The Company owns its home office building, located at 17800 Royalton Road, Strongsville, Ohio. The building, which consists of 121,625 square feet of gross floor area, was occupied in late 1990 by the Company and all its subsidiaries. Central, the principal operating subsidiary, entered into a 15 year triple net lease agreement with the Company for 100% of the space. All operations are conducted in this building. As indicated in the Capital Resources section, of Item 7, the Company is planning an addition to the existing building, but no capital commitments have been made as of March 18, 1996.
The only long-term debt the Company has at December 31, 1995, is $8,599,067, which is the principal amount payable under a loan secured by a mortgage on the Company's home office building. The Company entered into the loan agreement in 1990 for $9 million for a term of 10 years bearing interest at 9 1/2% per annum with a 30 year amortization period payment schedule. At the same time, the Company also entered into a 15 year lease agreement with Central for 100% of the space. The Company will use the monthly rental payments to pay, among other expenses, the required mortgage loan payments. In 1995, the Company started a search for a new computer system for claims and administration which includes, among other things, billing, rating and commission functions. The increase in the Company's business, new state mandates and new products have created the need for this new system. A system of this nature is expected to cost between $5 million and $7 million, including software, hardware and implementation, over an estimated three year period. The Company estimates these costs could be recovered over a 4 to 5 year period, through a combination of payroll cost savings, expense controls and new production capacity. The Company has not entered into any contract or commitment for the purchase of such a computer system, although such an acquisition is planned for 1996. In light of the Company's growth over the last several years, the Company is also planning an addition to its existing headquarters building. The addition would provide space for training, Managed Care and computer facilities. The preliminary plans indicate an estimated cost between $6 million and $7 million however, the Company has not made any capital commitment with respect to the addition as of March 18, 1996.
During 1995, premiums increased 4% to $233,168,529 from $223,679,071 in 1994. The increase was primarily in the group life and health division which accounted for about 98% of total premiums. Group certificates in force increased about 10% to 113,720 in 1995 from 102,959 in 1994. Certificates issued for new group policies were 44,398 in 1995, up 42%, from 31,270 in 1994. The increase came primarily from a new product, the Professional Multi-Option (PMO), which was introduced in late 1994 and targets small businesses with 2 to 25 lives. Total lapses (net of additions/decreases) in 1995 were 33,637, down slightly from 33,847 in 1994. Overall, the lapse ratio was in line with the Company's expectations and was lower than the industry average for small group business.
Net investment income decreased about 1% to $6,454,038 in 1995 from $6,515,927 in 1994. The decrease was primarily due to the overall decrease in interest rates during 1995. Also, during 1995 the Company
reduced its holdings in mortgage-backed securities and convertible bonds. The proceeds were invested in short term government type securities at lower interest rates, but produced a more liquid and stable position.
Benefits and claims incurred expenses increased 7% in 1995 to $165,472,603 from $155,257,560 in 1994. This compares to a 6% increase in 1994 over 1993. The incurred loss ratio was 71% for 1995 and 69.4% for 1994. The major increase in claims was during the last quarter, primarily the last month. The loss ratio increased to 73.6% for the fourth quarter of 1995 compared to 67.7% in the same quarter in 1994. During the fourth quarter the Company experienced, as many small group carriers did, an increase in claims due to utilization, state mandates and accidents. This trend continued into January 1996. In response, the Company has increased premium rates, not renewed certain blocks of business and is updating several managed care controls.
Commissions decreased slightly to $33,411,203 in 1995 from $33,573,278 in 1994 and were 14.3% of premiums in 1995 compared to 15% in 1994. The decrease is attributed to a lower commission rate for the new product (PMO) sold in 1995 and the growth in renewal premiums which carry a lower commission rate. Expenses, such as salaries, premium taxes, fees, etc., increased, in total, 1% in 1995 over 1994. However, as a percentage of premiums the ratio was lower in 1995, 15.0% compared to 15.4% in 1994.
The Federal income tax returns for the Company and its subsidiaries have been examined by the Internal Revenue Service (IRS) for 1991 and 1992. During the third quarter of 1994, the IRS issued a proposal for adjustments to the Company's returns for 1991 and 1992. The proposed deficiencies are approximately $2.4 million of which $215,303, pertaining to some non deductible expenses and certain assets expensed and not capitalized, was agreed to and paid in 1994. The balance primarily deals with whether or not the Company's subsidiary, Central, qualified as a life company, for tax purposes. The Company is vigorously protesting the proposed deficiency and management believes existing law supports the Company's position. Therefore, the Company has not recorded a liability for the difference.
27,225 in 1993. The increase is due to a combination of certain groups that were not renewed and the continued higher lapses in an association type product which is being used as a short term policy.
Net investment income increased 21% to $6,515,927 from $5,367,184 in 1993. Favorable cash flows in 1994 and 1993 aided in the increase in investments, primarily fixed maturities which generated the majority of the investment income. Offsetting the effect of the increase in investments was the effect of lower interest rates during the first half of 1994.
Benefits and claims incurred expenses increased 6% in 1994 to $155,257,560 from $146,017,738 in 1993. This compares to a 28% increase in 1993 over 1992. The incurred loss ratio was 69.4% in 1994 and 69.9% in 1993. The improvement can be attributed to managed care cost controls, certain rate adjustments, reduction in large claims and an overall moderation in the medical inflation rate for 1994.
Commissions increased 5% to $33,573,278 in 1994 from $32,120,808 in 1993 and were 15% of premiums in 1994 compared to 15.4% in 1993. The decrease in the ratio is primarily due to the increase in renewal premiums, which carry a lower commission than new business. Expenses increased 3% in 1994 over 1993 and were 15.4% of premiums compared to 16.1% in 1993.
