- 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, or $37.7 million net of expenses;
- acquired Provident American Life and Health Insurance Company from Provident American Corporation on December 31, 1998 for $5.5 million in cash and, immediately prior to the sale, Provident American Life ceded 100% of its policies in force to Provident Indemnity Life Insurance Company while in turn Hannover assumed from Provident Indemnity 100% of its health block of business with Central Reserve assuming 10% from Hannover;
- 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, of which $17.8 million was recovered and $1.6 million was expensed by us;
- discontinued new sales activities for United Benefit Life and Provident American Life, except for Internet sales of Provident American Life, in July 2000;
- implemented a program in July 2001 to mitigate losses at United Benefit Life and Provident American Life by notifying their policyholders that their policies would be terminated or replaced and the business in these two subsidiaries will be substantially wound down in the early part of 2002; and
- sold 16.1 million shares of our common stock, including the exercise of the underwriters' over-allotment option, on December 27, 2001 for $3.20 per share in a follow-on public offering for net proceeds of $46.5 million.
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 years ended December 31, 2000 and 2001 includes the operations of Pyramid Life subsequent to its acquisition on July 26, 2000. The financial information for the year ended December 31, 2001 includes the operations of all our subsidiaries for the entire period.
Our results of operations are affected 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, claims, losses and settlement expenses.
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
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 6.0% for Continental General and 7.0% 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 6.0% for Continental General and 7.0% for Pyramid Life, the market rate at the time of acquisition.
on major risks and limits our potential losses on reinsured business. Reinsurance involves one or more insurance companies participating in the liabilities or risks of another insurance company in exchange for a portion of the premiums. Although the effect of reinsurance is to lessen our risks, it may lower net income. We have entered into a variety of reinsurance arrangements under which we cede business to other insurance companies to mitigate risk. We also have assumed risk on a "quota share" basis from other insurance companies. Our results of operations are presented net of reinsurance.
As previously reported, on May 8, 2001, Central Reserve entered into an agreement to sell the stock of United Benefit Life, including United Benefit Life's licenses and certain liabilities, to Pelagian, LLC, a Texas limited liability company. The sale was subject to approval by the State of Ohio Department of Insurance and other customary terms and conditions. Based on recent discussions with the Ohio Department of Insurance, we believe that approval of this transaction is unlikely. The parties mutually terminated the stock purchase agreement on January 14, 2002.
On December 27, 2001, we sold 16.1 million shares of common stock at $3.20 per share, which included the exercise of the underwriters' over-allotment option of 2.1 million shares, in a follow-on public offering. We used the net proceeds of $46.5 million from this sale to:
- corporate and other -- includes primarily interest income, interest expense and corporate expenses.
For the year ended December 31, 2001, total net premiums were $635.0 million, an increase of 24.1%, from $511.5 million for 2000.
Medical premiums for 2001 were $408.2 million compared to $375.8 million for 2000, an increase of 8.6%. The increase in medical premiums was primarily the result of new sales, premium rate increases and reduced premiums ceded under reinsurance agreements. This increase was offset by our decision to terminate or replace the policies at United Benefit Life and Provident American Life and the cancellation of other medical business in certain states.
Net investment income increased to $32.0 million for 2001 from $26.9 million for 2000, an increase of 19.1%, due primarily to an increased investment base from the addition of Pyramid Life.
Net realized gains increased to $5.0 million for 2001 from zero for 2000 as a result of the sale of 30-year mortgage pass-through securities which reduced prepayment risk, and the sale of callable agency bonds which reduced call risk. Portfolio durations were also shortened to reduce the impact on bond values in a potentially rising interest rate environment. Cash was reinvested in corporate bonds and planned amortization class non-agency mortgage securities, which provide average life protection in a fluctuating interest rate environment. These gains were marginally offset by the write-down for other than temporary impairment of $0.8 million recorded on two commercial collateralized, mortgage-backed bonds with leasehold interests in the World Trade Center complex, most of which was destroyed by terrorists on September 11, 2001. No default has occurred on contractual payments for these securities.
