At December 31, 1999, the Company had the following 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 February 2002; (iii)
(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.
Forward-looking statements are based upon estimates and assumptions that are subject to significant business, economic and competitive uncertainties, many of which are beyond the Company's control and are subject to change. These uncertainties can affect actual results and could cause actual results to differ materially from those expressed in any forward-looking statements made by, or on behalf of the Company. Whether or not actual results differ materially from forward-looking statements may depend on numerous foreseeable and unforeseeable events or developments, some of which may be national in scope, such as general economic conditions and interest rates. Some of these events may be related to the insurance industry generally, such as pricing competition, regulatory developments and industry consolidation. Others may relate to Universal specifically, such as credit, volatility and other risks associated with the Company's investment portfolio, and other factors. Universal disclaims any obligation to update forward-looking information.
Universal is a life and accident and health insurance holding company, and consists of American Progressive, American Pioneer, American Exchange, WorldNet and Quincy. On July 30, 1999, Universal acquired all of the outstanding shares of common stock of certain direct and indirect subsidiaries of PennCorp Financial Group ("PFG"), including six insurance companies (the "Penn Union Companies"): Pennsylvania Life, PennCorp Canada, Peninsular, Union Bankers, Constitution and Marquette as well as certain other assets (the "Penn Union Acquisition").
The purchase price of $130.5 million in cash was financed with $92.8 million of proceeds from the sale of common stock (See - "Share Purchase Agreement with Capital Z Financial Services Fund II, L.P." and Note 2 to Notes to Consolidated Financial Statements) and from the $70 million term loan portion of an $80 million credit facility entered into on July 30, 1999. None of the $10 million revolving loan facility included in this credit facility was drawn at closing nor has been drawn upon to date. The proceeds of the financing in excess of the $130.5 million purchase price were used to pay transaction costs of the acquisition and the financing, to retire an existing Universal bank loan, to contribute to the surplus of Pennsylvania Life and for working capital.
The Penn Union Transaction was accounted for using the purchase method and, accordingly, the operating results generated by the acquired companies after July 30, 1999 are included in Universal's consolidated financial statements. In addition to the purchase price, the Company incurred costs totaling $17.5 million including a transition accrual of $10.0 million. At the time of closing, the fair value of net assets of the acquired companies amounted to $157.8 million resulting in a negative goodwill amount of $10.0 million, which will be amortized on a straight line basis over a ten year period.
In January 2000, the Company announced that it had approved a plan to consolidate the Raleigh location acquired in the Penn Union Transaction into its locations in Toronto (Canada), Pensacola (Florida), and Orlando (Florida) in order to improve operating efficiencies and capabilities. The plan to consolidate this location was being formulated at the date of acquisition. Accordingly, the Company recorded a $10.0 million restructuring liability in its accounting for the Penn Union acquisition.
This liability was accounted for under EITF No. 95-3, "Recognition of Liabilities in Connection with a Purchase Business Combination" (EITF 95-3"). The liability consisted of employee separation costs ($3.2 million), employee relocation costs ($2.6 million), and other relocation and exit costs.
In accordance with EITF 95-3, the Company's Board of Directors has approved the plan and the Company will finalize any changes to the restructuring plans no later than one year from the date of the Penn Union Acquisition (July 31, 2000). The Company will report changes to the accrued acquisition expenses in future financial statements. The Company expects the consolidation to be completed in early 2001.
SENIOR MARKET BROKERAGE - This distribution channel consists of a general agency system and insurance brokerage system that focus on the sale of products in the senior market segment, including Medicare Supplement and Long-term Care. The agents in this segment also distribute universal life products.
CAREER AGENCY SYSTEM - The Career Agency segment is comprised of a career agency field force, which distributes fixed benefit accident and sickness, life insurance and supplemental senior health insurance in
the United States and Canada. The Career Agents are under exclusive contract with Pennsylvania Life and PennCorp Canada.
SPECIAL MARKETS - Through its own operating history and through prior acquisitions, Universal has accumulated various lines of business that it manages in its Special Markets segments. These products include annuities, interest-sensitive and group life insurance, individual medical and other accident and health insurance.
