lease office space at various locations, including its principal executive office located at 4001 McEwen Drive, Dallas, Texas 75244.
In accordance with Section 302(a) of the Act, the Securities and Exchange Commission adopted rules effective August 29, 2002 requiring an issuer's principal executive officer and financial officer to certify the financial and other information contained in an issuer's quarterly and annual reports. The newly-adopted rules also require these officers to certify that they are responsible for establishing, maintaining and regularly evaluating the effectiveness of the issuer's internal controls, that they have made certain disclosures to the issuer's auditors and the audit committee of the board of directors about the issuer's internal controls, and that they have included information in the issuer's quarterly and annual reports about their evaluation and whether
The amount of student loan spread income that AMS may earn in any period depends in large part upon the level of prevailing market interest rates relative to the prescribed minimum rate that can be earned on AMS' student loan portfolio. The benchmark for yields on federally guaranteed student loans is reset annually in accordance with Department of Education regulations effective July 1 for the succeeding twelve-month period. While yields on student loans are indexed to the 91-day Treasury bill rate, the benchmark establishes a floor, below which a lender's yield will not fall during the succeeding twelve-month period. During the first six months of 2002, AMS benefited significantly from a favorable prescribed minimum rate earned on its student loan portfolio. On July 1, 2002, the floor rates on loans made under the Federal Family Education Loan Program (the "FFELP Loans") for the period July 1, 2002 through June 30, 2003 reset 193 basis points lower than the floor rates in effect for the period July 1, 2001 through June 30, 2002. Reflecting this downward adjustment on July 1, 2002 to the floor rate on FFELP Loans, AMS' student loan spread income declined significantly from $17.1 million in the first half of 2002 to $9.8 million in the second half of the year.
On July 1, 2003, the floor rates on FFELP Loans for the period July 1, 2003 through June 30, 2004 will again be reset. Based on current prevailing market interest rates, the Company currently expects that spread income in 2003 will be less than the level of spread income experienced in 2002. Due to the inherent uncertainty surrounding spread income and the seasonality of its tuition installment business, in any given financial period AMS may continue to rely on gains from timely sales of student loans to remain profitable for such period. AMS sold $271.2 million and $447.0 million principal amount of student loans during the year ended December 31, 2002 and 2001, respectively, from which AMS generated gains on sales in the amount of $5.9 million and $11.3 million, respectively.
At December 31, 2002, UICI held beneficially approximately 45% of the issued and outstanding shares of Healthaxis, Inc. ("HAI") (formerly Provident American Corporation) (Nasdaq: HAXS). See Note E of
The Company has accounted for its investment in HAI utilizing the equity method and has recognized its ratable share of HAI income and loss (computed prior to amortization of goodwill recorded in connection with the January 7, 2000 merger of Insurdata Incorporated (formerly a wholly-owned subsidiary of UICI) with and into HealthAxis.com, the sole operating subsidiary of HAI). The Company's carrying value of its investment in HAI was $4.9 million and $8.3 million at December 31, 2002 and 2001, respectively. See Note E of Notes to Consolidated Financial Statements.
Until termination of a Services Agreement with HAI on June 15, 2002, the Company constituted a significant customer of HAI. Under the Services Agreement, HAI formerly provided information systems and software development services (including administration of the Company's computer data center) to the Company and its insurance company affiliates at HAI's cost of such services (including direct costs of HAI personnel dedicated to providing services to the Company plus a portion of HAI's overhead costs) plus a 10% mark-up. Pursuant to the terms of the Services Agreement, UICI paid to HAI $8.1 million, $20.4 million and $21.0 million in 2002, 2001 and 2000, respectively. In addition, HAI has provided to the Company and its affiliates certain other information technology services, including claims imaging and software-related services, for which UICI paid to HAI $2.7 million, $10.1 million and $6.4 million in 2002, 2001 and 2000, respectively. The aggregate amounts paid by UICI to HAI in 2002, 2001 and 2000, respectively, represented 38%, 70% and 63% of HAI's total gross revenues of $28.1 million, $43.8 million and $43.7 million in such years, respectively. See Notes E and N of Notes to Consolidated Financial Statements.
Through its College First Alternative Loan Program, the Company's College Fund Life Division (based in Norcross, Georgia) has historically offered an interest-sensitive whole life insurance product that has generally been issued with an annuity rider and a child term rider. The child term rider includes a special provision under which the Company commits to provide private student loans to help fund the named child's higher education if certain restrictions and qualifications are satisfied.
The Company has determined that, effective May 31, 2003, it will no longer issue new life insurance policies under the College Fund Life Division program and that, effective June 30, 2003, it will cease all operations at the Company's Norcross, Georgia facility. In connection with such closedown, the Company currently estimates that it will incur exit costs (consisting primarily of employee severance and relocation expenses and lease termination costs) in the amount of approximately $900,000, which costs will be expensed as incurred over the period ending June 30, 2003 in accordance with Financial Accounting Standards Board "FASB" Statement No. 146, Accounting for Costs Associated with Exit or Disposal Activities.
The Company through its College Fund Life Division has outstanding commitments to fund student loans for the years 2003 through 2024. See Notes K and O of Notes to Consolidated Financial Statements.
In June 2001, FASB issued Statements No. 141, Business Combinations, and No. 142, Goodwill and Other Intangible Assets. Statement 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. Statement 141 also includes guidance on the initial recognition and measurement of goodwill and other intangible assets arising from business combinations completed after June 30, 2001. Statement 142 prohibits the amortization of goodwill and intangible assets with indefinite useful lives. Statement 142 requires that these assets be reviewed for impairment at least annually, or more frequently if certain indicators arise. The Company has determined that it will review goodwill and intangible assets for impairment as of November 1 of each year. Intangible assets with finite lives will continue
to be amortized over their estimated useful lives. Statement 142 also requires that goodwill included in the carrying value of equity method investments no longer be amortized.
