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. Westbridge Printing Services, Inc., the Company’s wholly-owned printing subsidiary, maintains its facility 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 9550 Forest Lane, Dallas, Texas under a lease agreement which expired in December 2003. In March 2004, PDS will relocate to a 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.
The information set forth below was derived from the Consolidated Financial Statements of the Company. The information set forth below should be read in conjunction with
Business Overview. Ascent Assurance, Inc. (“Ascent” or the “Company”) is the successor to a Delaware company incorporated in 1982 as an insurance holding company. Ascent, 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”), also a wholly-owned subsidiary. The Company, through applicable subsidiaries, also derives fee and service revenue from (i) tele-survey services, (ii) printing services, and (iii) renewal commissions for prior year sales of both affiliated and unaffiliated insurance products, and (iv) 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 2003 presentation.
Forward-Looking Statements. Statements contained in this analysis and elsewhere in this document that are not based on historical information are forward-looking statements and are based on management’s projections, estimates and assumptions. In particular, forward-looking statements can be identified by the use of words such as “may”, “will”, “should”, “expect”, “anticipate”, “estimate”, “continue”, or similar words. Management cautions readers regarding its forward-looking statements. The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking statements. Various statements contained in Item 1 - “Business” and Item 7 - “Management’s Discussion and Analysis of Results of Operation and Financial Condition”, are forward-looking statements. These forward-looking statements are based on the intent, belief or current expectations of the Company and members of its senior management team. While Ascent’s management believes that its expectations are based on reasonable assumptions within the bounds of its knowledge of its business and operations, prospective investors are cautioned that any such forward-looking statements are not guarantees of future performance, and involve risks and uncertainties, and that actual results may differ materially from those contemplated by such forward-looking statements.
Ascent’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;
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 cancelled. Fee and service income is recognized when earned, the services have been provided and collectibility is reasonably assured.
Mortgage-backed securities comprised 24.3% of the Company’s fixed maturity portfolio at December 31, 2003 as compared to 33.4% at December 31, 2002. Mortgage-backed securities are subject to risks associated with variable pre-payments. This may result in these securities having a different actual cash flow and maturity than expected at the time of purchase. Securities that have an amortized cost greater than par and are backed by mortgages that prepay faster than expected will incur a reduction in yield or a loss. Those securities with an amortized cost lower than par that prepay faster than expected will generate an increase in yield or a gain. In addition, the Company may incur reinvestment risks if market yields are lower than the book yields earned on the securities. Prepayments occurring slower than expected have the opposite impact. The Company may incur disinvestment risks if market yields are higher than the book yields earned on the securities and the Company is forced to sell the securities. The degree to which a security is susceptible to either gains or losses is influenced by 1) the difference between its amortized cost and par, 2) the relative sensitivity of the underlying mortgages backing the assets to prepayment in a changing interest rate environment and 3) the repayment priority of the securities in the overall securitization structure. There are negligible default risks in the mortgage-backed securities portfolio as a whole as the vast majority of the assets are either guaranteed by U.S. government-sponsored entities or are supported in the securitization structure by junior securities enabling the assets to achieve high investment grade status.
The average gross annual yield on fixed maturities declined in both 2003 and 2002 due to declining market reinvestment interest rates. The Company’s portfolio has an average effective duration of five years, which reflects the medium-term nature of its liabilities. As a result, a significant portion of the portfolio matures and is reinvested each year. Market interest rates dropped significantly from mid- 2002 to mid-2003. The average yield on a five-year U.S. Treasury note declined from 4.45% for the first half of 2002 to 3.18% for the second half of 2002 to 2.75% for the first half of 2003, and increased to 3.20% for the last half of 2003. At December 31, 2003, the market yield for five year U.S. Treasury Securities was 3.27%. The Company anticipates that the investment yield on its portfolio will continue to decline if market interest rates remain at 2003 levels.
The NAIC assigns securities quality ratings and uniform prices called "NAIC Designations", 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, 2003, 70.8%, 27.0% and 2.2% 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 value and the decline in value is determined to be other than temporary, an appropriate write-down is recorded.
The scheduled contractual maturities of the Company's fixed maturity securities, excluding short-term investments at December 31 are shown in the table below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalties.
At December 31, 2003, the Company had available tax net operating loss carryforwards (“NOLs”) of $63.4 million that expire between 2012 and 2018. 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.