INSURANCE SERVICES AND CORPORATE - This segment is primarily made up of the insurance administrative service company that processes certain business for the Insurance Subsidiaries, as well as unaffiliated insurers. It also includes the corporate operations of the holding company, including interest on debt.
The Special Markets segment includes a combination of existing Universal business from the Other Accident and Health and Life Insurance segments, as well as new business resulting from the acquisition of the Peninsular, Marquette, Union Bankers and Constitution.
The business included in the Insurance Services and Corporate Segment has not changed significantly from the prior year.
The Senior Market Brokerage segment nearly doubled its results, increasing by $1.5 million in addition to the $11.6 million added by the acquisition of the Career Agency segment. The Special Markets segment improved its results by $3.0 million primarily as a result of the business acquired in the Penn Union Acquisition. These are offset by a reduction of $3.9 million in the results from the Non-insurance segment. Discussion of the details by segment follows.
REVENUES. Total revenues for the Senior Market Brokerage Segment increased approximately $5.9 million to approximately $30.5 million for the year ended December 31, 1999, compared to total revenues of approximately $24.6 million in the prior year.
While the Company was able to increase its gross premium revenue from its core products, it continues to reinsure a portion of these risks to unaffiliated reinsurers. Reinsurance premiums ceded for the year ended December 31, 1999 for the Senior Market Brokerage Segment amounted to $74.4 million, a $11.5 million increase from the 1998 amount of $62.9 million. Details of the changes in reinsurance premiums ceded is as follows:
Net investment income of the Brokerage Agent Segment increased $0.2 million to $0.9 million for the year ended December 31, 1999, compared to $0.7 million in 1998. This increase is attributable to the increase in invested assets outstanding in this segment during 1999 compared to 1998. Realized gains on investments decreased slightly from the prior year.
The change in deferred acquisition costs increased by $1.0 million for the year ended December 31, 1999 compared to 1998. The amount of acquisition costs capitalized increased $1.4 million from $3.9 million in 1998 to $5.3 million in 1999. The overall increase in capitalized costs is the result of the increase in new premium production in the year ended December 31, 1999 compared to 1998. The amortization of deferred acquisition costs increased $0.4 million from $1.0 million in 1998 to $1.4 million in 1998.
Commissions in the Brokerage Agent Segment increased $4.2 million in the year ended December 31, 1999 to $18.3 million, compared to $14.1 million in 1998. This increase is the direct result of the $17.3 million increase in gross premium discussed above. Commissions and expense allowances on reinsurance ceded increased $4.4 million in the year ended December 31, 1999 to $23.2 million, compared to $18.8 million in 1998. This increase is the direct result of the $11.5 million increase in reinsurance premium ceded discussed above.
Other operating costs and expenses increased $1.8 million in the year ended December 31, 1999 to $13.9 million, compared to $12.1 million in 1998 due in part to the increase in expenses incurred in generating new business ($0.8 million) as well as the increase in taxes associated with the growth in new business in this segment. The ratio of general expenses to gross premium has remained at 13%.
REVENUES. Total revenues for the Career Agent segment amounted to $68.0 million of which $44.2 million was generated by Pennsylvania Life U.S. and $23.8 million was generated by the Canadian operations. Gross premium totaled $56.9 million, $36.6 million derived by Pennsylvania Life U.S. and $20.4 million derived from the Canadian operations. The Company reinsures a portion of these premiums to outside parties. Total ceded premiums for the five months since acquisition were $0.2 million at the Canadian operations and $1.1 million at Pennsylvania Life U.S.. Investment income of $12.1 million consists mostly of interest on bonds held by the company.
Deferred acquisition costs increased $2.9 million for the five months ended December 31, 1999. Acquisition costs capitalized at Pennsylvania Life U.S. totaled $1.6 million offset by amortization of $34 thousand. Canadian costs capitalized amounted to $1.3 million.