The Company adopted Statements 141 and 142 on January 1, 2002. In accordance with Statement 142, the Company tested for goodwill impairment effective January 1, 2002. As a result of the transitional impairment testing, completed during the quarter ended June 30, 2002, the Company determined that goodwill recorded in connection with the acquisition of Academic Management Services Corp. ("AMS") and Barron Risk Management Services ("Barron") was impaired in the aggregate amount of $6.9 million ($5.1 million net of tax). The Company has reflected this impairment charge in its financial statements as a cumulative effect of a change in accounting principle as of January 1, 2002 in accordance with Statement No. 142. On September 30, 2002, the Company sold to an unaffiliated third party all of the capital stock of Barron, in connection with which for financial reporting purposes the Company recognized a nominal gain.
With respect to health policies sold through the Company's Self Employed Agency Division, commissions paid to agents with respect to first year policies are higher than commissions paid to agents with respect to policies in renewal years. Accordingly, during periods of increasing first year premium revenue (such as occurred during 2002 and 2001), the Self Employed Agency Division's overall operating profit margin will be negatively impacted by the higher commission expense associated with first year premium revenue.
The Company sponsors a series of stock accumulation plans (the "Agent Plans") established for the benefit of the independent insurance agents and independent sales representatives associated with UGA -- Association Field Services, New United Agency, Cornerstone America, Guaranty Senior Assurance, SeniorsFirst and CFLD Association Field Services. Under EITF 96-18 "Accounting for Equity Instruments that are issued to Other Than Employees for Acquiring or in Connection with Selling Goods and Services," the Company has established a liability for future unvested benefits under the Agent Plans and adjusts the liability based on the market value of the Company's Common Stock. The accounting treatment of the Company's Agent Plans will result in unpredictable stock-based compensation charges, dependent upon fluctuations in the quoted price of UICI common stock. These unpredictable fluctuations in stock based compensation charges
may result in material non-cash fluctuations in the Company's results of operations. See Note P of Notes to Consolidated Financial Statements.
At its regular meeting held on February 28, 2001, the Board of Directors of the Company reconfirmed the Company's 1998 share repurchase program, in which it initially authorized the repurchase of up to 4,500,000 shares of UICI common stock from time to time in open market or private transactions. Through early 1999, the Company had previously purchased 198,000 shares of common stock pursuant to the program. Following reconfirmation of the program, through December 31, 2002, the Company had purchased an additional 2,000,000 shares pursuant to the program (with the most recent purchase made on December 31, 2002) at an aggregate cost of $29.3 million, or $14.64 per share. Through March 11, 2003, the Company had purchased an additional 324,200 shares at an aggregate cost of $4.9 million, or $15.02 per share. The timing and extent of additional repurchases, if any, will depend on market conditions and the Company's evaluation of its financial resources at the time of purchase.
In May 2001, the Company determined to exit its workers compensation business, in connection with which the Company incurred a charge in the three months ended June 30, 2001 of $8.7 million associated with a strengthening of reserves. In the fourth quarter of 2001, the Company also recorded a charge of $1.3 million, which represented the Company's share of an assessment to all workers' compensation insurance carriers by the Oklahoma Workers' Compensation Court Administrator. Reflecting a subsequent repeal of the assessment, in the first quarter of 2002 the Company reversed the $1.3 million charge and strengthened claims reserves in an equivalent amount.
The Company's reported results in 2002, 2001 and 2000 reflected income (loss) (net of tax) from discontinued operations (consisting of the Company's former sub-prime credit card unit, the Special Risk Division and UICI Administrators, Inc.) in the amount of $653,000 ($0.02 per diluted share), $(9.3) million ($(0.19) per diluted share) and $(27.5) million ($(0.58) per diluted share), respectively. Results from discontinued operations in 2002 included income (net of tax) at United CreditServ in the amount of $4.8 million, associated with a $7.4 million release of reserves in the three months ended December 31, 2002 resulting from the Company's assessment of certain favorable events related to credit card litigation matters. See Note B of Notes to Consolidated Financial Statements. The favorable 2002 results at United CreditServ were offset in large part by a $(4.2) million loss (net of tax benefit) at the Special Risk Division, which loss resulted from a $6.5 million charge in the three months ended December 31, 2002 to reflect a reassessment and strengthening of claims reserves.
cash assets associated with its United CreditServ credit card unit, including its credit card receivables portfolios and its Sioux Falls, South Dakota servicing operations, for a cash sales price of approximately $124.0 million, and on January 29, 2001, the Company completed the voluntary liquidation of UCNB, in accordance with the terms of a plan of voluntary liquidation approved by the Office of the Comptroller of the Currency.
In addition to the cash sales price received at the September 2000 closing of the sale of the non-cash assets associated with its United CreditServ credit card unit, the sale transaction contemplated an incentive cash payment contingent upon the post-closing performance of the ACE credit card portfolio over a one-year period. United CreditServ's results in 2001 included income (net of tax) in the amount of $3.7 million, associated with the receipt of a $5.7 million cash payment representing the deferred contingent portion of the purchase price in final settlement of the September 2000 sale of substantially all of the non-cash assets associated with its United CreditServ credit card unit.
In January 2001, the Board of Directors of the Company adopted certain modifications to the UICI Executive Stock Purchase Program (the "ESPP"), which was initially adopted and implemented in December 1998 to afford directors and key UICI executives the opportunity to purchase UICI common stock. See Note P of Notes to Consolidated Financial Statements. In connection with the January 2001 modifications to the ESPP, for financial reporting purposes UICI recorded in the quarter ended December 31, 2000 compensation expense in the amount of $4.8 million pre-tax, or $4.1 million net of tax.
