See Management's Discussion and Analysis of Financial Condition and Results of Operations and Notes to Consolidated Financial Statements.
Certain statements set forth herein or incorporated by reference herein from the Company's filings that are not historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act. Actual results may differ materially from those included in the forward-looking statements. These forward-looking statements involve risks and uncertainties including, but not limited to, the following: changes in general economic conditions, including the performance of financial markets, and interest rates; competitive, regulatory or tax changes that affect the cost of or demand for the Company's products; health care reform; the ability to predict and effectively manage claims related to health care costs; and reliance on key management and adequacy of claim liabilities. The Company's and its United CreditServ unit's future results also could be adversely affected by the inability to fully reserve for anticipated future credit card charge-offs and losses; the inability of the Company to generate cash from operations, from sales of assets and/or from the proceeds of debt and/or equity financings in an amount sufficient to fund in a timely manner future capital requirements at United Credit National Bank and operating losses at Specialized Card Services, Inc.; the inability of United Credit National Bank to issue certificates of deposit on a timely basis to refinance outstanding certificates of deposit as they mature; possible regulatory actions arising from the Consent Order issued by the OCC and other related activities; and the possibility of future economic downturns causing an increase in credit losses or changes in regulations for credit cards or credit card national banks. The Company's Educational Finance Group business could be adversely affected by changes in the Higher Education Act or other relevant federal or state laws, rules and regulations and the programs implemented thereunder may adversely impact the education credit market. In addition, existing legislation and future measures by the federal government may adversely affect the amount and nature of federal financial assistance available with respect to loans made through the U.S. Department of Education. Finally the level of competition currently in existence in the secondary market for loans made under the Federal Loan Programs could be reduced, resulting in fewer potential buyers of the Federal Loans and lower prices available in the secondary market for those loans.
Previously released quarterly financial information has been restated to reflect (a) the classification of the United CreditServ credit card business as a discontinued operation in 1998 and 1999; (b) the retroactive application, beginning on January 1, 1999, of a revised methodology for determining credit card loan losses and carrying value of residual assets, (c) the write-off in the second quarter of 1999 of the $35.9 million purchase price of the UMMG minority interest acquired by United CreditServ in the second quarter of 1999; (d) a downward adjustment to Educational Finance Group's
Other fee income. Other fee income increased to $122.9 million in 1999 from $111.1 million in 1998, an increase of $11.8 million. The increase was due to the increase in revenue from Educational Finance Group as a result of increased originations from higher student loan volume.
Other income. Other income decreased to $3.5 million in 1999 from $37.5 million in 1998, a decrease of $34.0 million. The decrease was primarily attributable to the disposition of the IPN, LLC and HealthCare Automation business units that were sold to a related party in July 1998, which units generated an aggregate of $20.4 million in revenues during 1998. In 1998 the Company also recognized a $9.7 million gain on sale of the ATM transaction processing assets of SunTech Processing Systems, LLC (an 80%- owned subsidiary of the Company).
Loss on sale of investments. The Company recognized losses on sale of investments of $367,000 in 1999 compared to a gain from sale of investments of $4.9 million in 1998. The amount of realized gains or losses on the sale of investments is a function of interest rates, market trends and the timing of sales. Losses are more likely during periods of increasing long-term interest rates, as occurred in 1999. In addition, due to increasing long-term interest rates in 1999, the net unrealized investment loss on securities classified as "available for sale", reported in accumulated other comprehensive income as a separate component of stockholders' equity and net of applicable income taxes, was $30.4 million at December 31, 1999, compared to an unrealized gain of $13.4 million at December 31, 1998.
Depreciation and amortization. Depreciation and amortization increased to $20.1 million in 1999 from $15.9 million in 1998, an increase of $4.2 million. The increase is primarily due to increased goodwill amortization as a result of the AMS Investment Group, Inc. acquisition by Educational Finance Group.
