The selected consolidated financial data presented below as of and for each of the five years ended December 31, 2000, 1999, 1998, 1997 and 1996 have been derived from our audited consolidated financial statements. The acquisitions of Provident American Life, Continental General and Pyramid Life occurred on December 31, 1998, February 17, 1999 and July 26, 2000, respectively. The acquisitions of Provident American Life, Continental General and Pyramid Life had no impact on our results of operations in 1998. Results for United Benefit Life are included from August 1, 1998 to July 20, 1999 under a reinsurance agreement and thereafter as an acquired entity. The financial information for the year ended December 31, 1999 includes the operations of Continental General since February 1, 1999 and for Provident American Life and United Benefit Life (through reinsurance) for the entire period, and the financial information for the year ended December 31, 2000 includes the operations of Pyramid Life since July 26, 2000. This data should be read in conjunction with the more detailed information contained in the consolidated financial statements and accompanying notes, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and other financial information included elsewhere in this filing.
- entered into a retroactive quota share reinsurance agreement with Hannover, effective January 1, 1997, under which Hannover reinsured 50% of certain group health policies in force at Central Reserve and written during 1997;
- completed a private placement of our common stock in July 1998 in which we issued and sold 7,300,000 shares of common stock at $5.50 per share and warrants to purchase an additional 3,650,000 shares of common stock at an exercise price of $5.50 per share for total proceeds of approximately $40.2 million, $37.7 million net of expenses;
- entered into a reinsurance agreement with Hannover, in which Hannover reinsured 50% of Provident American Life's direct business written after December 31, 1998 and 50% of the business reinsured from Provident Indemnity;
- acquired Continental General Insurance Company from The Western & Southern Life Insurance Company of Cincinnati, Ohio, on February 17, 1999 for $84.5 million including $40.0 million from a credit facility with Chase, $15.0 million from a private placement of 2,000,000 shares of our common stock, $22.5 million from a special dividend, and the balance in cash;
- entered into a reinsurance agreement with Hannover, under which Hannover reinsured 50% of all insurance business in force at Continental General on February 1, 1999;
- acquired United Benefit Life in July 1999 through foreclosure in order to satisfy, in part, a $19.4 million reserve shortfall at December 31, 1999, which has now been fully recovered;
- new sales activities for United Benefit Life were discontinued in July 2000;
- acquired Pyramid Life Insurance Company from United Insurance Company of America, a subsidiary of Unitrin, Inc., on July 26, 2000 for $67.5 million including $25.0 million from a special dividend, $20.0 million from a private placement offering of 3,333,334 shares of our common stock, $15.0 million from cash at Continental General and financing provided by Chase, and $7.5 million from the sale of our convertible voting preferred stock to United Insurance Company; and
All of our acquisitions were accounted for using the purchase method of accounting. The acquisitions of Provident American Life and Continental General had no impact on our results of operations in 1998. Results for United Benefit Life are included from August 1, 1998 to July 20, 1999 under a reinsurance agreement and thereafter as an acquired entity. The financial information for the year ended December 31, 1999 includes the operations of Continental General since February 1, 1999 and of Provident American Life for the entire year. The financial information for the year ended December 31, 2000 includes the operations of Pyramid Life subsequent to its acquisition on July 26, 2000.
Our results of operations are effected by the following accounting and insurance business factors:
Level of required reserves for policies in force. The amount of reserves relating to reported and unreported claims incurred is determined by periodically evaluating historical claims experience and statistical information with respect to the probable number and nature of such claims. Claim reserves reflect actual experience through the most recent time period and policy reserves reflect expectations of claims related to a block of business over its entire life. We compare actual experience with estimates and adjust our reserves on the basis of such comparisons. Revisions to reserves are reflected in our current results of operations through benefits to insured's expense.
We also maintain reserves for policies that are not currently in claim based upon actuarial expectations that a policy may go on claim in the future. These reserves are calculated based on factors that include estimates for mortality, morbidity, interest rates and persistency. Factor components generally include assumptions that are consistent with both our experience and industry practices.
Deferred acquisition costs. In connection with the sale of our insurance policies, we defer and amortize a portion of the policy acquisition costs over the related premium paying periods of the life of the policy. These costs include all expenses directly related to the acquisition of the policy, including commissions, underwriting and other policy issue expenses. The amortization of deferred acquisition costs is determined using the same projected actuarial assumptions used in computing policy reserves. Deferred acquisition costs associated with traditional life and accident and health contracts are charged to expense over the premium-paying period or as premiums are earned over the life of the contract. Deferred acquisition costs associated with interest-sensitive life and annuity products are charged to expense over the estimated duration of the policies in relation to the present value of the estimated gross profits from surrender charges and investments, mortality, and expense margins. Deferred acquisition costs are affected by unanticipated termination of policies because, upon such unanticipated termination, we expense fully the deferred acquisition costs associated with the terminated policy.