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 6 to the Consolidated Financial Statements at Item 8.
Because the discount factor used in calculating policy benefit reserves is based upon the rate of return of the investments designed to fund this reserve, the amount of the reserve is dependent upon the yield on these investments. Provided that there is no material adverse experience with respect to these benefits, changes in future market interest rates will not have an impact on the profitability of policies already sold. Because fluctuations in future market interest rates affect the yield on new investments, they also affect the discount factor used to establish, and thus the amount of, its policy benefit reserves for new sales. In addition, because an increase in the policy benefit reserves in any period is treated as an expense for income statement purposes, market interest rate fluctuations can directly affect the profitability for policies sold in such period. It is not possible to predict future market interest rate fluctuations.
The Insurance Subsidiaries reinsure risks under each of their respective major medical 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 $125,000. Risks under its Medicare Supplement policies are not reinsured. Certain risks under the Insurance Subsidiaries’ 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 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.
At December 31, 2003, approximately $1.4 million of the $3.1 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.
Statutory Accounting Practices. The Insurance Subsidiaries are required to report their results of operations and financial position to state regulatory agencies based upon statutory accounting practices (“SAP”). See Item 1 - “Business - State Regulation” for a description of the principle differences between GAAP and SAP accounting. The immediate charge off of sales and acquisition expenses and the sometimes conservative claim cost and other reserve valuation assumptions under SAP generally cause a lag between the sale of a policy and the emergence of reported earnings. Because this lag can reduce gain from operations on a SAP basis, it can have the effect of reducing the amount of funds available for dividend distributions from the Insurance Subsidiaries (see “Liquidity, Capital Resources and Statutory Capital and Surplus”).
On December 31, 2003, the Company completed an exchange of the redeemable convertible preferred stock and restructuring of the notes payable of Ascent held by Special Situations Holdings, Inc. - Westbridge (“SSHW”) and Credit Suisse First Boston Management LLC (“CSFBM”), respectively, both affiliates of Credit Suisse First Boston LLC (“CSFB”) (together, SSHW and CSFBM, the “CSFB entities”) that resulted in, among other things, an extension of the maturity dates of such preferred stock and notes held by the CSFB entities from March 24, 2004 and April 17, 2004, respectively, to March 24, 2010. The restructuring was effected pursuant to an Exchange Agreement dated as of December 31, 2003 between the Company, SSHW, and CSFBM (the “Exchange Agreement”).
Prior to the restructuring, CSFB, through SSHW, was the Company’s largest stockholder, owning approximately 49% of the outstanding shares of common stock of the Company and, on an as converted, fully-diluted basis assuming conversion of the outstanding Series A Preferred, approximately 75.4% of the common stock. As a result of the exchange for Series B Preferred, CSFB, through SSHW, now owns on an as converted, fully diluted basis, 93% of the common stock with the remaining 7% held by public stockholders. At a stockholders’ meeting to be held no later than June 30, 2004, the stockholders of the Company will be asked to adopt an amendment to the Company’s certificate of incorporation to authorize additional shares of common stock in an amount necessary to permit the conversion of Series B Preferred in full. Upon the effectiveness of such amendment and obtaining of all necessary insurance regulatory approvals, the Series B Preferred will convert into common stock and no preferred stock will remain outstanding. Under the Exchange Agreement, CSFB has agreed to be present in person or by proxy at the stockholders’ meeting and to vote all of its shares of common stock held by SSHW in favor of such amendment of the Company’s certificate of incorporation. The Company expects that conversion of the Series B Preferred will be effected as planned prior to June 30, 2004. The table below shows the pro forma impact on the stockholders’ equity section of the Company’s balance sheet, assuming that the conversion was completed as of December 31, 2003:
The restructuring of the notes payable to CSFBM in the amount of $15.3 million as of December 31, 2003 (including accrued interest) was effected by an amendment to the Credit Agreement dated as of April 17, 2001 between the Company and CSFBM (the “CSFBM Credit Agreement”). In addition to the extension of the maturity date to March 24, 2010, the interest rate of the note payable was reduced from 12% to 6% per annum. A $1.5 million facility fee, of which $1.35 million was accrued as of December 30, 2003, payable upon maturity of the note payable was waived. On December 31, 2003, the balance of the accrued facility fee was credited directly to capital in excess of par value. In the event that the Company fails to receive the approval of its stockholders in favor of the amendment to the certificate of incorporation described above by June 30, 2004, other than if such failure is the direct or indirect result of any action taken or failed to be taken by the CSFB entities, such failure shall constitute an event of default under the notes payable which, among other things, will result in the holder of the Series B Convertible Preferred Stock having the right to vote on all matters, other than the election of directors, thereafter brought to the stockholders of the Company. CSFBM has also agreed that the notes payable will be subordinate to up to $10 million in borrowings under the Company’s agent debit balance credit facility. The Company, certain of its subsidiaries, CSFBM and the lender under such credit facility have entered into an Intercreditor and Subordination Agreement dated as of December 31, 2003 to give effect to this subordination agreement.
