We currently own and occupy three office buildings in Tarrant County, Texas (including our executive offices located at 9151 Grapevine Hwy, North Richland Hills, Texas 76180-5605) comprising in the aggregate approximately 250,000 square feet of office space. In addition, we lease office space at various locations.
The Company’s revenues consist primarily of premiums derived from sales of its indemnity, PPO, student group and voluntary employer group health plans and from life insurance policies. Revenues also include investment income derived from its investment portfolio and other income, which consists primarily of income derived by the Self-Employed Agency Division from ancillary services and membership marketing and administrative services provided to the membership associations that make available to their members the Company’s health insurance products.
The Company’s expenses consist primarily of insurance claims expense and expenses associated with the underwriting and acquisition of insurance policies. Claims expenses consist primarily of payments to physicians, hospitals and other health care providers under health policies and include an estimated amount for incurred but not reported or paid claims. Underwriting, policy acquisition costs and insurance expenses consist of direct expenses incurred across all insurance lines in connection with issuance, maintenance and administration of in-force insurance policies, including amortization of deferred policy acquisition costs, commissions paid to agents, administrative expenses and premium taxes. The Company also incurs other direct expenses in connection with generating income derived by the Self-Employed Agency Division from ancillary services and membership marketing and administrative services provided to the membership associations that make available to their members the Company’s health insurance products.
The Company establishes liabilities for benefit claims that have been reported but not paid and claims that have been incurred but not reported under health and life insurance contracts. These claim liabilities are developed using actuarial principles and assumptions that consider a number of items, including historical and current claim payment patterns, product variations, the timely implementation of appropriate rate increases and seasonality. See discussion below, “Critical Accounting Policies and Estimates - Claim Liabilities”and Note F of Notes to Consolidated Financial Statements.
During 2003 the Company’s financial condition, cash flow and results from operations were impacted by several key factors and developments:
We classified AMS as a discontinued operation for financial reporting purposes as of September 30, 2003. Our recorded results in 2003 included a pre-tax loss at AMS in the amount of $(76.0) million ($(64.2) million net of tax), reflecting the loss upon disposal of AMS and AMS’ operating loss during the year.
Effective September 30, 2003, we sold to Healthaxis, Inc. (HAXS: Nasdaq) (“HAI”) our entire 48.27% equity interest in HAI for a total sale price of $3.9 million, of which $500,000 was paid in cash at closing, and the balance was paid by delivery of a promissory note payable to us in the amount of $3.4 million. We recognized a nominal loss for financial reporting purposes in connection with the sale. Prior to the sale, we had previously accounted for our investment in HAI utilizing the equity method and recognized our ratable share of HAI income and loss. See Note B of Notes to Consolidated Financial Statements.
Our Group Insurance Division (consisting of the Company’s Student Insurance and Star HRG business units) reported operating losses of $(7.9) million for the year ended December 31, 2003 compared to operating income in the amount of $13.2 million in 2002. These operating losses were primarily attributable to operating losses at the Company’s Student Insurance Division and, to a lesser extent, to disappointing results at the Star HRG unit. In the third quarter of 2003 the Company recorded a $(13.1) million ($(8.5) million net of tax, or ($0.18) per diluted share) charge, substantially all of which was attributable to unfavorable claims experience at the Company’s Student Insurance Division. Because Student Insurance policies are issued on a single school year basis and the 2003-2004 school year commenced in August 2003, the Student Insurance Division will be limited in its ability to reprice its overall book of business until August 2004.
The Company reported net income in 2003 in the amount of $14.3 million ($0.30 per diluted share), compared to net income of $46.9 million ($0.96 per diluted share) in 2002. Reported net income included income (losses) from discontinued operations in 2003 and 2002 in the amount of $(73.0) million ($(1.52) per diluted share) and $953,000 ($0.02 per diluted share), respectively. Overall results in the full year ended December 31, 2002 also included a goodwill impairment charge in the amount of $(5.1) million (net of tax) ($(0.11) per diluted share), which was reflected as a cumulative effect of a change in accounting principle in accordance with Financial Accounting Standards Board (“FASB”) Statement No. 142, Goodwill and Other Intangible Assets.
The Company generated a significant increase in health premium revenue (to $1.565 billion in 2003 from $1.181 billion in 2002, an increase of $383.5 million, or 32%) which resulted from new business as well as increased renewal business derived from new health business originally written in 2001 and 2002.
Despite a 16.8% increase in invested assets over the year ended December 31, 2003, investment income remained relatively constant ($77.7 million in 2003 compared to $80.8 million in 2002) due to a decrease in yield on invested assets resulting from lower prevailing market interest rates.
The Company recognized gains on sale of investments of $39.7 million in 2003 compared to losses of $(5.6) million in 2002, which increase resulted primarily from a $40.4 million (pre-tax) gain generated in the fourth quarter of 2003 on the sale of a substantial portion of the Company’s stake in AMLI Residential. Results in 2002 reflected impairment charges for certain fixed income securities in the amount of $(14.7) million. The impairment charges were partially offset by realized gains associated with other securities in the portfolio.