Value of business acquired. A portion of the purchase price paid for Pyramid Life and Continental General Corporation was allocated to the value of business acquired based on the actuarially-determined present value of the expected pre-tax future profits from the business assuming a discount rate of 15%. Interest
is accrued on the balance annually at a rate consistent with the rate credited on the acquired policies on the acquisition date, which ranges from 4.75% to 8.75%. Recoverability of the value of business acquired is evaluated periodically by comparing the current estimate of the present value of expected pre-tax future profits to the unamortized asset balance. If the current estimate is less than the existing asset balance, the difference would be charged to expense.
For accident and health and ordinary life business, the value of business acquired is amortized over the estimated life of the in force business using assumptions consistent with those in computing reserves. Interest of 6% for Continental General and 7% for Pyramid Life is credited to the unamortized balance. For interest sensitive products such as universal life and deferred annuities, the value of business acquired is amortized over the expected profit stream of the in force business. The expected profit stream is based upon actuarial assumptions as to mortality, lapses and expenses. Earned interest was assumed to be 6% for Continental General and 7% for Pyramid Life, the market rate at the time of acquisition.
Year-to-year financial results must be viewed in light of the change in control, reinsurance, acquisitions, changes to our equity and debt and the other factors described above.
Fee and other income increased to $31.5 million for 2000 compared to $17.4 million for 1999, an increase of 81.2%, primarily attributable to additional fees charged for new services, such as care coordination fees, as well as fees received on a larger volume of business.
Medical benefits, claims, losses and settlement expenses were $288.3 million for 2000 compared to $176.5 million for 1999, an increase of 63.3%. The increase was primarily a result of higher benefit utilization in 2000 versus 1999 on a larger volume of business and increased medical costs. The medical loss ratio was 76.7% for the year ended December 31, 2000 compared to 70.1% for 1999. Our loss ratios are defined as policy benefits, claims, losses and settlement expenses as a percentage of net premiums for each segment.
Senior and other benefits, claims, losses and settlement expenses were $101.6 million for 2000 compared to $56.6 million for 1999, an increase of 79.5%. The increase was a result of $17.4 million attributable to Pyramid Life, claims and benefits paid on a larger volume of business and the inclusion of Continental General's results for twelve months in 2000 compared to eleven months in 1999. The senior loss ratio was 74.8% for 2000 compared to 74.6% for 1999.
Selling, general and administrative expenses increased $47.3 million to $185.2 million in 2000 compared to $137.9 million in 1999, an increase of 34.3%. The increase in selling, general and administrative expenses resulted from a $42.6 million increase in commissions and a $12.6 million increase in other operating expenses and a $5.4 million increase in premium taxes, licenses and fees attributable to our increased business base. This increase was partially offset by a net change in reinsurance expenses and allowances of $13.3 million. Pyramid Life accounted for $10.0 million of the $47.3 million increase. As a percentage of consolidated revenues, selling, general and administrative expenses decreased to 32.2% in 2000 compared to 37.1% in 1999.
For the year ended December 31, 1999, total net premiums were $327.7 million, an increase of 112.6%, from $154.2 million for 1998.
Medical premiums for 1999 were $251.9 million compared to $143.1 million for 1998, an increase of 76.1%. The increase in medical premiums was the result of $49.4 million attributable to Provident American Life and Continental General, $22.6 million reinsurance assumed, and $36.8 million from rate increases and new business, net of lapses, at Central Reserve.
Net investment income increased to $21.4 million for 1999 from $7.5 million for 1998, an increase of 186.6%. Continental General accounted for $14.4 million of the increase. Central Reserve's net investment income decreased approximately $1.8 million during the year from 1998. The decrease was directly related to the decrease in invested assets from $84.7 million at December 31, 1998 to $67.2 million at December 31, 1999. The decrease in invested assets was primarily a result of acquiring Provident American and payment of claims under the United Benefit Life reinsurance agreement.
Fee and other income increased to $17.4 million for 1999 compared to $7.7 million for 1998, an increase of 126.3%. This increase was primarily attributed to $4.0 million in administrative fees for business reinsured through Provident American Life and United Benefit Life. The balance represents association fees and a partial recovery of $1.6 million from a fraud committed by a former employee in connection with claims administration at United Benefit Life prior to our 1998 reinsurance agreement.
The amortization of deferred reinsurance gain of $5.5 million for 1999 represented the recognition of the ceding commission allowances received on our reinsurance agreements. The unamortized amount of $20.9 million at December 31, 1999 was accounted for as a deferred reinsurance gain on the consolidated balance sheet.
