The Company’s principal offices are located at 801 Cherry Street, Unit 33, 3100 Burnett Plaza, Fort Worth, Texas. The lease for this facility expires February 28, 2011. The Company’s warehouse and storage facilities are located at 7333 Jack Newell Boulevard North, Fort Worth, Texas, under a lease agreement which expires in October, 2005. Precision Dialing Services (“PDS”), the Company’s wholly-owned telemarketing subsidiary, maintains its facility at 1100 East Campbell Road, Richardson, Texas, under a lease agreement which expires in March, 2009. The Company believes that its leased facilities will meet its existing needs and that the leases can be renewed or replaced on reasonable terms if necessary.
Business Overview. USHEALTH Group, Inc. (“USHEALTH” or the “Company”), formerly Ascent Assurance, Inc., is the successor to a Delaware company incorporated in 1982 as an insurance holding company. USHEALTH, through its applicable subsidiaries, is principally engaged in the development, marketing, underwriting, and administration of medical expense and supplemental health insurance products. The Company’s revenues result primarily from premiums and fees from the insurance products sold by its wholly-owned subsidiaries National Foundation Life Insurance Company (“NFL”), Freedom Life Insurance Company of America (“FLICA”), National Financial Insurance Company (“NFIC”) and American Insurance Company of Texas (“AICT”), and together with NFL, NFIC and FLICA, collectively, the “Insurance Subsidiaries”, and marketed by NationalCare® Marketing, Inc. (“NCM”) and AmeriCare Benefits, Inc. (“ACB”), also wholly-owned subsidiaries. The Company, through applicable subsidiaries, also derives fee and service revenue from (i) tele-marketing services, (ii) renewal commissions for prior year sales of both affiliated and unaffiliated insurance products, and (iii) commissions on the sale of the benefits of unaffiliated membership benefit programs. See Item 1 - “Business” for a discussion of the Company’s marketing distribution system, health insurance products, and market competition.
The following discussion provides management’s assessment of operating results and material changes in financial position and liquidity for the Company. This discussion is based upon the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. Certain reclassifications of prior years’ amounts have been made to conform with the 2004 presentation.
Important factors known to management that could cause actual results to differ materially from those contemplated by the forward-looking statements in this Report include, but are not limited to:
any limitation imposed on the Insurance Subsidiaries’ ability to control the impact of rising health care costs and rising medical service utilization rates through product and benefit design, underwriting criteria, premium rate increases, utilization management and negotiation of favorable provider contracts;
the impact of changing health care trends on the Insurance Subsidiaries’ ability to accurately estimate claim and settlement expense reserves;
USHEALTH’s ability to make additional investment in its Insurance Subsidiaries in the form of capital contributions, if needed, in order for such subsidiary to comply with regulatory capital or debt covenant requirements;
default by issuers of fixed maturity investments owned by the Insurance Subsidiaries; and
The Company’s accounting policies are more fully described in Note 2 of the Consolidated Financial Statements at Item 8. The Company believes that the following discussion addresses the Company’s most significant accounting policies, which are those that are most important to the portrayal of the Company’s financial condition and results of operations and require management’s most difficult, subjective and complex judgments. The Company’s significant accounting policies relate to revenue recognition, investments, agent receivables, deferred policy acquisition costs, deferred tax assets, claim reserves, future policy benefit reserves, reinsurance and statutory accounting practices. The application of these accounting policies requires management to make significant estimates and judgments that affect the reported amounts of assets, liabilities and expenses in the Company’s consolidated financial statements. Such estimates and judgments are based on historical experience, changes in laws and regulations, observance of industry trends, and various information received from third parties. While the estimates and judgments associated with the application of these accounting policies may be affected by different assumptions or conditions, the Company believes the estimates and judgments associated with the reported consolidated financial statement amounts are appropriate in the circumstances. Actual results could differ materially from these estimates under different assumptions or conditions.
Revenue Recognition. Premium revenues from insurance contracts are recognized when due from policyholders. Policies for which premium has not been received within the applicable grace period from the due date are canceled. Fee and service income is recognized when earned, the services have been provided and collectibility is reasonably assured.