Expenses. UICI’s total expenses increased to $1.681 billion in 2003 from $1.299 billion in 2002, an increase of $382.3 million, or 29%. The Company’s expenses were particularly impacted by the following factors:
Underwriting, policy acquisition costs and insurance expenses increased by 30% to $563.6 million in 2003 from $432.5 million in 2002, consistent with the increase in premium revenue.
Operating Income. Income from continuing operations before federal income taxes (“operating income”) increased by 72%, to $131.9 million in 2003 from $76.8 million in 2002. As discussed more fully below, the Company’s 2003 results from continuing operations benefited from a 30% year-over-year increase in operating income at its SEA Division (from $84.2 million in 2002 to $109.1 million in 2003) and a pre-tax gain in the amount of $40.4 million ($26.2 million or $0.55 per diluted share, net of tax) recognized in the fourth quarter of 2003 associated with the sale of a substantial portion of the Company’s stake in AMLI Residential. These favorable factors were offset by operating losses in 2003 at the Company’s Group Insurance and Life Insurance operations.
Operating income (loss) for each of the Company’s business segments and divisions in 2003 and 2002 was as follows:
Reflects the Company’s share of losses associated with its former investment in Healthaxis, Inc., which the Company disposed of in the third quarter of 2003.
The Other Key Factors segment includes investment income not allocated to the other business segments, realized gains or losses on sale of investments, interest expense on non-student loan indebtedness, general expenses relating to corporate operations, the operations of the Company’s AMLI Realty Co. subsidiary, minority interest, variable stock-based compensation, operations that do not constitute reportable operating segments (consisting primarily of the remaining portion of the Company’s former third party administration business, until sold by the Company in September 2002) and amortization of goodwill (with respect to periods ended prior to January 1, 2002).
Self-Employed Agency Division. Set forth below is certain summary financial and operating data for the Company’s Self-Employed Agency (“SEA”) Division for each of the three most recent fiscal years:
Results at the SEA Division in 2003 included a $(25.0) million charge associated with the reassessment of loss accruals established for certain pending litigation. See Note L of Notes to Consolidated Financial Information. The Company continues to actively engage in discussions with respect to possible settlement of a significant portion of its pending association group litigation.
Operating margin (operating income as a percentage of earned premium revenue) remained constant at 9.0% in each of 2003 and 2002.
Group Insurance Division. Set forth below is certain summary financial and operating data for the Company’s Group Division (consisting of the Company’s Student Insurance and Star HRG business units) for each of the three most recent fiscal years:
Defined as total benefits expenses as a percentage of earned premium revenue.
Operating losses at the Group Insurance Division in 2003 were attributable to operating losses at the Company’s Student Insurance Division. The Company also experienced disappointing results at its Star HRG unit. In the third quarter of 2003, the Company recorded a $(13.1) million ($(8.5) million net of tax, or $(0.18) per diluted share) charge, substantially all of which was attributable to unfavorable claims experience at the Company’s Student Insurance Division. Because Student Insurance policies are issued on a single school year basis and the 2003-2004 school year commenced in August 2003, the Student Insurance Division will be limited in its ability to reprice its overall book of business until August 2004.
Other Insurance. In the third quarter of 2003 the Company established a subsidiary (ZON Re USA, LLC) to underwrite, administer and issue accidental death, accidental death and dismemberment (AD&D), accident medical and accident disability insurance policies, both on a primary and on a reinsurance basis. To date, results of the start up operation have not been material to the consolidated results of operations of the Company.
Other Key Factors. The Other Key Factors category includes investment income not allocated to the other business segments, realized gains or losses on sale of investments, interest expense on non-student loan indebtedness, general expenses relating to corporate operations, the operations of the Company’s AMLI Realty Co. subsidiary, minority interest, variable stock-based compensation, operations that do not constitute reportable operating segments (consisting primarily of the remaining portion of the Company’s former third party administration business, until sold by the Company in September 2002) and amortization of goodwill (with respect to periods ended prior to January 1, 2002).
For the year ended December 31, 2003, Other Key Factors reported operating income of $36.0 million, compared to an operating loss of $(19.0) million in 2002. The increase in operating income for the year ended December 31, 2003 was attributable to various factors, including a gain in the amount of $40.4 million realized in the fourth quarter of 2003 upon the sale by the Company of a substantial portion of its stake in AMLI Residential and non-cash stock-based compensation income attributable to the Company’s stock accumulation plans in the aggregate amount of $459,000 (see discussion below). These favorable factors in 2003 were offset by a decrease of $5.3 million in investment income not allocated to other segments (which in turn resulted from a decrease in yield on invested assets).