Total benefits, claims and settlement expenses increased to $233.1 million for 1999 compared to $116.1 million for 1998, an increase of 100.8%. Provident American Life and Continental General accounted for $78.7 million of the total increase of $117.0 million. The remaining $38.3 million was primarily attributable to Central Reserve's portion of the increase in benefits at United Benefit Life, reflecting 12 months of operational activity in 1999 compared to five months in 1998. Medical benefits, claims, losses and settlement expenses were $176.5 million for 1999 compared to $108.4 million for 1998, an increase of 62.8%. The medical loss ratio was 70.1% for the year ended December 31, 1999 compared to 75.8% for 1998. Cost reduction and benefit program modifications implemented beginning in 1998, such as rate increases, improved underwriting, enhanced claim procedures, and medical cost management techniques, in addition to reduced loss ratios on increased new sales, led to the reduction in the medical loss ratio. Senior and other benefits, claims, losses and settlement expenses were $56.6 million for 1999 compared to $7.6 million for 1998, an increase of 642.4%. The senior loss ratio was 74.6% for 1999 compared to 68.5% for 1998. The increase was primarily attributable to the inclusion of Continental General's Medicare supplement business and interest sensitive life and annuity benefits and reserves, which traditionally support a higher benefit ratio, in addition to adverse claims of Continental General's long-term care business.
As a percentage of revenues, selling, general and administrative expenses increased to 37.1% in 1999 compared to 31.9% in 1998, primarily as a result of higher commission payments as a result of increased new business, hiring additional employees, consulting support, acquisitions, product development to help support our increased growth, and actions necessary to complete Year 2000 compliance conversions.
Net income for the year ended December 31, 1999 was $11.7 million, or $0.88 basic earnings per share and $0.77 diluted earnings per share, compared to a net loss of $3.8 million, or $0.49 loss per share on both a basic and diluted basis, for 1998. Our net income for 1999 was adversely affected by a net loss of $4.7 million at United Benefit Life due to high benefit and claims loss ratios and other related expenses.
Assets of $426.1 million, or 48.4% of the total assets, were in investments at December 31, 2000. Fixed maturities, our primary investment, were $415.3 million, or 97.5% of total investments, at December 31, 2000. Other investments consist of surplus notes, policy loans and mortgage loans. We have classified all of our fixed maturities as "available-for-sale" and accordingly have reported them at estimated fair value at December 31, 2000.
We hold few high-yield type securities, with 98.5% of our bonds being investment grade quality. In addition to the fixed maturities, we also had $59.5 million in cash and cash equivalents, and a $15.0 million line of credit, which was fully drawn, at December 31, 2000.
Assets increased 22.7% to $880.5 million at December 31, 2000 from $717.9 million at December 31, 1999. The increase was primarily due to the acquisition of Pyramid Life, which had assets of $136.2 million at December 31, 2000.
The total policy liabilities and accruals (reserves) were 80.7% of the total liabilities at December 31, 2000, compared to 80.0% at December 31, 1999.
To provide funds for the acquisition of Continental General in February 1999, we incurred debt of $40.0 million under a credit agreement. Under the terms of the credit agreement, dated as of February 17, 1999, among Ceres, various lending institutions and The Chase Manhattan Bank, as Administrative Agent,
quarterly principal payments of $1.5 million through February 17, 2002 and $2.25 million thereafter are due through February 2005.
- a leverage ratio (consolidated debt to consolidated total capital) of 0.40 to 1.00 through December 31, 2000, 0.35 to 1.00 thereafter through December 31, 2001, and 0.30 to 1.00 thereafter;
At December 31, 2000, we had a tax net operating loss, or NOL, carryforward of approximately $15.7 million for federal income tax purposes, which expires through 2013. We may not be able to utilize any or all of the NOL. Future changes in ownership, as defined by Sections 382 and 383 of the Internal Revenue Code, could limit the amount of NOL carryforwards used in any one year.
Additionally, we reduced the valuation allowance by $5.9 million during 2000 through an adjustment to goodwill related to the acquisition of Continental General. The reduction was attributable to Continental General, as management believes a sufficient amount of taxable income will be generated in future years to realize a greater amount of the deferred tax assets than previously anticipated.
Legal/Regulatory Risk is the risk that changes in the legal or regulatory environment in which an insurer operates will create additional expenses not anticipated by the insurer in pricing its products. For example, regulatory initiatives designed to reduce insurer profits or otherwise affecting the industry in which the insurer operates, new legal theories or insurance company insolvencies through guaranty fund assessments, may create costs for the insurer beyond those recorded in the financial statements. We attempt to mitigate this risk by offering a wide range of products and by operating in many states, thus reducing our exposure to any single product and by employing underwriting practices that identify and minimize the adverse impact of this risk.