Investment policy is determined by the applicable Board of Directors of the Company and each of the Insurance Subsidiaries. The Company’s current investment policy is to balance its portfolio between long-term and short-term investments so as to achieve long-term returns consistent with the preservation of capital and maintenance of adequate liquidity to meet the payment of the Company’s policy benefits and claims. The current schedule of the Company’s invested asset maturities corresponds with the Company’s expectations regarding anticipated cash flow payments based on the Company’s policy benefit and claim cycle, which the Company believes is medium term in nature. The Company invests primarily in fixed-income securities of the U.S. Government and its related agencies, investment grade fixed-income corporate securities and mortgage-backed securities. The Company’s entire fixed maturity portfolio is classified as “available for sale” and carried at market value.
The following table provides information on the Company’s fixed maturity investments, in thousands, as of December 31:
Ratings are the lower of those assigned primarily by Standard & Poor’s and Moody’s, when available, and are shown in the table using the Standard & Poor’s rating scale. Unrated securities are assigned ratings based on the applicable NAIC designation or the rating assigned to comparable debt outstanding of the same issuer. NAIC 1 fixed maturity securities have been classified as “A” and NAIC 2 fixed maturity securities have been classified as “BBB”.
The NAIC assigns securities quality ratings and uniform prices called “NAIC Designations” based upon the rating agencies’ ratings, which are used by insurers when preparing their annual statutory reports. The NAIC assigns designations to publicly-traded as well as privately-placed securities. The ratings assigned by the NAIC range from Class 1 (highest quality rating) to Class 6 (lowest quality rating). At December 31, 2004, 66.6%, 31.1% and 2.3% of the market value of the Company’s fixed maturity securities were rated NAIC 1, NAIC 2, and NAIC 3 and below, respectively.
The Company monitors the financial condition and operations of the securities rated below investment grade and of certain investment grade securities on which there are concerns regarding credit quality. In evaluating fixed maturities to determine whether any of the unrealized losses are other than temporary, management’s assessments as to the nature of declines in fair values are based upon historical operating trends, business prospects, status of the industry in which the Company operates, analyst ratings on the issuer and sector, the quality of the investments, the severity and duration of the unrealized losses and the Company’s ability or intent to hold the investments. If fair value is less than the carrying amount and the decline in value is determined to be other than temporary, an appropriate write-down is recorded.
Agent Receivables. In the ordinary course of business, a subsidiary of USHEALTH advances commissions on policies written by its general agencies and their agents. Net agent receivables were $3.5 million and $4.5 million at December 31, 2004 and 2003, respectively. Such subsidiary is reimbursed for these advances from the commissions earned over the respective policy’s life. In the event that policies lapse prior to the time the subsidiary has been fully reimbursed, the general agency or the individual agents, as the case may be, are responsible for reimbursing the outstanding balance of the commission advance. A reserve for uncollectible agent’s balances is routinely established based upon historical experience and projected commission earnings. As of December 31, 2004 and 2003, the allowance for uncollectible commission advances was $3.6 million and $3.4 million, respectively.
Deferred Tax Asset. The Company’s net deferred tax asset before valuation allowance at December 31, 2004 and 2003 was $17.8 million and $18.4 million, respectively. As the Company reported substantial pre-tax losses for the year ended December 31, 2000, principally due to losses from major medical products issued prior to July 2000, applicable GAAP literature required that the Company’s net deferred tax asset be fully reserved as of December 31, 2000. The Company reported pre-tax losses for the years ended December 31, 2004, 2003 and 2002. Accordingly, the Company has reported no income tax benefit for 2004, 2003, and 2002 and the net deferred tax asset remains fully reserved at December 31, 2004. Applicable GAAP literature provides that the deferred tax asset valuation allowance may be eliminated once the Company achieves sustained profitability, as defined, and management concludes that it is more likely than not, that all or some portion of the deferred tax asset will be realized.
At December 31, 2004, the Company had available tax net operating loss carryforwards (“NOLs”) of $62.1 million that expire between 2012 and 2019. The establishment of a valuation allowance for GAAP does not impair the availability of NOLs for utilization in the Company’s federal income tax return.
Claim Reserves. Claim reserves are established by the Insurance Subsidiaries for benefit payments which have already been incurred by the policyholder but which have not been paid by the applicable Insurance Subsidiary. Claim reserves totaled $24.6 million at December 31, 2004 as compared to $26.2 million at December 31, 2003. The process of estimating claim reserves involves the active participation of experienced actuaries with input from the underwriting, claims, and finance departments. The inherent uncertainty in estimating claim reserves is increased when significant changes occur. Changes impacting the Insurance Subsidiaries include: (1) changes in economic conditions; (2) changes in state or federal laws and regulations, particularly insurance reform measures; (3) writings of significant blocks of new business and (4) significant changes in claims payment patterns. Because claim reserves are estimates, management monitors reserve adequacy over time, evaluating new information as it becomes available and adjusting claim reserves as necessary. Such adjustments are reflected in current operations.
