The following selected financial data as of and for the years ended December 31, 1994, through 1998 has been derived from the Company's consolidated financial statements. The following data should be read in conjunction with the Company's Consolidated Financial Statements, the related notes thereto, and "Management's Discussion and Analysis of Financial Condition and Results of Operations."
Prior to and for most of the year 1998, the business of the Company, then known as "United Wisconsin Services, Inc.", consisted of two main components: the small group business and the managed care and specialty business. Prior to December 1996, the small group business consisted primarily of individual and small group insurance written through a joint venture with American Medical Security Group, Inc., a Delaware corporation ("Old AMS"). During that time, the Company owned approximately 12% of the issued and outstanding shares of Old AMS. The Company underwrote all of the individual and small group insurance marketed, produced and administered by Old AMS and ceded back to Old AMS approximately 50% of the individual and small group insurance written by the Company through the joint venture. On December 3, 1996, Old AMS merged with and into the Company.
As a result of the spin-off, the revenues and expenses, assets and liabilities, and cash flows of the managed care and specialty business have been classified as discontinued operations in the consolidated financial statements.
Membership increased to 636,238 at December 31, 1998, from 623,727 at the end of 1997. New sales grew each quarter during 1998 from 16,800 new members in January to 27,800 by December. In addition, the acquisition in July of the second Pan American block of business added approximately 46,000 members as of December 31,1998.
The Company's distribution system asset was acquired in 1996 as part of the merger with Old AMS. During 1997 and 1998, the Company experienced significant turnover of sales managers and began to reorganize sales offices. In particular, during that period, the Company replaced commissioned independent sales managers with salaried sales offices, while it evaluated the Company's distribution strategy. In the fourth quarter of 1998, management concluded that a salaried sales office structure was more consistent with current strategy and the Company's intangible distribution system asset was impaired. As a result, the Company recorded an after tax charge of $9.3 million to write off the intangible asset and to record other related costs at December 31, 1998. Management believes that no other material impairment of goodwill and other intangible assets existed at December 31, 1998.
Results for 1997 include an after tax charge of $4.1 million in non-recurring costs related to the acquisition of the Pan American small group business in October 1997.
The Company's results of continuing operations includes certain non-recurring charges as previously discussed and interest on debt assumed by Newco/UWS in conjunction with the spin-off. The following table reflects the Company's income from continuing operations adjusted for these items:
The expense ratio includes commissions, administrative expenses and premium taxes and assessments, but excludes non-recurring charges. For 1998, the expense ratio for health products was 23.9% compared to 23.0% for 1997. The increased health expense ratio for the year reflects higher commission costs related to growth in new business in 1998 over 1997 and an investment in the Company's distribution network. Also contributing to the increase in the expense ratio were expenses related to the Year 2000 initiative, and a one-time investment in re-engineering administrative work flow processes.
For 1998, interest expense decreased to $7.7 million from $9.3 million for 1997. The decrease in interest expense for 1998 reflects the assumption of $70.0 million in debt by Newco/UWS on September 11, 1998, as part of the spin-off transaction, as further described in Note 2 to the Consolidated Financial Statements. Excluding the interest on debt assumed by Newco/UWS, interest expense for 1998 was approximately $4.3 million which is consistent with management's ongoing expectations.
Results from continuing operations for 1997 was income of $1.6 million compared with a loss of $6.7 million for 1996. Excluding non-recurring charges and interest on debt assumed by Newco/UWS, income from continuing operations for 1997 was $8.9 million which compares to a 1996 pro forma loss of $25.1 million. The increase in income from continuing operations was due to an improved loss ratio on health business and an improved expense ratio, offset by increased expenses related to interest costs on debt and amortization of goodwill and intangibles.
For the year ended December 31, 1997, health insurance premiums increased 63.4% to $918.6 million from $562.1 million for 1996. The increase in 1997 was due primarily to the merger of the Company with Old AMS. Considering the effects of the merger with Old AMS, health insurance premiums decreased 12.4% from $1,094.5 million (pro forma) in 1996 to $957.2 million in 1997. The decline in health insurance premium is the result of management's efforts to return the business to profitability. Steps in this process included exiting certain unprofitable markets and lines of business, and implementing rate increases. Group life insurance premiums, which are generally tied to group health business, declined 13.9% to $28.9 million in 1997 from $33.6 million in 1996.