- developments in healthcare reform and other regulatory issues, including HIPAA and increased privacy regulation, and changes in laws and regulations in key states in which we operate;
- the performance of others on whom we rely for reinsurance, particularly Hannover upon whom we rely for substantially all of our reinsurance;
- the risk that issuers of securities owned by Ceres will default or that other parties will not pay or perform;
The foregoing review of important factors should not be construed as exhaustive and should be read in conjunction with other cautionary statements that are included in this report, including the risks detailed under "Market Risk and Management Policies." We undertake no obligation to update forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.
In September 2000, the Financial Accounting Standards Board, or FASB, issued Statement of Financial Accounting Standards No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities which replaces FASB Statement No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. This standard revises the methods for accounting for securitizations and other transfers of financial assets and collateral as outlined in FASB Statement No. 125, and requires certain additional disclosures. For transfers and servicing of financial assets and extinguishments of liabilities, this standard will be effective for our June 30, 2001 financial statements. However, for disclosures regarding securitizations and collateral, as well as the accounting for recognition and reclassification of collateral, this standard is effective for our December 31, 2000 financial statements. The adoption of this standard did not have a material effect on our financial position or results of operations as of December 31, 2000. In addition, the provisions, that will be effective June 30, 2001, are not expected to have a material effect on our financial position or results of operations.
Interpretation No. 44 became effective July 1, 2000, but some of the conclusions were retroactive. The adoption of this guidance on July 1, 2000 did not have a material impact on our results of operations or financial position.
We have audited the accompanying consolidated balance sheets of Ceres Group, Inc. and subsidiaries as of December 31, 2000 and 1999, and the related consolidated statements of operations, stockholders' equity, and cash flows for the three years in the period ended December 31, 2000. We have also audited the information presented in the financial statement schedules listed in the Index at Item 14(a). These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules based on our audits.
FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 (DOLLARS IN THOUSANDS)
Ceres Group, Inc. and its subsidiaries, known as Central Reserve Life Corporation prior to December 8, 1998, operated in 1998 and prior periods primarily through its wholly owned subsidiary, Central Reserve Life Insurance Company. As of December 31, 1999, the Company's consolidated statements also include the accounts of Provident American Life & Health Insurance Company acquired on December 31, 1998, Continental General Corporation and its wholly-owned subsidiary Continental General Insurance Company acquired on February 17, 1999 and United Benefit Life Insurance Company under a reinsurance arrangement effective August 1, 1998 and acquired on July 21, 1999 (through foreclosure). As of December 31, 2000, the Company's consolidated statements also include the accounts of Pyramid Life Insurance Company acquired on July 26, 2000. These acquisitions are discussed further in Note C, Business Combinations and Note K, Reinsurance Arrangements.
The Company provides through its wholly-owned subsidiaries a wide array of health and life insurance products to over 700,000 insureds. While the Company through its subsidiaries is licensed in 49 states, the District of Columbia and the U.S. Virgin Islands, approximately 67% of premium volume is generated from twelve states: Ohio, Florida, Texas, Indiana, Georgia, North Carolina, Tennessee, South Carolina, Missouri, Kansas, Nebraska and Illinois.
The accompanying consolidated financial statements include the accounts of Ceres and its wholly-owned subsidiaries. The consolidated statement of operations for the year ended December 31, 2000 reflects the results of operations for Pyramid Life for the period subsequent to its acquisition on July 26, 2000. The consolidated statement of operations for the year ended December 31, 1999 reflects the results of operations for Continental General Corporation for the period subsequent to its acquisition on February 17, 1999 and United Benefit Life for the period subsequent to its acquisition on July 21, 1999. All intercompany transactions have been eliminated in consolidation.
The accompanying financial statements have been prepared in accordance with generally accepted accounting principles, which differ from accounting practices prescribed or permitted by the various state departments of insurance in which the insurance subsidiaries are domiciled. See Note P, Statutory Financial Information for further discussion.
Liabilities for future policy reserves for accident and health and ordinary life business are based on the net level premium basis and estimates of future claims, investment yield, lapses using the Company's experience and actuarial judgment with an allowance for possible future adverse deviations from expected experience. Interest rates used range from 4.5% to 6.0%. Liabilities for interest sensitive products such as deferred annuities and universal life are based on the retrospective deposit method. This is the policyholder fund balance before adjusting for any surrender charges. Guaranteed minimum rates for universal life contracts are 4.0% to 4.5%. At December 31, 2000, credited rates ranged from 5.5% to 7.0%. Guaranteed base minimum rates for deferred annuities range from 3.0% to 5.75% depending on the duration of the contract. Current rates credited range from 5.0% to 8.6%.