Management considers many factors when setting reserves including: (1) historical trends; (2) current legal interpretations of coverage and liability; (3) loss payments and pending levels of unpaid claims; and (4) product mix. Based on these considerations, management believes that adequate provision has been made for the Company’s claim reserves. Actual claims paid may deviate, perhaps substantially, from such reserves. For a reconciliation of claim reserves, see Note 8 to the Consolidated Financial Statements at Item 8.
Future Policy Benefit Reserves. Policy benefit reserves are established by each of the Insurance Subsidiaries for benefit payments that have not been incurred, but are estimated to be incurred, in the future. Policy benefit reserves totaled $53.5 million at December 31, 2004 as compared to $54.9 million at December 31, 2003. Policy benefit reserves are calculated according to the net level premium reserve method and are equal to the discounted present value of the applicable Insurance Subsidiary’s expected future policyholder benefits minus the discounted present value of its expected future net premiums.
Policy benefit reserve requirements are also interrelated with product pricing and profitability. Each of the applicable Insurance Subsidiaries must price their respective products at a level sufficient to fund their policyholder benefits and still remain profitable. Because such claim and policyholder benefits represent the single largest category of its operating expenses, inaccuracies in the assumptions used to estimate the amount of such benefits can result in the Insurance Subsidiaries failing to price their respective products appropriately and to generate sufficient premiums to fund the payment thereof.
At December 31, 2004, approximately $1.0 million of the $2.4 million recoverable from reinsurers is related to paid losses. Of this balance, all was recoverable from reinsurers rated “A” or higher by the A.M. Best Company.
in 2004 of ($1,369) (1) (2,127 ) (1,066 ) (1,425 )
Ratios are calculated as a percent of premiums with the exception of the general and administrative expense ratio, which is calculated as a percent of premiums plus other insurance revenues.
Effective September 1, 2004, Benjamin M. Cutler was appointed Chairman and Chief Executive Officer of the Company. In connection with Mr. Cutler’s employment agreement, the Company recorded a $2.0 million liability for deferred compensation and $308,000 in employment expenses. In addition, the Company paid severance expense of approximately $727,000 to its former Chairman.
On March 15, 2004, USHEALTH’s shareholders approved an amendment to the Company’s Certificate of Incorporation to increase the authorized number of shares of common stock to 75 million shares from 30 million shares. The approval of this amendment resulted in the automatic conversion of all 37,504 outstanding shares of the Company’s convertible participating Series B preferred stock into 43,995,026 shares of common stock and eliminated the requirement to pay preferred stock dividends. As a result, preferred stock dividends of $430,000 accrued through March 15, 2004 were credited to capital in excess of par value and had no impact on total stockholders’ equity.
The results of operations for 2003 are not comparable to 2002 due to the third quarter 2003 implementation of Statement of Financial Accounting Standards No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity (“SFAS 150”). Pursuant to SFAS 150, dividends of $1.9 million accrued subsequent to June 30, 2003 on the Company’s Series A Preferred stock outstanding were classified as interest expense, a component of pre-tax income, instead of a direct deduction to common stockholders’ equity. Excluding the impact of SFAS 150, the $1.4 million improvement in net income for 2003 as compared to 2002 was comprised principally of a $0.9 million increase in insurance operating results attributable to a 3.0 percentage point decline in the benefits and claim ratio.
Premiums. The Insurance Subsidiaries’ premium revenue is derived principally from the following medical expense reimbursement products: comprehensive major medical, hospital/surgical medical expense, supplemental products including specified disease coverage and Medicare supplement. Comprehensive major medical products are generally designed to reimburse insureds for eligible expenses incurred for hospital confinement, surgical expenses, physician services, outpatient services, and the cost of laboratory and diagnostic services, as well as inpatient medicines. Hospital surgical medical expense products are similar to comprehensive major medical products with respect to benefits for inpatient services, except that deductibles and coinsurance provisions are generally higher. However, benefits for outpatient services are generally more limited under hospital/surgical medical expense coverage than comprehensive major medical coverage. Supplemental products include blanket group accident coverages, blanket group hospital daily indemnity coverages, as well as individual indemnity policies for hospital confinement and convalescent care for treatment of specified diseases and “event specific” individual policies, which provide fixed benefits or lump sum payments directly to the insured upon diagnosis of certain types of internal cancer or heart disease. Prior to 1998, the Insurance Subsidiaries also underwrote Medicare supplement products and continue to receive renewal premiums from such policies.