Results of operations for Ascent are reported below for the years ended December 31, 2003, 2002 and 2001.
Interest expense on note payable to related party (2,450 ) (2,199 ) (1,337 )
Net loss to common shareholders $ (3,107 ) $ (4,194 ) $ (5,051 )
*Ratios are calculated as a percent of premiums with the exception of the general and administrative expense ratio, which is
Overview. The Company reported pre-tax losses of ($1.3) million, ($0.9) million, and ($2.1) million for 2003, 2002 and 2001, respectively. The results of operations for 2003 are not comparable to 2002 and 2001 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") as discussed in Note 2 to the Consolidated Financial Statements at Item 8. Pursuant to SFAS 150, dividends of $1.9 million accrued subsequent to June 30, 2003 on the Company's Series A Preferred stock were classified as interest expense, a component of pre-tax income, instead of a direct deduction to common stockholders' equity. In accordance with SFAS 150, prior period financial statements were not restated. Excluding the impact of SFAS 150, the $1.4 million improvement in pre-tax income for 2003 as compared to 2002 was comprised of a $1.2 million increase in insurance operating results and a $0.5 million improvement in fee and service operations, net of a ($.03) million increase in interest expense on the note payable to related party. The $1.2 million improvement in pre-tax loss for 2002 as compared to 2001 was due to a $4.1 million increase in insurance operating results offset by a ($2.0) million decrease in fee and service results and a ($0.9) million increase in interest expense on the note payable to related party.
The primary factor behind the improvement in insurance operating results for both 2003 and 2002 as compared to the corresponding prior year period is the decline in the benefits and claims to premium ratio for both years. For the past several years the Company has focused on improving its product pricing for both new insurance product sales and in force insurance policies. The benefits of a lower claims and benefit ratio have been offset in both 2003 and 2002 by 1) reduced interest income from the Company's bond portfolio due to declining market re-investment rates, 2) reduced interest income on agent's balances receivable due to a decline in outstanding agents' balances as a result of lower new business production and 3) an increase in the general and administrative expense ratio due to reduced coverage of fixed general and administrative expenses as a result of lower premium revenues.
Fee and service operating results improved in 2003 as compared to 2002 as a result of expense reduction initiatives for the Company's tele-survey and printing subsidiaries. These operations were significantly impacted in 2002 by the economic downturn and experienced a reduction in the number of customers, reduced order volume from continuing customers and lower profit margins in comparison to 2001.
As previously discussed (see "Restructuring of Redeemable Preferred Stock and Notes Payable to Related Party"), the Company's Series A Preferred was exchanged for Series B Preferred on December 31, 2003. The Company expects that the Series B Preferred will be fully converted into common stock prior to June 30, 2004 and that no preferred stock will remain outstanding. Upon full conversion of the Series B Preferred, the preferred stock dividend will be eliminated.
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.
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 3.0 percentage point improvement in the ratio of consolidated benefits and claims to consolidated premiums in 2003 as compared to 2002 and the 4.1 percentage point improvement in 2002 as compared to 2001 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 0.8 and 1.7 percentage points in 2003 and 2002, 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.
Related Party Preferred Stock. Ascent’s redeemable convertible preferred stock is 100% owned by SSHW, which is the Company’s largest common stockholder and is also an affiliate of CSFBM and a subsidiary of CSFB. On December 31, 2003, the Company completed an exchange of Series A Preferred for Series B Preferred (see “Restructuring of Convertible Preferred Stock and Notes Payable to Related Party”). Dividends may be paid in cash or by issuance of additional shares of preferred stock, at the Company’s option. During 2003, Ascent paid dividends on the Series A Preferred through the issuance of 3,608, 3,261 and 2,930 additional shares of preferred stock in 2003, 2002 and 2001, respectively. The Series B Preferred is mandatorily redeemable in cash in March 2010 and has a dividend rate of 5.5%.