Commissions in the Career Agent Segment for the five months ended December 31, 1999 amounted to $15.0 million, of which $10.4 million related to Pennsylvania Life U.S. Commissions and expense allowances on reinsurance ceded totaled $0.8 million in the five months ended December 31, 1999.
In the year ended December 31, 1999, the Special Markets Segment gross premium and policyholder fees earned (including reinsurance assumed) amounted to $93.4 million, a $48.1 million increase over the $45.3 million amount in 1998. The gross earned premiums on the Company's special market products increased as follows:
While the Company was able to increase its gross premium revenue from its core products, it continues to reinsure a portion of these risks to unaffiliated reinsurers. Reinsurance premiums ceded for the year ended December 31, 1999 for the Special Markets Segment amounted to $63.1 million, a $36.4 million increase from the 1998 amount of $26.7 million. Details of the changes in reinsurance premiums ceded is as follows:
The change in deferred acquisition costs decreased by $0.6 million for the year ended December 31, 1999 compared to 1998. The amount of acquisition costs capitalized decreased $1.5 million from $4.7 million in 1998 to $3.2 million in 1999. The deferred acquisition costs decreased despite an increase in net earned premium primarily due to the fact that the increase in net earned premium related mainly to renewal business of the Penn Union companies. New business production is the main driver of deferred acquisition costs. The amortization of deferred acquisition costs decreased $0.3 million from $4.0 million in 1998 to $3.7 million in 1999. This decrease is the result of the decrease in the asset balance.
Commissions in the Special Markets Segment increased $0.3 million in the year ended December 31, 1999 to $13.3 million, compared to $13.0 million in 1998. This increase is due largely to the acquisition of the Penn Union Companies which increase was offset by a decrease in some of the life products no longer marketed. Commissions and expense allowances on reinsurance ceded increased $2.6 million in the year ended December 31, 1999 to $15.0 million, compared to $12.4 million in 1998. This increase is largely due to the acquisition of the Penn Union Companies.
Other operating costs and expenses increased $5.8 million in the year ended December 31, 1999 to $14.0 million, compared to $8.2 million in 1998. This increase is due mainly to expenses related to the newly acquired Penn Union lines of business. This increase is offset by a decrease in the cost of generating new business as some of the lines of business in this segment run off. The ratio of general expenses to gross premium has decreased from approximately 19% to approximately 15%.
Fees and other income increased $0.8 million due to increase in income at WorldNet. General expenses increased $4.8 million from $1.3 million in 1998 to $6.1 million in 1999. This increase is due to an increase in interest expense of $2.6 million related to a loan with Chase Manhattan to finance the purchase of the Penn Union Companies. In addition, the Parent Company incurred compensation expenses of approximately $1.0 million related to the issue of stock options and bonuses to employees and members of management related to the acquisition of the Penn Union Companies.
In the year ended December 31, 1998, the Senior Market Brokerage Segment gross premium and policyholder fees earned (including reinsurance assumed) amounted to $86.7 million, a $24.1 million increase over the $62.6 million amount in 1997. The gross earned premiums on the Company's senior market products increased as follows:
These increases totaled $39.4 million and were offset by the decrease in premiums on the products terminated and not currently marketed by the Company as follows:
BENEFITS, CLAIMS AND OTHER DEDUCTIONS. Total benefits, claims and other deductions in the Brokerage Agent Segment increased approximately $6.9 million to $23.0 million for the year ended December 31, 1998, compared to $16.1 million for the year ended December 31, 1997.
Claims and other benefits increased $2.6 million to $13.3 million for the year ended December 31, 1998 compared to $10.7 million in 1997. The change in reserves for the year ended December 31, 1998 amounted to an increase of $4.3 million compared to an increase of $0.5 million in 1997 generating a variance of $3.8 million. These increases in claims and change in reserves are the result of the $7.7 million increase in net premiums earned for the year ended December 31, 1998 discussed above.
Commissions increased $3.8 million in the year ended December 31, 1998 to $14.1 million, compared to $10.3 million in 1997. This increase is the direct result of the $24.1 million increase in gross premium discussed above. Commissions and expense allowances on reinsurance ceded increased $6.7 million in the year ended December 31, 1998 to $18.8 million, compared to $12.2 million in 1997. This increase is the direct result of the $16.3 million increase in reinsurance premium ceded discussed above.