Total premiums decreased by (9.2%) in 2004 and (8.5%) in 2003 as compared to the corresponding prior year period. Major medical premiums declined due to lower new business sales resulting from delays in new product deliveries to NCM and a disciplined pricing philosophy focused upon profitability. In addition, supplemental specified disease and Medicare supplement premiums declined due to normal lapsing of policies.
Benefits and Claims. Benefits and claims are comprised of (1) claims paid, (2) changes in claim reserves for claims incurred (whether or not reported), and (3) changes in future policy benefit reserves (see Financial Condition - “Claims Reserves” and “Future Policy Benefit Reserves”). The 2.1 percentage point improvement in the ratio of consolidated benefits and claims to consolidated premiums in 2004 as compared to 2003 and the 3.0 percentage point improvement in 2003 as compared to 2002 is principally attributable to the Company’s adherence to a disciplined pricing philosophy for both new major medical product sales and in force insurance policies and the accelerated lapsing of unprofitable major medical products marketed prior to July 2000.
Commissions. The commissions to premiums ratio decreased by 0.7 and 0.8 percentage points in 2004 and 2003, respectively, as compared to the corresponding prior year as a result of the decrease in first year major medical premiums. Commission rates on first year premiums are significantly higher than those for renewal premiums.
Conversion of Related Party Preferred Stock. On March 15, 2004, USHEALTH’s shareholders approved an amendment to the Company’s Certificate of Incorporation to increase the authorized number of shares of common stock to 75 million shares from 30 million shares. The approval of this amendment resulted in the automatic conversion of all 37,504 outstanding shares of the Company’s Series B convertible participating preferred stock (“Series B Preferred Stock”) into 43,995,026 shares of common stock. All outstanding shares of the Series B Preferred Stock were held by Special Situations Holdings, Inc. - Westbridge (“SSHW”), the Company’s largest shareholder. The conversion of the Series B Preferred Stock increased the ownership percentage of SSHW in the Company’s common stock to approximately 93% from 49%.
Related Party Financing. USHEALTH received debt financing to fund an $11 million capital contribution to FLICA in April 2001 from Credit Suisse First Boston Management LLC, (“CSFBM”), which is an affiliate of SSHW (USHEALTH’s largest common stockholder), and a subsidiary of Credit Suisse First Boston LLC (“CSFB”). The Credit Agreement relating to that loan (“CSFBM Credit Agreement”) provided USHEALTH with total loan commitments of $11 million, all of which were drawn in April 2001. Under restructured terms effective December 31, 2003, the loan bears interest at a rate of 6% per annum and matures in March 2010. Absent any acceleration following an event of default, USHEALTH may elect to pay interest in kind by issuance of additional notes. During 2004, USHEALTH issued approximately $958,000 in additional notes for payment of interest in kind which increased the notes payable balance to CSFBM at December 31, 2004 to approximately $16.2 million. USHEALTH’s obligations to CSFBM are secured, pursuant to a guaranty and security agreement and pledge agreements, by substantially all of the assets of USHEALTH and its subsidiaries (excluding the capital stock and the assets of AICT, FLICA, NFL, NFIC, NCM, Ascent Funding, Inc. and Ascent Management,Inc., some or all of which is pledged as collateral for bank financing described below). USHEALTH’s subsidiaries (other than those listed above) have also guaranteed USHEALTH’s obligations under the CSFBM Credit Agreement. At December 31, 2004, there were no events of default.
AFI’s obligations under the Credit Agreement are secured by liens upon substantially all of AFI’s assets. AFI’s principal assets at December 31, 2004 are net agent receivables of $3.5 million. In addition, NCM, ACB and USHEALTH have guaranteed AFI’s obligation under the Credit Agreement, and have pledged all of the issued and outstanding shares of the capital stock of AFI, NFL, and FLICA as collateral for those guaranties (the “Guaranty Agreements”). As of December 31, 2004, there were no events of default under the Credit or Guaranty Agreements.
The following table provides information on the Company’s known contractual obligations, in thousands, as of December 31, 2004:
Excludes interest at a rate equal to 6% that may be paid in cash or in kind by issuance of additional notes.
We have audited the accompanying consolidated balance sheets of USHEALTH Group, Inc., formerly Ascent Assurance, Inc., (“the Company”) as of December 31, 2004 and 2003, and the related consolidated statements of operations, comprehensive (loss) income, changes in stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2004. Our audits also included the financial statement schedules listed in the Index at Item 15(a)(2). 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.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of USHEALTH Group, Inc., at December 31, 2004 and 2003, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.