The health loss ratio for 1997 was 77.5% compared to 80.3% (pro forma) for 1996. The lower loss ratio in 1997 reflects improvements in medical cost trends and pricing increases as discussed above. For 1997, the life loss ratio was 35.3%, which compares to 32.8% for 1996.
Other revenue for the year ended December 31, 1997, increased to $24.2 million from $2.9 million for the year ended December 31, 1996. Other revenue principally represents administrative and other related fees from the administration of medical polices. The increase in other revenue in 1997 is principally due to the merger with Old AMS in December 1996.
The Company's insurance subsidiaries operate in states that require certain levels of regulatory capital and surplus and may restrict dividends to their parent companies. The National Association of Insurance Commissioners ("NAIC") has adopted risk-based capital ("RBC") standards for life and health insurers designed to evaluate the adequacy of statutory capital and surplus in relation to various business risks faced by such insurers. The RBC formula is used by state insurance regulators as an early warning tool to identify insurance companies that potentially are inadequately capitalized. At December 31, 1998, the Company's principal insurance company subsidiaries had an RBC ratio that was substantially above the levels which would require regulatory action.
On July 31, 1998, in anticipation of the spin-off transaction, the Company refinanced its subordinated notes outstanding in the amount of $44.9 million. The subordinated notes, including accrued interest, were replaced with borrowings of $45.2 million on a bank line of credit with a maximum commitment of $70.0 million. The line of credit contains certain covenants which, among other matters, requires the Company to maintain a minimum tangible net worth and restricts the Company's ability to incur additional debt, pay future cash dividends and transfer assets. The Company is in compliance with all such covenants at December 31, 1998.
In addition to internally generated funds and periodic borrowings on its bank line of credit, the Company believes that additional financing could be obtained through equity offerings, debt offerings or bank borrowings, as market conditions may permit or dictate.
The primary investment objective of the Company is to maximize investment income while controlling risks and preserving principal. The Company seeks to meet this investment objective through diversity of coupon rates, liquidity, investment type, industry, issuer and geographic location. The investment portfolio of the Company consists primarily of investment grade debt securities. Outside investment managers who seek to maximize return on the portfolio within the Company's investment guidelines are utilized. At December 31, 1998, $296.5 million or 99.2% of the Company's total investment portfolio was invested in debt securities.
The bond portfolio had an average quality rating of A1 at December 31, 1998, and Aa3 at December 31, 1997, as measured by Moody's Investor Service. Almost the entire portfolio was classified as available for sale. The Company had no investment mortgage loans, non-publicly traded securities (except for principal only strips of U.S. Government securities), real estate held for investment or financial derivatives. The market value of the total investment portfolio exceeded amortized cost by $1.9 million at December 31, 1998.
The primary market risk affecting the Company is interest rate risk. Assuming an immediate increase of 100 basis points in interest rates, the net hypothetical decline in fair value of shareholders' equity is estimated to be $7.2 million (after tax) at December 31, 1998. This amount represents approximately 2.7% of the Company's shareholders' equity.
The Year 2000 issue is the result of computer programs being written using two digits rather than four to define the applicable year. Computer equipment and software devices with embedded technology that are time-sensitive may recognize a date using "00" as the year 1900 rather that the year 2000. This could result in a system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions or engage in similar normal business activities.
In-house Applications represent the primary operating software of the Company and include applications that perform premium billing and cash posting, claims adjudication and commission payment processing. The project to make all In-House Applications Year 2000 compliant was completed in November 1998. The deletion of temporary bridges and workfiles used to facilitate communication between compliant and non-compliant computer codes during the course of the implementation was completed in early March 1999.
Customized Applications include electronic data interchange applications, publishing systems, fax capabilities, accounting packages and other special application software as well as utility software packages that serve as links between different packages. Each of these software packages is currently being upgraded or replaced. It is anticipated that all Customized Applications will be compliant prior to the end of the third quarter of 1999. With respect to Third Party Products, the Company has reviewed its business processes that may have Year 2000 concerns performed by, with or through external business associates. This includes computer hardware,
The cost of the Year 2000 project is being funded through operating cash flows and is not expected to be material to the Company's financial position. Through December 31,1998, the Company has incurred costs of $2.0 million ($1.5 million in 1998) relating to the Year 2000 project. In 1999, the Company anticipates an additional cost of $1.1 million which will be expensed as incurred. The Company has made capital expenditures of $1.8 million through December 31, 1998, and expects to make an additional $3.1 million in capital expenditures to complete the project.
