC financial plan is unsatisfactory. Failure to meet the capital requirements and interim capital targets included in Central's RBC financial plan could expose Central to such actions by the ODI as being placed under regulatory control. Management believes, that Central will be able to meet the plan's capital requirements and interim targets. The accompanying consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
The maximum amount of exposure that Central retains on any life is $50,000 on ordinary life and group life. No retention is maintained over age 70. Maximum retention on impaired risks is $10,000. Central also has reinsurance on group accident and health claims. Effective January 1, 1995, Central's reinsurance treaty provides that all individual claims in excess of $500,000 are 100% reinsured. The overall effect of reinsurance is not material to the Company's financial position or results of operations. Reinsurance treaties in effect at December 31, 1996 were with The Cologne Life Reinsurance Company, Life ReAssurance Corporation of America and Business Men's Assurance Company.
and, as applicable, eligible retirees, fund the payment of benefits under the program in amounts and at such times as premium payments or reimbursement of premium payments are incurred.
The program's net periodic postretirement benefit cost for the reported period is as follows:
These techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Although fair value estimates are calculated using assumptions that management believes are appropriate, changes in assumptions could cause these estimates to vary materially. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in the immediate settlement of the instruments. SFAS 107 excludes certain assets and liabilities from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.
CASH, SHORT-TERM INVESTMENTS, PREMIUMS RECEIVABLE AND POLICY LOANS: The carrying amount reported in the consolidated balance sheets for these instruments approximate their fair value.