As discussed in Note 2 to the consolidated financial statements, effective July 1, 2003, the Company adopted the provisions of Statement of Financial Accounting Standards No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.”
Property and equipment, net of accumulated depreciation of $4,891 and $5,000 1,942
operations per common share $ (0.02 ) $ (0.31 ) $ (0.42 )
Unrealized holding (loss) gain arising during period (94 ) (160 ) 3,490
Decrease in policy liabilities and accruals (2,956 ) (10,491 ) (7,215 )
USHEALTH Group, Inc. (“USHEALTH”), formerly Ascent Assurance, Inc., is the successor to a Delaware company originally incorporated in 1982 as an insurance holding company. USHEALTH, through its applicable subsidiaries, is engaged in the development, marketing, underwriting and administration of medical expense and supplemental health insurance products, primarily to self-employed individuals and small business owners.
Basis of Presentation. The consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) and include the accounts of USHEALTH Group, Inc. and its subsidiaries. All significant inter-company accounts and transactions have been eliminated. Certain reclassifications of prior years’ amounts have been made to conform to the 2004 financial statement presentation.
Deferred Policy Acquisition Costs (“DPAC”). Policy acquisition costs consisting of commissions and other policy issue costs, which vary with and are primarily related to the production of new business, are deferred and amortized over periods not to exceed the estimated premium-paying periods of the related policies. Also included in Other Assets is the value of business acquired. The amortization of these costs is based on actuarially estimated future premium revenues, and the amortization rate is adjusted periodically to reflect actual experience. Projected future levels of premium revenue are estimated using assumptions as to interest, mortality, morbidity and withdrawals consistent with those used in calculating liabilities for future policy benefits.
Property and Equipment. Property and equipment is stated on the basis of cost and consists primarily of furniture, fixtures, leasehold improvements and software. Depreciation is computed principally by the straight-line method for financial reporting purposes using estimated useful lives of 3 to 10 years.
Claim Reserves. Claim reserves represent the estimated liabilities on claims reported plus claims incurred but not yet reported. The process of estimating claim reserves involves the active participation of experienced actuaries with input from the underwriting, claims, and finance departments. The inherent uncertainty in estimating claim reserves is increased when significant changes occur. Changes impacting the Insurance Subsidiaries include: (1) changes in economic conditions; (2) changes in state or federal laws and regulations, particularly insurance reform measures; (3) writings of significant blocks of new business and (4) significant changes in claims payment patterns. Because claim reserves are estimates, management monitors reserve adequacy over time, evaluating new information as it becomes available and adjusting claim reserves as necessary. Such adjustments are reflected in current operations.
Federal Income Taxes. The Company records income taxes based on the asset and liability approach, which requires the recognition of deferred tax liabilities and assets for the expected future tax consequence of temporary differences between the carrying amounts and the tax basis of assets and liabilities. The tax effect of future taxable temporary differences (liabilities) and future deductible temporary differences (assets) are separately calculated and recorded when such differences arise. A valuation allowance, reducing any recognized deferred tax asset, must be recorded if it is determined that it is more likely than not that such deferred tax asset will not be realized. The net deferred tax asset at December 31, 2004 and 2003 is fully reserved as discussed at Note 10.
Basic and diluted loss per share from discontinuedoperations $ (0.05 ) $ (0.17 ) $ (0.22 )
the ability of the Company to fund competitive commission advances to its agents from internally generated cash flow or external financing;
Change in Accounting Estimates. During the third quarter of 2003, the Company redetermined the estimated useful life of certain software programs used by the Company to manage policyholder data. Effective July 1, 2003, the original estimated life was extended by twenty-four months, reducing software amortization expense by approximately $276,000 for the year ended December 31, 2003. The reduction in loss per basic and diluted share outstanding was approximately $0.04 for the year ended December 31, 2003.
CSFB Financing. USHEALTH received debt financing to fund an $11 million capital contribution to FLICA in April 2001 from Credit Suisse First Boston Management LLC (“CSFBM”), which is an affiliate of SSHW (USHEALTH’s largest stockholder.) The credit agreement relating to that loan (“CSFBM Credit Agreement”) provided USHEALTH with total loan commitments of $11 million, all of which were drawn in April 2001. Under reconstructed terms effective December 31, 2003, the loan bears interest at a rate of 6% per annum and matures in March 2010.
