The Company currently leases from unaffiliated parties: (i) approximately 9,000 square feet of office space in Rye Brook, New York, under a lease expiring in October 2004, (ii) 18,000 square feet in Orlando, Florida, under a lease expiring in January 2002; (iii) 32,000 square feet in Pensacola, Florida, under a lease expiring in November 2002, with two renewals at the Company's option for a period of five years each; (iv) 3,000 square feet in Dallas, Texas, under a lease expiring in March 2002 and (v) 4,000 square feet in Bay Harbour, Florida, under a lease expiring in August 1999. These leases represent the operating offices of American Progressive, American Pioneer, American Exchange and WorldNet, respectively, and carry an aggregate annual rental of approximately $750,000. The Company also leases a smaller office in Andalusia, Alabama, for an aggregate annual rental of approximately $17,000.
The selected consolidated financial data presented below should be read in conjunction with the consolidated financial statements of the Company, the related notes thereto and the auditors' report thereon and "Management's Discussion and Analysis of Financial Condition and Results of Operations". The selected consolidated financial data presented below as of, and for each of the years ended December 31, 1994 and 1995 are derived from the consolidated financial statements of the Company, which have been audited and reported upon by KPMG LLP, independent certified public accountants. The selected consolidated financial data presented below as of and for each of the years ended December 31, 1996 through 1998, have been audited and reported upon by Ernst & Young LLP, independent certified public accountants. See "Management's Discussion and Analysis of Financial Condition and Results of Operations".
- --------------------------------------------------------- (1) After provision for Series A Preferred Stock dividends of $576,000 for the year ended December 31, 1994 and Series C Preferred Stock dividends of $250,000 and $433,000 for the year ended December 31, 1997 and 1998, respectively. (2) Basic stockholders' equity per share of common stock represents stockholders' equity less the statement value of Series B Preferred Stock divided by outstanding shares of common stock. (3) Diluted stockholders' equity per share of common stock represents stockholders' equity plus the statement value of the Series C Preferred Stock, redemption accrual on the Series C Preferred Stock, the Series D Preferred Stock, the proceeds from the exercise of outstanding options and warrants divided by outstanding shares of common stock plus the stock issued pursuant to the conversion of the Series B, Series C and Series D Preferred Stock and the exercise of the options and warrants outstanding. (4) Includes the results of the First National block of business since its acquisition on October 1, 1996. See "Management's Discussion and Analysis of Financial Condition and Results of Operations". (5) Includes the results of American Exchange since its acquisition on December 1, 1997. See "Management's Discussion and Analysis of Financial Condition and Results of Operations".
The Company cautions readers regarding certain forward-looking statements contained in the following discussion and elsewhere in this report and in any other oral or written statements, either made by, or on behalf of the Company, whether or not in future filings with the Securities and Exchange Commission ("SEC"). Forward-looking statements are statements not based on historical information. They relate to future operations, strategies, financial results or other developments. In particular, statements using verbs such as "expect," "anticipate," "believe" or similar words generally involve forward-looking statements. Forward-looking statements include statements that represent the Company's products, investment spreads or yields, or the earnings or profitability of the Company's activities.
The results of operations for the years ended December 31, 1997 and 1998 include the operations of American Progressive, American Pioneer and WorldNet for the year ended December 31, 1997 and the operations of American Exchange for the period December 4, 1997, the date of its acquisition, to December 31, 1997. All references to per share amounts are on a diluted basis.
Revenues. Total revenues increased approximately $4.8 million to approximately $56.1 million for the year ended December 31, 1998, compared to total revenues of approximately $51.3 million in the prior year.
In the year ended December 31, 1998, the Company's gross premium and policyholder fees earned (including reinsurance assumed) amounted to $132.0 million, a $31.7 million increase over the $100.3 million amount in 1997. This gross premium increase is primarily related to the Company's acquisitions of the stock of American Exchange in December 1997 ($19.5 million) and a Medicare Supplement block of business from Dallas General effective January 1, 1998 ($10.5 million). In addition, the gross earned premiums on the Company's currently marketed programs increased as follows:
1998 Total Product Premium Decrease Premium Earned ------------------------------- ---------------- -------------- (in millions) (in millions) First National assumed business $ 3.95 $ 47.32 Non-marketed life insurance .53 6.74 Non-marketed accident & health 2.42 11.20 Group dental insurance 6.86 - ---------------- -------------- Totals $ 13.76 $ 65.26 ================ ==============
Interest credited to policyholders increased $0.6 million to $7.2 million, which increase is the result of more interest sensitive account values in force, primarily from the sale of the Asset Enhancer product.