Total benefits, claims, losses and settlement expenses increased to $500.5 million for 2001 compared to $389.8 million for 2000, an increase of 28.4%.
Senior and other benefits, claims, losses and settlement expenses were $166.7 million for 2001 compared to $101.6 million for 2000, an increase of 64.2%. The increase was a result of $34.3 million attributable to
Pyramid Life being included for a full year in 2001 and claims and benefits paid on a larger volume of business in force. The senior and other loss ratio decreased to 73.5% for 2001 compared to 74.8% for 2000, primarily attributable to increased volume of new premiums and lower benefit utilization.
A federal income tax expense of $2.7 million, or 54.3% of the income before federal taxes, was established for 2001. The 2000 effective rate was 33.8%. The increase in the effective tax rate resulted from permanent tax differences, which are proportionately higher compared to income in 2001 versus 2000.
As a result of the foregoing, for 2001, net income was $2.3 million and net income attributable to common stockholders was $5.2 million, or $0.29 basic and diluted earnings per share of common stock, compared to net income of $16.5 million, or $1.06 basic and $1.00 diluted earnings per share of common stock, for 2000. Excluding the United Benefit Life and Provident American Life operating losses and special charges, net income attributable to common stockholders would have been $17.9 million, or $1.00 per diluted share, for 2001.
Medical premiums for 2000 were $375.8 million compared to $251.9 million for 1999, an increase of 49.2%. The increase in medical premiums was primarily the result of increased new sales including sales arising from the selected major medical insureds of Central Benefits, premium rate increases, additional reinsurance assumed from American Chambers and the inclusion of Continental General's results for twelve months in 2000 compared to eleven months in 1999.
Net investment income increased to $26.9 million for 2000 from $21.4 million for 1999, an increase of 25.8%, due primarily to an increased investment base from the addition of Pyramid Life and the inclusion of Continental General's results for twelve months in 2000 compared to eleven months in 1999.
Fee and other income increased to $32.7 million for 2000 compared to $17.4 million for 1999, an increase of 87.9%, 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. Fee and other income from non-regulated subsidiaries accounted for $10.4 million in 2000.
Net income for the year ended December 31, 2000 was $16.5 million, or $1.06 basic earnings per share and $1.00 diluted earnings per share, compared to $11.7 million, or $0.88 basic earnings per share and $0.77 diluted earnings per share, for 1999. Our net income for 2000 was adversely affected by a net loss of $4.9 million at United Benefit Life due to high benefit and claims loss ratios and other related expenses. New sales activities for United Benefit Life were discontinued in July 2000. We have taken a number of actions to mitigate future adverse results, but future losses at United Benefit Life could continue to have a material adverse effect on our financial performance. In addition, new sales activities for Provident American Life, except for Internet sales, also were discontinued in July 2000.
Liquidity is our ability to generate adequate amounts of cash to meet our financial commitments. Our major needs for cash are to enable our insurance subsidiaries to pay claims and expenses as they come due and for Ceres to pay interest on, and to repay principal of, its indebtedness. The primary sources of cash are premiums, investment income, fee income, equity and debt financings, and reimbursements from reinsurers. Payments consist of current claim payments to insureds, medical cost management expenses, operating expenses such as salaries, employee benefits, commissions, taxes and interest on debts.
Assets increased 7.4% to $946.0 million at December 31, 2001 from $880.5 million at December 31, 2000. Assets of $482.6 million, or 51.0% of the total assets, were in investments at December 31, 2001. Fixed maturities, our primary investment, were $471.5 million, or 97.7% of total investments, at December 31, 2001. 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, 2001.
Approximately 94.8% of our bonds were of investment grade quality at December 31, 2001. In addition to the fixed maturities, we also had $74.6 million in cash and cash equivalents, and a $2.5 million revolver, at December 31, 2001. At December 31, 2001, there was no amount available for additional borrowings under the revolver. On February 17, 2002, the revolver balance of $2.5 million was paid in full with proceeds from our December 2001 public offering.