The Company reported net income in 2002 in the amount of $46.9 million ($0.96 per diluted share), compared to net income of $42.9 million ($0.90 per diluted share) in 2001. Reported net income included income (losses) from discontinued operations in 2002 and 2001 in the amount of $653,000 ($0.02 per diluted share) and $(9.3) million ($(0.19) per diluted share), respectively. Overall results in the full year ended December 31, 2002 also included a goodwill impairment charge in the amount of $(5.1) million (net of tax) ($(0.11) per diluted share), which has been reflected as a cumulative effect of a change in accounting principle in accordance with recently adopted Financial Accounting Standards Board ("FASB") Statement No. 142, Goodwill and Other Intangible Assets.
Revenues. UICI's revenues increased to $1,479.0 million in 2002 from $1,099.4 million in 2001, an increase of $379.6 million, or 35%, primarily as a result of a significant increase in health premium revenue from $776.3 million in 2001 to $1,181.2 million in 2002. The increase in health premium revenue in 2002 was offset by a 13% decrease in interest and investment income.
Investment income. Despite a 10% increase in invested assets over the year ended December 31, 2002, investment income remained relatively constant ($84.4 million in 2002 compared to $83.8 million in 2001) due to a decrease in yield on invested assets resulting from lower prevailing market interest rates.
Other interest income. Other interest income (consisting primarily of interest earned on the Company's AMS student loan portfolio) decreased by 25% to $66.3 million in 2002 from $88.4 million in 2001. The decrease in other interest income was due to declining market interest rates, resulting in a reduced yield on funds held in connection with AMS' tuition payment programs and a reduced yield on AMS' student loan portfolio.
The amount of realized gains or losses on the sale of investments is affected by changes in interest rates, market trends and the timing of sales. Losses are more likely during periods of increasing long-term interest rates. In addition, due to decreasing long-term interest rates in 2002, the net unrealized investment gain on securities classified as "available for sale", reported in accumulated other comprehensive income as a separate component of stockholders' equity and net of applicable income taxes, increased to $42.3 million at December 31, 2002, from a net unrealized investment gain of $30.3 million at December 31, 2001. The Company changed its method for accounting for its investment in AMLI Residential effective June 30, 2001, from the equity method to the investment method. The Company holds a 10% interest in AMLI Residential. The effect of the accounting change was to increase the carrying value of AMLI Residential on the consolidated balance sheet of the Company at June 30, 2001 from $22.6 million to $62.8 million; the accounting change had no effect on the Company's results of operations for the year ended December 31, 2001. As a result of the accounting change, the Company marks-to-market its investment in AMLI Residential and accordingly, changes in the Company's carrying value of its investment in AMLI Residential are recorded as unrealized gains (or losses) with corresponding changes to the Company's stockholders' equity (net of tax). At December 31, 2002 and 2001, the Company's carrying value of its investment in AMLI Residential was $54.3 million and $64.3 million, respectively.
Underwriting, policy acquisition costs and insurance expenses. Underwriting, policy acquisition costs and insurance expenses increased by 56% to $416.5 million in 2002 from $267.8 million in 2001. The increase in such expenses was primarily due to the increase in first year premium revenue from the SEA Division (with respect to which the Company records a higher commission expense than with respect to premium revenue in policy renewal years) and premium growth at the Group Division (including the incremental underwriting, acquisition and insurance expenses associated with the Company's Star HRG unit, which was acquired in February 2002).
Depreciation. Depreciation expense increased to $15.9 million in 2002 from $14.1 million in 2001. The 13% increase in depreciation expense was primarily due to additional depreciation associated with the capitalized costs of technology initiatives and upgrades.
The Company is currently reinsuring 20% of its risk with respect to long-term care coverage on a coinsurance basis with a third party reinsurer. In 2001 the Company entered into an agreement with an unaffiliated third party to serve as administrator for the Company's senior age insurance products, in which capacity the third party underwrote, billed, provided customer service and administered claims for all long-term care and Medicare supplement insurance products to be sold by the Company's two principal insurance subsidiaries. This third party arrangement will effectively terminate in the second quarter of 2003. In March 2003, the Company will bring in house all underwriting, billing, customer service and claims administration functions for all new long term care applications submitted. Conversion of in-force long-term care and Medicare supplement business will occur in the second quarter of 2003. Medicare supplement sales were suspended in February 2003 until the conversion of administrative functions to the Company's administration center is complete.
Academic Management Services Corp. For the year ended December 31, 2002, UICI's Academic Management Services Corp. subsidiary ("AMS") reported operating income of $7.4 million compared to operating income of $5.4 million for the comparable period in 2001. Set forth below is a summary comparative statement of operations for AMS for the year ended December 31, 2002 and 2001:
The improvement in AMS' operating results for the year ended December 31, 2002 resulted primarily from a decrease in operating expenses (attributable primarily to a reduction in interest expense on corporate borrowings) and increased student loan spread income (i.e., the difference between interest earned on outstanding student loans and interest expense associated with indebtedness incurred to fund such loans) attributable to a favorable interest rate environment. Spread income for the year 2002 was $26.9 million compared to $19.2 million in 2001. These increases in 2002 were partially offset by lower realized gains on sale of loans and reduced fee income and yields on the trust balances associated with AMS' tuition installment plan business, in each case as compared to results in 2001.
During the first six months of 2002, AMS benefited significantly from a favorable prescribed minimum rate earned on its student loan portfolio. On July 1, 2002, the floor rates on loans made under the Federal Family Education Loan Program ("FFELP Loans") for the period July 1, 2002 through June 30, 2003 reset 193 basis points lower than the floor rates in effect for the period July 1, 2001 through June 30, 2002. Reflecting this downward adjustment on July 1, 2002 to the floor rate on FFELP Loans, AMS' student loan spread income declined significantly from $17.1 million in the first half of 2002 to $9.8 million in the second half of the year.