Other operating costs and expenses increased $1.8 million in the year ended December 31, 1998 to $21.2 million, compared to $19.4 million in 1997. The insurance companies' expenses amounted to $19.8 million for the year ended December 31, 1998 compared to $16.7 million in 1997, an increase of $3.1 million. This increase is the result of an increase of expenses incurred in generating new business ($1.5 million) and the result of expenses incurred at American Exchange ($.5 million), which was not owned by the Company in the 1997 period as well as an increase in TPA fees ($2.1 million). These increases were offset by decreases in the general overhead incurred at the insurance companies ($1.1 million). The non-insurance companies' expenses decreased $0.3 million to $1.3 million for the year December 31, 1998. This decrease in expenses incurred by WorldNet ($1.1 million) offset by an increase in expenses incurred at the Parent Company ($.6 million), which is primarily the interest expense on the new loan outstanding and increased activity of the public company operations in 1998 relative to 1997.
For the year ended December 31, 1997, the Company earned net income after Federal income taxes of $2.1 million ($0.18 per share) compared to $0.1 million ($0.01 per share) in the prior year. Operating income before Federal income taxes amounted to $3.2 million for the year ended December 31, 1997 compared to $0.4 million in the prior year. In September 1997, the Company sold AmeriFirst Insurance Company, an inactive insurance company, to an unaffiliated third party, for $3.4 million and realized a pretax gain of $0.6 million ($0.4 million after tax or $0.03 per share).
Product Premium Increase Premium Earned --------------------------------- ---------------- --------------- Senior market supplemental health $ 4.39 $ 11.37 Senior market life insurance .77 2.37 Group life insurance .12 3.41 ---------------- --------------- Totals $ 5.28 $ 17.15 ================ ===============
In addition, other life insurance premium increased $2.1 million to $8.4 million in 1997.
These increases totaled $44.5 million and were offset by the net decrease in premiums on the products terminated and not currently marketed by the Company. Effective December 31, 1996, the Company withdrew its participation in the NAIU specialty accident & health insurance pool and also sold its New York State DBL business in force. The decrease in premium from the exit from these lines amounted to $11.2 million for the year ended December 31, 1997. Effective September 1, 1997, the Company decided to exit the group dental business and executed an agreement with an unaffiliated reinsurer to cede 100% of all business earned after September 1, 1997. The premium will continue to be received by American Pioneer and will be ceded to the reinsurer on a 100% quota share basis. Gross premiums for the group dental business increased $1.1 million in 1997. Other accident & health insurance premiums increased $0.1 million for the year ended December 31, 1997. Premiums on the international medical insurance product (which was 90% and 95% reinsured to unaffiliated reinsurers in 1997 and 1996, respectively) increased $1.3 million in 1997, while the premiums on the non-marketed accident & health products decreased $1.1 million in 1997.
Effective January 1, 1997, the Company entered into a new reinsurance agreement on American Pioneer's major medical/major hospital business. Under the new treaty, the Company retains 50% of the first $60,000 in claims risk compared to 25% under the prior agreement. As a result, premiums ceded on this product decreased $1.7 million in 1997. Accident & health premiums ceded on the policies not currently marketed also decreased $1.0 million.
In connection with the restructuring activity previously discussed, reinsurance on the NAIU pool business amounted to $1.1 million and reinsurance on the group dental business amounted to $2.2 million.
Net investment income of the Company increased $0.2 million to $10.0 million for the year ended December 31, 1997, compared to $9.9 million in the prior year. Realized gains on investments amounted to $1.1 million for the year ended December 31, 1997 compared to $0.2 million in the prior year. Included in the 1997 amount is the $0.6 million gain realized on the sale of AmeriFirst Insurance Company to an unaffiliated third party.