The Company’s reported results in 2003 and 2002 reflected income (loss) (net of tax) from discontinued operations (consisting of the Company’s AMS unit, its Senior Market Division, its Special Risk Division, its former sub-prime credit card unit and its third party administration (TPA) business) in the amount of $(73.0) million ($(1.52) per diluted share), and $953,000 ($0.02 per diluted share), respectively. Results from discontinued operations in 2003 included significant losses (net of tax) from AMS in the amount of $(64.2) million (which included a $(61.2) million expense reflecting the estimated loss on disposal recorded in the third quarter of 2003) and the costs associated with the close down of the Company’s former Senior Market Division.
For the year ended December 31, 2003 and 2002, AMS reported earnings (losses) (net of tax) in the amount of $(64.2) million and $5.3 million, respectively. Reflecting the anticipated sale of AMS, the Company recorded during the third quarter of 2003 an estimated loss upon disposal of AMS in the amount of $(61.2) million.
Other income (consisting primarily of income derived by the SEA Division from ancillary services and membership marketing and administrative services provided to the membership associations that have made available to their members the Company’s health insurance products) increased by 21%, to $87.9 million in 2002 from $72.4 million in 2001.
Included in 2001 gains was a $5.3 million gain related to the Company’s investment in AMLI Commercial Properties Trust (“ACPT”) and $3.4 million in other gains from the Company’s investment portfolio, which gains were offset by impairment charges for certain investments in the amount of $3.5 million. During 2001, ACPT, an equity method investee in which the Company held a 20% equity interest, sold substantially all of its assets for an aggregate sale price of approximately $226.3 million. In connection with such sale, the Company recognized a gain in the amount of $5.3 million. See Note C of Notes to Consolidated Financial Statements.
claims and settlements expenses associated with the Company’s Star HRG unit, which was acquired in February 2002).
Other expenses (consisting primarily of direct expenses incurred by the Company in connection with providing ancillary services and membership marketing and administrative services provided to the membership associations that make available to their members the Company’s health insurance products) increased by 16%, to $61.9 million in 2002 from $53.5 million in 2001, primarily due to the increase in SEA Division expenses.
Interest expense on corporate borrowings decreased to $1.4 million in 2002 from $2.9 million in 2001, primarily due to the decreased level of borrowings outstanding during 2002 compared to 2001. Interest expense on student loan obligations (consisting of borrowings incurred to fund student loan obligations under the Company’s College Fund Life Division program - see Note H of Notes to Consolidated Financial Statements) increased to $2.7 million in 2002 from $2.4 million in 2001, primarily as a result of the completion of an additional $50.0 million securitization in April 2002.
Operating Income. Income from continuing operations before federal income taxes (“operating income”) increased to $76.8 million in 2002 from $73.2 million in 2001. As discussed more fully below, a 43% increase in operating income from its insurance segment (to $105.4 million in 2002 from $73.8 million in 2001) was offset by a decrease in yield on invested assets, losses on sale of investments (losses of $(5.6) million in 2002 compared to gains of $5.2 million in 2001) and a significant increase in stock based compensation expense associated with various stock-based compensation plans maintained by the Company for the benefit of its employees and independent agents.
In the 2002 period, the SEA Division continued to experience significant increases in submitted annualized premium volume ($929.3 million in 2002 compared to $578.5 million in 2001), which increase was due primarily to a 49.5% increase in the average number of writing agents in 2002 compared to 2001 and a 6% increase in annualized premium volume submitted per writing agent in 2002 compared to 2001. Total revenue at the SEA Division increased from $713.3 million in 2001 to $1,035.9 million in 2002 (a 45% increase). Operating income as a percentage of SEA Division premium in the year ended December 31, 2002 was 9.0% compared to 10.3% in the prior year. The lower operating margin during the 2002 period was attributable to higher effective commission rates due to the increase in first year premium (which carries a higher
commission rate compared to renewal commissions), and lower investment and other income as a percentage of total revenue. These factors were partially offset by lower administrative expenses as a percentage of total premium in 2002 and a slightly lower loss ratio in 2002 compared to the loss ratio in 2001.
Other. The Company has classified its former investment in Healthaxis, Inc. (“HAI”) as its “Other” business segment. Prior to its disposal in 2003, the Company accounted for its investment in HAI utilizing the equity method and, accordingly, recognized its ratable share of HAI income and loss (computed prior to amortization of goodwill recorded by HealthAxis.com in connection with the January 7, 2000 merger of Insurdata Incorporated (formerly a wholly-owned subsidiary of UICI) with and into HealthAxis.com). See Note B of Notes to Consolidated Financial Statements.
During 2001, AMLI Commercial Properties Trust (“ACPT”), an equity method investee in which the Company held a 20% equity interest, sold substantially all of its assets for an aggregate sale price of approximately $226.3 million. In connection with such sales, the Company recognized a gain in the amount of $5.3 million.