Fee income from AMS' tuition payment programs in the year ended December 31, 2002 was $12.8 million, compared to fee income in the year ended December 31, 2001 of $14.1 million. For the year ended December 31, 2002, investment income on funds held in connection with tuition payment programs declined to $3.9 million in 2002 from $6.6 million in 2001 as a result of lower prevailing market interest rates (despite a 10% increase in average trust fund balance).
Other Key Factors. The Other Key Factors category includes (a) investment income not allocated to other business segments, (b) interest expense on non-student loan indebtedness, (c) general expenses relating to corporate operations, (d) realized gains or losses on investments, (e) the operations of the Company's
For the year ended December 31, 2002, Other Key Factors reported an operating loss of $(33.1) million, compared to an operating loss of $(8.0) million in 2001. The increase in operating loss for the year ended December 31, 2002 was attributable to various factors, including a $7.6 million decrease in investment income not allocated to other segments (which in turn resulted from a decrease in yield on invested assets), a $5.6 million realized loss on sale of investments resulting primarily from a $6.1 million impairment charge taken in the second quarter of 2002 associated with the Company's WorldCom, Inc. bond holdings (compared to a realized gain of $5.2 million in the corresponding period in 2001, and an increase in variable stock-based compensation expense of $11.1 million (see discussion below). These factors contributing to the increase in Other Key Factors operating loss in the year ended December 31, 2002 were offset by the positive impact of the non-amortization of goodwill as required by Statement No. 142 for all periods commencing after January 1, 2002. In the year ended December 31, 2001, the Company recorded goodwill amortization in the amount of $4.5 million.
Variable Stock-Based Compensation. 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 in amounts that depend and fluctuate based upon the market performance of the Company's common stock. See Note P of Notes to Consolidated Financial Statements.
UICI reported revenues and income from continuing operations in 2001 of $1.1 billion and $52.2 million ($1.09 per diluted share), respectively, compared to 2000 revenues and income from continuing operations of $1.0 billion and $33.3 million ($0.70 per diluted share), respectively.
Revenues. UICI's revenues increased to $1,099.4 million in 2001 from $1,018.8 million in 2000, an increase of $80.6 million, or 8%, primarily as a result of a 20% increase in health premiums, from $644.6 million in 2000 to $776.3 million in 2001. The increase in health premium revenue in 2001 was offset by a 14% decrease in interest and investment income. Revenues in 2000 also were favorably impacted by a realized gain of $26.3 million from a sale of HealthAxis.com shares completed in the first quarter of 2000.
Life premiums and other considerations. Life premiums and other considerations decreased to $34.7 million in 2001 from $36.8 million in 2000, a decrease of $2.1 million, or 6%. This decrease resulted primarily from reduced premiums and other considerations from closed blocks of life and annuity business. The Company last acquired a closed block of life insurance and annuities in 1994. Although the Company believes that it can continue to explore acquisition opportunities and continues to analyze potential transactions, the Company believes that the current climate for acquisitions of blocks of life insurance and annuities has become very competitive, making it more difficult to successfully complete acquisitions that meet the Company's acquisition rate of return criteria.
Other interest income. Other interest income (consisting primarily of interest earned on the Company's student loan portfolio) decreased to $88.4 million in 2001 from $111.4 million in 2000, a decrease of $23.0 million, or 21%. The decrease was due to declining market interest rates, resulting in a reduced yield on funds held in connection with AMS' tuition payment programs and a reduced yield on AMS' student loan portfolio.
Gains (losses) on sale of investments. The Company recognized gains on sale of investments of $5.2 million in 2001 compared to losses of $(1.9) million in 2000. Included in 2001 gains is a $5.3 million gain related to the Company's investment in Amli Commercial Properties Trust ("ACPT") and $3.4 million in gains from the Company's investment portfolio, which were offset by impairment charges for certain investments in the amount of $3.5 million. During 2001, ACPT, an equity method investee, in which the Company held a 20% equity interest, sold substantially all of its assets for an aggregate sale price of approximately $226.3 million. In connection with such sale, the Company recognized a gain in the amount of $5.3 million.
Benefits, claims, and settlement expenses. Benefits, claims and settlement expenses increased to $531.0 million in 2001 from $439.7 million in 2000, an increase of $91.3 million, or 21%. The increase in benefits, claims and settlement expenses was primarily due to the increase in premium revenue from the SEA and Group Divisions and the strengthening of reserves associated with the Company's workers compensation business. In May 2001 the Company discontinued its workers compensation business, in connection with which the Company incurred a charge of $8.7 million associated with a strengthening of reserves.
Underwriting, policy acquisition costs and insurance expenses. Underwriting, policy acquisition costs and insurance expenses increased to $267.8 million in 2001 from $225.2 million in 2000, an increase of $42.6 million, or 19%. The increase was primarily due to increased commission expense attributable to the growth in first year premium revenue in the SEA Division (with respect to which the Company records a higher commission expense than with respect to premium revenue in policy renewal years).
Other expenses. Other expenses consist primarily of operating expenses at AMS and direct expenses incurred by the Company in connection with generating other income at the SEA Division. Other expenses decreased to $119.1 million in 2001 from $129.0 million in 2000, a decrease of $9.9 million or 8%. The decrease was primarily due to the sale of National Motor Club ("NMC") in July 2000. NMC incurred $17.2 million in other expenses for the seven-month period ended July 2000.
Depreciation. Depreciation expense increased to $14.1 million in 2001 from $13.3 million in 2000, an increase of $800,000 or 6%. The increase was primarily due to additional depreciation associated with the capitalized costs of technology initiatives and upgrades.
