The principal executive offices of the Company and its subsidiaries are located in 40,281 square feet of leased office space at 650 Town Center Drive, Costa Mesa, California. The lease on this facility was renewed for the period from October 1, 1995 through March 31, 2007, with a five-year option to extend. Additional offices are maintained in leased premises in Skokie, Illinois; Indianapolis, Indiana; Florham Park, New Jersey; Atlanta, Georgia; and Tulsa, Oklahoma.
The income statement data for each of the three years to the period ended December 31, 1998, and the balance sheet data at December 31, 1997 and 1998, are derived from the audited consolidated financial statements and notes thereto, which are included elsewhere in this report, and are qualified by reference to such financial statements and notes thereto. The data set forth below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Consolidated Financial Statements and Notes thereto included elsewhere in this report.
- -------- (a) Amounts have been reclassified to present the Company's property/casualty segment as discontinued operations.
(b) The increase in total assets and notes payable as of December 31, 1998 primarily reflects the acquisition of Seaboard Life Insurance Company (USA) and VASA North America, Inc. through additional borrowings under the Company's existing credit agreement. The fair value of assets acquired was $245.8 million.
During 1998, The Centris Group, Inc., (the "Company") made the decision to exit the property/casualty reinsurance market by offering its wholly owned subsidiary, USF RE INSURANCE COMPANY ("USF RE"), for sale. Accordingly, the Company discontinued its property/casualty segment and has segregated 1998 results between income from continuing operations and discontinued operations. Effective December 31, 1998 the Company adopted the provisions of SFAS No. 130, "Disclosures about Segments of an Enterprise and Related Information" and established three reportable segments (medical lines, specialty insurance and holding company). Information in this Management's Discussion and Analysis is presented for the Company's continuing reportable segments and its discontinued segment.
In January, 1997, USBenefits acquired the operations of Global Excess Holdings, Inc. ("Global") a Michigan based managing general underwriter of medical stop-loss insurance that produced approximately $30 million of medical stop-loss premiums in 1996. The results of this operation were incorporated into the medical lines segment.
USFIC is domiciled in Pennsylvania but operates out of its administrative offices in Florham Park, NJ. It is eligible to offer surplus lines coverage in 34 states, the District of Columbia and the U.S. Virgin Islands. In addition, USFIC holds admitted licenses in Pennsylvania, New York and Florida. USFIC writes both standard and surplus lines insurance on commercial and personal property/casualty risks which are marketed exclusively through managing general agents, general agents and program administrators. In 1999 USFIC will change its focus to include writing specialty risks for medically related lines of business where it can leverage existing relationships and opportunities through US Benefits and INTERRA.
The table below presents certain consolidated financial information regarding the Company's operations.
opposed to equity securities and short term investments. Increases in realized gains between years are generally a result of continuous evaluation of the investment portfolio to enhance and maintain yields and total return consistent with the Company's investment guidelines. Increases in realized gains in 1998 as compared to prior periods include the effect of positioning the USF RE subsidiary for sale by decreasing its exposure to market risk.
Income taxes as a percentage of pre-tax income fluctuate depending on the proportion of tax exempt investment income to total pre-tax income and the proportion of total income subject to state income taxes. Fluctuations in effective income tax rates between the periods presented primarily result from the tax effect of acquired companies and utilization of tax benefits and changes in valuation allowances which were available in prior periods. Tax benefits arising from the loss on disposal of discontinued operations are limited due to the effect of loss disallowance rules applicable to the divestiture of USF RE which takes the form of a sale of stock.
Net income from continuing operations for 1998 as compared to prior periods reflects a higher level of realized gains and growth of the provider excess component of the medical lines segment offset by increases in the Company's insurance expenses, primarily losses and loss adjustment expenses. Net income from continuing operations in 1997 as compared to 1996 is primarily the result of 1997 acquisitions and growth in the provider excess line offset by increases in medical lines reserves.