The Company’s reported results in 2002 and 2001 reflected income (loss) (net of tax) from discontinued operations (consisting of the Company’s AMS unit, its Senior Market Division, its Special Risk Division, its former sub-prime credit card unit and its third party administration business) in the amount of $953,000 ($0.02 per diluted share) and $(6.6) million ($(0.13) per diluted share), respectively. Results from discontinued operations in 2001 included losses (net of tax) of $(9.2) million, $(3.8) million and $(1.4) million from the Company’s Special Risk Division, third party administration business and Senior Market Division, respectively. These losses were slightly offset by income of $4.1 million and $3.7 million from the Company’s AMS and sub-prime credit card operations, respectively.
The Company maintains for the benefit of its employees and independent agents various stock-based compensation plans, in connection with which it records non-cash variable stock-based compensation expense in amounts that depend and fluctuate based upon the market performance of the Company’s common stock. For financial reporting purposes, the Company reflects all variable stock based compensation in its “Other Key Factors” business segment. See Note M of Notes to Consolidated Financial Statements.
In the year ended December 31, 2003, the Company recorded non-cash stock-based compensation income attributable to the Company’s stock accumulation plans established for the benefit of its independent agents in the aggregate amount of $459,000. In the year ended December 31, 2002, the Company recorded non-cash stock-based compensation expense in the aggregate amount of $(16.3) million, of which $(5.7) million was attributable to the ESOP feature of the Company’s Employee Plan, $(9.2) million was attributable to the Company’s stock accumulation plans established for the benefit of its independent agents and $(1.4) million was attributable to other stock-based plans. In the year ended December 31, 2001, the Company recorded non-cash stock-based compensation expense in the aggregate amount of $(6.1) million, of which $(2.3) million was attributable to the ESOP feature of the Company’s Employee Plan, $(2.8) million was attributable to the Company’s stock accumulation plans established for the benefit of its independent agents and $(1.0) million was attributable to other stock-based plans. The significant decrease in non-cash variable stock-based compensation expense in 2003 compared to 2002 was primarily attributable to the lower average share price in 2003 compared to the average share price in 2002. The significant increase in non-cash variable stock-based compensation expense in 2002 compared to 2001 was attributable to the higher average share price in 2002 compared to the average share price in 2001.
The Company also sponsors a series of stock accumulation plans established for the benefit of the independent insurance agents and independent sales representatives associated with its independent agent field forces, including UGA - Association Field Services and Cornerstone America. The agent plans generally combine an agent-contribution feature and a Company-match feature. The Company has established a liability for future unvested benefits under the plans and adjusts the liability based on the market value of the Company’s common stock. For the year ended December 31, 2003, the Company recorded total compensation expense associated with these agent plans in the amount of $10.0 million, of which $459,000 represented the non-cash stock based income associated with the adjustment to the liability for future unvested benefits. For the years ended December 31, 2002 and 2001, the Company recorded total compensation expense associated with these agent plans in the amount of $16.3 million and $6.6 million, respectively, of which $9.2 million and $2.8 million, respectively, represented the non-cash stock based compensation expense associated with the adjustment to the liability for future unvested benefits. See Note M of Notes to Consolidated Financial Statements.
January of each year; accordingly, in periods of general appreciation in the quoted price of UICI common stock, the Company’s cumulative liability, and corresponding charge to income, for unvested stock-based compensation is expected to be greater in each successive quarter during any given year.
The following table presents the information for each of the Company’s fiscal quarters in 2003 and 2002, as adjusted to reflect the sale of the Company’s AMS subsidiary and the Senior Market Division as discontinued operations. The results of operations of AMS, and the Senior Market Division (together with the results of operations of Company’s Special Risk Division, the Sub-prime credit card operations and the Third Party Administration business) are reflected in discontinued operations for all periods presented. This information is unaudited and has been prepared on the same basis as the audited Consolidated Financial Statements of the Company included herein and, in management’s opinion, reflects all adjustments necessary for a fair presentation of the information for the periods presented. The operating results for any quarter are not necessarily indicative of results for any future period.
On a consolidated level, the Company’s primary sources of liquidity have been premium revenues from policies issued, investment income, fees and other income, and borrowings to fund student loans. The primary uses of cash have been payments for benefits, claims and commissions under those policies, operating expenses, stock repurchases and the funding of student loans. During 2003, the Company generated net cash from operations on a consolidated basis in the amount of $291.2 million, compared to $266.0 million in 2002 and $189.7 million in 2001.
UICI is a holding company, the principal assets of which are its investments in its separate operating subsidiaries, including its regulated insurance subsidiaries. The holding company’s ability to fund its cash requirements is largely dependent upon its ability to access cash, by means of dividends or other means, from its subsidiaries. The laws governing the Company’s insurance subsidiaries restrict dividends paid by the Company’s domestic insurance subsidiaries in any year. Inability to access cash from its subsidiaries could have a material adverse effect upon the Company’s liquidity and capital resources.
Includes repurchase of UICI common stock under the Company’s stock repurchase program in the amount of $5.1 million (349,200 shares), $29.3 million (2,000,000 shares) and $8.8 million (980,400 shares) in 2003, 2002 and 2001, respectively. Also includes in 2003, 2002 and 2001 the amounts of $14.5 million, $1.3 million and $5.2 million, respectively, representing repurchases of UICI common stock for agents stock accumulation plans and purchases from employees and officers of the Company.