Interest expense. Interest expense on corporate borrowings decreased to $5.0 million in 2001 from $13.6 million in 2000, a decrease of $8.6 million. The decrease was due primarily to the decreased level of borrowings outstanding during 2001 compared to 2000. Interest expense on student loan obligations decreased to $69.4 million in 2001 from $101.6 million in 2000, a decrease of $32.2 million or 32%, primarily resulting from a decline in prevailing market interest rates.
Operating Income. Income from continuing operations before federal income taxes ("operating income") increased to $70.9 million in 2001 from $69.4 million in 2000. Operating income (loss) for each of the Company's segments and divisions was as follows:
Self-Employed Agency Division. Operating income at UICI's SEA Division increased by 6% to $74.8 million in 2001 from $70.9 million in 2000.
Group Insurance Division (formerly Student Insurance Division). For the year ended December 31, 2001, the Group Insurance Division reported operating income of $4.0 million compared to an operating loss of $(1.9) million in 2000. The increase in operating income for the year ended December 31, 2001 was attributable to a 13% increase in earned premium revenue, continued improvement in loss ratios, and improvement in administrative efficiencies.
The significant improvement in operating results for the year ended December 31, 2001 resulted primarily from increased student loan spread income (i.e., the difference between interest earned on outstanding student loans and interest expense associated with indebtedness incurred to fund such loans) attributable to a favorable interest rate environment, increased gains on sales of loans and continued efforts to reduce operating expenses.
Other Key Factors. The Other Key Factors category includes (a) investment income not allocated to other business segments, (b) interest expense on non-student loan indebtedness, (c) general expenses relating to corporate operations, (d) realized gains or losses on sale of investments, (e) the operations of the Company's AMLI Realty Co. subsidiary, (f) minority interest expense, (g) variable stock-based compensation, (h) operations that do not constitute reportable operating segments (consisting primarily of the remaining portion of the Company's former TPA Division and (i) amortization of goodwill. Operating losses for the year ended December 31, 2001 attributable to this category were $(8.0) million compared to $(1.3) million for the comparable period in 2000. The increase in operating losses was primarily attributable to a $7.5 million increase in corporate technology expenses, a $1.7 million increase in variable stock compensation, a $3.7 million increase in minority interest expense attributable to AMS' return to profitability in 2001, and a $3.5 million impairment charge from the Company's investment portfolio. These increases were partially offset by $3.4 million in realized gains from the Company's investment portfolio (excluding the impairment charge) and a $5.3 million gain recognized in 2001 on the sale of the Company's interest in
AMLI Commercial Properties Trust. The amount of realized gains or losses on the sale of investments is a function of interest rates, market trends and the timing of sales.
The Company changed its method for accounting for its investment in AMLI Residential Properties Trust (a publicly-traded (NYSE: AML) real estate investment trust) ("AMLI Residential") from the equity method to the investment method effective June 30, 2001 due to its decreased ownership interest to 10.3%. The effect of the accounting change was to increase the carrying value of AMLI Residential on the consolidated balance sheet of the Company at June 30, 2001 from $22.6 million to $62.8 million. As a result of the accounting change, the Company no longer records its share of AMLI Residential's gains and losses but, rather, marks-to-market its investment in AMLI Residential. Accordingly, increases (or decreases) in the Company's carrying value of its investment in AMLI Residential are now recorded as unrealized gains (or losses) with corresponding increases (or decreases) to the Company's stockholders' equity (net of tax). At December 31, 2001 and 2000, the Company's carrying value of its investment in AMLI Residential was $64.3 million and $23.1 million, respectively.
Variable Stock-Based Compensation. 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 in amounts that depend and fluctuate based upon the market performance of the Company's common stock. In the year ended December 31, 2001, the Company recorded non-cash stock-based compensation expense in the aggregate amount of $6.9 million, of which $3.0 million was attributable to the ESOP feature of the Company's Employee Stock Ownership and Savings Plan, $2.8 million was attributable to the Company's stock accumulation plans established for the benefit of its independent agents and $1.1 million was attributable to other stock-based plans. See Note P of Notes to Consolidated Financial Statements.
The Company's primary sources of cash have been premium revenues from policies issued, investment income, fees and other income, and borrowings to fund student loans. The primary uses of cash have been payments for benefits, claims and commissions under those policies, operating expenses, stock repurchases and the funding of student loans. During 2002, the Company generated net cash provided by operations on a consolidated basis in the amount of $266.0 million, compared to net cash provided by operations in the amount of $189.7 million in 2001. During 2000, the Company used net cash in operations of $21.3 million.
constituted the Company's 8.75% Senior Notes, which are obligations of the holding company). See Note J of Notes to Consolidated Financial Statements. In addition, during 2002 the Company utilized approximately $29.3 million to repurchase 2,000,000 shares of its common stock pursuant to its previously announced share repurchase program, which was reconfirmed by the Board of Directors of the Company at its July 31, 2002 meeting.
On January 25, 2002, the Company entered into a three-year bank credit facility with Bank of America, NA and LaSalle Bank National Association. Under the facility, the Company may borrow from time to time up to $30.0 million on a revolving, unsecured basis. Loans outstanding under the facility will bear interest at the option of the Company at prime plus 1% or LIBOR plus 1%. The Company intends to utilize the proceeds of the facility for general working capital purposes. The Company has not to date borrowed any funds under the facility.
On January 17, 2002, the Company completed the purchase, for a cash purchase price of $8.0 million, of a 50% interest in SeniorsFirst, a Dallas-based career agency specializing in the sale of long-term care and Medicare supplement insurance products.