Interest expense. Interest expense on corporate borrowings increased to $7.4 million in 1999 from $3.1 million in 1998, an increase of $4.3 million. The increase was due primarily to the increased level of borrowings outstanding during 1999. Interest expense on student loan obligations increased to $57.5 million in 1999 from $19.2 million in 1998, an increase of $38.3 million. The increase was due primarily to EFG's increased student loan origination volume.
Self Employed Agency Division ("SEA"). The SEA Division reported operating income of $50.4 million in 1999 compared to a loss of $4.8 million in 1998. Revenue for the SEA Division decreased to $566.8 million for the year ended in 1999 from $610.1 million in 1998, an decrease of 7%. The increase in operating income was the result of continued success on directing a larger portion of new sales to traditional indemnity products and the improved loss ratio on the PPO products. The decrease in revenues was attributable to the negative impact of rate increases, imposed beginning in 1998, on new sales and recruiting efforts.
Student Insurance Division. The Student Insurance Division generated near breakeven operating income in 1999 compared to operating income of $6.1 million in 1998. The reduced earnings reflect lower margins resulting from increased loss ratios on the 1998-1999 policy year and a write off of previously capitalized software and system development costs in the amount of $2.3 million. Revenue for the Student Insurance Division decreased to $108.0 million in 1999 from $111.0 million in 1998, a decrease of 3%.
Special Risk Division. Operating income for the Special Risk Division decreased to a loss of $4.1 million in 1999 from a gain of $5.8 million in 1998. The decrease in operating income was due to higher loss ratios on closed blocks of business and a significant strengthening of reserves in the Division's marine medical business. Revenue for the Special Risk Division was $59.0 million in 1999 compared to $66.8 million in 1998, a decrease of 12%. The decrease in revenue was primarily due to elimination of unprofitable blocks of business and implementation of rate increases on stop-loss accounts causing customers to terminate their policies.
Educational Finance Group ("EFG"). EFG incurred an operating loss of $19.9 million in 1999 compared to an operating loss of $1.3 million in 1998. Revenue for EFG increased to $104.6 million in 1999 from $57.2 million in 1998. The increase in revenue in 1999 was attributable to the increased origination and interest income derived from EFG's higher student loan volume. The increased loss was attributable primarily to increases in interest expense from higher borrowings and interest rates and sustained operating losses at EFG Technologies Inc. and Education Loan Administrators Group. EFG's AMS unit also incurred an operating loss in 1999, due to the timing of the acquisition and the recording of revenues in the tuition installment plan business of AMS, which revenues are recorded primarily in May through August. The AMS acquisition was completed on July 26, 1999.
Insurdata. Insurdata reported operating income of $2.3 million in 1999 compared to $3.3 million in 1998. Revenue for Insurdata increased to $46.2 million in 1999 from $41.2 million in 1998, an increase of 12%. Insurdata revenue derived from other divisions and operating units of the Company were $24.4 million and $21.1 million in 1999 and 1998, respectively. These revenues and costs are eliminated in consolidating the Company's operations.
Other Business Units. During 1998, this category ceased to exist, with the Other Business Units sold, closed or reclassified.
performance of its ACE credit card product. The Company believes that such operating losses were due primarily to inadequate attention to ACE collections during much of 1999, inefficiencies associated with administrative and operating systems conversions during a period of significant increases in card issuance volumes, mis-pricing of the ACE product, and the failure of the AFCA credit card portfolio performance to be sufficiently predictive of the performance of the ACE credit card loan portfolio. The Company has also recorded a pre-tax estimated loss on disposal of United CreditServ in the amount of $130.0 million. See "Liquidity and Capital Resources".
Health premiums. Health premiums increased to $747.3 million in 1998 from $653.9 million in 1997, an increase of $93.4 million, or 14%. The increase in health premiums in 1998 resulted primarily from increased premiums in the self-employed market, which increase was due to increased sales of new health policies by the Company's independent agent force and due to discontinuing the coinsurance arrangement originally reached in 1996 for new business written by UGA.