USHEALTH’s obligations to CSFBM are secured, pursuant to a guarantee and security agreement and pledge agreements, by substantially all of the assets of USHEALTH and its subsidiaries (excluding the capital stock and the assets of AICT, FLICA, NFL, NFIC, NCM, Ascent Funding, Inc. and Ascent Management,Inc., some or all of which is pledged as collateral for bank financing described below). USHEALTH’s subsidiaries (other than those listed above) have also guaranteed USHEALTH’s obligations under the CSFBM Credit Agreement. Under this agreement, the Company is required to meet certain restrictive requirements including minimum statutory capital and surplus, and RBC ratios for its Insurance Subsidiaries, minimum net worth and other customary covenants. At December 31, 2004, there were no events of default.
Bank Financing. The majority of commission advances to NCM’s and ACB’s agents are financed through Ascent Funding, Inc. (“AFI”), an indirect wholly owned subsidiary of USHEALTH. On December 31, 2003, AFI entered into a Credit Agreement (the “Credit Agreement”) with Frost National Bank (“Frost”) that provides AFI with a $3.0 million revolving loan facility, the proceeds of which are used to purchase agent advance receivables from NCM and other affiliates. As of December 31, 2004 and 2003, $250,000 and $500,000, respectively, were outstanding under the Credit Agreement. The Credit Agreement as amended matures on January 15, 2007, at which time the outstanding principal and interest will be due and payable.
The amortized cost and estimated market value of investments in available-for-sale fixed maturities as of December 31, 2004, are shown below summarized by year to contractual maturity. Mortgage-backed securities are listed separately. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalties.
Net unrealized appreciation on investments at December 31, 2003 consists of gross unrealized gains of $4 million and gross unrealized losses of $1 million. Gross unrealized losses consist of thirty-eight issues of investment-grade fixed maturities with $26.2 million fair value with unrealized losses of $0.9 million that have been in an unrealized loss position for less than on year and four issues of fixed maturities with $1.5 million fair value with unrealized losses of $0.1 million that have been in an unrealized loss position for one year or more.
Proceeds from sales and maturities of investments in fixed maturity securities were approximately $16.4 million, $69.2 million and $57.2 million for 2004, 2003 and 2002 respectively. Gross gains of $0.2 million and gross losses of ($0.1) million were realized on fixed maturity investment sales during 2004. Gross gains of $0.7 million and gross losses of ($0.5) million were realized on fixed maturity investment sales during 2003. Gross gains of $1.6 million and gross losses of ($1.8) million were realized on fixed maturity investment sales during 2002. The basis used in determining the cost of securities sold was the specific identification method.
Future policy benefits for Accident and Health insurance products have been calculated using assumptions (which generally contemplate the risk of adverse deviation) for lapses, interest, mortality and morbidity appropriate at the time the policies were issued.
Included in reinsurance recoverables on claim reserves is approximately $1.0 million, $1.4 million, and $0.5 million relating to paid claims as of December 31, 2004, 2003 and 2002, respectively.
The provision for income taxes is calculated as the amount of income taxes expected to be payable for the current year plus (or minus) the deferred income tax expense (or benefit) represented by the change in the deferred income tax assets and liabilities at the beginning and end of the year. The effect of changes in tax rates and federal income tax laws are reflected in income from continuing operations in the period such changes are enacted. USHEALTH incurred and recorded a total federal alternative minimum tax liability of approximately $31,000 in 2004. No federal income taxes were paid or incurred in 2003 or 2002.
Realization of the Company’s deferred tax asset is dependent upon the return of the Company’s operations to sustained profitability. However, projections of future profitability are significantly discounted when evaluating the recoverability of deferred tax assets and do not overcome the negative evidence of cumulative losses. Accordingly, the Company has recorded a 100% deferred tax asset valuation allowance at December 31, 2004 and 2003.
At both December 31, 2004 and 2003 NFL had approximately $7.8 million in its shareholders surplus account from which it could make distributions to the Company without incurring any federal tax liability. The amount of dividends that may be paid by NFL to the Company is limited by statutory regulations.
At December 31, 2004 the Company and its wholly-owned subsidiaries have aggregate net operating loss carryforwards of approximately $62.1 million for regular tax and $62.2 million for alternative minimum tax purposes, which will expire in 2012 through 2019.