The total reinsurance receivable was $223.3 million at December 31, 2001. Of this amount, $185.5 million represents reserves held by our reinsurers under our various reinsurance treaties in place. Hannover holds most of these reserves.
The total policy liabilities and accruals (reserves) were 82.9% of the total liabilities at December 31, 2001 compared to 80.8% at December 31, 2000.
On May 25, 2001, we entered into an agreement with Royalton Investors, LLC and Big T Investments, LLC to sell our Cleveland headquarters. The transaction was effective July 31, 2001. The building was sold to
- consolidated net worth of $110.0 million through December 31, 2001, and beginning in 2002, consolidated net worth, excluding goodwill, of no less than the sum of (i) $85.0 million plus (ii) 80% of the net proceeds from the equity offering excluding the $5.0 million repurchase of our convertible
voting preferred stock plus (iii) 50% of our aggregate consolidated net income calculated quarterly; and
- a fixed charge coverage ratio of not less than 1.05 to 1.00 through June 30, 2003, and 1.10 to 1.00 thereafter.
- increase the interest rate of the tranche B term loan by 0.5% per annum.
- restructured our scheduled tranche A term loan debt payments as follows: quarterly principal payments of $0.5 million through May 17, 2002, $0.8 million through November 17, 2002, $0.9 million through November 17, 2004, and a payment of $8.5 million on February 17, 2005;
At December 31, 2001, the balance of our fully drawn revolver was $2.5 million. The pay-off and final maturity of this revolver was February 17, 2002.
We believe that cash flow from operating activities will be sufficient to meet the currently anticipated operating and capital expenditure requirements of our subsidiaries over the next 12 months. Due to the equity offering and the amendment to our credit agreement, we believe that funds should be sufficient to meet all our debt obligations over the next 12 months. Funds to meet our debt obligations are generated from fee income from our non-regulated subsidiaries and from dividends of our insurance subsidiaries, if available. Our ability to make scheduled payments of the principal and interest on our indebtedness depends on our future performance and the future performance of our non-regulated subsidiaries, which are subject to economic, financial, competitive and other factors beyond our control. Dividends from our regulated insurance subsidiaries are subject to, and limited by, state insurance regulations. As of December 31, 2001, none of our direct insurance subsidiaries (Central Reserve and Continental General) could pay a dividend to Ceres Group, the parent company, without prior approval of their respective state regulators as a result of their
respective statutory levels of unassigned surplus. If our non-regulated subsidiaries do not generate sufficient fee income to service all of our debt obligations, there may be a material adverse effect on our business, financial condition and results of operations, and a significant adverse effect on the market value of our common stock. In addition, if necessary, additional financing may not be available on terms favorable to us or at all.
The following is a description of certain risks facing health and life insurers and how we mitigate those risks:
Interest Rate Risk is the risk that interest rates will change and cause a decrease in the value of an insurer's investments. This change in rates may cause certain interest-sensitive products to become uncompetitive or may cause disintermediation if we attempt to mitigate this risk by charging fees for non-conformance with certain policy provisions and/or by attempting to match the maturity schedule of our assets with the expected payouts of its liabilities. To the extent that liabilities come due more quickly than assets mature, we would have to sell assets prior to maturity and recognize a gain or loss. Assuming an immediate increase of 100 basis points in interest rates, the net hypothetical decline in fair value of stockholders' equity is estimated to be $19.7 million after-tax at December 31, 2001. This amount represents approximately 12.6% of our stockholders' equity at such date.
- the performance of others on whom we rely for reinsurance, particularly Hannover Life Reassurance Company of America upon whom we have relied for substantially all of our reinsurance;
- the adequacy of funds, including fee income, received from our non-regulated subsidiaries to meet Ceres' debt obligations;
The factors listed above should not be constructed as exhaustive. We undertake no obligation to release publicly the results of any future revisions we may make to forward-looking statements to reflect events or circumstances after the date of this report or to reflect the occurrence of unanticipated events.