See Note R of Notes to Consolidated Financial Statements for additional information regarding parent-only cash flow.
approximately $18.2 million, which will consist primarily of currently budgeted operating expenses at the holding company level. The Company currently anticipates that these cash requirements at the holding company level will be funded by cash on hand, dividends to be paid from insurance subsidiaries and non-insurance subsidiaries and tax sharing reimbursements from subsidiaries (which will be partially offset by holding company operating expenses). There can be no assurance that the cash requirements at the holding company level will not exceed current estimates, or that the holding company will be able to raise sufficient cash to fund cash requirements on a timely basis.
Prior approval by insurance regulatory authorities is required for the payment by a domestic insurance company of dividends that exceed certain limitations based on statutory surplus and net income. During the fourth quarter of 2003, Mid-West paid dividends in the amount of $5.0 million to the holding company. The MEGA Life and Health Insurance Company did not pay any dividends in 2003.
On January 25, 2002, UICI entered into a three-year bank credit facility with Bank of America, NA and LaSalle Bank National Association. Under the facility, UICI may borrow from time to time up to $30.0 million on a revolving, unsecured basis. Loans outstanding under the facility will bear interest at the option of the Company at prime plus 1% or LIBOR plus 1%. The Company intends to utilize the proceeds of the facility for general working capital purposes. Effective December 17, 2003, LaSalle Bank assigned its rights and obligations under the bank credit facility to JP Morgan Chase Bank. The Company has not to date borrowed any funds under the facility.
Through the Company’s former College Fund Life Division, the Company previously offered an interest-sensitive whole life insurance product issued with a child term rider, under which the Company committed to provide private student loans to help fund the named child’s higher education if certain restrictions and qualifications are satisfied. The Company has historically funded its College Fund Life Division student loan commitments with the proceeds of indebtedness issued by a bankruptcy-remote special purpose entity (the “SPE”). See Note H of Notes to Consolidated Financial Statements. At December 31, 2003, $32.5 million of cash, cash equivalents and other qualified investments held by the SPE were available to fund the purchase from the Company of additional student loans generated under the Company’s College First Alternative Loan program, which purchases may be made in accordance with the terms of the agreements governing the SPE until February 2006. If market conditions permit, the Company anticipates that it will cause the SPE to issue additional indebtedness during 2004, the proceeds of which may be used to fund the balance of its expected student loan fundings under the College Fund Life Division program.
During 2003 and 2002, the Company’s principal uses of cash at the holding company level were the following:
Through the Company’s former College Fund Life Division, the Company previously offered an interest-sensitive whole life insurance product issued with a child term rider, under which the Company committed to provide private student loans to help fund the named child’s higher education if certain restrictions and qualifications are satisfied. At December 31, 2003, the Company had outstanding commitments to fund student loans under the College Fund Life Division program for the years 2004 through 2025. The interest rates on these commitments vary as described below. Loans are limited to the cost of school or prescribed maximums. These loans are generally guaranteed as to principal and interest by a private guarantee agency and are also collateralized by either the related insurance policy or the co-signature of a parent or guardian. The total student loan funding commitments for each of the next five school years and thereafter, as well as the amount the Company expects to be required to fund based on historical utilization rates and policy lapse rates, are as follows as of December 31, 2003:
General. The Company’s Investment Committee monitors the investment portfolio of the Company and its subsidiaries. The Investment Committee receives investment management services from external professionals.
Set forth below is a summary of the Company’s investments by category at December 31, 2003 and 2002:
Fixed maturity securities. Fixed maturity securities accounted for 89.8% and 81.2% of the Company’s total investments at December 31, 2003 and 2002, respectively. Fixed maturity securities at December 31, 2003 consisted of the following:
Included in the fixed maturity portfolio is a concentration of mortgage-backed securities, including collateralized mortgage obligations and mortgage-backed pass-through certificates. To limit its credit risk, the Company invests in mortgage-backed securities that are rated investment grade by the public rating agencies. The Company’s mortgage-backed securities portfolio is a conservatively structured portfolio that is concentrated in the less volatile tranches, in the form of planned amortization classes, sequential payment and commercial mortgage-backed securities. The Company seeks to minimize prepayment risk during periods of declining interest rates and minimize duration extension risk during periods of rising interest rates. The Company has less than 1% of its investment portfolio invested in the more volatile tranches.
As of December 31, 2003 and 2002, $1,382.9 million (or 98.4%) and $1,058.7 million (or 97.3%), respectively, of the fixed maturity securities portfolio was rated BBB or better (investment grade) and $22.2 million (or 1.6%) and $29.4 million (or 2.7%), respectively, of the fixed maturity securities portfolio was invested in below investment grade securities (rated less than BBB).