Liabilities for unpaid life and accident and health claims, which include a provision for estimated costs to investigate and settle claims, are estimated based upon past experience for pending, incurred but not reported, and reopened claims. Accident and health claims incurred but not reported are computed using actuarially-determined factors based on a combination of claim completion and projected claim cost methods, utilizing durational experience, seasonal cycle, changes in health care practice, changes in inflation rates, and the claims backlog.
Other policyholders' funds consist of supplementary contracts without life contingencies, premiums, and annuity considerations received in advance and remittance and items not allocated.
In September 2000, the Financial Accounting Standards Board, or FASB, issued Statement of Financial Accounting Standards No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities which replaces FASB Statement No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. This standard revises the methods for accounting for securitizations and other transfers of financial assets and collateral as outlined in FASB Statement No. 125,
In June 1998, the FASB issued Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities as amended by FASB Statement No. 137, Accounting for Derivative Instruments and Hedging Activities -- Deferral of the Effective Date of FASB Statement No. 133, which was required to be adopted for all fiscal quarters of all fiscal years beginning after June 15, 2000. We adopted the new statement effective January 1, 2001. If in the future we have derivative instruments, this Statement will require us to recognize all derivatives on the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through income. If a derivative is a hedge, depending on the nature of the hedge, changes in the fair value of the derivative will either be offset against the change in fair value of the hedged asset, liability, or firm commitment through earnings, or recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative's change in fair value will be immediately recognized in earnings. The adoption of FASB Statement No. 133 did not have a significant effect on our results of operations or financial position.
Interpretation No. 44 became effective July 1, 2000, but some of the conclusions are retroactive. The adoption of this guidance on July 1, 2000 did not have a material impact on our results of operations or financial position.
On February 17, 1999, the Company entered into a series of stock subscription agreements with a group of investors, principally Peter W. Nauert and Insurance Partners, wherein the Company issued 2,000,000 common shares at $7.50 per share for $15.0 million. The $15.0 million proceeds from these sales were used for the purchase of Continental General Corporation from the Western & Southern Life Insurance Company. See Note C, Business Combinations, for further information.
In November 1997, the Company entered into a Stock Purchase Agreement, or Original Stock Purchase Agreement, with Strategic Acquisition Partners, LLC, or Strategic, wherein the Company agreed to issue and sell 5,000,000 common shares and warrants to purchase an additional 2,500,000 common shares at an exercise price of $6.50 per share, for aggregate proceeds of $27.5 million. On March 30, 1998, the Company entered into an amended and restated Stock Purchase Agreement, or New Stock Purchase Agreement, with Strategic and two additional investors: Insurance Partners, L.P. and Insurance Partners Offshore (Bermuda), L.P., collectively, Insurance Partners. The New Stock Purchase Agreement was subsequently approved by stockholders, and accordingly, in July 1998 the Company issued and sold 7,300,000 common shares at $5.50 per share and warrants to purchase an additional 3,650,000 common shares at an exercise price of $5.50 per share, which expire July 2, 2005, and received proceeds of $37.7 million, which are net of transaction expenses.
In connection with the Original Stock Purchase Agreement, Strategic arranged an interim loan, or the Bridge Loan of $20.0 million to the Company. The Bridge Loan was due June 30, 1998, and bore interest at the prime rate of a major commercial bank. As consideration for the arrangement, the Company issued Strategic and Richard M. Osborne warrants to purchase 800,000 common shares at $6.00 per share on December 1997, which expire December 17, 2002, and additional warrants to purchase 200,000 common shares at $6.00 per share on July 3, 1998, which expire on December 17, 2002. Proceeds from the Bridge Loan were used as follows:
- $20.0 million from the sale of 3,333,334 newly-issued shares of our common stock at $6.00 per share, in a private placement offering;
- $15.0 million from a combination of funds from Continental General and financing provided by The Chase Manhattan Bank and associated banks.
In connection with purchase accounting rules, the total purchase cost for the acquisition has been allocated to the assets and liabilities of Pyramid Life based on their fair values. Allocations are subject to valuations as of the date of the acquisition based on appraisals and other studies which are not yet fully completed. Accordingly, the final allocations may be different from the amounts reflected herein. Although the final allocations may differ, the unaudited pro forma financial statements reflect management's best estimates based on currently available information as of the date of this filing.
Other fundings were provided by a $40.0 million credit facility with a syndicate of major commercial banks led by The Chase Manhattan Bank. The Company has pledged the common stock of Continental General Corporation and Central Reserve as security for the loan. See Note M, Debt for further discussion of the credit facility. In addition, effective February 17, 1999, the Company entered into a series of stock subscription agreements with a group of investors, principally Peter Nauert and Insurance Partners whereby the Company issued 2,000,000 common shares at $7.50 per share for $15.0 million.