Claims and other benefits decreased $0.3 million to $23.7 million for the year ended December 31, 1997 compared to $24.0 million in the prior year. The increase in net claims on the business assumed from First National amounted to $6.5 million, while net claims on the senior market accident & health increased $0.8 million. As discussed above, the Company is retaining a higher amount of major medical/major hospital business under a new reinsurance agreement and, as a result, the Company's claims on this product increased $1.1 million to $2.2 million. (This increase corresponds to the $1.1 million increase in retained premiums.) In addition, claims on the non-marketed accident & health products increased $0.4 million in 1997.
These increases of $8.7 million were offset by decreases in the claims incurred on the terminated businesses (NAIU - $4.2 million; New York State DBL - $3.7 million; group dental - $0.9 million). The remaining decrease of $0.2 million represents a decrease in life insurance claims.
The insurance companies' expenses amounted to $16.8 million for the year ended December 31, 1997 compared to $14.8 million in the prior year, an increase of $2.0 million. Expenses incurred administrating the recently acquired business from First National amounted to $4.3 million, while premium taxes increased $0.8 million. These increases totaled $5.0 million and were offset by the decrease in new business expenses of $0.3 million, general overhead of the insurance companies of $1.1 million and expenses incurred by the NAIU pool of $1.6 million.
In December 1997, the Company entered into an agreement with Chase Manhattan Bank for a $3.5 million five-year, secured term loan and during the nine months ended September 30, 1998, the Company made principal payments totaling $0.4 million. The loan agreement called for interest at the London Interbank Offered Rate ("LIBOR") plus 200 basis points. However, in order for it hedge the interest rate risk on this loan agreement, the Company entered into a three-year interest rate swap agreement, (the "Swap Agreement") with Chase Securities Corp., effective January 1, 1998 and locked in a fixed interest rate of 8.19%. During the nine months ended September 30, 1998, the Company paid $0.2 million in interest for the period December 4, 1997 to September 30, 1998.
On September 30, 1998, the Company executed the First Amendment to its Credit Agreement with Chase Manhattan Bank, which Amendment refinanced the current loan agreement with the bank. Under the Amendment, the Company executed a new $5.0 million five-year secured term loan. The principle amount outstanding on the prior loan was $3.2 million and was paid off with the proceeds of the new loan. The new loan agreement calls for interest at the LIBOR plus 200 basis points. The Company's three-year interest rate swap agreement with the Bank remains in effect on the original $3.5 million loan, which locked in a fixed interest rate on the refinanced loan of 7.8%. The effect of this swap agreement was to increase interest expense by $24,000 in 1998. In the fourth quarter, the Company paid $0.3 million in principal and $0.1 million in interest under the amended loan agreement.
In connection with the Unstacking Agreement (see "Business - Unstacking"), Universal has $7.9 million in debentures outstanding to its American Progressive subsidiary. The debentures pay interest quarterly at 8.5% and are due between September 2002 and May 2003.
Management believes that the current cash position and expected cash flows of the non-insurance companies and the availability of dividends from American Pioneer can support the obligations of Universal noted above for the foreseeable future. Although, there can be no assurance as to the expected future cash flows or to the availability of dividends from American Pioneer.
As a result of the decrease in economic interest rates, the net yield on the Company's cash and invested assets decreased from 6.81% in 1997 to 6.67% in 1998. A significant portion of these securities are held to support the liabilities for policyholder account balances, which liabilities are subject to periodic adjustments to their credited interest rates. The credited interest rates of the interest-sensitive policyholder account balances are determined by management based upon factors such as portfolio rates of return and prevailing market rates and typically follow the pattern of yields on the assets supporting these liabilities.
At December 31, 1998, the Insurance Subsidiaries held cash and cash equivalents totaling $17.1 million, as well as fixed maturity and equity securities that could readily be converted to cash with carrying values (and fair values) of $135.8 million. The fair values of these liquid holdings totaled more than $152.9 million.