A quality distribution for fixed maturity securities at December 31, 2003 is set forth below:
Investment accounting policies. The Company has classified its entire fixed maturity portfolio as “available for sale.” This classification requires the portfolio to be carried at fair value with the resulting unrealized gains or losses, net of applicable income taxes, reported in accumulated other comprehensive income as a separate component of stockholders’ equity. As a result, fluctuations in fair value, which is affected by changes in interest rates, will result in increases or decreases to the Company’s stockholders’ equity.
Following is a summary of the Company’s gross unrealized losses in its fixed maturities as of December 31, 2003:
The largest unrealized loss ($1.1 million) is represented by a security issued by a corporate borrower secured by manufactured housing. The security carries an A+ rating from Standard & Poor’s and, in terms of repossession inventories and delinquencies, is currently performing better than both the industry index and other securities of the issuer.
The second largest unrealized loss ($860,000) is represented by a special obligation bond issued by the New York City Industrial Development Corporation. The principal amount and interest on the bond are payable solely from and secured by a pledge of lease payments by the issuer derived from a lease of office space located in Brooklyn. The space is currently occupied by a government agency under a lease with a remaining term of 17 years.
The Company continually monitors these investments and believes the unrealized loss in these investments is temporary.
The Company regularly monitors its investment portfolio to attempt to minimize its concentration of credit risk in any single issuer. Set forth in the table below is a schedule of all investments representing greater than 1% of the Company’s aggregate investment portfolio at December 31, 2003 and 2002.
The Company recognized a pre-tax gain in the fourth quarter of 2003 in the amount of $40.4 million associated with the sale of a substantial portion of the Company’s stake in AMLI Residential. The Company effected such sales to diversify its portfolio and to generate taxable capital gains that could be used to offset capital losses recognized from other investments. The Company through its various subsidiaries continues to hold 618,815 AMLI Residential shares with an aggregate cost basis of $13.8 million ($22.22 average cost per share). These remaining AMLI Residential shares are subject to various resale restrictions imposed by federal and state securities laws.
At its regular meeting held on February 11, 2004, the Board of Directors of the Company reconfirmed the Company’s 1998 share repurchase program, in which it initially authorized the repurchase of up to 4,500,000 shares of UICI common stock from time to time in open market or private transactions. Through February 2004, the Company had purchased an aggregate of 3,527,600 shares (aggregate cost of $47.8 million; average cost of $13.55) pursuant to the program and has remaining authority pursuant to the program to repurchase an additional 972,400 shares. The timing and extent of additional repurchases, if any, will depend on market conditions and the Company’s evaluation of its financial resources at the time of purchase.
Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
The Group Insurance Division assigns incurred dates based on the date of service. This definition estimates the liability for all medical services received by the insured prior to the end of the applicable financial period. Appropriate adjustments are made in the completion factors to account for pending claim inventory changes and contractual continuation of coverage beyond the end of the financial period.
Set forth below is a summary of the claims liability development experience (favorable) unfavorable by business unit in the Company’s Insurance segment for each of the years ended December 31, 2003, 2002 and 2001:
business has a “short tail,” which means that a favorable development or unfavorable development shown for prior years relates primarily to actual experience in the most recent prior year. The favorable development reflected in the Group Insurance Division is from better than expected experience and is not unusual for a medical line of business. The majority of the favorable development experienced for 2003 related to the Star HRG business unit. Since the Star HRG business was new to the Company (acquired in 2002), an expected loss ratio was used to set the claims liability at December 31, 2002.
The Company incurs various costs in connection with the origination and initial issuance of its health insurance policies, including underwriting and policy issuance costs, costs associated with lead generation activities and distribution costs (i.e., sales commissions paid to agents). The Company defers those costs that vary with production. The Company defers commissions paid to agents and premium taxes with respect to the portion of health premium collected but not yet earned, and the Company amortizes the deferred expense over the period as and when the premium is earned. Costs associated with generating sales leads with respect to the health business issued through the SEA Division are capitalized and amortized over a two-year period, which approximates the average life of a policy. For financial reporting purposes, underwriting and policy issuance costs (which the Company estimates are more fixed than variable) with respect to health policies issued through the Company’s SEA and Group Divisions are expensed as incurred. See Note A of Notes to Consolidated Financial Statements.
such determination was made. The Company’s annual review in 2003 of the goodwill related to continuing operations indicated no impairment.
The Company sponsors a series of stock accumulation plans (the “Agent Plans”) established for the benefit of the independent insurance agents and independent sales representatives associated with UGA - Association Field Services, New United Agency and Cornerstone America. The Company has established a liability for future unvested benefits under the Agent Plans and adjusts the liability based on the market value of the Company’s Common Stock. The accounting treatment of the Company’s Agent Plans will result in unpredictable stock-based compensation charges, dependent upon fluctuations in the quoted price of UICI common stock. These unpredictable fluctuations in stock based compensation charges may result in material non-cash fluctuations in the Company’s results of operations. See discussion above included in the section captioned “Variable Stock Based Compensation” and Note M of Notes to Consolidated Financial Statements.