Life premiums and other considerations. Life premiums and other considerations were comparable in 1998 and 1997. Increases from the sale of new life policies were offset by the decrease in premiums and other considerations from closed blocks of life and annuity business.
Other income. Other income decreased to $37.5 million in 1998 from $45.9 million in 1997, a decrease of $8.4 million or 18%. The decrease was due primarily to the disposition of business units in 1998 that contributed approximately $34.9 million of income in 1997. This decrease in other income was partially offset by the $9.7 million gain recognized by the Company on the sale of the assets of SunTech Processing LLC.
Operating Income. Operating income decreased to $47.3 million in 1998 from $111.8 million in 1997, a decrease of $64.5 million, or 58%. Operating income (loss) for each of the Company's segments and divisions was as follows:
Self Employed Agency Division ("SEA"). The SEA Division generated a loss of $4.8 million in 1998 compared to income of $47.6 million in 1997. The lower earnings of SEA were the result of the losses on certain managed care products and adjustments in the estimates of claim reserves based on an analysis completed in 1998.
Revenue for the SEA Division increased to $610.1 million for the year ended in 1998 from $538.3 million in 1997, an increase of 13%. The increase in revenues was the result of an increase in the proportion of direct business compared to coinsured business. New sales in 1998 were lower than 1997 as a result of fewer PPO products being sold.
Student Insurance Division. The Student Insurance Division reported operating income of $6.1 million in 1998 compared to operating income of $15.6 million in 1997. The reduced earnings reflected lower margins resulting from aggressive pricing in response to increased price competition and the impact of regulatory and compliance issues, particularly in the university health insurance market. Revenue for the Student Insurance Division increased to $111.0 million in 1998 from $97.6 million in 1997, an increase of 14%.
OKC Division. Operating income for the OKC Division increased to $20.4 million for the year ended in 1998 from operating income of $18.9 million in 1997, an increase of 8%. Operating income for this Division continued to increase while the capital invested in this Division decreased. The reduced capital is attributable to the fact that no major purchases of closed blocks of life insurance policies were made during 1998 or 1997. The increased earnings are the result of the development and marketing of new products and continuing efforts to realize more profits from the closed blocks of policies. Revenue for the OKC Division decreased to $98.8 million in 1998 from $100.5 million in 1997, a decrease of 2%. The decrease in revenue is the result of lower revenues on the closed blocks of life policies.
Special Risk Division. Operating income for the Special Risk Division decreased to $5.8 million for the year in 1998 from operating income of $8.0 million in 1997. Included in operating income in 1997 is a gain of $2.7 million from the sale of a discontinued health care solutions company. Revenue for the Special Risk Division was $66.8 million in 1998 compared to $56.1 million in 1997, an increase of 19%. The major operations of this Division were acquired in the second and third quarter of 1997.
Other Business Units. In the past, Other Business Units have primarily been HealthCare Solutions companies. Over the past 18 months most companies in this category have been sold or closed down, with the exception of Insurdata. For 1998, the Company reported net income of $441,000, which included the sale of IPN, LLC and HealthCare Automation, Inc. (collectively, "IPN") business units (which were sold in July 1998) and the sale of the ATM transaction processing assets of SunTech Processing Systems, LLC. ("STP"). The STP sale resulted in a gain of $9.7 million from the sale of the assets of the business and IPN had a loss from operations of $10.5 million in 1998.
