We own our headquarters building in Cleveland, Ohio, which consists of 121,625 square feet. Our headquarters are also occupied by Central Reserve. At December 31, 1999, the outstanding principal balance of the mortgage note on the building was approximately $8.2 million. Continental General owns and occupies a building in Omaha, Nebraska, which consists of approximately 61,400 square feet. United Benefit Life owns two buildings in Fort Worth, Texas, which consist of approximately 210,000 square feet. The buildings owned by United Benefit Life are for sale, and we do not expect any material gain or loss upon completion of the sale.
(2) Earnings per share amounts for 1997 have been restated to comply with Statement of Financial Accounting Standard No. 128 "Earnings Per Share."
- began executing a new business plan designed to expand our distribution systems, lower medical claim costs, reduce underwriting risks, consolidate administrative functions, increase fee-based revenue and acquire complementary businesses;
- entered into an agreement with United Benefit Life as of August 1, 1998 to reinsure 100% of the major medical policies of United Benefit Life, covering approximately 100,000 members with estimated annual premiums of $100.0 million;
- acquired Provident American Life and Health from Provident American Corporation on December 31, 1998 for $5.5 million in cash;
On October 7, 1999, we announced a definitive agreement to purchase The Pyramid Life Insurance Company from United Insurance Company of America, a subsidiary of Unitrin, Inc. of Chicago, Illinois. In addition, we expect that Continental General will sell specialty senior medical insurance products through the independent agent distribution systems of selected Unitrin insurance subsidiaries. Pyramid, based in Mission, Kansas, provides health and life insurance primarily for the senior market, including Medicare supplement, long-term care, home health care, and senior life products. Pyramid, on a statutory basis, had assets of approximately $120.0 million, capital and surplus of approximately $43.0 million at December 31, 1999, and 1999 revenue of $72.0 million. Pyramid markets senior insurance products through 2,500 independent agents in 40 states.
The acquisition, subject to regulatory approvals and other customary terms and conditions, is expected to be completed in the second quarter of 2000. At completion, Pyramid will be a wholly-owned subsidiary. The $67.5 million purchase price is expected to be financed through private equity offerings, an increase in our existing line of credit and a special dividend from Pyramid. We have not yet completed the private equity offerings or the amendment to our existing line of credit, and we cannot guarantee that the acquisition of Pyramid will be completed.
For the year ended December 31, 1999, total net premiums were $327.7 million, an increase of 112.6%, from $154.2 million for 1998. Medical premiums for 1999 were $251.9 million compared to $143.1 million for 1998, an increase of 76.1%. The increase in medical premiums was the result of $49.4 million attributable to Provident American Life and Health and Continental General, $22.6 million reinsurance assumed, and $36.8 million from rate increases and new business, net of lapses, at Central Reserve. Specialty and other premiums were $75.9 million for 1999 compared to $11.1 million for 1998, an increase of 582.0%. The increase in specialty and other premiums was primarily the result of $63.3 million attributable to Continental General and Provident American Life and Health.
through Provident American Life and Health and United Benefit Life. The balance represents association fees and a partial recovery of $1.6 million from the fraud committed in connection with claims administration at United Benefit Life. The amortization of deferred reinsurance gain of $5.5 million for 1999 represents the recognition of the ceding commission allowances received on our reinsurance agreements. The unamortized amount of $20.9 million at December 31, 1999 is accounted for as a deferred reinsurance gain on the consolidated balance sheet.
Total benefits, claims and settlement expenses increased to $233.1 million for 1999 compared to $116.1 million for 1998, an increase of 100.8%. Provident American Life and Health and Continental General accounted for $78.7 million of the total increase of $117.0 million. The remaining $38.3 million is primarily attributable to Central Reserve's portion of the increase in benefits at United Benefit Life, reflecting 12 months of operational activity in 1999 compared to five months in 1998. Medical benefits, claims, losses and settlement expenses were $176.5 million for 1999 compared to $108.4 million for 1998, an increase of 62.8%. The medical loss ratio was 70.1% for the year ended December 31, 1999 compared to 75.8% for 1998. Cost reduction and benefit program modifications implemented beginning in 1998, such as rate increases, improved underwriting, enhanced claim procedures, and medical cost management techniques, in addition to reduced loss ratios on increased new sales, led to the reduction in the medical loss ratio. Specialty and other benefits, claims, losses and settlement expenses were $56.6 million for 1999 compared to $7.6 million for 1998, an increase of 642.4%. The specialty benefit ratio was 74.6% for 1999 compared to 68.5% for 1998. The increase is primarily attributable to the inclusion of Continental General's Medicare supplement business and interest sensitive life and annuity benefits and reserves, which traditionally support a higher benefit ratio, in addition to adverse claims of Continental General's long-term care business.