In August 2001, the Financial Accounting Standards Board, or FASB, issued Statement of Financial Accounting Standards, or SFAS, No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. This Statement will supersede, effective January 1, 2002, SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of, and the accounting and reporting provisions of Accounting Principles Board Opinion, or APB Opinion No. 30, Reporting the Results of Operations -- Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions, for the disposal of a segment of a business. This Statement also amended Accounting Research Bulletin No. 51, Consolidated Financial Statements.
individually or with a group of other assets (but not those acquired in a business combination) should be accounted for in financial statements upon their acquisition. Additionally, this Statement discussed how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements. This Statement:
In June 2001, the FASB issued SFAS No. 141, Business Combinations, which addressed the accounting and reporting for business combinations and expanded the criteria for recording intangible assets separate from goodwill. On July 1, 2001, we adopted this Statement which requires us to use the purchase method of accounting for all business combinations initiated after June 30, 2001.
We have audited the accompanying consolidated balance sheets of Ceres Group, Inc. and subsidiaries as of December 31, 2001 and 2000, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2001. 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.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Ceres Group, Inc. and subsidiaries at December 31, 2001 and 2000, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States. Also in our opinion, the related financial statement schedules when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
Ceres Group, Inc. and its subsidiaries operated in 1998 and prior periods primarily through its wholly owned subsidiary, Central Reserve Life Insurance Company. As of December 31, 2000, 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, United Benefit Life Insurance Company under a reinsurance arrangement effective August 1, 1998 and acquired on July 21, 1999 (through foreclosure), and Pyramid Life Insurance Company acquired on July 26, 2000. As of December 31, 2001, the Company's consolidated statements include the operations of all these subsidiaries for the entire year. These acquisitions are discussed further in Note C, Business Combinations and Note J, Reinsurance Arrangements.
The accompanying consolidated financial statements include the accounts of Ceres and its wholly-owned subsidiaries. The consolidated statement of income 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 income 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.
Cash and cash equivalents include cash and all liquid securities with maturities of 90 days or less when purchased. See Note D, Cash and Investments for further information.
Investments in bonds and mandatorily redeemable preferred stocks are designated at purchase as held-to-maturity or available-for-sale. Held-to-maturity investments are securities which management has the positive intent and ability to hold until maturity, and are reported at amortized cost. Available-for-sale investments and surplus notes are reported at fair value, with unrealized holding gains and losses reported in accumulated other comprehensive income (losses), net of deferred federal income taxes. All investments as of December 31, 2001 are designated as available-for-sale.
Property and equipment are carried at cost less allowances for depreciation and amortization. Office buildings are depreciated on the straight-line method over 31.5 years, except for certain components, which are depreciated over 15 years. Depreciation for other property and equipment is computed on the straight-line basis over the estimated useful lives of the equipment, principally five and seven years. Property held for sale is stated at estimated fair value less cost to sell. No depreciation or amortization is provided for property held for sale.
Claim liabilities with a long pay out period, such as long term care and disability income claims, are discounted at interest rates ranging from 3.0% to 6.0%. Although considerable variability is inherent in such computations, management believes that the liabilities for unpaid life and accident and health claims are adequate. The estimates are continually reviewed and adjusted as necessary as experience develops or new information becomes known with such adjustments included in current operations.
The intrinsic value method of accounting is used for stock-based compensation plans. In accordance with the intrinsic value method, compensation cost is measured as the excess, if any, of the quoted market price of the equity instrument awarded at the measurement date over the amount an employee must pay to acquire the equity instrument. Stock-based compensation costs are recognized over the period in which employees render services associated with the awards.
Basic earnings per share is computed by dividing the income available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if common stock equivalents were exercised and shared in the earnings of the Company. Only those potential common shares, which are dilutive, are included in the computation of diluted earnings per share. See Note R, Computation of Net Income Per Common Share for further information.
The consolidated financial statements reflect estimates and judgments made by management that affect the amounts reported herein and the disclosure of contingent assets and liabilities. Actual results could differ significantly from those estimates.
In June 2001, the FASB issued SFAS No. 141, Business Combinations, which addressed the accounting and reporting for business combinations and expanded the criteria for recording intangible assets separate from
goodwill. On July 1, 2001, we adopted this Statement which requires us to use the purchase method of accounting for all business combinations initiated after June 30, 2001.