Net income for the 1998 period (as compared to the 1997 period) incorporates the effect of discontinuing the Company's property/casualty segment which includes a loss on disposal of $19,621,000 net of available tax benefits and includes losses from operations of the segment of $3,647,000 caused by catastrophes occurring in the 1998 period. Net income in 1997 as compared to 1996 includes the impact of increases in reserves in the medical lines segment in the third quarter of 1997 and favorable underwriting results in the property/casualty segment.
resemble a commodity financial product with significant exposures to natural catastrophic events. In 1998, the Company concluded that its capital can be deployed more efficiently by focusing on the medical lines business, where it is a market leader. Accordingly, the Company discontinued its property/casualty segment effective December 31, 1998.
The Company has signed a Letter of Intent with Folksamerica Holding Company, Inc. for the sale of USF RE for $92,500,000. The consideration is expected to be $71,750,000 in cash and an adjustable subordinated 5 year note for $20,750,000. The note, which accrues interest at the U.S. Treasury Note rate plus 50 basis points, is adjustable downward based on adverse loss development of the Company's reinsurance reserves at December 31, 1998. It is management's expectation and intention to negotiate a definitive agreement for the sale of USF RE to Folksamerica. In the event that the sale is not consummated the reinsurance subsidiary will be put in run-off. Financial information pertaining to the discontinued operations assumes a sale of USF RE under terms outlined herein.
Increases in premiums earned in 1998 over 1997 were modest as the medical stop loss premium volume was off 2% as a result of pricing and underwriting actions taken in late 1997 to support the underwriting profitability of this line of business. These actions included a focus on larger groups where there is more predictability and better opportunities to write profitable business, specific rating actions in those parts of the country where managed care is not firmly established and a reduction of business from producers whose book of business has been less profitable. Offsetting the medical stop loss result, provider excess premium volume was up 35% over the prior year and now represents 12% of total medical lines premium volume. Increases in commissions and fees at a rate in excess of premium growth results from Interra's operations which produces fee income without the corresponding risk premium. Increases in revenues for 1997 as compared to 1996 are primarily due to additional medical stop-loss business from the acquisition of Global in January 1997 combined with the growth of the provider excess line.
The change in medical lines pre-tax income between the 1997 and 1996 periods primarily reflects third quarter 1997 additions of $8 million to medical lines reserves resulting from the Company's continuous review of its reserves, which indicated increases in the severity and frequency of specific and aggregate claims in the second half of 1996 and the first half of 1997.
Policy acquisition expenses vary due to the level of production activity, mix of business and market conditions. Policy acquisition costs include producer commissions and bonuses, unallocated loss adjustment expenses and fees under the Company's contracts with Continental. The Company added a loss ratio modifier to its producer bonus arrangement in 1998, which combined with the other pricing actions described, had the effect of moderating the growth of policy acquisition costs in 1998. Increases in general and administrative expenses in 1998 primarily result from including Interra's activities for a full year. Increases in general and administrative expenses in 1997 over 1996 related to the acquired Global operations.
In the specialty lines segment, revenue growth in 1998 was achieved as a result of a redirection in the Company's operations. In late 1997 USFIC, a wholly owned subsidiary of the Company, began to focus on
The Company evaluates the financial condition of potential retrocessionaires to determine whether to cede premium to such companies. Retrocession agreements are placed with unaffiliated companies which management believes are financially secure and experienced in this type of business. Reinsurance recoverables are monitored continually, and retrocessionaires who are not qualified in the states of domicile of the Company's insurance carriers are required to post security in the amount of their estimated liability.
In 1998, the Company decreased its exposure to bond market fluctuations resulting in higher levels of realized gains in its fixed income portfolio. Realized gains in 1997 were due to the Company lessening its exposure to stock market volatility resulting in $10,213,000 in pre-tax gains primarily from its equity portfolio. Interest expense declined in 1998 and 1997 as the Company made principal payments on its outstanding bank loan. Interest expense will increase in 1999 due to the purchase of the VASA group which was funded by an increase in the Company's Credit Agreement with Fleet National Bank.