Amortization of goodwill of $1.0 million relates to the February 1999 acquisition of Continental General and the December 1998 acquisition of Provident American Life and Health. The goodwill asset of $22.8 million as of December 31, 1999 consists of a balance of $20.8 for Continental General being amortized over 25 years, and $2.0 for Provident American Life and Health being amortized over 15 years.
Total net premiums in 1998 decreased 38.3% to $154.2 million from $249.7 million in 1997 primarily as a result of the 50% reinsurance treaty with Hannover. Medical premiums for 1998 were $143.1 million compared to $235.1 million in 1997, a decrease of 39.2%. The decrease in net medical premiums was primarily the result of the reinsurance agreement with Hannover. Specialty and other premiums were $11.1 million for 1998 compared to $14.6 million in 1997, a decrease of 23.7%. The decrease in specialty and other premiums was the result of reinsurance with Hannover.
Total benefits, claims, losses and settlement expenses were $116.1 million for 1998 compared to $210.8 million for 1997, a decrease of 44.9%. The decrease in 1998 was due to Central Reserve's reinsurance agreements. Medical benefits, claims, losses and settlement expenses were $108.4 million for 1998 compared to $198.7 million for 1997, a decrease of 45.4%. The medical loss ratio was 75.8% for 1998 compared to 84.5% for 1997. The lower loss ratio of 75.8% for 1998 is a combination of reinsurance ceded, rate renewal actions and medical cost management programs and benefits changes. Specialty and other benefits, claims, losses and settlement expenses were $7.6 million for 1998 compared to $12.1 million for 1997, a decrease of 36.9% resulting from the amount of business ceded.
provision of approximately $1.5 million taken in connection with a United Benefit Life note receivable, and a $1.5 million expense related to a fraud committed in connection with claims administration at the United Benefit Life facility.
The $0.6 million net amortization and change in deferral of acquisition costs and value of business acquired in 1998 was primarily the amortization of Central Reserve's portion of the ceding commission paid for the United Benefit Life block of group health policies.
Although we reported a loss for 1998, a provision for federal income taxes of $1.1 million was required principally due to the tax treatment related to the reinsurance transactions effective in 1998. For further information concerning the provision for income taxes, as well as information regarding differences between effective tax rates and statutory tax rates, see Note H of the Notes to Consolidated Financial Statements.
Liquidity is our ability to generate adequate amounts of cash to meet our financial commitments. The major needs for cash are to enable our insurance subsidiaries to pay claims and expenses as they come due. The primary sources of cash are premiums, investment income and reimbursements from reinsurers. Payments consist of current claim payments to insureds, managed care expenses, and operating expenses such as salaries, employee benefits, commissions, taxes and interests on debts.
We hold few high-yield type securities, with nearly 100% of our bonds being investment grade quality. In addition to the fixed maturities, we also had $42.9 million in cash and cash equivalents, and a $10.0 million line of credit with a major bank at December 31, 1999. There was no amount outstanding on the line of credit at December 31, 1999.
The total reinsurable receivable was $263.3 million at December 31, 1999. Of this amount, $253.1 million represents reserves held by our reinsurers under our various reinsurance treaties in place. Most all of these reserves are held by Hannover, supported by investment grade securities.
Assets increased 298.3% to $717.9 million at December 31, 1999 from $180.2 million at December 31, 1998. The increase was primarily due to the acquisition of Continental General, which had assets of $504.4 million at December 31, 1999, with the remaining increase attributable to the acquisition of Provident American Life and Health and United Benefit Life. These increases were, in part, offset by a related increase in liabilities of $528.8 million during the period to $673.2 million. Continental General's liabilities were $447.1 million and Provident American Life and Health's and United Benefit Life's were $27.4 million at December 31, 1999.
The total policy liabilities and accruals (reserves) were 80.0% of the total liabilities at December 31, 1999, compared to 67.3% at December 31, 1998. Continental General accounted for 75.7% of the reserves at December 31, 1999. Continental General's reserves were 80.9% of its total liabilities at December 31, 1999, accounting for the increase. This is a result of Continental General's life insurance and annuity reserves comprising a significant portion of its total liabilities.