Effective February 28, 2002, the Company acquired all of the outstanding capital stock of Star Human Resources Group, Inc. and STAR Administrative Services, Inc. (collectively referred to by the Company as its "Star HRG" unit), a Phoenix, Arizona based business specializing in the marketing and administration of limited benefit plans for entry level, high turnover, hourly employees for an initial cash purchase price of
$25.0 million, plus additional contingent consideration based on the future annualized performance of Star HRG measured over the three-month period ending May 31, 2003. The contingent consideration will be in an amount not to exceed $15.0 million and is payable, at the Company's option, in cash or by delivery of UICI's 6.0% convertible subordinated notes due March 1, 2012 plus, in each case, interest payable in cash computed at a rate of 6% from the initial closing.
In 2002 the Company incurred $13.8 million of capitalized construction costs and investments in furniture and fixtures associated with an expansion of its facilities in North Richland Hills, Texas. The Company currently anticipates that it will incur additional costs of approximately $6.4 million in 2003 to complete the facilities expansion project.
At December 31, 2002 and 2001, the Company, through AMS and the College Fund Life Insurance Division, had outstanding an aggregate of $1,752.6 million and $1,506.2 million of indebtedness under secured student loan credit facilities, of which $1,726.1 million and $1,242.8 million were issued by bankruptcy-remote special purpose entities (each, an "SPE" or "Special Purpose Entity") which are included in the Company's Consolidated Financial Statements. At December 31, 2002 and 2001, indebtedness outstanding under secured student loan credit facilities (including indebtedness issued by Special Purpose Entities) was secured by federally guaranteed and alternative (i.e., non-federally guaranteed) student loans in the carrying amount of $1,430.8 million and $1,276.1 million, respectively, and by a pledge of cash, cash equivalents and other qualified investments in the amount of $222.5 million and $129.4 million, respectively. All such indebtedness issued under secured student loan credit facilities is reflected as student loan indebtedness on the Company's consolidated balance sheet; all such student loans pledged to secure such facilities are reflected as student loan assets on the Company's consolidated balance sheet; and all such cash, cash equivalents and qualified investments specifically pledged under the student loan credit facilities are reflected as restricted cash on the Company's consolidated balance sheet.
Set forth below is a summary unaudited pro forma December 31, 2002 balance sheet of UICI, adjusted to exclude certain assets (student loans and restricted cash) and certain liabilities (student loan credit facilities) associated with the Company's AMS and College Fund Life Division) operations:
(1) Obligations under AMS' master repurchase agreement and credit facility are partially (approximately $13.0 million at December 31, 2002) guaranteed by the Company.
(2) A trust created for the benefit of participants in AMS' tuition installment program held invested assets in the amount of approximately $156.4 million and $141.7 million at amortized cost (which approximated market) at December 31, 2002 and 2001, respectively, all of which assets are classified as restricted cash on the Company's consolidated balance sheet. See Note A of Notes to Consolidated Financial Statements.
(3) Represents cash and cash equivalents required to be held by College Fund Life Division to support certain loan servicing obligations under College Fund Life Division's SPE financing.
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. Management's review considers the following indicators of impairment: fair value is significantly below cost; the decline in fair value is attributable to specific adverse conditions affecting a particular investment; the decline in fair value is attributable to specific conditions, such as conditions in an industry or in a geographic area; the decline in fair value has existed for an extended period of time; downgrades by rating agencies from investment grade to non-investment grade; the financial condition of the issuer has deteriorated and dividends have been reduced or eliminated or scheduled interest payments have not been made. Management monitors investments where two or more of the above indicators exist and investments are identified by the Company in economically challenged industries. If investments are determined to be impaired, a loss is recognized at the date of determination.
Set forth below is a summary of the Company's investments by category at December 31, 2002 and 2001:
2005 and $3.525 million principal amount matures in 2031. During the three months ended September 30, 2002, the Company's insurance company subsidiaries sold all of their WorldCom Inc. bonds for a nominal loss (giving effect to the $6.1 million impairment charge taken in the second quarter of 2002).
Included in the fixed maturity portfolio is a concentration of mortgage-backed securities, including collateralized mortgage obligations and mortgage-backed pass-throughs. To limit its credit risk, the Company invests in mortgage-backed securities that are rated investment grade by the public rating agencies. The Company's mortgage-backed securities portfolio is a conservatively structured portfolio that is concentrated in the less volatile tranches, in the form of planned amortization classes, sequential payment and commercial mortgage-backed securities. The Company seeks to minimize prepayment risk during periods of declining interest rates and minimize duration extension risk during periods of rising interest rates. The Company has less than 1% of its investment portfolio invested in the more volatile tranches.
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, 2002 and 2001.
The Company's short-term investments are held in a diversified institutional money market fund that invests solely in the highest quality United States dollar denominated money market securities of domestic and foreign issuers.
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 reserves 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.
The Company uses the developmental method to estimate claims reserves. This method applies completion factors to paid claims in order to estimate the ultimate claim payments. These completion factors are derived from historical experience and are dependent on the incurred dates of the paid claims.
The SEA Division assigns original incurred dates for the paid claims utilized in the estimation of the claim reserves. This original incurred date technique results in estimating a liability for all medical services related to an accident or illness incurred prior to the end of the period, even though the medical services may not be received by the insured until a later financial reporting period. In addition to the developmental reserves, various additional claim reserves are estimated as appropriate. The additional claim reserves estimate liabilities for situations, such as excess pending claims inventory and disputed claims.
The Company estimates the relevant items, based primarily on historical and current data, and uses this information to determine the assumptions underlying its claims reserve calculations. An extensive degree of judgment is used in this estimation process. For health care costs payable, the reserve balances and the related benefit expenses are highly sensitive to changes in the assumptions used in the reserve calculations. With respect to health claims, the items that have the greatest impact on the Company's financial results are the medical cost trend, which is the rate of increase in health care costs and the unpredictable variability in actual experience. Any adjustments to prior period reserves are included in the benefit expense of the period in which the need for the adjustment becomes known. Due to the considerable variability of health care costs and actual experience, adjustments to health reserves occur each quarter and are sometimes significant.