In accordance with the terms of the Consent Order, on March 29, 2000, UCNB submitted to the OCC for its review and approval a capital plan (the "Proposed Capital Plan"). The Proposed Capital Plan contemplates the orderly disposition of United CreditServ's ownership interest in UCNB or the liquidation of UCNB, the payment of all of UCNB's insured deposits and satisfaction of all other UCNB liabilities, and the maintenance of minimum capital ratios. The Proposed Capital Plan provides that United CreditServ will dispose of its interest in UCNB or UCNB will dispose of all of its assets on or before December 31, 2000 (the "Plan Period"). To support its implementation, the Proposed Capital Plan further contemplates that (a) UICI, United CreditServ and UICI's principal shareholder will provide financial support to UCNB and deliver collateral to UCNB to secure its obligations to provide such financial support and (b) UCNB will be able to access the brokered deposit market on a limited basis. Under the Proposed Capital Plan, it is currently expected that UICI will be required to contribute an additional $25.0 million to the capital of UCNB during the Plan Period. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources"
The Proposed Capital Plan is expressly subject to the review and approval of the OCC and the FDIC. There can be no assurance that the OCC or the FDIC will approve the Proposed Capital Plan in its current form. If the OCC and/or FDIC fails to approve the Proposed Capital Plan or some mutually acceptable alternative plan, UCNB could be required to liquidate its assets on a short term basis and the Company could be required to fund the resulting losses immediately. Such a requirement could have a material adverse effect upon the Company's liquidity, results of operations and financial condition.
Transactions between an insured bank (including UCNB, the Company's indirect wholly owned subsidiary) and its affiliates are subject to, among other things, the quantitative and qualitative restrictions of Section 23A of the Federal Reserve Act, as well as safety and soundness considerations. The OCC has expressed criticism with respect to certain of the transactions that have taken place between UCNB and the Company and/or certain of its wholly owned subsidiaries. The Company disagrees, but it cannot predict at this time what action, if any, the OCC will ultimately take with respect to these transactions.
On January 26, 2000, HAI and HealthAxis.com entered into an Agreement and Plan of Merger, pursuant to which HAI will acquire all of the outstanding shares of HealthAxis.com that HAI does not currently own through the merger of HealthAxis.com with a wholly-owned subsidiary of HAI. Upon consummation of the reorganization
transactions, HealthAxis.com shareholders (including the Company) will receive 1.127 shares of HAI common stock for each share of HealthAxis.com common stock outstanding. Under the terms of the transaction, HAI will issue new shares to acquire all of the outstanding HealthAxis.com shares that HAI does not already own. The consummation of the merger is subject to various conditions, including the approval of both HAI and HealthAxis.com shareholders, as well as regulatory approval. The closing of the merger is currently anticipated to occur during the second quarter of 2000. It is anticipated that, following the merger, the Company will hold approximately 20.1 million shares (representing 43.2%) of the issued and outstanding shares of HAI, of which 10.0 million shares (representing 21.6%) will be subject to the terms of a Voting Trust Agreement, pursuant to which trustees unaffiliated with the Company will have the right to vote such shares.
On March 14, 2000, UICI reduced indebtedness outstanding under the credit facility from $100.0 million to $25.0 million, utilizing $5.0 million of cash on hand and the proceeds of a $70.0 million loan from a limited liability company controlled by the Company's Chairman ("Lender LLC"). As part of the paydown, the bank credit facility was amended to provide, among other things, that the $25.0 million balance outstanding will be due and payable on July 10, 2000, amounts outstanding under the facility are secured by a pledge of investment securities and shares of Mid-West National Life Insurance Company of Tennessee, and the restrictive covenants formerly applicable to UICI and its restricted subsidiaries (primarily the Company's insurance companies) will now be applicable solely to Mid-West. Amounts outstanding under the bank credit facility will continue to bear interest at LIBOR plus 100 basis points per annum.
Lender LLC loaned $70.0 million to a newly-formed subsidiary of the Company. The loan bears interest at the prevailing prime rate, is guaranteed by UICI, is due and payable in July 2001 and is secured by a pledge of investment securities and shares of the Company's National Motor Club unit. No principal outstanding under the loan from Lender LLC can be paid unless all amounts outstanding under the bank credit facility are paid in full.
On March 17, 2000 the Board of Directors of UICI determined, after a thorough assessment of the unit's prospects, that it will exit from its United CreditServ sub-prime credit card business. Accordingly, the United CreditServ unit has been reflected as a discontinued operation for financial reporting purposes. The Company currently expects to complete the sale of the United CreditServ unit during the year 2000. UICI has recorded in the fourth quarter of 1999 its current estimate of loss that it believes it will incur on disposal of the United CreditServ unit. The Company currently estimates that such pre-tax loss will be $130 million. The estimate includes asset write-downs, the estimated loss on the sale of the business and/or the assets and continuing losses through date of sale. The loss the Company will ultimately realize upon disposal of the discontinued operation could differ materially from the current estimate.