The credit agreement contains financial and other covenants that, among other matters: (1) prohibit the payment of cash dividends on our shares of common stock, except upon compliance with certain conditions; (2) restrict the creation of liens and sales of assets; and (3) require that we at a minimum maintain (a) a leverage ratio (consolidated debt to consolidated total capital) of 0.50 to 1.00 through December 31, 1999, 0.45 to 1.00 thereafter through December 31, 2000, 0.40 to 1.00 thereafter through December 31, 2001, and 0.35 to 1.00 thereafter, (b) an interest coverage ratio (consolidated EBITDA to consolidated interest expense) of 2.0 to 1 through December 31, 1999, 2.5 to 1 through December 31, 2000, and 3.0 to 1 thereafter, (c) a risk-based capital ratio for any regulated insurance company subsidiary of the Company of not less than 125.0%, and (d) consolidated net worth of $35.0 million through December 31,1999, $40.0 million thereafter through December 31, 2000, $50.0 million thereafter through December 31, 2001, $60.0 million thereafter through December 31, 2002, and $70.0 million thereafter. In addition, we pledged the common stock of Continental General, Central Reserve, Provident American Life and Health and other insignificant subsidiaries as security for the credit agreement. At December 31, 1999, we were in compliance with the covenants contained in the credit agreement.
We believe that cash flow from operating activities will be sufficient to meet our currently anticipated operating and capital expenditure requirements. We are seeking to raise $27.5 million in private equity to finance the acquisition of Pyramid and will also borrow $15.0 million in additional funds from Chase and the other lending banks through an increase in our line of credit. We have not yet completed the private equity offerings or the amendment to our existing line of credit. If we are unable to do so, we may not be able to complete the acquisition of Pyramid. If additional funds are required for long-term growth, we believe that these funds could be obtained through equity or debt offerings as market conditions permit or dictate. We may not be able to obtain any additional financing on terms that are favorable to us.
At December 31, 1999, we had a tax net operating loss (NOL) carryforward of approximately $16.9 million for federal income tax purposes which expires through 2012. Future changes in ownership, as defined in Section 382 and 383 of the Internal Revenue Code, could limit the amount of NOL carryforwards used in any one year. We determine a valuation allowance based on an analysis of amounts recoverable in the statutory carryback period and available tax planning strategies. In assessing the valuation allowance of $14.7 million and $9.0 million established at December 31, 1999 and 1998, respectively, estimates were made as to the potential financial impact on us of recent NOLs and our financial condition in 1997. We believe that we will generate sufficient future taxable income to realize the $1.8 million net deferred tax asset prior to the expiration of any NOLs.
The following is a description of certain risks facing life and accident and health insurers and how we mitigate those risks:
Legal/Regulatory Risk is the risk that changes in the legal or regulatory environment in which an insurer operates will create additional expenses not anticipated by the insurer in pricing its products. That is, regulatory initiatives designed to reduce insurer profits or otherwise affecting the industry in which the insurer operates, new legal theories or insurance company insolvencies through guaranty fund assessments, may create costs for the insurer beyond those recorded in the financial statements. We attempt to mitigate this risk by offering a wide range of products and by operating in many states, thus reducing our exposure to any single product of non-Federal jurisdiction, and also by employing underwriting practices which identify and minimize the adverse impact of this risk.
Inadequate Pricing Risk is the risk that the premium charged for insurance and insurance related products is insufficient to cover the costs associated with the distribution of such products which include: benefits, claims and losses, settlement expenses, acquisition expenses and other corporate expenses. We utilize a variety of actuarial and/or qualitative methods to set such pricing levels.
We also have long-term debt that bears interest at variable rates; therefore our results of operations would be affected by interest rate changes. We do not expect a significant rate change in the near future that would have a material effect on our near-term results of operations.
Inflation has had an impact on claim costs and overall operating costs and although it has been lower in the last few years, hospital and medical costs have still increased at a higher rate than general inflation, especially prescription drug costs. New, more expensive and wider use of pharmaceuticals is inflating health care costs. The Office of Personnel Management reported the costs of prescription drugs increased by 22% in 1998. While to a certain extent these increased costs are offset by interest rates (investment income), the rate of income from investments has not increased proportionately. We will continue to establish premium rates in accordance with trends in hospital and medical costs along with concentrating on various cost containment programs. However, there can be no assurance that these efforts by us will fully offset the impact of inflation or that premiums will equal or exceed increasing healthcare costs.