The amortized cost and estimated fair market value of securities available-for-sale as of December 31, 2000 were as follows:
The Company has evaluated the recoverability of deferred acquisition costs on a quarterly basis and determined that these amounts are recoverable.
The Company files a consolidated federal income tax return with its subsidiaries, except for Continental General and Pyramid Life, which are required to file a separate return through fiscal years 2003 and 2004, respectively.
At December 31, 2000, the Company had a tax net operating loss carryforward, or NOL, of approximately $15.7 million for federal income tax purposes, which expires through 2013. Future changes in ownership, as defined by Sections 382 and 383 of the Internal Revenue Code, could limit the amount of NOL carryforwards used in any one year.
Additionally, the Company reduced its valuation allowance by $5.9 million during 2000 through a reduction of goodwill related to the acquisition of Continental General. Management reviewed the Company's projections for taxable income of Continental General to be generated in future periods and concluded a greater amount of the deferred tax asset will be realized.
in a memorandum account designated "policyholders' surplus." At December 31, 2000, the accumulated untaxed policyholders' surplus for the Company, all of which relates to Central Reserve, is $2.9 million.
In December 2000, Central Reserve entered into a reinsurance transaction with Lincoln National Reassurance Company, or Lincoln, for a ceding allowance of $4,000,000. The policies reinsured, on a combined coinsurance and modified coinsurance basis, were 80% of all group term life insurance and 35% of all individual deferred annuities in force on and after December 31, 2000. The ceding allowance is being accounted for as a deferred reinsurance gain in the accompanying consolidated financial statements and will be amortized into income over the duration of the underlying policies. Due to the structure of this transaction, no assets will be transferred relating to the ceding allowance or policy liabilities assumed by Lincoln.
In December 1997, Central Reserve entered into a retroactive reinsurance treaty (the "1997 Treaty") with Hannover. The quota share treaty was effective January 1, 1997, and covered certain group accident and health policies in force and written during 1997. Under the provisions of the 1997 Treaty, Central Reserve cedes 50% of the premiums of the eligible policies, and in return receives reimbursement for 50% of the claims paid, plus a commission and expense allowance. In connection with the 1997 Treaty, Central Reserve transferred $24.5 million of reserves to Hannover, and received an initial ceding allowance of $10.0 million, resulting in a net cash transfer of $14.5 million to Hannover. The initial ceding allowance was reported as a deferred reinsurance gain, in the accompanying consolidated financial statements, and is amortized into income over the duration of the underlying block of business.
Effective August 1, 1998, Central Reserve entered into a reinsurance treaty with United Benefit Life, a life and accident and health insurer in Texas. Under the terms of the treaty, Central Reserve agreed to assume 100% of United Benefit Life's block of business, until such time as profits earned by Central Reserve on the assumed block reach a contractual threshold, which approximates $20.0 million of pre-tax income. Central Reserve paid to United Benefit Life a $20.0 million ceding allowance in connection with this transaction. In
In connection with the United Benefit Life reinsurance treaty, Central Reserve ceded 80% of the business in force on August 1, 1998 to Hannover, thereby retaining a net risk of 20%. Additionally, Central Reserve ceded 50% of the policies written by United Benefit Life subsequent to August 1, 1998 and reinsured by Central Reserve to Hannover. This treaty provided Central Reserve an initial ceding allowance of $20.0 million, which is being accounted for as a deferred reinsurance gain in the accompanying consolidated financial statements, and will be amortized into income over the duration of the underlying block of business.
The insurance companies remain obligated for amounts ceded in the event that the reinsurers do not meet their obligations. Initial ceding allowances received from reinsurers are accounted for as deferred reinsurance gain and are amortized into income over the estimated remaining life of the underlying policies reinsured, except for interest sensitive products that are amortized over the expected profit stream of the in force business. Amortization of deferred reinsurance gain for the years ended December 31, 2000, 1999 and 1998 was $6.1 million, $5.5 million and $0.6 million, respectively. The above table does not include the initial ceding allowances received from Hannover.
On March 5, 2001, plaintiffs amended their complaint to again include Billy Hill; to add additional defendants, including Rhonda Immoos (Mr. Hill's paralegal), Pyramid Life and Continental General; to add additional allegations of civil conspiracy, tortious interference with business and existing and future contractual relationships toward Nauert, Hill and Immoos; and to demand a jury trial. Actual damages now sought by the plaintiffs are in excess of $100.0 million. In addition, plaintiffs now seek punitive damages in excess of $100.0 million.