The Company utilizes cash from operations and maturing investments to meet its insurance obligations to policyholders and claimants, as well as to meet operating costs. Primary sources of cash from operations include premium collections, commissions and fees and investment income. The principal uses of cash from operations are for premium payments to insurance companies, payments of claims under reinsurance and insurance contracts, and operating expenses such as salaries, commissions, taxes and general overhead. The Company secured a $25,000,000 bank loan in December 1994 which was increased to $75,000,000 by December 1998. Of this amount, the Company contributed $30,500,000 million to the surplus of its insurance group prior to 1997 to support additional growth and borrowed $42,700,000 for the purchase of Seaboard Life and the VNA companies in 1998. At December 31,1998, $72,550,000 was outstanding under the bank loan. The Company is required to pay down the loan to $47,550,000 by June 30, 1999. Proceeds from the expected sale of USF RE, or an extraordinary dividend from USF RE in the event of a runoff scenario, will be used to meet this obligation. The Credit Agreement with the Company's lender contains certain covenants, restrictions and dividend payment limitations and call provisions in the event of non-compliance. The Company notified its lender, Fleet National Bank, that it would not meet one of its debt covenants related to the surplus level of Seaboard Life and VNAIC. The covenant was based on best estimates of the surplus of these companies when it was adopted in November, 1998. An audit of these companies, as required by the Stock Purchase Agreement to determine the purchase price, revealed that statutory surplus was less than expected in the covenant calculation. The Company expects to increase the surplus of Seaboard Life by a capital contribution in the first quarter of 1999 to cure this item and has received a waiver from Fleet National Bank for this item as of December 31, 1998. The Company also notified its lender that it is in non-compliance with one of its debt covenants related to the maintenance of a minimum level of stockholders' equity of the Company. The charge of $19,621,000 taken by the Company in connection with discontinuing the property/casualty segment through the expected sale of USF RE, caused the Company's equity to drop below $100,000,000. The Company believes that its 1999 operating results will be adequate to cure this item and has been informed that it will receive a waiver for this item upon completion of the definitive agreement for the sale of USF RE. In the event that the Company's actual results are below 1999 estimates, it has the option of paying down the debt utilizing the remaining expected free cash of $45,000,000 from the sale of USF RE and/or renegotiating this individual covenant. In the event that Company expectations to cure non-compliance with this covenant are not met, Fleet National Bank retains the option to call the note as prescribed in the Credit Agreement. The Company has received no indication that Fleet National Bank intends to call the debt. The Company was otherwise in compliance with its debt covenants at December 31, 1998. See Footnote 8 to the Company's Consolidated Financial Statements appearing elsewhere in this Form 10-K for additional discussion.
The Company anticipates that it will continue to generate sufficient cash flow from operations to cover its short-term (1-18 months) and long-term (18 months to 3 years) liquidity needs. While the Company currently has no immediate plans for significant capital outlays, from time to time it contemplates acquisition opportunities that complement its business operations. The sale of USF RE is expected to generate free cash of approximately $45,000,000 after expenses and the required pay down of the Company's debt noted above.
During 1998, the investment portfolio grew by 6% prior to the acquisition of the Seaboard Life and VNA companies on December 31, 1998 as a result of operating cash flows. The acquisition of Seaboard Life and VNAIC added $55,893,000 to the invested assets of the Company. The portfolio currently reflects an allocation of approximately 96% in fixed income investments, both taxable and tax preferenced, with an "AA" average fixed income portfolio rating, and 4% in equities. All such securities are carried at quoted market values at the latest balance sheet date. The portfolio does not contain any real estate investments, derivatives, high yield bonds, private placements or mortgage loans. Assets held for resale include fixed income securities and mortgage loans.
These assets support the reserves of Seaboard Life's individual life and annuity business. Such business is in the process of being reinsured on a 100% indemnity basis and will not be part of the Company's operations.
USF RE, USFIC, Seaboard Life and VNAIC are restricted in the annual amount of dividends which they may pay to the Company without receiving prior approval from the Commissioner of Insurance in the respective state of domicile. During 1999, the amount which may be paid without such prior approval by Seaboard Life, VNAIC and USFIC is $5,709,000. In the event that USF RE is not sold an additional $9,365,000 is available for dividend purposes. Since the Company's inception, it has not received any dividends from any of its insurance company subsidiaries.