This report contains both historical and forward-looking statements. Forward-looking statements are statements other than historical information or statements of current condition. The forward-looking statements relate to our plans and objectives for future operations. In addition to statements, which are forward-looking by reason of context, the words "believe," "expect," "anticipate," "intend," "designed," "goal," "objective," "optimistic," "will" and other similar expressions identify forward-looking statements. In light of the risks and uncertainties inherent in all future projections, the inclusion of forward-looking
statements should not be regarded as a representation by Ceres or any other person that our objectives or plans will be achieved.
- the failure to successfully integrate the businesses of Continental General, Provident American Life and Health and United Benefit Life into Ceres, including the failure to achieve cost savings;
- the failure to complete the acquisition of Pyramid or if the acquisition is completed, the failure to successfully integrate the operations of Pyramid into those of Ceres, including the failure to achieve cost savings;
- rising healthcare costs, especially the rising costs of prescription drug costs that are rising faster than other medical costs;
- the costs of defending litigation and the risk of unanticipated material adverse outcomes in such litigation;
- our ability to obtain additional debt or equity financing on terms favorable to us to facilitate long-term growth.
No. 137, Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133, which is required to be adopted for all fiscal quarters of all fiscal years beginning June 15, 2000. We expect to adopt the new statement effective January 1, 2001. This statement will require us to recognize all derivatives on the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through income. If a derivative is a hedge, depending on the nature of the hedge, changes in the fair value of the derivative will either be offset against the change in fair value of the hedged asset, liability, or firm commitment through earnings, or recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative's change in fair value will be immediately recognized in earnings. We anticipate that the adoption of this statement will not have a significant effect on our results of operations or financial position.
The accompanying consolidated financial statements and financial statement schedules have been prepared assuming that the Company will continue as a going concern. As discussed in Note C to the consolidated financial statements, the Company has suffered substantial losses from operations in 1997 that resulted in a significantly reduced net capital position. The Company has entered into an Amended and Restated Stock Purchase Agreement to issue and sell 7,300,000 Common Shares and warrants to purchase an additional 3,650,000 Common Shares at an exercise price of $5.50 per share for an aggregate purchase price of $40,150,000. The closing of the Amended and Restated Stock Purchase Agreement is subject to shareholder approval and regulatory approvals. In December 1997, the Company obtained an interim loan of $20 million and that loan is due June 30, 1998. Should the Amended and Restated Stock Purchase Agreement not be completed before June 30, 1998, and due to regulatory limitations on the Company's ability to receive dividends from its insurance subsidiary, the Company, absent some alternative capital resource, will not have the ability to repay the interim loan. These matters raise substantial doubt about the ability of the Company to continue as a going concern. Management's plans in regard to these matters are also described in Note C to the consolidated financial statements. The accompanying consolidated financial statements and financial statement schedules do not include any adjustments that might result from the outcome of this uncertainty.
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 (DOLLARS IN THOUSANDS) - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
Ceres Group, Inc. and its subsidiaries ("Ceres" or the "Company"), known as Central Reserve Life Corporation prior to December 8, 1998, operated in 1998 and prior periods primarily through its wholly-owned subsidiary, Central Reserve Life Insurance Company ("Central"). As of December 31, 1999, the Company's consolidated statements also include the accounts of Provident American Life & Health Insurance Company ("Provident") acquired on December 31, 1998, Continental General Corporation ("Continental General") and its wholly-owned subsidiary Continental General Insurance Company ("Continental") acquired on February 17, 1999 and United Benefit Life Insurance Company ("United Benefit") under a reinsurance arrangement effective August 1, 1998 and acquired on July 21, 1999. These acquisitions are discussed further in Notes D and J.
The Company provides through its wholly-owned subsidiaries a broad spectrum of health insurance, medical cost management, and specialty products and services distributed through 60,000 independent licensed agents. While the Company through its subsidiaries is licensed in 49 states, the District of Columbia and the U.S. Virgin Islands, approximately 67% of premium volume is generated from eleven states: Ohio, Florida, Indiana, Georgia, North Carolina, Texas, Kansas, South Carolina, Tennessee, Missouri, and Illinois.