Investments are reviewed quarterly (or more frequently if certain indicators arise) to determine if they have suffered an impairment of value that is considered other than temporary. Management’s review considers the following indicators of impairment: fair value is significantly below cost; the decline in fair value is attributable to specific adverse conditions affecting a particular investment; the decline in fair value is attributable to specific conditions, such as conditions in an industry or in a geographic area; the decline in fair value has existed for an extended period of time; downgrades by rating agencies from investment grade to non-investment grade; the financial condition of the issuer has deteriorated and dividends have been reduced or eliminated or scheduled interest payments have not been made. Management monitors investments where two or more of the above indicators exist and investments are identified by the Company in economically challenged industries. If investments are determined to be impaired, a loss is recognized at the date of determination.
During 2002 the Company determined that it was more likely than not that it would be able to realize its deferred tax assets, which related primarily to operating losses in prior years at the Company’s AMS subsidiary. Accordingly, in 2002, the Company released and recognized as income the then remaining valuation allowance of $4.0 million.
During 2003 the Company realized $59.3 million of net capital losses for federal tax purposes. The capital losses were generated in 2003 from the sale of AMS, Healthaxis and SeniorsFirst LLC and were partially offset by the gain from the sale of a substantial portion of the Company’s equity stake in AMLI Residential. To the extent not utilized to offset capital gains generated in prior years, the net capital losses generated in 2003 will be carried forward to future years, with the ability to utilize the remaining capital losses in 2004 through 2008. During 2003, the Company determined that it was more likely than not that it would not be able to realize its deferred tax assets related to a portion of the capital loss carryforwards generated in 2003. Accordingly, the Company established a valuation allowance of $19.8 million associated with the carryforwards at December 31, 2003.
Recently-adopted legislation and regulations governing the use and security of individuals’ nonpublic personal data by financial institutions, including insurance companies, may have a significant impact on the Company’s business and future results of operations.
GLBA provides that there is no federal preemption of a state’s insurance related privacy laws if the state law is more stringent than the privacy rules imposed under GLBA. Accordingly, state insurance regulators or
state legislatures will likely adopt rules that will limit the ability of insurance companies, insurance agents and brokers and certain other entities licensed by state insurance regulatory authorities to disclose and use non-public information about consumers to third parties. These limitations will require the disclosure by these entities of their privacy policies to consumers and, in some circumstances, will allow consumers to prevent the disclosure or use of certain personal information to an unaffiliated third party. Pursuant to the authority granted under GLBA to state insurance regulatory authorities to regulate the privacy of nonpublic personal information provided to consumers and customers of insurance companies, insurance agents and brokers and certain other entities licensed by state insurance regulatory authorities, the National Association of Insurance Commissioners has recently promulgated a new model regulation called Privacy of Consumer Financial and Health Information Regulation. Some states issued this model regulation before July 1, 2001, while other states must pass certain legislative reforms to implement new state privacy rules pursuant to GLBA. In addition, GLBA requires state insurance regulators to establish standards for administrative, technical and physical safeguards pertaining to customer records and information to (a) ensure their security and confidentiality, (b) protect against anticipated threats and hazards to their security and integrity, and (c) protect against unauthorized access to and use of these records and information. The privacy and security provisions of GLBA will significantly affect how a consumer’s nonpublic personal information is transmitted through and used by diversified financial services companies and conveyed to and used by outside vendors and other unaffiliated third parties.
Due to the increasing popularity of the Internet, laws and regulations may be passed dealing with issues such as user privacy, pricing, content and quality of products and services, and those regulations could adversely affect the growth of the online financial services industry. If Internet use does not grow as a result of privacy or security concerns, increasing regulation or for other reasons, the growth of UICI’s Internet-based business would be hindered. It is not possible at this time to assess the impact of the privacy provisions on UICI’s financial condition or results of operations.
In December 2000, HHS issued final regulations regarding the privacy of individually-identifiable health information. This final rule on privacy applies to both electronic and paper records and imposes extensive requirements on the way in which health care providers, health plan sponsors, health insurance companies and their business associates use and disclose protected information. Under the new HIPAA privacy rules, the Company is required to (a) comply with a variety of requirements concerning its use and disclosure of individuals’ protected health information, (b) establish rigorous internal procedures to protect health information and (c) enter into business associate contracts with other companies that use similar privacy protection procedures. The final rules do not provide for complete federal preemption of state laws, but, rather, preempt all contrary state laws unless the state law is more stringent. The Company believes that it was in material compliance with the privacy requirements imposed by HIPAA and the rules thereunder as of April 14, 2003, the date the rules became effective.
In August 2000, HHS published for comment proposed rules related to the security of electronic health data, including individual health information and medical records, for health plans, health care providers, and health care clearinghouses that maintain or transmit health information electronically. The proposed rules would require these businesses to establish and maintain responsible and appropriate safeguards to ensure the integrity and confidentiality of this information. The standards embraced by these rules include the implementation of technical and organization policies, practices and procedures for security and confidentiality of health information and protecting its integrity, education and training programs, authentication of individuals who access this information, system controls, physical security and disaster recovery systems, protection of external communications and use of electronic signatures. The final HIPAA security rules were issued by the HHS in February 2003, and the compliance date for HIPAA covered entities is April 21, 2005.