AFI formerly financed agent receivables through a Credit Agreement (the “LaSalle Credit Agreement”) with LaSalle Bank NA (“LaSalle”). On January 31, 2003, pursuant to terms of the LaSalle Credit Agreement, AFI liquidated a $2.6 million cash collateral account pledged to LaSalle. Pursuant to an agreement with LaSalle, AFI paid a dividend of $1.6 million to Ascent. The proceeds were used to fully pay off Ascent Management Inc.‘s (“AMI”) term loan facility with LaSalle on January 31, 2003. On November 28, 2003, the amount outstanding of $1.4 million under the LaSalle Credit Agreement was paid off, the revolving loan facility and all guaranties provided by AAI were terminated, and all collateral held by LaSalle was returned to the Company.
(2) Excludes interest at a rate equal to the Prime Rate, plus one-half percent per annum.
Index to Financial Statements and Financial Statement Schedules Covered by the Following Reports of Independent Auditors.
Consolidated Statements of Operations for the Years Ended December 31, 2003, 2002 and 2001
Consolidated Statements of Changes in Stockholders’ Equity for the Years Ended December 31, 2003,
Consolidated Statements of Cash Flows for the Years Ended December 31, 2003, 2002 and 2001
We have audited the accompanying consolidated balance sheets of Ascent Assurance, Inc., as of December 31, 2003 and 2002, and the related consolidated statements of operations, comprehensive (loss) income, stockholders’ equity, and cash flows for the years then ended. Our audits also included the financial statement schedules as of December 31, 2003 and 2002, and for the years then ended 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.
Available-for-sale, at market value (amortized cost $93,922 and $95,580) $ 96,968
Basic and diluted net loss per common share $ (0.48 ) $ (0.64 ) $ (0.78 )
Purchase of fixed maturity investments (68,054 ) (62,903 ) (24,423 )
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 Ascent Assurance, 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 2003 financial statement presentation.
Investments. The Company’s fixed maturity portfolio is classified as available-for-sale and is carried at estimated market value. Equity securities (common and non-redeemable preferred stocks), which are included in other investments, are also carried at estimated market value. Changes in aggregate unrealized appreciation or depreciation on fixed maturity and equity securities are reported directly in stockholders’ equity and, accordingly, will have no effect on current operations.
Agent Receivables. In the ordinary course of business, a subsidiary of Ascent advances commissions on policies written by its general agencies and their agents. Net agent receivables were $4.5 million and $6.3 million at December 31, 2003 and 2002, 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 advances. A reserve for uncollectible agent’s balances is routinely established based upon historical experience and projected commission earnings. As of December 31, 2003 and 2002, the allowance for uncollectible commission advances was $3.4 million and $4.6 million, respectively.
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 actuarial consultants 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.
Notes Payable. Notes payable are stated at cost, which approximates market.
Recognition of Revenue. Premium revenues from insurance contracts are recognized when due from policyholders. Fee and service income is recognized when earned, the services have been provided and collectiblity is reasonably assured.
On December 31, 2003, the Company completed an exchange of the redeemable convertible preferred stock and restructuring of the notes payable of AAI held by Special Situations Holdings, Inc. - Westbridge (“SSHW”) and Credit Suisse First Boston Management LLC (“CSFBM”), respectively, both affiliates of Credit Suisse First Boston LLC (“CSFB”) (together, SSHW and CSFBM, the “CSFB entities”), that resulted in, among other things, an extension of the maturity dates of such preferred stock and notes held by the CSFB entities from March 24, 2004 and April 17, 2004, respectively, to March 24, 2010. The restructuring was effected pursuant to an Exchange Agreement dated as of December 31, 2003 between the Company and CSFBM (the “Exchange Agreement”).