The accompanying consolidated financial statements include the accounts of Ceres and its wholly-owned subsidiaries. The consolidated statement of operations for the year ended December 31, 1999 reflects the results of operations for Continental General for the period subsequent to its acquisition on February 17, 1999 and United Benefit's for the period subsequent to its acquisition (through foreclosure) on August 1, 1999. All intercompany transactions have been eliminated in consolidation.
The accompanying financial statements have been prepared in accordance with generally accepted accounting principles ("GAAP"), which differ from accounting practices prescribed or permitted by the various state departments of insurance in which the insurance subsidiaries are domiciled (see Note O). A summary of significant accounting policies is as follows:
Investments in bonds and mandatory redeemable preferred stocks are designated at purchase as held-to-maturity or available-for-sale. Held-to-maturity investments are securities which management has the positive intent and ability to hold until maturity, and are reported at amortized cost. Available-for-sale investments are reported at fair value, with unrealized holding gains and losses reported in accumulated other comprehensive income, net of deferred federal income taxes. All investments as of December 31, 1999 are designated as available-for-sale.
The balance of the value of business acquired was $16.7 million at December 31, 1999. During the year, $2.5 million was established as an additional expense reserve, increasing the value of business acquired. The
increased expense reserve is primarily a result of the higher commission rates paid in the initial policy years of the Medicare supplement business acquired. Under the current assumptions, amortizations for the next five years is expected to be as follows (dollars in thousands):
Goodwill represents the excess of cost over the fair value of net assets acquired. Goodwill is being amortized on a straight-line basis over periods of 25 years or less. On a periodic basis, management reviews goodwill to determine if events or changes in circumstances indicate the carrying value of such assets is not recoverable, in which case an impairment charge would be recorded in current operations. Management believes that no impairment of goodwill exists at December 31, 1999.
Claim liabilities with long pay-out periods, such as long term care and disability income claims, are discounted at interest rates ranging from 3.0% to 6.0%. Although considerable variability is inherent in such computations, management believes that the liabilities for unpaid life and accident and health claims are adequate. The estimates are continually reviewed and adjusted as necessary as experience develops or new information becomes known with such adjustments included in current operations.
In December 1997, the American Institute of Certified Public Accountants issued Statement of Position 97-3, Accounting by Insurance and Other Enterprises for Insurance-Related Assessments, which provides guidance for determining when an insurance or other enterprise should recognize a liability for guaranty-fund and other insurance-related assessments and guidance for measuring the liability. The adoption of this statement effective January 1, 1999 resulted in a $0.2 million charge to general operating expenses.
Fee and other income consists of association, collection, management, and administrative fees, and are recognized when earned.
In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities as amended by SFAS No. 137, Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133, which is required to be adopted for all fiscal quarters of all fiscal years beginning after June 15, 2000. The Company expects to adopt the new statement effective January 1, 2001. This Statement will require the Company to recognize all derivatives on the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through income. If a derivative is a hedge, depending on the nature of the hedge, changes in the fair value of the derivative will either be offset against the change in fair value of the hedged asset, liability, or firm commitment through earnings, or recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative's change in fair value will be immediately recognized in earnings. The Company anticipates that the adoption of this Statement will not have a significant effect on its results of operations or financial position.
In November 1997, the Company entered into a Stock Purchase Agreement ("Original Stock Purchase Agreement") with Strategic Acquisition Partners, LLC ("Strategic"), wherein the Company agreed to issue and sell 5,000,000 common shares and warrants to purchase an additional 2,500,000 common shares at an exercise price of $6.50 per share, for an aggregate purchase price of $27.5 million. On March 30, 1998, the Company entered into an amended and restated Stock Purchase Agreement ("New Stock Purchase Agreement") with Strategic and two additional investors: Insurance Partners, L.P. and Insurance Partners Offshore (Bermuda), L.P. (collectively, "Insurance Partners"). The New Stock Purchase Agreement was subsequently approved by shareholders, and accordingly, in July 1998 the Company issued and sold 7,300,000 common shares at $5.50 per share and warrants to purchase an additional 3,650,000 common shares at an exercise price of $5.50 per share, which expire July 2, 2005, and received proceeds of $37.7 million, which are net of transaction expenses.
Other fundings were provided by a $40.0 million credit facility with a syndicate of major commercial banks led by The Chase Manhattan Bank. The Company has pledged the common stock of Continental General and Central as security for the loan. See Note L, Long-Term Debt footnote for further discussion of the credit facility. In addition, effective February 17, 1999, the Company entered into a series of stock subscription agreements with a group of investors, principally Peter W. Nauert, and Insurance Partners wherein the Company issued 2,000,000 common shares at $7.50 per share for $15.0 million.