In June 2001, FASB issued Statements No. 141, Business Combinations, and No. 142, Goodwill and Other Intangible Assets. Statement 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. Statement 141 also includes guidance on the initial recognition and measurement of goodwill and other intangible assets arising from business combinations completed after June 30, 2001. Statement 142 prohibits the amortization of goodwill and intangible assets with indefinite useful lives. Statement 142 requires that these assets be reviewed for impairment at least annually, or more frequently if certain indicators arise. The Company has determined that it will review goodwill and intangible assets for impairment as of November 1 of each year or more frequently if certain indicators arise. An impairment loss would be recorded in the period such determination was made. Intangible assets with finite lives will continue to be amortized over their estimated useful lives. Statement 142 also requires that goodwill included in the carrying value of equity method investments no longer be amortized.
The Company adopted Statements 141 and 142 on January 1, 2002. In accordance with Statement No. 142, the Company tested for goodwill impairment effective January 1, 2002. As a result of the transitional impairment testing, completed during the quarter ended June 30, 2002, the Company determined that goodwill recorded in connection with the acquisition of Academic Management Services Corp. ("AMS") and Barron Risk Management Services ("Barron") was impaired in the aggregate amount of $6.9 million
($5.1 million net of tax). The Company has reflected this impairment charge in its financial statements as a cumulative effect of a change in accounting principle as of January 1, 2002 in accordance with Statement No. 142. On September 30, 2002, the Company sold to an unaffiliated third party all of the capital stock of Barron, in connection with which for financial reporting purposes the Company recognized a nominal gain.
Historically, the Company generally had amortized the excess of cost over the underlying value of the net assets of companies acquired on a straight-line basis over twenty to twenty-five years. The Company continually reevaluated the propriety of the carrying amount of goodwill, as well as the amortization period to determine whether current events and circumstances warrant adjustments to the carrying value and/or revised estimates of useful life. The Company assessed the recoverability of goodwill based upon several factors, including management's intention with respect to the operations to which the goodwill relates and those operations' projected future income and undiscounted cash flows. An impairment loss would be recorded in the period such determination was made.
At December 31, 2002 and 2001, the Company had other intangibles in the amount of $10.5 million and $-0-, respectively, and accumulated amortization of $1.8 million and $-0- at December 31, 2002 and 2001, respectively, resulting in net other intangibles of $8.7 million and $-0- at December 31, 2002 and 2001, respectively. The Company recorded other intangibles amortization expense in continuing operations in the amount of $1.8 million, $-0- and $-0- in 2002, 2001 and 2000, respectively.
Testing for impairment of investments also requires significant management judgment. The identification of potentially impaired investments, the determination of their fair value and the assessment of whether any decline in value is other than temporary are the key judgment elements. The discovery of new information and the passage of time can significantly change these judgments. Revisions of impairment judgments are made when new information becomes known, and any resulting impairment adjustments are made at that time. The current economic environment and recent volatility of securities markets increase the difficulty of determining
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. 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 2002 the Company determined that it was more likely than not that it would be able to realize its deferred tax assets. Accordingly, the Company eliminated or released the remaining valuation allowance related to the operating loss carryover of AMS. In the event that the Company were to determine that it would not be able to realize all or part of its net deferred tax asset in the future, a valuation allowance would be recorded to reduce its deferred tax assets to the amount that it believes is more likely than not to be realized. Recording a valuation allowance would result in a charge to income in the period such determination was made. The Company will consider future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need to record a valuation allowance. In the event the Company were to determine that it would be able to realize its deferred tax assets in the future in excess of its net recorded amount, an adjustment to the deferred tax asset would increase income in the period such determination was made.
The Company has reflected as discontinued operations for financial reporting purposes the results of its former United CreditServ sub-prime credit card business, its Special Risk Division operations and its UICI Administrators, Inc. unit. The Company has established a liability for losses on disposal of the discontinued operations. The liability for losses on disposal established by the Company at December 31, 2002 (which is reflected, in the case of United CreditServ, in "other liabilities" on the Company's consolidated balance sheet and, in the case of the Special Risk Division and UICI Administrators, as "net liabilities of discontinued operations, including reserve for losses on disposal" on the Company's consolidated balance sheet) represents the Company's current estimate of all additional losses (including asset write-downs, estimated losses on the sale of the business and/or the assets and continuing operating losses through the date of sale or shut down) that it believes it will incur as part of any sale or shut down of the discontinued operations. The Company regularly monitors and reassesses its estimates for losses on disposal, and if and when such estimates change, the Company will make appropriate adjustments to the liability.
The Company is subject to proceedings and lawsuits related to insurance claims and other matters. See Note O of Notes to Consolidated Financial Statements. The Company is required to assess the likelihood of any adverse judgments or outcomes to these matters, as well as potential ranges of probable losses. A determination of the amount of reserves required, if any, for these contingencies is made after careful analysis of each individual issue. The required reserves may change in the future due to new developments in each matter or changes in approach, such as a change in settlement strategy in dealing with these matters.