On December 27, 2001, we sold 16.1 million shares of common stock, at $3.20 per share, which included the exercise of the underwriter's over-allotment option of 2.1 million shares, in a follow-on public offering or the December 2001 public offering. We used the net proceeds of $46.5 million from this sale to:
On July 25, 2000, we sold 3,333,334 shares of our common stock at $6.00 per share in a private placement offering, and, on July 26, 2000, we sold 75,000 shares of our convertible voting preferred stock at $100.00 per share to United Insurance Company of America in a private placement offering. The $27.5 million proceeds from these sales were used for the purchase of Pyramid Life from United Insurance, a subsidiary of Unitrin, Inc. See Note C, Business Combinations and Note O, Preferred Shares, 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 in 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:
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.
Effective February 1, 1999, the Company acquired 100% of the outstanding common stock of Continental General Corporation from The Western & Southern Life Insurance Company. Continental General Corporation is a holding company that primarily conducts business through its wholly-owned subsidiary, Continental General, a life and accident and health insurer domiciled in Nebraska, which is licensed in 49 states, the District of Columbia, and the U.S. Virgin Islands. Continental General offers Medicare supplement and individual major medical products, distributed through independent agents. Continental General also offers long-term care, Medicare supplement, ordinary life, universal life, and annuity policies. Total consideration paid by the Company for the common stock was $84.5 million, and was financed through reinsurance, debt, cash, an equity offering as described further below and a pre-closing dividend of $22.5 million paid to Western & Southern. This transaction was accounted for in accordance with the purchase method, and accordingly, the purchase price was allocated to assets and liabilities acquired based upon estimates of their fair value.
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.
Immediately prior to the completion of this transaction, Provident American Life ceded 100% of its insurance in force to Provident Indemnity Life Insurance Company, a subsidiary of Provident American Corporation.
The amortized cost and estimated fair value of invested assets as of December 31, 2001 by contractual maturity were as follows:
At December 31, 2001 and 2000, the Company's insurance subsidiaries had certificates of deposit and fixed maturity securities with a carrying value of $39.3 million and $32.6 million, respectively, on deposit with various state insurance departments to satisfy regulatory requirements.
At December 31, 2001 and 2000, $7.4 million and $9.4 million, respectively, of cash was held for fully insured employer shared risk plans, which is restricted to use. Ceres Group is entitled to investment income from these funds. Additionally, at December 31, 2001, $2.5 million of cash was held in escrow for the permanent repayment of the balance of the revolver due February 17, 2002. A corresponding liability is included in the accompanying consolidated financial statements.
Property and equipment are stated at cost and are summarized by category as follows:
The Company files a consolidated federal income tax return with its subsidiaries, except for Continental General and Pyramid Life, which are required to file separate returns through fiscal years 2003 and 2004, respectively.
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 summarized as follows:
In December 1999, Central Reserve entered into a reinsurance transaction with Hannover for certain health insurance policies issued during the period from July 1, 1998 through June 30, 1999. As part of the coinsurance funds withheld transaction, Hannover will pay Central Reserve on a quarterly basis, an experience refund, the amount of which shall be based upon the earnings derived from the business reinsured. Concurrent with this transaction, Hannover will reinsure to Continental General on a stop loss basis 100% of any losses incurred for the business reinsured in excess of a pre-determined aggregate annualized loss ratio of 76.0% in 2000, 78.0% in 2001 and 80.0% thereafter. In exchange for coverage under the stop loss reinsurance, Hannover pays Continental General a stop loss premium on the business reinsured. The effects of the transaction, except the net risk charge to Hannover, are eliminated in consolidation.
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, and is being amortized into income over the duration of the underlying block of business.