On September 5, 2000, we filed a claim, Ceres Group, Inc., Central Reserve Life Insurance Company, Provident American Life and Health Insurance Company, and United Benefit Life Insurance Company vs. Insurance Advisors of America, Inc., Robert H. Merrill, Private Business Management, Inc., Transcend Group, Inc. and Jimmy K. Walker, in the Court of Common Pleas of Cuyahoga County, Ohio, relating to the foreclosure on the United Benefit Life stock and Insurance Advisors' failure to make payments under the promissory note. On September 15, 2000, the Court of Common Pleas entered a temporary restraining order in our favor, prohibiting defendants from making any false statements regarding us and prohibiting them from inducing our insureds to lapse coverage. This order was superceded by an agreed order dated October 2, 2000, which made permanent the temporary order and required defendants to send a mailing to the agents of Insurance Advisors advising them of the same.
Presently, we cannot predict the ultimate outcome or the financial impact, if any, of the lawsuit filed against us. We do not believe that the outcome of this matter will have a material adverse impact on us. We have denied liability to plaintiffs and we intend to vigorously contest this matter, as well as pursue the claims we have against Insurance Advisors, Jimmy Walker and their affiliates both in the litigation we initiated in Ohio and in our counterclaim in the Texas action. Further, we are not aware of any actions taken by any of our employees or representatives which justify the allegations made by plaintiffs in the Texas litigation, and we believe these allegations to be groundless.
In addition to the above litigation, we have recently been sued for compensatory damages and, in some cases, unspecified punitive damages in a number of actions pertaining to the insureds of United Benefit Life arising from claims payment issues. While we do not believe that United Benefit Life has harmed any of the plaintiffs in these lawsuits and we believe our reserves are adequate, we cannot predict their outcome, including the award of punitive damages, at this time. To the extent we are found liable with respect to any of these cases, we may have a right to indemnification from our third party administrator that administers United Benefit Life's claims, and our reinsurers may be liable for some of the costs pursuant to our reinsurance agreements.
Other than the above matters, neither Ceres nor any of our subsidiaries, including any of our property, is party to any material pending legal proceeding.
The Company executed a mortgage note payable in December 1990 for $9.0 million bearing interest at 9.5% per annum for 10 years. The mortgage note is collateralized by the home office building and by an assignment of the tenant lease for the building. The Company is required to make monthly payments based on a 30-year amortization schedule, of $75,700 for 10 years. In December 2000, the note was extended at the same rate for a two year period. Principal payments due in the next three years, assuming no prepayments are $0.2 million in 2001, $0.1 million in 2002 and $7.7 million in 2003. The Company has a right to prepay the loan with a 1.0% prepayment fee.
Interest on the outstanding balance will be determined based on our selection each quarter of either a "Base Rate Loan" or a "Eurodollar Loan." Under the Base Rate Loan, the interest rate will be 2.5% per annum plus the higher of (a) the rate which is 0.50% of 1% in excess of a federal funds rate and (b) Chase's prime rate as in effect from time to time. Under the Eurodollar Loan, the interest rate will be 3.5% per annum plus an Eurodollar rate, which is the arithmetic average of the offered quotation to first-class banks in the interbank Eurodollar market by Chase, adjusted for certain reserve requirements. At December 31, 2000, the interest rate was 10.3%.
The credit agreement was amended on July 25, 2000 to increase the revolver from $10.0 million to $15.0 million in connection with the acquisition of Pyramid Life. Any amount outstanding on the revolver must be repaid on February 17, 2002. The revolver bears interest at the same rate choices as the $40.0 million loan. At December 31, 2000, the interest rate was 10.2% on the outstanding balance of $15.0 million.
- an interest coverage ratio (consolidated earning before interest, income taxes, depreciation, and amortization to consolidated interest expense) of 2.50 to 1.00 through December 31, 2000, and 3.00 to 1.00 thereafter;
- consolidated net worth of $80.0 million through December 31, 2000, $110.0 million thereafter through December 31, 2001, $160.0 million thereafter through December 31, 2002, and $200.0 million thereafter; and
In addition, we pledged the common stock of Continental General Corporation, Central Reserve, Provident American Life, Pyramid Life and other subsidiaries as security for the credit agreement. At December 31, 2000, we were in compliance with the covenants contained in the credit agreement, as amended. Future annual principal payments due for the mortgage note and all long-term debt are $5.7 million for 2001, $23.4 million for 2002, $16.7 million for 2003, $9.0 million for 2004 and $2.2 million for 2005.