GLBA provides that there is no federal preemption of a state's insurance related privacy laws if the state law is more stringent than the privacy rules imposed under GLBA. Accordingly, state insurance regulators or state legislatures will likely adopt rules that will limit the ability of insurance companies, insurance agents and brokers and certain other entities licensed by state insurance regulatory authorities to disclose and use non-public information about consumers to third parties. These limitations will require the disclosure by these entities of their privacy policies to consumers and, in some circumstances, will allow consumers to prevent the disclosure or use of certain personal information to an unaffiliated third party. Pursuant to the authority granted under GLBA to state insurance regulatory authorities to regulate the privacy of nonpublic personal information provided to consumers and customers of insurance companies, insurance agents and brokers and certain other entities licensed by state insurance regulatory authorities, the National Association of Insurance Commissioners has recently promulgated a new model regulation called Privacy of Consumer Financial and Health Information Regulation. Some states issued this model regulation before July 1, 2001, while other states must pass certain legislative reforms to implement new state privacy rules pursuant to GLBA. In addition, GLBA requires state insurance regulators to establish standards for administrative, technical and physical safeguards pertaining to customer records and information to (a) ensure their security and confidentiality, (b) protect against anticipated threats and hazards to their security and integrity, and (c) protect against unauthorized access to and use of these records and information. However, no state insurance regulators have yet issued any final regulations in response to such security and confidentiality requirements. The privacy and security provisions of GLBA will significantly affect how a consumer's nonpublic personal information is transmitted through and used by diversified financial services companies and conveyed to and used by outside vendors and other unaffiliated third parties.
In December 2000, HHS issued final regulations regarding the privacy of individually-identifiable health information. This final rule on privacy applies to both electronic and paper records and imposes extensive requirements on the way in which health care providers, health plan sponsors, health insurance companies and their business associates use and disclose protected information. Under the new HIPAA privacy rules, the Company will now be required to (a) comply with a variety of requirements concerning its use and disclosure of individuals' protected health information, (b) establish rigorous internal procedures to protect health information and (c) enter into business associate contracts with other companies that use similar privacy protection procedures. The final rules do not provide for complete federal preemption of state laws, but, rather, preempt all contrary state laws unless the state law is more stringent. These rules must be complied with by April 14, 2003.
UICI is currently reviewing the potential impact of the HIPAA privacy regulations on its operations, including its information technology and security systems. The Company cannot at this time predict with specificity what impact (a) the recently adopted final HIPAA rules governing the privacy of individually-identifiable health information and (b) the proposed HIPAA rules for ensuring the security of individually-identifiable health information may have on the business or results of operations of the Company. However, these new rules will likely increase the Company's burden of regulatory compliance with respect to our life and health insurance products and other information-based products, and may reduce the amount of information the Company may disclose and use if the Company's customers do not consent to such disclosure and use. The Company does not currently believe that the restrictions and duties imposed by the recently adopted final rules on the privacy of individually-identifiable health information, or the proposed rule on security of individually- identifiable health information, will have a material adverse effect on UICI's business and future results of operations.
The Company's effective tax rate from continuing operations was 31.0% for 2002 compared to 26.4% for 2001 and 52.0% for 2000. The 2002 effective tax rate varied from the federal tax rate of 35%, primarily due to the release of the remaining valuation allowance on the operating loss carryover of AMS. The 2001 effective
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 M of Notes to the Consolidated Financial Statements.
In June 2001, the FASB issued Statements No. 141, Business Combinations, and No. 142, Goodwill and Other Intangible Assets. Statement 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. Statement 141 also includes guidance on the initial recognition and measurement of goodwill and other intangible assets arising from business combinations completed after June 30, 2001. Statement 142 prohibits the amortization of goodwill and intangible assets with indefinite useful lives. Statement 142 requires that these assets be reviewed for impairment at least annually. The Company has determined that it will review goodwill and intangible assets for impairment as of November 1 of each year or more frequently if certain indicators arise. An impairment loss would be recorded in the period such determination was made. Intangible assets with finite lives will continue to be amortized over their estimated useful lives. Statement No. 142 also requires that goodwill included in the carrying value of equity method investments no longer be amortized.
In June 2002, the FASB issued Statement No. 146, Accounting for Costs Associated with Exit or Disposal Activities. Statement 146 is effective for exit or disposal activities initiated after December 31, 2002. The impact of implementation on our financial position or results of operations is not expected to be material.
based awards under the fair value method. The Company adopted the transition provisions that require expensing options prospectively in the year of adoption. Existing awards will continue to follow the intrinsic value method prescribed by APB 25. Assuming award levels and fair values similar to past years, the impact of adoption is not material on results of operations. This change will primarily impact the accounting for stock options.
The Company's future results will depend in large part on accurately predicting health care costs incurred on existing business and upon the Company's ability to control future health care costs through product and benefit design, underwriting criteria, utilization management and negotiation of favorable provider contracts. Changes in mandated benefits, utilization rates, demographic characteristics, health care practices, provider consolidation, inflation, new pharmaceuticals/technologies, clusters of high-cost cases, the regulatory environment and numerous other factors are beyond the control of any health plan provider and may adversely affect the Company's ability to predict and control health care costs and claims, as well as the Company's financial condition, results of operations or cash flows. Periodic renegotiations of hospital and other provider contracts coupled with continued consolidation of physician, hospital and other provider groups may result in increased health care costs and limit the Company's ability to negotiate favorable rates. In addition, the Company faces competitive and regulatory pressure to contain premium prices. Fiscal concerns regarding the continued viability of government-sponsored programs such as Medicare and Medicaid may cause decreasing reimbursement rates for these programs. Any limitation on the Company's ability to increase or maintain its premium levels, design products, implement underwriting criteria or negotiate competitive provider contracts may adversely affect the Company's financial condition or results of operations.
The Company's Academic Management Services Corp. business could be adversely affected by changes in the Federal Higher Education Act of 1965, which authorizes and governs most federal student aid and student loan programs, and/or changes in other relevant federal or state laws, rules and regulations. The Higher Education Act is subject to review and reauthorization by the recently convened 108th Congress. Congress last reauthorized the Higher Education Act in 1998. While the Company believes that the Higher Education Act of 1965 will in fact be reauthorized, there can be no assurance of the form that reauthorization will take or the changes that the reauthorization bill will bring to the law and regulations governing student finance.