The Company files a consolidated return for federal income tax purposes, in which American Pioneer and American Exchange are not currently permitted to be included. At December 31, 1998 the Company (exclusive of American Pioneer and American Exchange) had a net operating tax loss carry forwards of approximately $11.6 million which expire in the years 1999 to 2012. At December 31, 1998 the Company also had Alternative Minimum Tax (AMT) credit carryforward for Federal income tax purposes of approximately $0.3 million which can be used indefinitely.
American Pioneer and American Exchange file a separate consolidated federal income tax return. At December 31, 1998 American Pioneer and American Exchange had net operating tax loss carry forwards, most of them incurred prior to their acquisition by the Company, of approximately $3.7 million which expire in the years 1999 to 2013. As a result of changes in ownership of American Pioneer in May 1993, use of most of the loss carry forwards of American Pioneer are subject to annual limitations.
The Clinton Administration has made two tax proposals relating to the insurance industry that may have an impact on the Company. One proposal is to require recapture of untaxed profits on policyholder surplus accounts. Between 1959 and 1983, stock life insurance companies deferred tax on a portion of their profits. These untaxed profits were added to a policyholders surplus account ("PSA"). In 1984, Congress precluded life insurance companies from continuing to defer taxes on any future profits. The Clinton Administration argues that there is no continuing justification for permitting stock life companies to defer tax on profits that were earned between 1959 and 1983. Accordingly, the stock life companies would be required to include in their gross income over a ten years their PSA balances. American Pioneer has $1.1 million of untaxed profits in its PSA, while American Progressive and American Exchange have none.
A second proposal the Clinton Administration has made modifies the rules for capitalizing policy acquisition costs of life insurance companies on the grounds that life insurance companies generally only capitalize a fraction of their actual policy acquisition costs. The proposed modifications to capitalization percentages apply only to group or individual term life insurance, non-pension annuity contracts, cash value life insurance, credit life insurance and credit health insurance and are higher than the current capitalization percentages. For the 1998 tax year, the Company had $44.3 million of premium receipts subject to proposed modifications to capitalization percentages.
In addition to its policy administration system, the Company performed assessments of other processing systems and determined that a claims paying system for a small block of business was not Year 2000 compliant. The Company obtained the vendor upgrade for this system. It is anticipated that the installation, testing and implementation of this upgrade will be completed by March 31, 1999.
The Company recently acquired blocks of business (the First National and Dallas General blocks) and American Exchange. In connection with those acquisitions, the Company has converted all of the acquired businesses into the Year 2000 compliant systems currently in place.
The Company's plan includes the development of contingency plans for any significant risks that might result from the Year 2000 issue. As discussed above, the Company is not presently aware of any specific significant business risk that it believes it is exposed to regarding the Year 2000 issue. Therefore, the Company has not developed a contingency plan for the Year 2000 issue. The Company will continue to monitor and assess risks for which contingency plans will be required.
A possible worst case scenario, although this is not considered likely, would occur if the Federal government and its vendors were unable to continue to process Medicare supplement claims electronically. In the event that this would occur, the Company's current procedure of obtaining Medicare claim data through an electronic interface would not occur and the Company would have to revert to manually entering this data into the claims paying system. This would result in the Company hiring approximately 20 additional employees to handle the increase in this data entry function. The Company considers the clerical marketplace in each of its primary office locations (Pensacola, Orlando, Miami and Rye Brooke) to be able to handle this situation in a satisfactory manner.
In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities," which is required to be adopted in years beginning after June 15, 1999. Because of Universal's minimal use of derivatives, management does not anticipate that the adoption of the new statement will have a significant effect on earnings or the financial position of the Company.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information" ("Statement 131"), effective for years beginning after December 15, 1997, which Statement was adopted by the Company. Statement 131 requires that a public company report financial and descriptive information about its reportable operating segments pursuant to criteria that differ from current accounting practice. Operating segments, as defined, are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision-makers in deciding how to allocate resources and in assessing performance. The financial information reported includes segment profit and loss, certain revenue and expense items and segment assets and reconciliations to corresponding amounts in the general purpose financial statements. Statement 131 also requires information about revenues from products or services, countries where the Company has operations or assets, and major customers. The adoption of Statement 131 did not affect results of operations or financial position.