The Company's principal office, located at 2500 DeKalb Pike, Norristown, Pennsylvania, is owned by PILIC. This property is comprised of approximately 6.5 acres of land and buildings containing approximately 44,000 square feet of space. The Company believes its existing facilities are suitable to conduct its present business.
(1) Assumes conversion of Series A and Series B Preferred stock into common stock of the Company on a share-for-share basis in years 1995 and 1994 and conversion of Series A Preferred stock in 1998, 1997 and 1996 on a share-for-share basis.
During 1998 the Company revised its strategy to focus predominately on HealthAxis, the Company's E-Commerce insurance marketing subsidiary along with more focused strategy for PILIC. In early 1998 the Company determined that the Internet provided the opportunity to sell health insurance direct to the consumer thereby reaching individuals under-served by insurance agents at a cost potentially lower than the Company's current traditional agency marketing channel. In light of the losses experienced in the Company's small group and managed care products and the need to devote capital and focus to HealthAxis, the Company entered into various agreements to sell PILIC's subsidiaries MMC, PALHIC and NIA and cede 100% of the group medical and group life business during 1998.
Accident and health gross premium was $110.7 million for 1998 compared to $87.7 million for 1997. Accident and health ceded premium was $49.7 million for 1998 compared to $39.5 for 1997. These increases were the result of increased new business relating to the Company's managed care health insurance products. As a result of the transactions with CRLC and RCH, the Company anticipates a substantial decline in premium in future years. The Company will cede 100% of the Company's small group and managed care business to RCH. The Company's small group and managed care business comprised $104 million and $49.2 million of accident and health gross and ceded premiums, respectively. The Company's future gross, ceded and net health premium will be derived from the assumption of stop loss business administered by MMC and business assumed from CRLC.
Net investment income of $3.8 million for 1998 increased modestly compared to $3.5 million for 1997, primarily due to an increase in bond investments. Net realized gains on investments of $0.3 million for 1998 relates to the Company's sale of an investment in real estate while 1997's realized gain of $0.8 million relates to the Company's sale of Loewen common stock acquired as a result of a lawsuit.
Accident and health policy benefits ratio net of reinsurance decreased to 79.3% for 1998 compared to 86.3% for 1997 as a result of premium increases and improved claim experience on the Company's managed care products. The Company's small group and managed care business will be 100% ceded to RCH in the future. The Company's small group and managed care business loss ratio was 77% in 1998. Although the Company believes policy claim liabilities are adequate, experience with these newer managed care products is limited and continues to evolve. A greater then anticipated claim experience could have a materially adverse impact on the financial position and results of operations.
Commissions, net of ceding allowance and deferred acquisition costs of $7.1 million for 1998 increased from $6.8 million for 1997 due to increased premium volume. Commissions, net of ceding allowance and deferred acquisition costs for group health and group life business which is 100% ceded to RCH effective January 1, 1999 was approximately $6.3 million.
Policy claims are based on a variety of estimation methods, which are continually revised incorporating the Company's most recent benefit experience. As a result of higher than expected out-of-network claim utilization and greater than expected claim frequency, the Company increased its loss ratio assumptions during the year, which, in turn, resulted in an underwriting loss for 1997. In reaction to these items, the Company began a series of corrective actions, including premium rate increases, more stringent underwriting and revised policy designs providing for more severe penalties for those policyholders who elect to receive medical treatment outside of the authorized PPO networks.
Accident and health gross premium was $87.7 million for 1997 compared to $57.2 million for 1996. Accident and health ceded premium was $39.5 million for 1997 compared to $25.7 for 1996. These increases were the result of increased new business relating to the Company's managed care health insurance products.
The lapse ratio on small group and managed care accident and health insurance business based on annualized premium was 45% for 1997 compared to 38% for 1996. The lapse ratios reflect the results of premium rate increases as well as the Company's continued shift toward managed care plans and away from traditional healthcare insurance. The Company's traditional healthcare insurance plans have higher premiums and higher policy benefits than its managed care plans. The accident and health lapse ratios include small group medical plans, which by their nature have high lapsation.
Net investment income of $3.5 million for 1997 increased modestly compared to $3.3 million for 1996, primarily due to an increase in bond investments. Net realized gains on investments of $0.8 million for 1997 decreased from $2.1 million for 1996, and reflect the sale of the Company's remaining holdings of Loewen stock.
The primary sources of cash for insurance operations are premiums, investment income and investment sales and maturities. The primary uses of cash for insurance operations are benefit payments to insureds, operating costs including policy acquisition costs and investment purchases.