Previously released quarterly financial information has been restated to reflect (a) the classification of the United CreditServ credit card business as a discontinued operation in 1998 and 1999; (b) the retroactive application, beginning on January 1, 1999, of a revised methodology for determining credit card loan losses and carrying value of residual assets, (c) the write-off in the second quarter of 1999 of the $35.9 million purchase price of the UMMG minority interest acquired in the second quarter of 1999; (d) a downward adjustment to Educational Finance Group's
interest income in the amount of $5.5 million in the second quarter of 1999; and (e) the recording of compensation expense in the amount of $5.3 million associated with stock option exercises in the third quarter of 1999. The application of the revised methodology for determining loan loss reserves and the carrying value of a residual interest in securitized assets, the write-off of the UMMG minority interest purchase price, the adjustment to EFG's interest income and the recording of additional compensation expense reduced in the aggregate previously reported net income in the second and third quarters of 1999 by $51.7 million ($1.08 per share) and $38.3 million ($0.80 per share), respectively.
Computation of earnings per share for each quarter is made independently of earnings per share for the year.
Many proposals have been introduced in Congress and various state legislatures to further reform the present health care system. Current initiatives are specifically directed toward protecting patient's rights and confidentiality. These initiatives are expected to affect the Company's business processes and procedures. At the federal level, new laws and regulations directed toward patient's rights and privacy have been introduced, passed, and/or adopted. At the state level, a number of states have followed Congress's lead and have passed or are considering legislation that would provide further patient protection and confidentiality requirements. In some cases, the states are mandated by federal law to functionally regulate insurance entities in these areas.
The Company's effective tax rate was 34.3% for 1999 compared to 31.0% for 1998 and 31.9% for 1997. The 1999, 1998, and 1997 effective rate varied from the federal tax rate of 35% primarily due to the small life insurance company deduction allowed for certain insurance subsidiaries of the Company along with certain tax credits and the change in the valuation allowance related to deferred tax assets. In 1999, no tax benefit was recognized for certain operating loss carryforwards. As of December 31, 1999, the Company has recognized a net deferred tax asset of $84.2 million. Realization of the net deferred tax asset is dependent on generating sufficient taxable income prior to expiration of loss carryforwards. Although realization is not assured, management believes it is more likely than not that all of the deferred tax assets will be realized. The amount of the deferred tax asset considered realizable, however, could be reduced in the near term if estimates of future taxable income during the carryforward period are reduced.
The 1999 operating losses at United CreditServ have had and will continue to have a material adverse effect upon the liquidity and cash flow of the Company. Since December 30, 1999, UICI through United CreditServ has contributed to UCNB as capital an aggregate of $105.1 million in cash, including additional cash in the amount of $17.0 million contributed on March 27, 2000. UICI has funded these cash contributions with the proceeds of sale of investment securities, regular cash dividends from its insurance company subsidiaries and cash on hand.
The Company currently anticipates that these cash requirements at the holding company level will be funded by cash on hand ($40.0 million at April 4, 2000), possible sales of certain of its operating subsidiaries, sales of investment securities, proceeds from refinancing of indebtedness, proceeds from the issuance by the holding company of debt and/or equity securities, or regular dividends from its regulated insurance subsidiaries, if required. It is likely that the payment of dividends from its regulated insurance subsidiaries will adversely affect the insurance subsidiaries' claims paying and AM Best ratings. Nonetheless, the Company's domestic insurance subsidiaries, without prior approval of the state regulatory authorities, could currently pay aggregate dividends to the holding company in the amount of approximately $30.7 million and an additional $19.8 million after December 22, 2000.