We have audited the accompanying consolidated balance sheets of American Medical Security Group, Inc. and its subsidiaries, formerly known as United Wisconsin Services, Inc., (the Company) as of December 31, 1998 and 1997, and the related consolidated statements of income, changes in shareholders' equity and comprehensive income and cash flows for each of the three years in the period ended December 31, 1998. Our audits also included the financial statement schedules listed in the Index at Item 14(a). These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles ("GAAP"). The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.
Investments are classified as either held-to-maturity or available-for-sale. Investments which the Company has the positive intent and ability to hold to maturity are designated as held-to-maturity and are stated at amortized cost. All other investments are classified as available-for-sale and are stated at fair value based on quoted market prices, with unrealized gains and losses excluded from earnings and reported as a separate component of shareholders' equity as accumulated other comprehensive income, net of income tax effects. Realized gains and losses from the sale of available-for-sale debt securities and equity securities are based on the first-in, first-out basis.
Goodwill represents the excess of cost over the fair market value of net assets acquired. Goodwill and other intangible assets are being amortized on a straight-line basis over a period of 40 years or less. Accumulated amortization was $8,403,000 and $8,895,000 at December 31, 1998 and 1997, respectively.
The liabilities for medical and other benefits are determined using statistical analyses and represent estimates of the ultimate net cost of all reported and unreported claims that are unpaid at year end. The Company's year-end claim liabilities are substantially satisfied through claim payments in the subsequent year. Management believes that the liabilities for insurance claims are adequate. The liability for medical and other benefits, excluding reinsurance recoverables, of $123,907,000 at December 31, 1997, was deficient in the subsequent year by $1,228,000. At December 31, 1996, medical and other benefits payable, including reinsurance recoverables of $155,114,000, developed favorably by $9,418,000 in the subsequent year. The estimates are reviewed periodically and, as adjustments to the liabilities become necessary, the adjustments are reflected in current operations.
Reinsurance premiums, commissions and expense reimbursements on reinsured business are accounted for on a basis consistent with those used in accounting for the original policies issued and the terms of the reinsurance contracts. Premiums and benefits ceded to other companies have been reported as a reduction of premium revenue and benefits. Reinsurance receivables and prepaid reinsurance premium amounts are reported as assets.
The Company limits the maximum net loss that can arise from certain lines of business by reinsuring (ceding) a portion of these risks with other insurance organizations (reinsurers) on an excess of loss or quota share basis. The Company is contingently liable on reinsurance ceded in the event that the reinsurers do not meet their contractual obligations.
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial statement purposes and the amounts used for income tax purposes. A valuation allowance is recorded on deferred tax assets that management believes more likely than not will not be realized.
In 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings per Share," which replaces the presentation of primary and fully diluted earnings per share ("EPS") with a presentation of basic and diluted EPS.
The following table sets forth the computation of basic and diluted EPS:
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income" which established standards for the reporting and display of comprehensive income and its components in a full set of comparative general-purpose financial statements. The statement became effective for the Company as of January 1, 1998. Comprehensive income is defined in this statement as net income plus other comprehensive income, which for the Company, under existing accounting standards, includes unrealized gains and losses, net of income tax effects, on certain investments in debt and equity securities. Comprehensive income is reported by the Company in the consolidated statements of changes in shareholders' equity and comprehensive income.
On May 27, 1998, the Board of Directors of the Company, then known as United Wisconsin Services, Inc., ("UWS") approved a plan to spin off its managed care companies and specialty management business to its shareholders (the "Distribution"). In connection with the spin-off, the Company changed its name to "American Medical Security Group, Inc." On September 25, 1998, the distribution date, shareholders of AMSG received one share of common stock of a newly formed company, Newco/UWS, Inc. ("Newco/UWS"), for every share of AMSG owned as of September 11, 1998, the record date. At December 31, 1998, Blue Cross and Blue Shield United of Wisconsin ("BCBSUW") holds approximately 38% of the outstanding stock of AMSG.
The above acquisition has been accounted for using the purchase method of accounting, and the accompanying consolidated financial statements include the results of operations from the date of acquisition.