During 1999, the Company's liquidity requirements will be primarily created and met by HealthAxis through the issuance of debt and equity securities by the Company to outside parties. PILIC's contribution will be limited to individual life premiums and administrative fees. The primary uses of cash for HealthAxis will continue to be operating costs and payments to AOL, Lycos and CNet, while PILIC's primary uses will be claim payments and associated general expenses related to the 1998 claim run-off, which have been established as claim reserves.
Cash and investments carried at market value at December 31, 1998 amounted to $59.2 million. This included $31.9 million of bonds issued by the U.S. Government, government agencies, public utilities and other corporations, $1.1 million invested in policy loans and other invested assets and $26.2 million in cash and cash equivalents. Bonds are investment grade securities with fixed incomes ranging in maturity from one to 30 years. The gross average yield on fixed income bonds as of December 31, 1998, 1997 and 1996 was 6.3%, 6.8%, and 6.5%, respectively. The Company's investment policy is to buy medium term U.S. government direct and agency bonds. All bonds are considered to be "available for sale". The Company and its subsidiaries do not invest in high-yield debt instruments, defined as securities below investment grade with interest rates or yields significantly above market rates nor does the Company invest in derivatives or hedging in financial instruments.
The Company entered into a line of credit with a bank during 1997 in the amount of $1.0 million with interest at 1% above the prime rate. The outstanding borrowing at December 31, 1997 amounted to $1.0 million. The Company repaid this amount during 1998.
In connection with the Company's outsourcing to HPS the Company received premiums, net of commissions, HPS fees and certain out of pocket expenses monthly on or before the 15th of following month. The $6.8 million change in amounts due from third party administrator represented December 1998's net cash settlement collected from HPS in January 1999.
Change in future policy benefits and claims of $4.3 million in the current year in comparison to the prior year reflects higher paid claim volume on the Company's group medical business and is partially offset by the change in amounts due from reinsurers.
The Company sold an 80% interest in MMC for $4.0 million realizing a gain for the same amount during the first quarter of 1998. The Company also sold PALHIC and NIA for $5.6 million, resulting in a $1.0 million loss.
The statutory capital and surplus of PILIC, was $4.8 million at December 31, 1998. At December 31, 1998, PILIC calculated its "Risk Based Capital" utilizing a formula required by the National Association of Insurance Commissioners. The results of this computation indicate that PILIC's adjusted capital of $5.3 million exceeded Regulatory Action Level but was below Company Action Level. PILIC's year end 1998 RBC calculation included approximately $4.8 million of RBC related to PILIC's one life group health and group life business 100% ceded to RCH effective January 1, 1999. The RBC formula estimates RBC based on a variety of historical data including 1998 net earned premium. The effects of the reinsurance agreement between PILIC and RCH on PILIC's RBC calculation will not be realized until 1999. In concept, Risk Based Capital standards are designed to measure the acceptable amounts of capital an insurer should have based on inherent and specific risks of the insurers business. This formula is a primary measurement as to the adequacy of total capital and surplus of life insurance companies. Since PILIC failed to meet its RBC requirement as of December 31, 1998 it may be subject to regulatory action. Insurers failing to meet their RBC requirement may be subject to scrutiny by its domiciled insurance department and other insurance departments, which the insurer does business in, and, ultimately, rehabilitation or liquidation.
The higher interest rates, which have traditionally accompanied inflation, also affect the Company's investment operation. The market value of the Company's fixed rate long-term investments decreases as interest rates increase.
As of December 31, 1998 HealthAxis does not have sufficient funds to satisfy HealthAxis cash needs for 1999. HealthAxis is seeking $15 million through issuance of 2,599,653 shares of Series C Preferred Stock in order to fund payments to its marketing partners and operating expenses. No assurances can be given with regard to the success or timing of the Company's efforts in obtaining such funding. In the event that HealthAxis is unable to obtain funding or launch its web site in accordance with the AOL, CNet and Lycos agreements, HealthAxis will be in breach of one or more of those agreements. HealthAxis would forfeit all amounts paid to AOL, CNet or Lycos if it is in breach of any of the aforementioned agreements.
The Company utilizes various computer software programs, operating systems and vendors whose software programs and communication links ("Computer Systems") are used in the Company's insurance and HealthAxis e-commerce businesses. For the Company's insurance business these Computer Systems include health insurance administration provided by HPS, life insurance administration, health claims discount repricing provided by First Health Group along with financial accounting and actuarial systems. For HealthAxis, these Computer Systems include the www.healthaxis.com web site, links to AOL along with the AOL online network, HPS, First Health Group, along with HealthAxis' data warehouse. In 1999, the Company expects to have links to CNet, Lycos, Snap.com as well as Carrier Partners who will offer their products through the HealthAxis web site. To the extent that the Company's Computer Systems contain source codes that are unable to appropriately interpret the Year 2000 then some level of modification, or even replacement of such applications may be necessary. The result of these Year 2000 issues may, if not corrected, have a significant negative impact on Company's business.