The following unaudited proforma information presents the consolidated results of operations of the Company assuming the acquisition of Continental was completed at the beginning of January 1, 1998 and 1999:
On December 31, 1998, Central acquired 100% of the outstanding common stock of Provident from Provident American Corporation ("Provident American") for $5.5 million. Provident is a life and accident and health insurer, domiciled in Pennsylvania, licensed in 40 states and the District of Columbia, that markets managed care health insurance products to individuals and small businesses, and critical illness coverage.
Funds for the acquisition were provided from Central's working capital. This transaction was accounted for in the accompanying consolidated financial statements in accordance with the purchase method and accordingly, the purchase price was allocated to assets and liabilities acquired based upon estimates of their fair values. There was no impact on the accompanying consolidated statement of operations for 1998 as a result of this transaction.
The following is a summary of net investment income by category of investments:
At December 31, 1999, $4.8 million of cash is held for self-funded accident and health accounts, which is restricted to use. Central is entitled to investment income from these funds. A corresponding liability is included in the accompanying consolidated financial statements.
The Company files a consolidated federal income tax return with its subsidiaries, except for Continental, which is required to file a separate return through fiscal year 2003. The provision for federal income tax does not bear the customary relationship to pretax accounting income because of special tax provisions available to life insurance companies.
The federal income tax returns for the Company and its subsidiaries have been examined by the Internal Revenue Service ("IRS") for 1991 and 1992. During the third quarter of 1994, the IRS issued a proposal for adjustments to the Company's returns for 1991 and 1992. The proposed deficiencies were approximately $2.4 million of which $0.2 million was paid in 1994 and $0.6 million paid in 1997. The balance of approximately $1.6 million relates to whether or not the Company's subsidiary, Central, qualified as a life company for tax purposes. The Company vigorously protested the proposed deficiency. Based on discussions with counsel, management believed existing law supported the Company's position. On October 12, 1999, the United States Tax Court ruled that Central did qualify as a life company for tax reporting purposes. A final computation of amounts due for 1991 and 1992 was filed in February 2000. The Company had established a liability for the amounts due, which had no material impact on the accompanying financial statements. The IRS has until May 31, 2000 to appeal the decision to the United States Tax Court.
At December 31, 1999, the Company has a tax net operating loss ("NOL") carryforward of approximately $16.9 million for federal income tax purposes, which expires through 2012. Future changes in ownership, as defined by Sections 382 and 383 of the Internal Revenue Code, could limit the amount of NOL carryforwards used in any one year.
The Company determines a valuation allowance based on an analysis of amounts recoverable in the statutory carryback period and available tax planning strategies. In assessing the valuation allowance established at December 31, 1999 and 1998, estimates were made as to the potential financial impact on the Company of recent NOLs and the Company's financial condition described in Notes B and C. Management believes that the Company will generate sufficient future taxable income to realize the $1.8 million net deferred tax asset prior to the expiration of any NOLs.
In accordance with federal tax law, a portion of insurance companies' net income, prior to 1984, is not subject to federal income taxes (within certain limitations) until it is distributed to policyholders, at which time it is taxed at regular corporate rates. For federal income tax purposes this untaxed income is accumulated in a memorandum account designated "policyholders' surplus." At December 31, 1999, the accumulated untaxed policyholders' surplus for the Company, all of which relates to Central, is $2.9 million.
The foregoing indicates that a $1.5 million redundancy in the 1998 reserves emerged in 1999, a $1.7 million redundancy in the 1997 reserves emerged in 1998, and a $8.3 million deficiency emerged in 1997. The deficiency in the 1996 reserves resulted from substantial losses developing on insurance plans issued in 1995, and higher utilization than anticipated.
Reserve liabilities assumed by Central under the United Benefit agreement on August 1, 1998 exceeded the cash transferred to Central by United Benefit as reimbursement for this assumption by $3.0 million which was reflected in a note receivable. Subsequent to August 1, 1998, the balance of the note receivable was increased as a result of adverse developments in the assumed policy liabilities, net of amounts ceded to
In connection with the United Benefit reinsurance treaty, Central ceded 80% of the business in force on August 1, 1998 to Hannover, thereby retaining a net risk of 20%. Additionally, Central ceded 50% of the policies to be written by United Benefit from and after August 1, 1998 and reinsured by Central to Hannover. This treaty provided Central an initial ceding allowance of $20.0 million, which is being accounted for as a deferred reinsurance gain in the accompanying consolidated financial statements, and will be amortized into income over the duration of the underlying block of business.