The following states where the companies are licensed require greater amounts of capital and surplus: California $2.5 million of capital and $2.5 million of surplus, Michigan $7.5 million of aggregate capital and surplus and Nebraska and Tennessee $1 million of capital and $1 million of surplus. Accordingly, the minimum aggregate statutory capital and surplus NFL, FLICA, NFIC and AICT must each maintain equals $5 million, $7.5 million, $5 million and $2 million, respectively. At December 31, 2004, aggregate statutory capital and surplus for NFL, FLICA, NFIC, and AICT was approximately $9.0 million, $9.4 million, $1.7 million and $1.9 million, respectively. Although NFIC’s capital and surplus was less than $5 million and AICT’s capital and surplus was less than $2 million at December 31, 2004, NFIC and AICT voluntarily ceased writing new business effective December 15, 1997. Moreover, the capital and surplus of NFIC and AICT exceeds the minimum requirements of their state of domicile, Texas. AICT is wholly-owned by NFIC. Accordingly, statutory capital and surplus of NFIC includes the statutory capital and surplus of AICT.
In December 1992, the NAIC adopted the Risk-Based Capital for Life and/or Health Insurers Model Act (the “Model Act”). The Model Act provides a tool for insurance regulators to determine the levels of statutory capital and surplus an insurer must maintain in relation to its insurance and investment risks and whether there is a need for possible regulatory attention. The Model Act (or similar legislation or regulation) has been adopted in states where the Insurance Subsidiaries are domiciled. The Model Act provides four levels of regulatory attention, varying with the ratio of the insurance company’s total adjusted capital (defined as the total of its statutory capital and surplus, asset valuation reserve and certain other adjustments) to its authorized control level risk-based capital (“RBC”):
A reconciliation of combined capital and surplus, and combined net income (loss) as reported on a statutory basis by the Company’s Insurance Subsidiaries to the Company’s consolidated GAAP stockholders’ equity and net loss is as follows:
Deferred acquisition costs, net of amortization (1,119 ) (727 ) (11 )
Effective September 1, 2004, Benjamin M. Cutler, former Chairman of Assurance Health (previously Fortis Health), was appointed Chairman and Chief Executive Officer of USHEALTH. In connection with Mr. Cutler’s employment agreement, USHEALTH recorded a $2 million liability for deferred compensation and $308,000 in employment expenses for 2004. Under the employment agreement, Mr. Cutler also is to receive options to purchase 5,025,619 shares of USHEALTH’s common stock and receive a liquidity performance bonus. The exercise price of the options equals the fair market value of USHEALTH’s common shares as determined by USHEALTH’s Board of Directors in good faith based on generally accepted industry valuation methodologies on the Early Exercise Date as defined in Mr. Cutler’s employment agreement.
Stock Option Plan. On March 24, 1999, USHEALTH’s Board of Directors adopted the 1999 Stock Option Plan (the “1999 Plan”) in order to further and promote the interest of USHEALTH, its subsidiaries and its shareholders by enabling USHEALTH and its subsidiaries to attract, retain and motivate employees of one of its subsidiaries, non-employee directors and consultants (including marketing agents) or those who will become such employees, non-employee directors and consultants (including marketing agents). Pursuant to the 1999 Plan, 1,139,835 shares of common stock are reserved for issuance to such employees and directors and 387,119 shares are reserved for issuance to marketing agents. The maximum term of an award under the 1999 Plan is 10 years.
A summary of stock option activity under the 1999 stock option plan is as follows:
In addition to options granted under the 1999 stock option plan, the Company’s Chairman and Chief Executive Officer is to receive options to purchase 5,025,619 shares of USHEALTH’s common stock under his employment agreement effective September 1, 2004. The options may be exercised at an exercise price to be determined by the Board of Directors in good faith based on generally accepted industry valuation methodologies were deemed outstanding at December 31, 2004 with an average remaining contractual life of approximately five years. In addition, under Mr. Cutler's employment agreement, an additional equity pool of 20.1% (subject to adjustment to 20% in the event of certain transactions) of the fully-diluted shares of the Company as of September 1, 2004 is to be reserved for options and/or other equity awards to be granted to other employees as recommended by management and approved by the Board (or a designated committee thereof). In the event that such additional pool is not entirely allocated to grants made to other employees, Mr. Cutler shall be eligible to receive additional options and/or other equity awards with respect to such unallocated shares available in such pool, up to a maximum level of 15% (including the shares subject to the initial options granted to Mr. Cutler) of the fully-diluted shares of common stock of the Company as of September 1, 2004. If such additional pool is allocated to grants made to other employees, then Mr. Cutler will not receive any options or other equity awards in addition to the initial options granted to him.