Other operating costs and expenses increased $3.6 million in the year ended December 31, 1998 to $12.1 million, compared to $8.5 million in 1997 due in part to the increase in expenses incurred in generating new business ($1.5 million) as well as the increase in third party administration fees and taxes associated with the growth in new business in this segment.
These increases totaled $38.1 million and were offset by the decrease in premiums on the products terminated and not currently marketed by the Company as follows:
Interest credited to policyholders increased $0.6 million to $7.2 million, which is the result of more interest sensitive account values in force.
Claims and other benefits decreased $0.6 million to $12.4 million for the year ended December 31, 1998 compared to $13.0 million in 1997. The change in reserves for the year ended December 31, 1998 amounted to a increase of $1.1 million compared to a decrease of $22 thousand in 1997 generating a variance of $1.1 million. Interest credited to policyholders amounted to $7.2 million in 1998, an increase of $0.6 million over the 1997 amount of $6.6 million.
Commissions increased $2.2 million in the year ended December 31, 1998 to $13.0 million, compared to $10.8 million in 1997. This increase is the direct result of the $7.6 million increase in total premium discussed above. Commissions and expense allowances on reinsurance ceded increased $4.3 million in the year ended December 31, 1998 to $12.4 million, compared to $8.1 million in 1997. This increase is the direct result of the $10.7 million increase in reinsurance premium ceded discussed above.
Total revenue decreased $0.4 million from $2.7 million in 1997 to $2.3 million in 1998 due to a realized gain of $0.6 million in 1997 related to the sale of Amerifirst Insurance Company, an inactive insurance company. This decrease in realized gains was partially offset by an increase in fee income of $0.2 million. General expenses decreased $0.2 million from $1.5 million in 1997 to $1.3 million in 1998. The decrease in expenses at WorldNet ($1.1 million) was offset by an increase in expenses at the Parent Company ($0.6 million) related to increased interest expense and activity in public company activities compared to 1997.
The Company requires cash to pay the operating expenses necessary to function as an insurance holding company (which under applicable Insurance Department regulations must bear its own expenses), and to meet the cost involved in being a publicly owned company. In addition, it requires cash to meet Universal's obligations under the loan agreement discussed below, the debentures outstanding with American Progressive and to fund the planned reorganization of the Company being performed in connection with the acquisition of the Penn Union Companies.
In connection with an agreement entered into 1996 whereby American Pioneer became a direct subsidiary of Universal, rather than an indirect subsidiary owned through American Progressive, Universal has $7.9 million in debentures outstanding to its subsidiary, American Progressive. The debentures pay interest quarterly at 8.50% and are due between September 2002 and May 2003. During the year ended December 31, 1999 the Company paid $0.7 million in interest on these debentures to American Progressive, which was eliminated in consolidation.
Share Purchase Agreement with Capital Z Financial Services Fund II, L.P.
On December 31, 1998, the Company executed a Share Purchase Agreement with Capital Z Financial Services Fund II, L.P. ("Capital Z"), which was amended on July 2, 1999 (as amended the "Share Purchase Agreement"). Under the amended agreement, Capital Z agreed to purchase up to 28,888,888 shares of Universal common stock for a purchase price of up to $91.0 million (the "Capital Z Transaction"). The Share Purchase Agreement received the approvals of the Florida, New York and Texas Insurance Departments (the states in which Universal's Insurance Subsidiaries prior to the Penn Union Acquisition are domiciled). The stockholder approvals required for the closing of the UA Purchase Agreement were given on July 27, 1999.
Under the terms of the Series C Preferred Stock, the Company had the right to require its conversion to common stock if certain conditions were met, which conditions were satisfied on March 5, 1999. All of the 51,680 outstanding shares of Series C Preferred Stock were converted to 2,175,986 shares of common stock on April 1, 1999. As a result of this conversion, the cumulative redemption accrual of $0.8 million was eliminated and credited to retained earnings.