UCNB's unsecuritized net credit card receivables increased from $136.3 million at December 31, 1998 to $190.7 million at December 31, 1999, which growth was funded with the proceeds of deposits at UCNB. Time deposits at UCNB increased from $99 million at December 31, 1998 to $290 million at December 31, 1999. In accordance with the terms of a Consent Order issued by the OCC, UCNB is currently prohibited from accessing the brokered deposit market and from soliciting or accepting deposits over the Internet. At March 31, 2000, UCNB had $296.0 million of certificates of deposits outstanding, the majority of which are scheduled to mature over the next six months. At March 31, 2000, UCNB had approximately $160.0 million in cash, cash equivalents and short term U.S. Treasury securities.
UCNB is subject to risk-based capital guidelines adopted by the OCC. Risk-based capital ratios are determined by allocating assets and specified off-balance sheet commitments to several weighted categories, with higher levels of capital being required for the categories perceived as representing greater risk. Under current guidelines, in order to be considered "adequately capitalized," institutions are required to maintain a minimum total risk-based capital ratio (total Tier 1 and Tier 2 capital to risk-weighted assets) of 8%, and a Tier 1 risk-based capital ratio (Tier 1 capital to risk-weighted assets) of 4%. The OCC has also established guidelines prescribing a minimum "leverage ratio" (Tier 1 capital to adjusted total assets as specified in the guidelines) of 3% for institutions that meet certain criteria, including the requirement that they have the highest regulatory rating, and a minimum of 4% for institutions that do not meet the criteria. The OCC may, however, set higher capital requirements when an institution's particular circumstances warrant.
In addition, in the event that the OCC determines that the Proposed Capital Plan does not comply with the terms of the Consent Order, the OCC may take a number of actions, including directing that a new capital plan be submitted, seeking an order from a Federal District Court directing compliance with the Consent Order, or seeking the assessment of civil money penalties.
UCNB has commitments to fund the unused credit limits on issued credit card accounts. At December 31, 1999 and 1998, the outstanding commitment was $33.8 million and $31.0 million, respectively.
In March 1998, Educational Finance Group, Inc. entered into a master repurchase agreement and credit facility with a financial institution that is partially guaranteed by the Company. The repurchase agreement provides for the purchase of student loans by the financial institution, and the financial institution may put the student loans back to EFG on the last day of each month. EFG, in turn, has the right to require the financial institution to repurchase the student loans on such date, with the interest rate on the credit facility reset on such date. The credit facility provides for up to $150 million of financing and may be increased subject to monthly confirmations. The credit facility had an outstanding balance of $318.8 million and $318.9 million at December 31, 1999 and 1998, respectively, and bears interest at a variable annual rate of LIBOR plus 75 basis points (7.23% at December 31, 1999). The credit facility has a term of one year and is secured by student loans originated under the Federal Family Education Loan Program ("FFELP"), which are guaranteed by the federal government or alternative loans guaranteed by private guarantors. The financial institution may value the loans at any time and require EFG to repay any amount by which the market value of the loans is less than the amount required by the credit facility.
In connection with its AMS business, at December 31, 1999, the Company had $113 million of restricted cash representing amounts collected under the tuition plan program and a corresponding liability due to the various educational institutions.
General. The Company has an Investment Committee that monitors the investment portfolio of the Company and its subsidiaries. The Investment Committee receives investment management services from external professionals.
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 interest rates will result in increases or decreases to the Company's stockholders' equity.
As of December 31, 1999, $826.6 million or 96% of the fixed maturity securities portfolio was rated BBB or better (investment grade) and only $34.7 million or 4% of the fixed maturity securities portfolio was invested in below investment grade securities (less than BBB). A quality distribution for fixed maturity securities is as follows:
At December 31, 1999 and 1998, the Company had accrued $1.8 million and $1.9 million, respectively, for future assessments. The period over which the assessments are expected to be paid and the recorded premium tax offsets and/or policy surcharges are expected to be realized is up to 5 and 10 years, respectively. Expenses incurred for guaranty fund assessments were $587,000 and $331,000 in 1999 and 1998, respectively.