Inflation has had an impact on claim costs and overall operating costs and although it has been lower in the last few years, hospital and medical costs have still increased at a higher rate than general inflation. While to a certain extent these increased costs are offset by interest rates (investment income), hospital charges increased, while the rate of income from investments decreased. The Company will continue to establish premium rates in accordance with trends in hospital and medical costs along with concentrating on various cost containment programs.
It appears that no major Federal health care reform is scheduled to take effect in 1996. However, incremental changes such as portability and limited pre-existing conditions, are probable and even more likely to be enacted on the state level. The Company cannot predict the ultimate timing or effect of any legislative efforts, and no assurance can be given that any such efforts will not have a material adverse effect on the Company's business and results of operations.
In December 1991, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 107, "Disclosures about Fair Value of Financial Instruments". The statement requires disclosure about the fair value of financial instruments and was adopted by the Company in 1995.
In 1995, the Company adopted SFAS No. 106 "Employers' Accounting for Postretirement Benefits Other Than Pensions." The focus of SFAS 106 is principally on postretirement health care benefits and the effect on the consolidated financial statements is discussed in the notes to the consolidated financial statements.
In March 1995, FASB issued SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of." SFAS 121 requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amount. SFAS 121 also addresses the accounting for long-lived assets that are expected to be disposed of. The statement is effective for fiscal years beginning after December 15, 1995. Previously issued consolidated financial statements will not be restated. The Company will adopt SFAS 121 in 1996 and the impact on the consolidated financial statements of adopting SFAS 121 is not expected to be material.
In October 1995, FASB issued SFAS No. 123, "Accounting for Stock-Based Compensation". The Company did not grant any of its shares of stock or other equity instruments to employees in 1995 and therefore has not adopted SFAS 123 as of December 31, 1995.
It appears that no major Federal health care reform will take place in 1996. However, incremental changes are more probable than major changes and it is more likely this will be on the state level than Federal. The Federal government has already enacted a series of health care mandates which has resulted in cost shifting from the Federal government to state government and the private sector. The Company cannot predict the ultimate timing or effect of such legislative efforts, and no assurance can be given that any such efforts will not have a material adverse effect on the Company's business and results of operations.
(1) The guaranteed interest rate on policies currently being issued is 4.5%.
The liabilities for unpaid accident and health and death claims are estimated principally based upon past experience for pending, incurred but not reported, and reopened claims. The liability includes a provision for the estimated cost of investigating and settling the claim liability. The liability is particularly sensitive to recent claims frequency and severity experience of Central. Management believes the liabilities for unpaid claims are adequate. A consulting actuary is retained by Central to assist in the estimation process and to certify to the statutory reserves.
Net income per share is computed using the weighted average number of common shares outstanding. The number of shares was increased to reflect shares issuable on the exercise of options, reduced by the number of shares assumed to have been purchased with the proceeds from the exercise of these common stock equivalents. The number of shares used to calculate the earnings per share was 4,221,636 in 1995, 4,201,069 in 1994 and 4,182,384 in 1993.
The amortized cost and estimated fair value of fixed maturities at December 31, 1995, by contractual maturity, are as follows. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalties.
At December 31, 1995, $27,477,972 of consolidated shareholders' equity represents net assets of the Company's insurance subsidiary which is subject to certain regulatory restrictions on paying dividends and making loans or advances to the parent company. Generally, the net assets of the Company's insurance subsidiary available for transfer to the parent company are limited to the amounts by which the insurance subsidiary's net assets, as determined in accordance with statutory accounting practices, exceed minimum statutory requirements. In addition, payments of such amounts as dividends are subject to approval by
December 31, 1993. The model act was adopted in Ohio, Central's state of domicile, in 1995. Based upon the December 31, 1995 statutory financial statements, Central exceeded all the required RBC levels.
Income tax expense attributable to income from operations differs from the amounts computed by applying the U.S. Federal income tax rate of 35%. Those effects are as follows:
Charges for the leases were $1,069,723, $854,358 and $533,329 for 1995, 1994 and 1993, respectively. Future net minimum payments for the operating leases are as follows:
The Company's employment agreement with its Chief Executive Officer was entered into in 1982 and amended in 1983. The agreement expires December 31, 2001 and calls for annual increases of 11% per year through 1996. The 1995 compensation under the agreement was $871,166. The agreement has a change of control provision, which if exercised, upon such a change would require a lump sum payment for the unexpired term.
Central has a $1 million line of credit with a major bank, which was unused as of December 31, 1995 and 1994.
Outstanding stock options consist of options granted by the Company at prices equal to or above market price on the date of grant. On March 15, 1983, an Incentive Stock Option Plan was adopted. The plan, which expired in May 1993, provided that key full-time employees of the Company and its subsidiaries were eligible for participation in the Plan. Also 300,000 options were granted to the CEO in 1984, expiring in 1997, of which 255,000 at $2.83 per share remain outstanding at December 31, 1995. No options are available for future grants. The following table summarizes data regarding all stock options:
The program's funded status as of the reported date is as follows:
The assumed health care cost trend rates have a significant effect on determining the cost of benefits provided under the program. The effect of a 1% increase in the health care cost trend rates as noted above would be an increase of $18,000 or 22% in the service and interest cost components of net periodic benefit cost for the period reported, and an increase of $98,000 or 19% in the accumulated postretirement benefit obligation amount as of the date reported.
The discount rate used to measure the program's obligations was 7%.
The following table presents the revenues and income (loss), on a GAAP basis, attributable to the Company's consolidated industry segments. The Company is not required to allocate investment assets or identifiable assets by industry segments.
Carrying amount and estimated fair value of financial instruments subject to SFAS 107 are as follows as of December 31:
FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 ================================================================================