These pro forma results are not necessarily indicative of the results that would have occurred had the acquisition taken place on January 1, 1996, or indicative of future results of operations for the combined companies.
At December 31, 1998, the insurance subsidiaries had fixed securities and cash equivalents on deposit with various state insurance departments with carrying values of approximately $3,361,000.
As further discussed in Note 2, the note payable to BCBSUW was assumed by Newco/UWS in conjunction with the Distribution.
On July 31, 1998, the Company entered into a five year revolving bank line of credit with a maximum commitment of $70,000,000, and a $10,000,000 sublimit for swingline loans. Under the bank line of credit, the Company has the option to select an interest rate at the Eurodollar rate or the alternate base rate. The alternate base rate is the larger of the bank's corporate base rate of interest or the federal funds rate plus 1/2% per annum. The swingline loans are used for short term borrowing and are required to be repaid no later than 30 days after they are made. Swingline loans are charged the bank's daily floating rate of interest. The agreement contains certain convenants which, among other matters, require the Company to maintain a minimum tangible net worth and restrict the Company's ability to incur additional debt, pay future cash dividends and transfer assets. The aggregate commitment on the line of credit must be reduced to $60,000,000, $50,000,000 and $35,000,000 on July 31, 2000, July 31, 2001 and July 31, 2002, respectively.
During 1998 the Company borrowed $45,158,000 on the bank line of credit to retire its subordinated notes outstanding. A six month Eurodollar rate of 6.00% was selected on November 5, 1998 for the outstanding line of credit borrowings. The weighted average interest rate on swingline loans as of December 31, 1998 was 7.75%. The mortgage payable is collateralized by the Company's home office property located in Green Bay, Wisconsin.
The Company has loans and advances receivable from employees, agents and joint venture partners of $2,517,000 and $2,204,000 at December 31, 1998 and 1997, respectively. The Company has a deferred compensation payable to executives of $1,421,000 and $1,288,000 for 1998 and 1997, respectively.
The Company had a net federal income tax payable of $620,000 and a net federal income tax receivable of $1,373,000 at December 31, 1998 and 1997, respectively. The Company and its subsidiaries have state net business loss carryforwards totaling $45,622,000 at December 31, 1998, which expire in the year 2013. Federal and state income tax payments related to continuing operations, net of refunds, were $710,000 in 1998 and $3,534,000 in 1997, while 1996 netted a refund of $1,495,000.
State insurance regulations also require the maintenance of a minimum compulsory surplus based on a percentage of premiums written. At December 31, 1998, the Company's insurance subsidiaries were in compliance with these compulsory regulatory requirements.
On November 17, 1998, the Company and a key executive entered into a deferred stock agreement. Under the agreement the Company has an obligation to issue 73,506 shares of AMSG common stock provided the
The Company also has a Director Stock Option Plan which permits the grant of NQSOs. As of December 31, 1998, 29,000 shares are available for grant.
The Company follows Accounting Principles Board Opinion No. 25 under which no compensation expense is recorded when the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant. The Company's pro forma information regarding net income and net income per share has been determined as if these options had been accounted for since January 1, 1995, in accordance with the fair value method of SFAS No. 123, "Accounting for Stock-Based Compensation".
The Company's employees are included in a defined contribution plan (the "Retirement Savings Plan") with profit sharing and discretionary savings provisions covering all eligible salaried and hourly employees. Beginning in 1998, participant contributions up to 6% of the participants compensation are matched 50% by the Company. Profit sharing contributions to the Retirement Savings Plan are determined annually by the Company. Participants vest in company contributions over seven years. The Company recognized expense associated with the Retirement Savings Plan of $1,449,000 and $1,044,000 in 1998 and 1997, respectively.
The Company has two reportable segments: 1) health insurance products and 2) life insurance products. The Company's health insurance products consist of the following coverages related to small group PPO products: fully insured medical, self funded medical, dental and short-term disability. Life products consist primarily of group term-life insurance. The "All Other" segment includes operations not directly related to the business segments and unallocated corporate items (i.e., corporate investment income, interest expense on corporate debt, amortization of goodwill and intangibles and unallocated overhead expenses). The Company's all other segment also includes data for its 80% owned HMO subsidiary. The reportable segments are managed separately because they differ in the nature of the products offered and in profit margins.