The Company intends to conduct an analysis to determine whether its vendors, Carrier Partners, Distribution Partners, and other business partners (in so far as they are material to the Company's business) have any Year 2000 issues. As part of this process, the Company intends to request its vendors provide them with information regarding their progress in identifying and addressing their Year 2000 problems. Based on information reported in quarterly SEC filings, AOL and HPS anticipate being Year 2000 compliant no later than December 31, 1999 and June 30, 1999, respectively.
To date the Company has eliminated its health administration system by outsourcing of the health administration and claims processing to HPS effective February 1998 and assigned responsibility of the oversight of HPS' health administration and claims processing along with the Company's former health agent and underwriting Computer Systems to CRLC effective December 31, 1998.
Consolidated Statements of Operations Years ended December 31, 1998, 1997 and 1996
We have audited the accompanying consolidated balance sheets of Provident American Corporation and Subsidiaries as of December 31, 1998 and 1997 and the related consolidated statements of operations, stockholders' equity and cash flows for each of the two years in the period ended December 31, 1998. Our audits also included the financial statement schedules listed in the index at Item 14(a) of the Form 10-K. These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Provident American Corporation and Subsidiaries as of December 31, 1998 and 1997, and the results of their operations and their cash flows for each of two years in the period ended December 31, 1998 in conformity with generally accepted accounting principles. In addition, in our opinion, the financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.
We have audited the consolidated financial statements and the financial statement schedules of Provident American Corporation and Subsidiaries listed in Item 14(a) of this Form 10-K. These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits.
Coopers & Lybrand, LLP 2400 Eleven Penn Center Philadelphia, Pennsylvania March 11, 1997
Provident American Corporation and Subsidiaries Notes to Consolidated Financial Statements December 31, 1998
Provident American Corporation ("PAMCO") is a Pennsylvania corporation organized in 1982 and regulated as an insurance holding company by the states in which its wholly owned insurance subsidiary are licensed. The operations of PAMCO and its subsidiaries (the "Company") are principally those of its majority-owned subsidiary HealthAxis.com, Inc. ("HealthAxis") and its insurance operations. PAMCO's insurance operations are conducted through its wholly owned life insurance company Provident Indemnity Life Insurance Company ("PILIC") and PILIC's subsidiaries which during 1996 through 1998 were Provident American Life and Health Insurance Company ("PALHIC"), Montgomery Management Corporation ("MMC") and NIA Corporation ("NIA"). Hereinafter, PAMCO and all of its subsidiaries are collectively referred to as the Company and PILIC and all of its subsidiaries are referred to as the Company's Insurance Operations. During 1998, the Company sold 80% of MMC's outstanding common stock and on December 31, 1998 sold 100% of the outstanding common stock of PALHIC and NIA.
Cash equivalents consist of highly liquid investments with maturities of three months or less from date of purchase. The Company maintains its cash accounts at several commercial and savings banks. Cash accounts at each bank are insured by the Federal Deposit Insurance Corporation for up to $100,000. During the year, uninsured balances at times exceed insured limits.
Prepaid interactive marketing expense represents cash and other consideration paid to AOL, Cnet and Lycos for exclusivity and advertising impressions related to services to be provided to the Company under the terms of the respective marketing agreements. Prepayments related to exclusivity are amortized on a straight-line basis over the respective contract term. Prepayments related to advertising impressions are expensed as impressions are delivered under the respective agreements.
Deferred policy acquisition costs are costs, which vary with and in direct proportion to new business volume and include excess first year commissions, policy issue and underwriting expenses net of application fees and reinsurance ceding allowances. Accordingly, policy acquisition costs are deferred and amortized in order to match the costs of writing new business against the expected future revenues. Amortization of deferred policy acquisition costs relating to managed care business ("The Provident Solution" and HealthQuest) are established when polices are issued. It is based on projected premium over a four-year period incorporating current lapse experience and for life insurance business based on the same projected premium assumptions used in computing reserves for future policy benefits. Effective December 31, 1998, all unamortized policy acquisition costs for the Company's managed care business was netted against the ceding commission received as described in Note E - Reinsurance of Inforce Group Medical and Group Life Inforce. Unamortized costs relate to the Company's individual life business and are compared to the estimated future profitability for these products. If the unamortized costs exceed the estimated future profitability for these products, the unamortized cost will be written down to equal the estimated future profitability. The Company's estimates of future profitability consider investment income.
Property and equipment (principally home office property) are recorded at cost. Expenditures for improvements that increase the estimated useful life of the asset are capitalized. Expenditures for repairs and maintenance are charged to operations as incurred. Depreciation is provided using the straight-line method over the estimated useful lives of the assets. Upon sale or retirement, the cost of the asset and the related accumulated depreciation are removed from the accounts and the resulting gain or loss, if any, is included in operations.