In February 1999, Continental entered into a reinsurance agreement with Hannover, under which Hannover reinsured 50% of all insurance business in force at Continental on February 1, 1999 for a ceding allowance of $13.0 million. The ceding allowance is being accounted for as a deferred reinsurance gain in the accompanying consolidated financial statements and will be amortized into income over the duration of the underlying block of business. Various assets, primarily comprised of fixed income securities with a market value of $188.4 million, were transferred from Continental to Hannover for the policy liabilities assumed by Hannover.
In the ordinary course of business, the Company maintains other reinsurance arrangements with other insurers. These arrangements are designed to limit the maximum amount of exposure that the Company retains on a given policy. For ordinary and group life claims, Continental's maximum retention is $125,000 and Central's maximum retention is $50,000, with no retention maintained over age 70. For accident and health claims, maximum retention on individual claims is $500,000.
The following table summarizes the net impact of reinsurance arrangements on premiums and benefits, claims, losses and settlement expenses, commissions, and other operating expenses:
The insurance companies remain obligated for amounts ceded in the event that the reinsurers do not meet their obligations.
On February 17, 1999, the Company entered into a $40.0 million credit facility with a syndicate of major commercial banks and the Chase Manhattan Bank, as the administrative agent. In accordance with the terms of the loan, the first principal payment of $3.0 million is due February 17, 2000. Quarterly principal payments are due thereafter as follows: $1.0 million through February 17, 2001; $1.5 million thereafter through
February 17, 2002; and $2.25 million every three months thereafter to February 17, 2005. Interest on the outstanding balance will be determined based on whether we select a "Base Rate Loan" or a "Eurodollar Loan". Under the Base Rate Loan, the interest rate will be 2.5% per annum plus the higher of (a) the rate which is 1/2 of 1% in excess of a federal funds rate and (b) Chase's prime rate as in effect from time to time. Under the Eurodollar Loan, the interest rate will be 3.5% per annum plus a Eurodollar rate, which is the arithmetic average of the offered quotation to first-class banks in the interbank Eurodollar market by Chase, adjusted for certain reserve requirements. At December 31, 1999, the interest rate was 9.41%. The credit agreement also provides for a $10.0 million line of credit, which bears interest at the same rate as the $40.0 million loan. A commitment fee of 3/4 of 1% per annum on the average daily unutilized line of credit is charged to the Company under the credit agreement. At December 31, 1999, there was no amount outstanding under the line of credit.
The credit agreement contains financial and other covenants with respect to the Company that, among other matters: (1) prohibit the payment of cash dividends on Ceres' shares of common stock, except upon compliance with certain conditions; (2) restrict the creation of liens and sales of assets; and (3) require that the Company maintain (a) a leverage ratio (consolidated debt to consolidated total capital) of 0.50 to 1.00 through December 31, 1999, 0.45 to 1.00 thereafter through December 31, 2000, 0.40 to 1.00 thereafter through December 31, 2001, and 0.35 to 1.00 thereafter, (b) an interest coverage ratio (consolidated earnings before interest, income taxes, depreciation, and amortization to consolidated interest expense) of 2.0 to 1 through December 31, 1999, 2.5 to 1 through December 31, 2000, and 3.0 to 1 thereafter, (c) a minimum risk-based capital ratio for any regulated insurance company subsidiary of Ceres not less that 125%, and (d) a minimum consolidated net worth of $35.0 million through December 31, 1999, $40.0 million thereafter through December 31, 2000, $50.0 million thereafter through December 31, 2001, $60.0 million thereafter through December 31, 2002, and $70.0 million thereafter. In addition, the common stock of Continental General, Central and other insignificant subsidiaries are pledged as security for the credit agreement. At December 31, 1999, the Company is in compliance with the covenants contained in the credit agreement.
Based on the methodology and assumptions delineated above, the weighted average fair value of options granted in 1999, at grant date, was $2.10 per share. The pro forma impact would be to decrease net income by $0.9 million and decrease net income per share by $0.07 for basic and $0.06 for fully diluted for the year ended December 31, 1999.