In 1999, 373 employees each received 1,000 common stock options under the 1998 Employee Stock Option Plan. A second grant was made for new employees hired from January 1, 1999 through September 30, 1999, and still employed as of December 31, 1999. Under this second grant in 2000, 75 employees received 1,000 common stock options. Each grant vests after three years and expires ten years from the date of the grant. The vesting accelerates in the event of a change in control of the Company. There are 500,000 shares of our common stock reserved for issuance under this plan. The Company terminated this plan in December 2000.
Also, pursuant to an employment contract, the Company provided an award of common shares to Peter Nauert. The number of shares awarded is contingent upon the weighted average fair value of the common shares over specified periods, but is based on a stock award equal to $1.0 million per year through July 1, 2001. Management currently estimates that 474,256 shares (including 141,442 shares issued in 1999 and 144,488
The Company also had outstanding at December 31, 2000 3,657,743 warrants at $5.41, expiring in 2005 and 900,000 warrants at $6.00, expiring in 2002.
Our 2000 Employee Stock Purchase Plan was adopted by our stockholders on June 27, 2000. Under the plan, employees may purchase shares of our common stock at a discount from fair value. All of our full time employees, including officers, are eligible to participate in the employee stock purchase plan, subject to limited exceptions. Eligible employees participate voluntarily, and may withdraw from an offering at any time before the stock is purchased. Participation terminates automatically upon termination of employment other than for death, disability or retirement. We make six-month offerings beginning May 1 and November 1 of each year. The purchase price per share in an offering will not be less than 85% of the lesser of the stock's fair value at the beginning of the offering period or on the applicable exercise date and may be paid through payroll deductions. As of December 31, 2000, 18,807 shares had been issued under the employee plan.
The Company recognized stock compensation expense of $1.1 million, $0.8 million and $0.6 million in 2000, 1999 and 1998, respectively. As required by FASB Statement 123, Accounting for Stock-Based Compensation, the Company has estimated the pro forma impact on net income and earnings per share of stock-based compensation under the fair value method, using the Black-Scholes option valuation model.
The Company has authorized 1,900,000 Non-Voting Preferred Shares, $.001 par value. The Company has never issued any Non-Voting Preferred Shares; however, the Board of Directors is authorized at any time to provide for the issuance of, such shares in one or more series, and to determine the designations, preferences, limitations and other rights of the shares issued, including but not limited to the dividend rate, liquidation preference, redemption rights and price, sinking fund requirements, conversion rights and restrictions on the issuance of such shares. Holders of Non-Voting Preferred Shares shall have no voting rights except as required by law.
State insurance laws and regulations prescribe accounting practices for determining statutory net income and equity for insurance companies. In addition, state regulators may permit statutory accounting practices that differ from prescribed practices. The use of such permitted practices by Ceres and its insurance subsidiaries did not have a material effect on their statutory equity at December 31, 2000.
Statutory accounting practices prescribed or permitted by regulatory authorities for Ceres' insurance subsidiaries differ from generally accepted accounting principles. Shareholders' equity and net income, as
determined in accordance with statutory accounting practices, for Ceres and its subsidiaries are summarized as follows:
(b) Statutory capital and surplus for Continental General includes Pyramid Life.
Effective January 1, 1998, the Company's noncontributory pension plan was converted into a defined contribution 401(k) savings plan, or the Plan. Employees become eligible to participate in the Plan after six months of service. Based on the provisions of the Plan, participants may contribute up to 15% of their pre-tax annual compensation. The Plan provides for a 100% employer matching contribution only for that portion of
participant contributions made to a fund, which holds principally the Company's common shares, up to $1,000 annually.
Fair values of financial instruments are based upon quoted market prices, where available, or on values obtained from independent pricing services. In cases where quoted market prices are not available, fair value is based on estimates using present value or other valuation techniques. These techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Although fair value estimates are calculated using assumptions that management believes are appropriate, changes in assumptions could cause these estimates to vary materially. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in the immediate settlement of the instruments.
Carrying amounts and estimated fair values of financial instruments at December 31, 2000 and 1999, are summarized as follows:
Substantially all of the Company's reinsurance recoverable is due from a single reinsurer, Hannover. At December 31, 2000, Hannover maintained an "A" rating from the A.M. Best Company. The Company performs periodic evaluations of this reinsurer's credit standing.
- --------------- (a) The increase in the fourth quarter net income is primarily a result of a decrease in claim reserves held for the health business of Continental General and a leveling of the increased reserves held for adverse deviations in the long-term care business of Continental General.
CERES GROUP, INC. AND SUBSIDIARIES CONDENSED FINANCIAL INFORMATION OF REGISTRANT CERES GROUP, INC. (PARENT ONLY) STATEMENTS OF OPERATIONS FOR THE YEARS DECEMBER 31, 2000, 1999 AND 1998 (DOLLARS IN THOUSANDS) - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------