Reserve liabilities assumed by Central Reserve under the United Benefit Life agreement on August 1, 1998 exceeded the cash transferred to Central Reserve by United Benefit Life as reimbursement for this assumption by $3.0 million, which was reflected in a note receivable. Subsequent to August 1, 1998, the balance of the note receivable was increased as a result of adverse developments in the assumed policy liabilities, net of amounts ceded to Hannover, and net of an allowance for uncollectability. The note receivable was secured by the outstanding common stock and assets of United Benefit Life. The assets included real estate, bonds and reinsurance receivables from an unrelated party, and commissions due IAA.
The Company is involved in litigation arising in the ordinary course of business. In the opinion of management, the effects, if any, of such litigation are not expected to be material to the Company's consolidated financial condition.
On May 25, 2001, we entered into an agreement with Royalton Investors, LLC and Big T Investments, LLC to sell our Cleveland headquarters. The transaction was effective July 31, 2001. The building was sold to Royalton Investors, LLC and Big T Investments, LLC for $16.0 million and concurrently we leased it back for a term of 15 years with four optional five-year extensions. Monthly rent payments began in August 2001 and annually total $1.7 million through July 2003, $1.8 million through July 2006, $2.0 million through July 2011, and $2.1 million through July 2016. The net proceeds were used to:
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 had to be repaid on February 17, 2002. The revolver bore interest at the same rate choices as the $40.0 million tranche A term loan. At December 31, 2001, the interest rate on the revolver was 5.7% on the outstanding balance of $2.5 million. On February 17, 2002, the balance of the revolver was repaid from proceeds of our December 2001 public offering.
On December 27, 2001, our credit agreement was again amended in connection with the stock offering. The credit agreement, as amended, contains financial and other covenants that among other things:
- restrict the creation of liens and sales of assets; and
- repay the term loans with 25% of the net cash proceeds from any future sale or issuance of our equity, excluding warrants and compensation awards or plans;
- set aside $2.5 million of the proceeds from the equity offering for the permanent repayment of the balance of our revolver due February 17, 2002; and
The Company reported special charges of $7.1 million in the first quarter of 2001 related to:
The Company has experienced excessive losses at United Benefit Life and Provident American Life due to high benefit utilization and higher than anticipated claims costs. These blocks had a $17.9 million pre-tax loss in 2001 compared to a $7.6 million pre-tax loss in 2000, including special charges and legal expenses.
In July 2001, we implemented a program to mitigate future losses of United Benefit Life and Provident American Life by notifying policyholders that their policies would be terminated or replaced with a different Provident American Life product. The business should be substantially wound down by the early part of 2002.
In 1998, pursuant to the 1998 Key Employee Share Incentive Plan, the Company granted common stock options to certain key employees. In 2000 and 1999, the Company granted additional common stock options to certain employees under the 1998 Key Employee Share Incentive Plan. Such grants generally vest over three years, and expire ten years from the date of the grant. In the event of a change in control, all options granted immediately vest and become exercisable in full. There are 2,000,000 shares of our common stock reserved for
issuance under this plan, pending stockholder approval. At December 31, 2001, there were options outstanding under the plan to purchase 1,659,926 shares.
At December 31, 2001, there were 1,049,947 options exercisable ranging from $5.50 to $10.50. Approximately 47% were between $5.50 and $6.99, 17% between $7.00 and $7.99, 14% between $8.00 and $8.99, and 22% between $9.00 and $10.50.
The Company also had outstanding at December 31, 2001 3,657,743 warrants at $5.41, expiring in 2005, 770,000 warrants at $6.00, expiring in 2002, and 130,000 warrants at $6.00, expiring in 2003.
We also have a 2000 Agent Stock Purchase Plan similar to the employee plan under which certain of our agents may purchase shares of our common stock at the same discount from fair value. The agent stock purchase plan does not qualify as an employee stock purchase plan within the meaning of Section 423 of the Code. As of December 31, 2001 and 2000, 76,621 and 10,603 shares, respectively, had been issued under the agent plan. There are 1,000,000 shares of common stock reserved for issuance in the aggregate under both plans. Both of the plans will terminate when all of the shares reserved for issuance under the plans have been purchased unless sooner terminated by the Board of Directors.