The Company has authorized 2,000,000, $.001 par value Non-Voting Preferred Shares. The Company has never issued any Non-Voting Preferred Shares; however, the Board of Directors is authorized at any time to provide for the issuance of, such shares in one or more series, and to determine the designations, preferences, limitations and other rights of the shares issued, including but not limited to the dividend rate, liquidation preference, redemption rights and price, sinking fund requirements, conversion rights and restrictions on the issuance of such shares. Holders of Non-Voting Preferred Shares shall have no voting rights except as required by law.
The Company's insurance subsidiaries are subject to certain Risk-Based Capital ("RBC") requirements as specified by the NAIC. The RBC model serves as a benchmark for the regulation of life and accident and health insurance companies by state insurance regulators. At December 31, 1999, the statutory capital and surplus of Central, Provident, Continental, and United Benefit each exceed the minimum RBC requirements to which the entity is subject.
The amount of dividends, which the Company's subsidiaries can pay, is subject to certain regulatory restrictions. In 2000, Central, Provident and United Benefit cannot pay any dividends without the prior approval of the respective Commissioner of Insurance of the State of domicile as a result of specific regulatory requirements. Continental can pay approximately $3.4 million in dividends, in 2000, without the prior approval
Net income (loss) per common share has been computed in accordance with FASB's Statement of Financial Accounting Standards No. 128, Earnings Per Share. In computing diluted earnings per share, only potential common shares that are dilutive, those that reduce earnings per share, are included. The exercise of options and warrants is not assumed if the result would be antidilutive, such as when a loss from operations is reported.
Continental employees are eligible to participate in the Continental Retirement Savings Plan ("Continental Plan") after completing one full year of service and 1,000 hours of service within any one calendar year. Participants of the Continental Plan may contribute up to 10% of their pre-tax annual compensation. The
In conjunction with the Company's continued growth and refinement of defined organization structure, the Company expanded its operating segments to the following three distinct operating segments based upon product types: medical, specialty and other, and corporate and other. Products included in the medical segment include comprehensive major medical plans. Significant products in the specialty and other segment include Medicare supplement, long-term care, dental, life insurance, and annuities.
The corporate segment encompasses all other activities of the Company, including interest income and expense of the parent company. Revenues from each segment are primarily generated from premiums charged
to external policyholders and interest earned on cash and investments and are summarized in the following tables:
based on estimates using present value or other valuation techniques. These techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Although fair value estimates are calculated using assumptions that management believes are appropriate, changes in assumptions could cause these estimates to vary materially. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in the immediate settlement of the instruments.
INVESTMENT SECURITIES--Fair value for fixed maturity securities is based on quoted market prices, where available. For fixed maturity securities not actively traded, fair value is estimated using values obtained from independent pricing services.
OTHER POLICYHOLDERS' FUNDS--The carrying amount reported in the consolidated balance sheets for these instruments approximate their fair value.
Carrying amounts and estimated fair values of financial instruments at December 31, 1999 and 1998, are summarized as follows:
Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of fixed maturity investments, cash, cash equivalents, and reinsurance receivable.
Substantially all of the Company's reinsurance recoverable is due from a single reinsurer, Hannover. At December 31, 1999, Hannover maintained an "A" rating from the A.M. Best Company. The Company performs periodic evaluation of this reinsurer's credit standing.
The following is a summary of quarterly results of operations for the years ended December 31, 1999 and 1998:
(a) In 1998, the Company reclassified certain items from commissions and general expenses to benefits and claims related to the first and second quarters. There was no effect on earnings (loss) or the per share amounts resulting from these reclassifications.
(b) Includes $3.7 million related to policy administration fees expensed to Hannover in 1998.
(d) The increase in the fourth quarter net income is primarily a result of a decrease in claim reserves held for the health business of Continental and a leveling of the increased reserves held for adverse deviations in the long-term care business of Continental.
CERES GROUP, INC. AND SUBSIDIARIES CONDENSED FINANCIAL INFORMATION OF REGISTRANT CERES GROUP, INC. (PARENT ONLY) STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 (DOLLARS IN THOUSANDS) - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
CERES GROUP, INC. AND SUBSIDIARIES CONDENSED FINANCIAL INFORMATION OF REGISTRANT CERES GROUP, INC. (PARENT ONLY) STATEMENT OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 (DOLLARS IN THOUSANDS) - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------