The Company has a formal plan in place to evaluate and implement solutions to year 2000 related problems which focuses on eight separate compliance issues: (i) the ability of the Company's systems to handle the transition to the Year 2000; (ii) the ability of the Company's customers and business partners to handle the transition to the Year 2000; (iii) the ability of the Company's vendors and service providers to handle the transition to the Year 2000; (iv) the Company's disclosure of its Year 2000 compliance efforts to investors and regulators; (v) the Company's potential exposure to losses from Year 2000 claims under its reinsurance contracts and insurance policies; (vi) the Company's ability to secure and maintain insurance coverages protecting the Company against Year 2000 losses; (vii) budget and resource issues; and (viii) development and implementation of a Contingency Plan.
reinsurance operations and its medical lines operations. The Company believes that all of its internal systems have reached a state of year 2000 readiness and expects to continue testing its systems during 1999.
In the event that the Company's systems do not function as expected and the Company has to implement its contingency plan, the Company does not believe there will be a material impact on the Company's operations. Critical operational tasks which could be negatively impacted include: insured name clearance, quote issuance, binder issuance, policy contract issuance, claims processing, generation of management reports, accounting, and communications with clients. Critical operational task data currently being produced is backed-up daily and stored at an off-site facility and will be available for processing by either an outside third party vendor or by the Company on a manual basis or on off-the-shelf software which could be readily purchased.
The Company is developing contingency plans for its primary operating units and critical computer operations to address issues that may arise due to an inability of the Company's systems or the systems of one or more of its business partners, to process data into the 21st century. Strategies have been developed to include identification of and management of resources which can be operated in reduced or minimal modes, appropriate recovery processes and use of alternate methods to process data. For example, insured name clearance can be accomplished using copies of data currently being compiled and stored off-premises, quote issuance can be performed manually, and binder issuance and policy issuance can also be performed manually, so long as the Company has access to photocopy systems and can maintain a log, either via spreadsheet or manual listing. If necessary, claims could be processed and paid manually and the data could be input into its systems once any problems are resolved. Premiums, commissions, and other financial data could be processed on a spreadsheet and checks typed on a manual basis. Alternatively, record keeping could be kept in spreadsheet format, and the Company may rely on the systems of one or more of its affiliated companies to perform some of the functions affected.
As mentioned, the Company is working to make certain that its business partners are aware of the potential risks and that they are taking steps to make certain their systems are Year 2000 compliant. In the event a vendor, supplier or service provider cannot certify or establish Year 2000 compliance status to the Company by October 1, 1999, the Company will contract with alternative sources for products and services. Further, the failure of one of the Company's business partners to achieve compliance, or a finding that its systems do not function as expected, may have an impact on the Company. The Company has communicated with its business
Some of the statements included within this Annual Report on Form 10-K, including but not limited to Management's Discussion and Analysis of Financial Condition and Results of Operations, Condensed Consolidated Financial Statements and related notes thereto, which are not historical facts may be considered to be forward looking statements within the meaning of Section 29A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, and therefore are subject to certain risks and uncertainties which could cause the actual results to differ materially from those suggested by such statements. Such risks and uncertainties include, but are not limited to the following: catastrophic losses or a material aggregation of such losses in the Company's insurance lines; changes in federal or state law affecting an employer's ability to self-insure or other adverse regulatory changes; the adequacy of the Company's reinsurance program; general economic conditions in this country or abroad; adverse developments in the securities markets and their impact on the Company's investment portfolio; the effects of competitive market pressures within the medical lines or property/casualty marketplaces; the effect of changes required by generally accepted accounting practices or statutory accounting practices; failure of the company's computer systems to perform in an appropriate manner following year 2000 remediation efforts; failure of the company's trading partners, customer or key vendors to make their computer systems year 2000 compliant in a timely manner; and other risks which are described from time to time in the company's filings with the Securities and Exchange Commission. The words "believes", "anticipates", "expects" and similar expressions are intended to identify forward looking statements.