The following historical financial data for the nine years ended December 31, 1996 have been derived from the Consolidated Financial Statements of the Company audited by Price Waterhouse LLP, independent accountants. The following selected financial data of the Company should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations and the Company's audited Consolidated Financial Statements appearing elsewhere herein.
On December 2, 1996, the Company announced that it had entered into a definitive agreement to sell the Annuity Operations to SunAmerica Life Insurance Company ("SunAmerica"). The transaction includes the sale of all of the common stock of John Alden Life Insurance Company of New York ("JANY") and the coinsurance of substantially all of the annuity block of John Alden Life Insurance Company ("JALIC"). This coinsurance will initially be on an indemnity basis and, pursuant to the agreement, will transition to an assumption basis as soon as practical. In certain states, the transition to an assumption basis is subject to policyholder approval. To the extent that such transition does not take place with respect to any particular policy, such policy will remain indemnity reinsured. A substantial portion of the transition to an assumption basis is expected to be completed within two years. The transaction is contingent upon customary terms and conditions, including required regulatory approvals and is scheduled to close by the end of the first quarter of 1997.
- ----------------------------- (1) Applicable to common stock excluding net realized investment gains (losses) and cumulative effect of change in accounting principle and is after preferred stock dividends. (2) Income (loss) before cumulative effect of change in accounting principle.
- ------------------- (1) Includes 32,000, 40,000 and 24,000 groups, each group made up of one individual, as of December 31, 1996, 1995 and 1994, respectively, marketed through an association trust.
During the three years ended December 31, 1996, the Company's continuing operations' profitability was primarily a result of the amount of business sold, the claims incurred and the control of sales and general expenses.
During 1996, the Company continued to experience increased utilization of medical services. The group gross medical loss ratio increased to 76.3% for the year ended December 31, 1996 from 75.0% for the year ended December 31, 1995. Premium rate increases are established approximately three months prior to the quarter in which they become effective. Subsequent to establishing the first quarter 1996 premium rate increases in October 1995, the Company identified several factors, in addition to the increased utilization, that were contributing to the relatively high medical loss ratios. These factors resulted primarily from small group and individual healthcare reform legislation. The Company also enhanced its ability to analyze claims experience by various specific characteristics including, among other things, initial and current group size, duration of policy, geographic location, level of deductibles and utilization of particular benefits. Consistent with the objective of maintaining profit margins at the risk of reducing market share, the Company continued to significantly increase premium rates throughout 1996, specifically targeting those blocks of business with profit margins lower than that which the Company deems acceptable. While the number of group covered lives decreased 24.3% to 901,000 at December 31, 1996 from 1,190,000 at December 31, 1995, the rate increases offset, in part, the decline in covered lives. Additionally, gross premiums from the Company's HMO joint venture discussed below increased 191.8% in 1996 to $107.4 million from $36.8 million in 1995. Total gross premiums decreased 5.1% to $1,838.3 million for the year ended December 31, 1996 from $1,936.3 million for the year ended December 31, 1995.
Other income consists primarily of profit sharing provisions in accordance with a Group Reinsurance Agreement with London Life Insurance Company and Transamerica Occidental Life Insurance Company (the "Group Reinsurance Agreement"), which became effective October 1, 1991 for small groups under 25 employee lives. The Group Reinsurance Agreement was amended effective January 1, 1994 to include all fully-insured groups, regardless of size. See further discussion in "Liquidity and Capital Resources -- Reinsurance". The amount of these profit sharing provisions has declined in 1995 and 1996 due to the decline in the gross profitability.
Commissions, as a percent of net premiums, declined from 9.4% in 1994 to 7.9% in 1995. This decline was primarily the result of a reduction of commission rates effective in late 1994. In addition, during the third quarter of 1994, the Company began to defer acquisition costs related to a product within the small group health insurance product line as it achieved sufficient size to warrant recoverability against future profits.
The amortization of deferred policy acquisition costs, as a percent of net premiums, increased from 0.8% in 1994 to 1.3% in 1995 and 1.4% in 1996. As discussed above, the Company began to defer acquisition costs related to a small group product in the third quarter of 1994.
Pre-tax income increased 100.0% to $3.2 million for the year ended December 31, 1995 from $1.6 million for the year ended December 31, 1994. Pre-tax income decreased 118.8% to a pre-tax loss of $0.6 million for the year ended December 31, 1996 from pre-tax income of $3.2 million for the year ended December 31, 1995. This decrease is primarily attributable to additional profit sharing liabilities recorded during 1996 relating to amounts ceded to reinsurers in the credit and extended service product lines.