Prior to the restructuring, CSFB, through SSHW, was the Company’s largest stockholder, owning approximately 49% of the outstanding shares of common stock of the Company and, on an as converted, fully-diluted basis assuming conversion of the outstanding Series A Preferred, approximately 75.4% of the common stock. As a result of the exchange for Series B Preferred, CSFB, through SSHW, now owns on an as converted, fully diluted basis, 93% of the common stockholders with the remaining 7% held by public stockholders. At a stockholders meeting to be held no later than June 30, 2004, the stockholders of the Company will be asked to adopt an amendment to the Company’s certificate of incorporation to authorize additional shares of common stock in an amount necessary to permit the conversion of the Series B Preferred in full. Upon the effectiveness of such amendment and obtaining of all necessary insurance regulatory approvals, the Series B Preferred will convert into common stock and no preferred stock will remain outstanding. Under the Exchange Agreement, CSFB has agreed to be present in person or by proxy at the stockholders meeting and to vote all of its shares of common stock held by SSHW in favor of such amendment of the Company’s certificate of incorporation.
The restructuring of the notes payable to CSFBM in the amount of $15.3 million (including accrued interest) was effected by an amendment to the Credit Agreement dated as of April 17, 2001 between the Company and CSFBM. In addition to the extension of the maturity date to March 24, 2010, the interest rate of the note payable was reduced from 12% to 6% per annum. A $1.5 million facility fee, of which $1.35 million was accrued as of December 30, 2003, payable upon maturity of the note payable was waived. On December 31, 2003, the balance of the accrued facility fee was credited directly to capital in excess of par value. In the event that the Company fails to receive the approval of its stockholders in favor of the amendment to the certificate of incorporation described above by June 30, 2004, other than if such failure is the direct or indirect result of any action taken or failed to be taken by the CSFB entities, such failure shall constitute an event of default under the notes payable which, among other things, will result in the holder of the Series B Preferred having the right to vote on all matters, other than the election of directors, thereafter brought to the stockholders of the Company. CSFBM has also agreed that the notes payable will be subordinate to up to $10 million in borrowings under the Company’s agent debit balance credit facility. The Company, certain of its subsidiaries, CSFBM and the lender under such credit facility have entered into an Intercreditor and Subordination Agreement dated as of December 31, 2003 to give effect to this subordination agreement.
The amortized cost and estimated market value of investments in available-for-sale fixed maturities as of December 31, 2003, are shown below, in thousands, 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.
A summary of unrealized appreciation on investments in fixed maturities and equity securities available-for-sale, which is reflected directly in stockholders’ equity as a component of accumulated other comprehensive loss, is as follows:
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 one 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 $69.2 million, $57.2 million and $37.9 million for 2003, 2002 and 2001 respectively. 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. Gross gains of $0.7 million and gross losses of ($0.3) million were realized on fixed maturity investment sales during 2001. The basis used in determining the cost of securities sold was the specific identification method.
Included in fixed maturities at December 31, 2003 and 2002, are high-yield, unrated or less than investment grade corporate debt securities comprising approximately 2.2% and 1.7% of fixed maturities at December 31, 2003 and 2002, respectively.
Investment securities on deposit with insurance regulators in accordance with statutory requirements at December 31, 2003 and 2002 had a par value totaling $21.1 million and $20.9 million, respectively, and market value totaling $23.1 million and $23.1 million, respectively. At December 31, 2002, the Company had pledged short-term investments totaling $2.6 million in connection with its receivables financing program (see Note 7).
Issues through 1980 are based on industry experience; 1981 through 2003 issues are based on industry experience and applicable Insurance Subsidiary experience, where available. Policies acquired in acquisitions are based on recent experience of the blocks acquired.
Issues through 1980 are 6.5% graded to 4.5% in 25 years; most 1981 through 1992 issues are 10% graded to 7% in 10 years. Issues for 1993 through 2002 are 7% level. Issues for 2003 are 5% level.
Based on industry tables published in 1974 by Tillinghast, Nelson and Warren, Inc. and the 1985 NAIC cancer tables, as well as other population statistics and morbidity studies. Issues for 2003 are based on the July 2002 Milliman Health Cost Guidelines adjusted for the Insurance Subsidiaries’ anticipated claims levels.
The CSFBM Credit Agreement is secured, pursuant to a guarantee and security agreement and pledge agreements, by substantially all of the assets of Ascent 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). Ascent’s subsidiaries (other than those listed above) have also guaranteed Ascent’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, 2003, 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, 2003 are net agent receivables of $4.5 million. In addition, NCM and Ascent 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”). Ascent, certain of its subsidiaries, CSFBM and Frost have entered into an Intercreditor and Subordination Agreement dated as of December 31, 2003 to give effect to a subordination of the notes payable to CSFBM to up to $10 million in borrowings under the Credit Agreement. As of December 31, 2003, there were no events of default under the Credit or Guaranty Agreements.