all awards, net of related tax effects (136 ) (306 ) (273 )
Basic and diluted- as reported $ (0.02 ) $ (0.31 ) $ (0.42 )
Basic and diluted - pro forma $ (0.02 ) $ (0.35 ) $ (0.47 )
Diluted - as reported $ (0.07 ) $ (0.48 ) $ (0.64 )
Diluted - pro forma $ (0.07 ) $ (0.52 ) $ (0.69 )
The Insurance Subsidiaries cede insurance to other insurers and reinsurers on both life and accident and health business. Reinsurance agreements are used to limit maximum losses and provide greater diversity of risk. Each Insurance Subsidiary remains liable to policyholders to the extent the reinsuring companies are unable to meet their treaty obligations. Total premiums ceded to other companies were $3.2 million, $3.7 million and $4.0 million for 2004, 2003 and 2002, respectively. Face amounts of life insurance in force ceded approximated $10.1 million, $13.5 million and $17.2 million at December 31, 2004, 2003 and 2002, respectively. Benefits and claims ceded to other companies were $3.2 million, $3.9 million and $3.7 million, respectively.
The Insurance Subsidiaries reinsure their respective risks under their Medical Expense policies on an excess of loss basis so that its net payments on any one life insured under the policy are limited for any one calendar year to $150,000. Risks under its Medicare Supplement policies are not reinsured. Risks under certain Accidental Death policies are one hundred percent (100%) reinsured. Under its life insurance reinsurance agreement, FLICA and NFL retain fifty percent (50%) of the coverage amount of each of its life insurance policies written prior to June 30, 2004 and in force up to a maximum of $65,000. NFL reinsures, through an excess of loss reinsurance treaty, a closed block of annually renewable term life insurance policies. NFL’s retention limit is $25,000 per year. In accordance with industry practice, the reinsurance arrangements in force with respect to these policies are terminable by either party with respect to claims incurred after the termination and expiration dates. All reinsurers of the Company’s Insurance Subsidiaries are rated “A” or higher by the A.M. Best Company.
The Company’s future minimum lease payments for non-cancelable operating leases, relating primarily to office facilities and data processing equipment having a remaining term in excess of one year, at December 31, 2004 aggregated $3.6 million. The amounts due by year are as follows: 2005 - $734,000; 2006 - $678,000; 2007 - $573,000; 2008 - $560,000; 2009 - $507,000; and thereafter - $546,000. Aggregate rental expense included in the consolidated financial statements for all operating leases approximated $1.6 million, $2.2 million and $1.8 million in 2004, 2003 and 2002, respectively.
In the normal course of its business operations, the Company is involved in various claims, other business related suits (alleging actual as well as substantial exemplary damages) and regulatory matters. In the opinion of management, the Company is not a party to any pending litigation which is reasonably likely to have an adverse result or disposition that would have a material adverse effect on the Company’s business, consolidated financial position or consolidated results of operations.
Basic and diluted loss per share from discontinued operations $ (0.01 ) $ -
Loss applicable to common stockholders (680 ) (528 ) (1,028 ) (871 )
Basic and diluted loss per share from discontinued operations $ (0.04 ) $ (0.03 ) $ (0.05 ) $ (0.05 )
Basic and diluted loss per common share $ (0.10 ) $ (0.08 ) $ (0.16 ) $ (0.13 )
In October 2004, the Company sold its printing subsidiary, Westbridge Pringint Services, Inc. (“WPS”). The operating results of WPS are presented as loss from discontinued operations. Fee, service and other income has been restated to exclude the service income attributable to WPS.
Accounts receivable and accounts payable. The carrying amounts reported in the balance sheets for accounts receivable and accounts payable approximates their fair value.
Available-for-sale securities. The fair values for available-for-sale securities are based on quoted market prices (See Note 6).
equity in undistributed net earning of subsidiaries (5,060 ) (5,386 ) (2,890 )
Net loss $ (2,283 ) $ (1,348 ) $ (931 )
Net Cash Used For Operating Activities (792 ) (3,637 ) (2,342 )
Cost of fixed maturity investments acquired (470 ) (1,494 ) -
$ 53,493 $ 24,619 $ 92,239 $ 5,446 $ 60,344 $ 7,665 $ 35,369 $ 92,626
Total $ 21,819 $ 54,872 $ 26,196 $ 101,574 $ 6,151 $ 68,536 $ 7,433 $ 41,688 $ 101,957