The holders of the Series C Preferred Stock had preemptive rights, which were triggered by the execution of the Share Purchase Agreement on December 31, 1998, subject to the closing of the sale pursuant to that agreement. 1,159,243 shares were purchased pursuant to these preemptive rights at a price of $3.15 per share.
At December 31, 1998, the Company had 658,231 common stock warrants issued and outstanding which were registered under the Securities Act of 1933 and 2,015,760 warrants outstanding
Beginning in 1993, the National Association of Insurance Commissioners ("NAIC") imposed regulatory risk-based capital ("RBC") requirements on life insurance enterprises. At December 31, 1999 all of the Insurance Subsidiaries maintained ratios of total adjusted capital to RBC in excess of the Authorized Control Level.
PennCorp Canada and Pennsylvania Life's Canadian branch report to Canadian regulatory authorities based upon Canadian statutory accounting principles that vary in some respects from U.S. statutory accounting principles. Canadian net assets based upon Canadian statutory accounting principles were $63.9 million as of December 31, 1999. PennCorp Canada maintained a Minimum Continuing Capital and Surplus Requirement Ratio ("MCCSR") in excess of the minimum requirement and Pennsylvania Life's Canadian branch maintained a Test of Adequacy of Assets in Canada and Margin Ratio ("TAAM") in excess of the minimum requirement at December 31, 1999.
Cash generated by the Insurance Subsidiaries will be made available to Universal, the ultimate parent, principally through periodic payments of principal and interest on surplus debentures. Currently, the surplus notes between Universal and American Exchange total $70 million and anticipates that it will be primarily serviced by dividends from Pennsylvania Life, a wholly owned subsidiary of American Exchange, and by tax-sharing payments among the insurance companies which are wholly owned by American Exchange filing a consolidated Federal income tax return.
The net yield on the Company's cash and invested assets increased slightly from 6.67% in 1998 to 6.79% in 1999. 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, 1999, the Insurance Subsidiaries held cash and cash equivalents totaling $45.6 million, as well as fixed maturity and equity securities that could readily be converted to cash with carrying values (and fair values) of $717.6 million. The fair values of these liquid holdings totaled more than $763.2 million.
The Company's investment policy is to balance the portfolio between long-term and short-term investments so as to continue to achieve investment returns consistent with the preservation of capital and maintenance of liquidity adequate to meet payment of policy benefits and claims. The Company invests in assets permitted under the insurance laws of the various states in which it operates. Such laws generally prescribe the nature, quality of and limitations on various types of investments that may be made. The Company currently engages the services of two investment advisors, Conning Asset Management and Asset Allocation and Management Company, to manage the Company's fixed maturity portfolio, under the direction of the management of the Insurance Subsidiaries and in accordance with guidelines adopted by their respective Boards of Directors. The Company's policy is not to invest in derivative programs or other hybrid securities, except for GNMA's, FNMA's and investment grade corporate collateralized mortgage obligations. It invests primarily in fixed maturity securities of the U.S. Government and its agencies and in corporate fixed maturity securities with investment grade ratings of "Baa3" (Moody's), "BBB-" (Standard & Poor's) or higher. However, the Company does own some investments that are rated "BB" or below (together 1.1% and 2.5% of total fixed maturities as of December 31, 1999 and 1998, respectively). As of December 31, 1999 all of the Company's securities were current in the payment of principal and interest. During the year ended December 31, 1999 the Company wrote down the value of a certain fixed maturity security by $0.6 million which represents management's estimate of other than temporary declines in value and was included in net realized gains (losses) on investments in the accompanying consolidated statement of operations.
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. Peninsular has $8.4 million and American Pioneer has $1.1 million of untaxed profits in its PSA. None of the other life Insurance Subsidiaries owned by the Company have PSA balances.
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
The Company can not predict whether or not these proposals will pass or pass in some modified form and, therefore, can not predict the impact caused by these proposed tax changes.
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, 2000. Management does not anticipate that the adoption of the new statement will have a significant impact on earnings or the financial position of the Company.