AFI formerly financed agent receivables through a Credit Agreement (the “LaSalle Credit Agreement”) with LaSalle Bank NA (“LaSalle”). On January 31, 2003, pursuant to terms of the LaSalle Credit Agreement, AFI liquidated a $2.6 million cash collateral account pledged to LaSalle. Pursuant to an agreement with LaSalle, AFI paid a dividend of $1.6 million to Ascent. The proceeds were used to fully pay off Ascent Management Inc.‘s (“AMI”) term loan facility with LaSalle on January 31, 2003. On November 28, 2003, the amount outstanding of $1.4 million under AFI’s LaSalle Credit Agreement was paid off, AFI’s revolving loan facility and all guaranties provided by AAI were terminated, and all collateral held by LaSalle was returned to the Company. Interest of $78,000, $0.3 million and $0.6 million was expensed and paid in 2003, 2002 and 2001, respectively on credit facilities with LaSalle.
The following summarizes the significant terms of the Series B Preferred:
The preferred stock is mandatorily redeemable in cash on March 24, 2010 in an amount equal to the stated value per share plus all accrued and unpaid dividends thereon to the date of redemption.
As described in Note 3 - Restructuring of Redeemable Preferred and Notes Payable to Related Party, the shares of Series B Preferred were issued in exchange for 36,567 shares plus accrued dividends equal to 937 shares of 10.25% Series A Preferred. Prior to cancellation on December 31, 2003, the Series A Preferred had a stated value of $1,000 per share with a cumulative annual dividend rate of $102.50 per share payable, at a minimum, annually in arrears by the last day of January in each year by issuance of cash or additional shares of preferred stock. Each share of Series A Preferred was convertible on or before March 24, 2004 into 204.8897 shares of common stock at an initial conversion price of $4.88 per share, subject to customary anti-dilution adjustment.
Statutory tax rate $ 34 % $ (34 %) $ (34 %)
Realization of the Company’s deferred tax asset is dependent upon the return of the Company’s operations to 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, 2003 and 2002.
At both December 31, 2003 and 2002, 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, 2003, the Company and its wholly-owned subsidiaries have aggregate net operating loss carryforwards of approximately $63.4 million for regular tax and $63.1 million for alternative minimum tax purposes, which will expire in 2012 through 2018.
Under the applicable laws of the states in which insurance companies are licensed, the companies are required to maintain minimum amounts of capital and surplus. Effective September 28, 2000, NFL and FLICA redomesticated from the states of Delaware and Mississippi, respectively, to the state of Texas. As a result, NFL, FLICA, NFIC and AICT are Texas domestic companies and are subject to regulation under Texas insurance laws. Under the Texas Insurance Code, the insurance subsidiaries are required to maintain aggregate capital and surplus of $1.4 million. 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, respectfully. At December 31, 2003, aggregate statutory capital and surplus for NFL, FLICA, NFIC, and AICT was approximately $7.2 million, $8.8 million, $1.6 million and $2.0 million, respectively. Although NFIC’s capital and surplus was less than $5 million at December 31, 2003, NFIC voluntarily ceased writing new business effective December 15, 1997. Moreover, NFIC’s capital and surplus exceeds the minimum requirements of its 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.
If a company’s total adjusted capital is less than or equal to 150 percent but greater than 100 percent of its RBC (the “Regulatory Action Level”), the regulatory authority will perform a special examination of the company and issue an order specifying the corrective actions that must be followed.
Under Florida Statutes Section 624.4095, Florida licensed insurance companies’ ratio of actual or projected annual written premiums to current or projected surplus as regards to policyholders (“the premium-writing ratio”) may not exceed specified levels for gross and net written premiums as defined by the statute. If a company exceeds the premium-writing ratio, the Florida Department of Insurance shall suspend the company’s certificate of authority in Florida or establish by order maximum gross or net annual premiums to be written by the company consistent with maintaining the ratios specified. At December 31, 2003, the premium-writing ratio for FLICA, which currently underwrites insurance policies in Florida, met the limit mandated by Florida law.