Group insurance business historically has been subject to pricing and profitability cycles that are driven by competitive price pressures within the industry. These pressures and other factors make it difficult to predict with certainty the effect pricing changes will have on the Company's combined ratios. Traditionally, the cycle has been characterized by a period of lower combined ratios, which has fostered intense price competition and aggressive marketing by new entrants as well as existing companies striving to increase market share, resulting in higher combined ratios and lower profitability. The higher combined ratios typically resulted in a withdrawal of competitors and a firming of prices, resulting once again in lower combined ratios and increased profitability and, thus, a renewal of the cycle. There are factors in the current cycle that were not present in previous cycles. The first significant factor is small group and individual healthcare reform and its effect on medical underwriting and pricing. Small group and individual healthcare reforms, primarily at the state level and increasingly at the federal level, include legislation on matters such as guaranteed issue, mandated benefits, premium rate limits (including community rating and modified community rating), guaranteed renewability, minimum loss ratio mandates, risk adjustment mechanisms which allocate losses of individual carriers to group carriers, and other reforms. Secondly, HMO's now represent a more significant source of competition than in previous cycles.
In January 1997, the Company announced that it would be focusing its marketing efforts and resources in those markets and states in which it believes it can best increase profitability and market share. In these markets,
provider relationships are continuing to be strengthened and the new product discussed above will be introduced. Conversely, the Company intends to reduce its marketing efforts and significantly reduce its financial exposure and may, in some cases, withdraw from business in those states where legislative reform and intense competition have significantly increased the risk profile of writing small employer health coverage. Approximately 25% of 1996 group health premiums were generated in these states. In line with this strategy, the Company has decided to stop selling small group insurance plans in California, Maryland and New Jersey, and to terminate existing small group insurance plans in these states. In addition, the Company continues to closely manage its expense structure, including maintaining its workforce proportionate to its business.
The principal amounts of outstanding indebtedness of the Company at December 31, 1996, 1995 and 1994 were $101.5 million, $107.1 million and $125.1 million, respectively. At December 31, 1996, the Company's ratio of debt and redeemable securities to stockholders' equity was 0.26 to 1 compared to 0.27 to 1 at December 31, 1995, and 0.36 to 1 at December 31, 1994. The weighted average interest rates on the Company's indebtedness were approximately 6.3%, 6.9% and 4.9% for 1996, 1995 and 1994, respectively.
The Company paid preferred stock dividends of approximately $0.7 million in each April and October of 1995 and 1996. On March 6, 1997, the Company declared a preferred stock dividend in the amount of approximately $0.7 million and a common stock dividend of approximately $3.0 million which are both to be paid in April 1997. A summary of common stock dividends declared or paid during 1995, 1996 and 1997 is as follows (dollars in millions, except per share amounts):
The Company's sources of cash are payments of principal and interest on the Surplus Debentures of, and dividends from, its direct life insurance subsidiary, HNLIC, and dividends, management fees and tax allocation payments from the Company's principal non-insurance subsidiary, JA Services, Inc. ("JASI") and JASI's subsidiaries. HNLIC's primary sources of cash are dividends from its subsidiary, JALIC, and tax allocation payments from JALIC and its subsidiaries. The Surplus Debentures require HNLIC to make principal payments to the Company of $33.6 million in 1997 and $43.0 million in 1998. JALIC paid cash dividends to HNLIC of $12.0 million in 1996, $30.0 million in 1995 and $29.0 million in 1994.
Principal sources of funds at the insurance company level are insurance premiums, contract charges earned, annuity considerations collected, net investment income received and proceeds from investments that have been sold, called or matured, or from loans that have been repaid. The principal uses of these funds are the payment of operating expenses, the payment of claims and benefits on insurance policies, the purchase of investments and the payment of indebtedness. Net cash provided by operating activities (reflecting principally (i) premiums and contract charges collected less claims and benefits on insurance products plus (ii) interest collected on invested assets less (iii) commissions and other general expenses paid, together with (iv) the inflows or outflows from the purchases or sales of trading account securities) was $301.7 million, $383.0 million and $524.5 million in 1996, 1995 and 1994, respectively. The net decrease in cash flows from operating activities from 1995 to 1996 was generally due to a reduction in the volume of business, partially offset by decreased operating expenses. Net inflows from trading account securities were $1.0 million and $6.6 million in 1996 and 1995, respectively, compared to $153.2 million in 1994. The Company reduced the size of the trading account in 1994 so as to limit volatility in net income. In addition to the reduction in inflows from trading account securities, cash provided by operations was also reduced in 1996 and 1995 by the reduction in net income to $30.9 million and $6.4 million in 1996 and 1995, respectively, from $75.8 million in 1994.