Inflation historically has had a significant impact on the health insurance business. In recent years, inflation in the costs of medical care covered by such insurance has exceeded the general rate of inflation. Under basic hospital medical insurance coverage, established ceilings for covered expenses limit the impact of inflation on the amount of claims paid. Under catastrophic hospital expense plans and preferred provider contracts, covered expenses are generally limited only by a maximum lifetime benefit and a maximum lifetime benefit per accident or sickness. Thus, inflation may have a significantly greater impact on the amount of claims paid under catastrophic hospital expense and preferred provider plans as compared to claims under basic hospital medical coverage. As a result, trends in health care costs must be monitored and rates adjusted accordingly. Under the health insurance policies issued in the self-employed market, the primary insurer generally has the right to increase rates upon 30-60 days written notice and subject to regulatory approval in some cases.
A final SOP would be effective for internal replacements occurring in fiscal years beginning after December 15, 2003, with earlier adoption encouraged. Restatement of previously issued annual financial statements is not permitted. Initial application of this SOP should be as of the beginning of an entity’s fiscal year (that is, if the SOP is adopted prior to the effective date and during an interim period, all prior interim periods of the year of adoption should be restated). The impact of implementation of the SOP, Accounting by Insurance Enterprises for Deferred Acquisition Costs on Internal Replacements Other Than Those Specifically Described in FASB Statement No. 97 on our financial position or results of operations is not expected to be material.
On July 7, 2003, the AICPA issued SOP 03-1, Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts. This SOP provides guidance on accounting and reporting by insurance enterprises for certain nontraditional long-duration contracts and for separate accounts. This SOP requires, among other things, the following: separate account presentation, interest in separate accounts, gains and losses on the transfer of assets from the general account to a separate account, liability valuation return based on a contractually referenced pool of assets or index, determining the significance of mortality and morbidity risk and classification of contracts that contain death or other insurance benefit features, accounting for contracts that contain death or other insurance benefit features, accounting for reinsurance and other similar contracts, accounting for annuitization benefits, sales inducements to contract holders and related disclosures.
This SOP is effective for financial statements for fiscal years beginning after December 15, 2003, with earlier adoption encouraged. This SOP should not be applied retroactively to prior years’ financial statements. Initial application of this SOP should be as of the beginning of an entity’s fiscal year. The impact of implementation of the SOP, Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts on our financial position or results of operations is not expected to be material.
Changes in mandated benefits, utilization rates, demographic characteristics, health care practices, provider consolidation, inflation, new pharmaceuticals/technologies, clusters of high-cost cases, the regulatory environment and numerous other factors are beyond the control of any health plan provider and may adversely affect the Company’s ability to predict and control health care costs and claims, as well as the Company’s financial condition, results of operations or cash flows. Periodic renegotiations of hospital and other provider contracts coupled with continued consolidation of physician, hospital and other provider groups may result in increased health care costs and limit the Company’s ability to negotiate favorable rates. In addition, the Company faces competitive and regulatory pressure to contain premium prices. Fiscal concerns regarding the continued viability of government-sponsored programs such as Medicare and Medicaid may cause decreasing reimbursement rates for these programs. Any limitation on the Company’s ability to increase or maintain its premium levels, design products, implement underwriting criteria or negotiate competitive provider contracts may adversely affect the Company’s financial condition or results of operations.
The Company’s insurance subsidiaries are subject to extensive regulation in their states of domicile and the other states in which they do business under statutes that typically delegate broad regulatory, supervisory and administrative powers to state insurance departments and agencies. State insurance departments have also periodically conducted and continue to conduct financial and market conduct examinations and other inquiries of UICI’s insurance subsidiaries. State insurance regulatory agencies have authority to levy monetary fines and penalties resulting from findings made during the course of such examinations and inquiries. Historically, the Company’s insurance subsidiaries have from time to time been subject to such regulatory fines and penalties. While none of such fines or penalties individually or in the aggregate have to date had a material adverse effect on the results of operations or financial condition of the Company, the Company could be adversely affected by increases in regulatory fines or penalties and/or changes in the scope, nature and/or intensity of regulatory scrutiny and review.
In December 2002, the National Association of Insurance Commissioners (NAIC) convened a special task force to review association group coverage, and the Company is aware that selected states are reviewing the laws and regulations under which association group policies are issued. The Company and its insurance company subsidiaries are also parties to several lawsuits challenging the nature of the relationship between the insurance companies and the membership associations that make available to their members the insurance companies’ health insurance products. See Note L of Notes to Consolidated Financial Statements. While the Company believes that its insurance company subsidiaries are providing association group coverage in full compliance with applicable law, changes in the Company’s relationship with the membership associations