A reconciliation of capital and surplus, and net 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:
Consolidated GAAP net loss $ (1,348 ) $ (931 ) $ (2,119 )
In September 1986, a subsidiary of the Company established a retirement savings plan (“401(k) plan”) for its employees. As amended in August 1999, such employees are eligible to participate in the 401(k) plan upon completion of six months of service. The 401(k) plan is qualified under Section 401(a) of the Internal Revenue Code (“IRC”) and the trust established to hold the assets of the 401(k) plan is tax-exempt under Section 501 (a) of the IRC. The subsidiary is the plan administrator, and may amend, terminate or suspend contributions to the plan at any time it may deem advisable. Employees of this subsidiary who participate may contribute up to 100% of pre-tax compensation, including commissions, bonuses and overtime, but not to exceed $12,000 ($13,000 in 2004). This subsidiary may make discretionary contributions, determined by its Board of Directors, up to 50% of the employees’ first 6% of deferred compensation, but not to exceed a matching contribution of $6,000 per plan participant ($6,150 in 2004). Certain IRC required limitations, may be imposed for participants who are treated as “highly compensated employees” for purposes of the IRC. Participants vest 25% after one year of service, 50% after two years of service, 75% after three years of service and 100% after 4 years of service. Employee contributions are invested in any of ten investment funds at the discretion of the employee. Contributions to the 401(k) plan in 2003, 2002 and 2001 by the Company’s subsidiaries approximated $119,000, $72,000 and $81,000, respectively.
1999 Stock Option Plan On March 24, 1999, Ascent’s Board of Directors adopted the 1999 Stock Option Plan (the “1999 Plan”) in order to further and promote the interest of Ascent, its subsidiaries and its shareholders by enabling Ascent 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, 1,251,685 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.
The weighted average option exercise price was $2.32, $2.30 and $2.63 for options outstanding at December 31, 2003, 2002 and 2001, respectively. For options granted, weighted average exercise price was $0.65 and $1.49 for 2002, and 2001. For options forfeited/cancelled/expired in 2003, 2002 and 2001, the weighted average exercise price was $2.59, $3.23 and $2.77, respectively. For options exercised in 2003 and 2002, the weighted average exercise price was $.01.
awards, net of related tax effects (306 ) (273 ) (392 )
Basic - as reported $ (0.48 ) $ (0.64 ) $ (0.78 )
For purposes of pro forma disclosure, the estimated fair value of the stock compensation is amortized to expense over the stock’s vesting period. The effect on net loss of the stock compensation amortization for the year presented above is not likely to be representative of the effects on reported income or loss for future years.
The following table summarizes information about the stock options outstanding at December 31, 2003:
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 $3.7 million, $4.0 million and $2.8 million for 2003, 2002 and 2001, respectively. Face amounts of life insurance in force ceded approximated $13.5 million, $17.2 million and $16.6 million at December 31, 2003, 2002 and 2001, respectively. Benefits and claims ceded to other companies were $3.9 million, $3.7 million and $3.2 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 $125,000. 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 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, 2003 aggregated $7.3 million. The amounts due by year are as follows: 2004 - $1.5 million; 2005 - $1.4 million; 2006 - $1.1 million; 2007 - $1.0 million; 2008 - $1.0 million; and thereafter - $1.1 million. Aggregate rental expense included in the consolidated financial statements for all operating leases approximated $2.2 million, $1.8 million and $2.0 million in 2003, 2002 and 2001, respectively.
Basic $ (0.18 ) $ (0.12 ) $ (0.10 ) $ (0.25 )
Diluted $ (0.18 ) $ (0.12 ) $ (0.10 ) $ (0.25 )
(1) For the quarters ended September 2003 and December 2003, Series A redeemable convertible preferred stock dividends of $914 and $937, respectively, were recorded as interest expense as required under FAS150 (see Note 2 - Summary of Significant Accounting Policies).
Cash and short-term investments. The carrying amount reported in the balance sheet for cash and short-term investments approximates its fair value.
Notes payable. The carrying amounts of the Company’s notes payable approximate their fair value.
undistributed net earning of subsidiaries (5,386 ) (2,890 ) (2,219 )
Decrease in payables to subsidiaries (2,171 ) (362 ) (3,980 )
Retirement of redeemable convertible Series A preferred stock (37,504 ) -
Total $ 22,557 $ 61,571 $ 37,202 $ 125,206 $ 8,867 $ 93,376 $ 8,115 $ 56,009 $ 125,515