Net cash provided by (used in) investing activities (reflecting principally investments purchased and loans made, less investments sold or matured, and loans repaid) was $36.6 million, $(186.5) million and $(968.8) million in 1996, 1995 and 1994, respectively. In conjunction with the Company's announcement in March 1996 that it was selling its Annuity Operations, the Company slowed production of new mortgages in 1996 while experiencing increased repayments. In anticipation of cash needs relating to the sale of the Annuity Operations as discussed below, the Company has kept the additional cash generated from the mortgage repayments in cash equivalents, as opposed to reinvesting these funds. This resulted in the increase in cash provided by investing activities in 1996. The principal reasons for the decrease in cash used in 1995 as compared to 1994 were the sale of $342.0 million of securities to
Cash flow from financing activities consists of net proceeds from public stock offerings and debt refinancing, payments on redemption of redeemable common and preferred stock, dividend payments on preferred and common stock, additions to and repayments of indebtedness, as well as receipts and payments on the Company's annuity and universal life products. Net cash (used in) provided by financing activities was $(270.4) million, $(155.4) million and $480.2 million in 1996, 1995 and 1994, respectively. In 1996, the Company borrowed $26.0 million and repaid $31.5 million under the amended Credit Agreement and related revolving credit facility. In 1995, the Company borrowed $27.0 million and repaid $15.0 million under the amended Credit Agreement and related revolving credit facility. Additionally, in 1995, the Company paid in full a $29.8 million loan for fixed assets and capitalized software. The Company made principal payments under the Credit Agreement of $19.7 million in 1994 and borrowed additional funds of $13.5 million. Deposits received from universal life and investment-type contracts were $453.2 million, $886.3 million and $859.4 million in 1996, 1995 and 1994, respectively. Payments to contract holders of these products consist of surrenders, partial withdrawals, death claims and annuitized benefits. Such payments for these same periods aggregated $705.6 million, $666.7 million and $401.2 million, respectively. During 1995, the Company paid $342.0 million for the reinsurance treaty discussed above. The amount of cash and cash equivalents at December 31, 1996, 1995 and 1994 was $167.5 million, $99.6 million and $58.5 million, respectively.
In accordance with the terms of the definitive agreement to sell the Annuity Operations, the Company will be required to remit cash or cash equivalents to SunAmerica. In anticipation of this obligation, the cash and cash equivalents of the Company have increased from $99.6 million at December 31, 1995 to $167.5 million at December 31, 1996. The total purchase price of the Annuity Operations is approximately $240 million. The Company's available capital will be enhanced by both the after-tax gain generated from the transaction and by the release of the capital previously allocated to support the annuity business. The Company intends to use a portion of this available capital to strengthen its healthcare operations, after which it estimates there will be approximately $175 million to $200 million of capital available for other uses. Subject to applicable regulatory approvals, this additional capital may be used to repurchase common stock, pay dividends, pay down debt and, to a lesser extent, for general corporate purposes.
The Annuity Operations have historically represented a significant source of cash flows to the Company. As a result of the sale, it is expected that liquidity and cash flows from operating, investing and financing activities will be decreased. In addition, as discussed above, the Company has recently developed a new small group health insurance product which will be introduced into the marketplace beginning in the second quarter of 1997. The Company will also be enhancing its management of provider relationships and risk-sharing programs. In conjunction with these actions, the Company will be reviewing its current and future information systems needs. As a result, the Company may need to make additional investments in its information systems in the future to support the operations of the business and as the Company prepares for the transitioning of operations into the year 2000. However, the Company believes that sufficient sources of cash flow exist which will be available in
Receivables from reinsurers and investment deposits recoverable, consisting primarily of contract holder liabilities transferred to reinsurers, increased $0.9 million to $970.7 million at December 31, 1996 from $969.8 million at December 31, 1995. Of the total receivables from reinsurers and investment deposits recoverable as of December 31, 1996, $768.1 million, or 79.1%, has been placed in trusts. These trust agreements generally require that assets be maintained at least equal to 100% of the underlying regulatory liabilities and that the assets in trust be left on deposit with an independent trustee. The Company generally requires that its reinsurers be rated "A (Excellent)" or better by A.M. Best. Upon the coinsurance of the JALIC Annuity Operations, the amount of investment deposits recoverable will increase by approximately $3.8 billion. Assets equal to this amount will be placed in trust for the benefit of JALIC. SunAmerica is rated "A+ (Superior)" by A.M. Best. In addition, substantially all of the Company's existing coinsurance of JALIC's Annuity Operations will be assigned to SunAmerica.
transition of the Annuity Operations. The Company is pursuing the execution of a definitive agreement for the sale of the Western Diversified Group and expects to enter into a non-binding letter of intent in the second quarter of 1997. Such sale may be in the form of a sale of all of the common stock of the subsidiaries which comprise the Western Diversified Group or the reinsurance of the applicable business and would be subject to applicable regulatory approvals. There can be no assurance that such sales will be consummated. For further discussion, see "General Overview -- Sale of Annuity Operations and Western Diversified Group".
The Company's consolidated financial statements, together with the report thereon of Price Waterhouse LLP dated March 10, 1997, are filed as part of this Report, beginning on page. Unaudited quarterly financial information is filed as a part of this Report on page.