The Company recognized stock compensation expense of $0.9 million, $1.1 million, and $0.8 million in 2001, 2000 and 1999, 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.
Based on the methodology and assumptions delineated above, the weighted average fair value of options was $1.17, $1.26 and $2.10 per share for 2001, 2000 and 1999, respectively. The pro forma impact would be to decrease net income by $0.8 million, $0.6 million and $0.9 million and decrease net income per share by $0.05, $0.04 and $0.07 for basic and $0.05, $0.04 and $0.06 for fully diluted for the years ended December 31, 2001, 2000 and 1999, respectively.
The Company has authorized 100,000 Convertible Voting Preferred Shares, $.001 par value, of which none are outstanding at December 31, 2001. On December 27, 2001, the Company repurchased our
The National Association of Insurance Commissioners revised the Accounting Practices and Procedures Manual in a process referred to as Codification. The revised manual was effective January 1, 2001. The domiciliary states of Ceres and its insurance subsidiaries have adopted the provisions of the revised manual. The revised manual has changed, to some extent, prescribed statutory accounting practices and has resulted in changes to the accounting practices that Ceres and its subsidiaries use to prepare their statutory-basis financial statements. The impact of these changes to statutory-basis capital and surplus of Ceres insurance subsidiaries was not significant.
Basic and diluted earnings per share are calculated in accordance with SFAS No. 128, Earnings per Share. Basic earnings per common share is computed by dividing net income (loss) attributable to common stockholders by the weighted average number of shares outstanding during the period. Diluted earnings per common share is computed by dividing net income (loss) by the weighted average number of shares outstanding during the period including the effect of the assumed exercise of dilutive stock options under the treasury stock method. In 2001, the diluted earnings per share calculation was adjusted for a one time net gain on repurchase of the convertible voting preferred stock. All stock options are antidilutive for the year ended December 31, 2001 and therefore are excluded from the calculation of diluted earnings per share. Basic and diluted weighted average shares of common stock are as follows:
The Company sponsors the Ceres Group, Inc. 401(k) Plan, a defined contribution 401(k) savings plan, or the Plan. Effective January 1, 2001, the Plan was amended to increase the employer match (Company Match Contribution) to 50% of the first 6% of each participant's salary deferrals.
In addition, Ceres may contribute a Profit Sharing Contribution to the Plan, as determined by the Board of Directors. All eligible, active employees who have worked over 1,000 hours during the plan year and who are employed on the last day of the plan year share in this contribution. Participants who leave employment during the plan year due to retirement, death or disability will also share in the contribution. There were no Profit Sharing Contributions made for the 2001, 2000 and 1999 plan years, respectively.
A participant's interest in the Company Match Contribution, Stock Match Contribution and Profit Sharing Contribution allocated to the participant's account becomes vested over a five-year graded vesting schedule with 100% vesting over five years. Total matching contributions by the Company were approximately $768,000 for 2001, $376,000 for 2000, and $133,000 for 1999.
The Company does not separately allocate investments or other identifiable assets by industry segment, nor are income tax (benefits) expenses allocated by industry segment. The Company also expanded the detail of its disclosures for 2001, 2000 and 1999, which included certain reclassifications.
ANNUITY CONTRACTS -- The fair value for the annuity reserves included in the liability for future policy benefit, losses, and claims is the amount payable on demand.
MORTGAGE NOTE PAYABLE, DEBT AND REINSURANCE PAYABLE -- The carrying amounts reported in the consolidated balance sheets for the mortgage note payable and long-term debt approximates their fair value.
Carrying amounts and estimated fair values of financial instruments at December 31, 2001 and 2000, are summarized as follows:
Substantially all of the Company's reinsurance recoverable is due from a single reinsurer, Hannover. At December 31, 2001, Hannover maintained an "A" rating from the A.M. Best Company. The Company performs periodic evaluations of this reinsurer's credit standing.
The following is a summary of quarterly results of operations for the years ended December 31, 2001 and 2000:
(2) Includes $8.0 million and $6.3 million in advances from non-regulated subsidiaries in 2001 and 2000, respectively.