Start-Up Costs: In accordance with AICPA statement of position No. 98-5 "Reporting on the Costs of Start-Up Activities", Start-Up Cost have been expensed as incurred.
Recognition of premium revenue: For accident and health policies, premiums are recognized when earned. For life insurance policies, premiums are recognized when due. Limited-payment contract premiums received in excess of net premiums are deferred and recognized into income in a constant relationship with insurance in-force. Considerations from annuity contracts are accounted for as fund deposits with revenues reflecting administrative and other charges.
Provident American Corporation and Subsidiaries Notes to Consolidated Financial Statements - (Continued)
Effective March 1, 1996, PILIC acquired all of the issued and outstanding stock of Union Benefit Life Insurance Company, a Pennsylvania stock life insurance company, ("UBLIC") for an amount equal to its adjusted capital and surplus (approximately $3,750), $500 in cash, plus the issuance of 100,000 shares of PAMCO's common stock. The shares issued are registered securities but have trading restrictions attached. The Company has changed UBLIC's name to PALHIC. Concurrently, the Company, PALHIC and PILIC entered into an agreement for the purchase and sale of the PALHIC business with Life and Health Insurance Company of America, a Pennsylvania insurer ("LHI"), pursuant to which all of the insurance business of PALHIC was purchased by LHI immediately prior to the purchase of the PALHIC stock by PILIC. The purchase price payable by LHI to PALHIC for the purchase of the PALHIC business was $1,800. PALHIC is licensed to transact life, accident and health insurance in forty (40) states and the District of Columbia. PALHIC began underwriting the Company's life, accident and health insurance products in 1997. This transaction was accounted for as a purchase . On December 31, 1998 the Company sold all of the outstanding shares of PALHIC to Central Reserve Life Insurance Company ("CRLC") for $5,600 which approximates PALHIC's capital and surplus. The Company recognized, loss of approximately $1,300 on the sale of PALHIC.
Effective January 1996, the Company acquired all of the stock of Richard E. Field & Associates, Inc., d/b/a REF & Associates, Inc. ("REF"), for 610,000 shares of PAMCO's common stock. REF, a California corporation, is engaged in marketing certain life and health insurance products of PILIC. This transaction was accounted for as a pooling of interests. REF did not conduct any business in 1998.
The Company has incurred costs to develop and enhance its technology, to create and introduce its website, to establish marketing, insurance carrier and claims administration relationships. As a result, the Company has incurred significant losses and expects to continue to incur losses on a quarterly basis at least through 2000. The Company currently intends to increase, substantially, its operating expenses as a result of the Company's strategic alliances, to fund increased sales and marketing, to enhance its existing web site and to fund increased salaries and other costs. Consequently, the Company expects negative cash flow from operations to continue for the foreseeable future as it continues to develop and market its Internet-based health insurance business.
Summary of net changes in unrealized appreciation and depreciation of investment securities was as follows:
Bond investments on deposit as required by regulatory agencies were valued at approximately $8,846 at December 31, 1998. In addition, approximately $1,210 of bonds or other interest bearing deposits have been placed in escrow with a bank in connection with certain reinsurance agreements (see note W).
Amortized Recorded Fair Contractual Maturity Cost Value -------------------- --------- ------------- Within one year $ 241 $ 254 After one year but within five years 13,185 13,548 After five years but within ten years 8,787 9,335 Over ten years 5,126 5,168 -------- -------- 27,339 28,305 Mortgage-backed securities 3,516 3,575 -------- -------- $ 30,855 $ 31,880 ======== ========
1998 1997 1996 ------- ------- ------- Bonds $ 2,636 $ 3,293 $ 3,072 Equity securities 293 14 39 Mortgage loans 21 27 28 Real estate 386 250 160 Policy loans 75 19 22 Cash and cash equivalents 482 329 244 Other 72 116 36 ------- ------- ------- 3,965 4,048 3,601 Investment expenses (201) (561) (321) ------- ------- ------- Net investment income $ 3,764 $ 3,487 $ 3,280 ======= ======= =======
Under the terms of the IM Agreement, HealthAxis shall make payments to AOL of $10,000 for the initial term (of which $8,500 has been paid and is accounted for as prepaid interactive marketing expense and the remaining $1,500 is due during 1999) and $33,500 due in 2000 for the renewal term. HealthAxis also has agreed to pay administrative fees to AOL if approved applications exceed certain thresholds. See Note AA
Under the original IM Agreement, PAMCO issued to AOL warrants to purchase 300,000 shares of PAMCO's common stock at an exercise price of $4.48 per share for a period of seven years. In addition, warrant agreements executed in connection with the amendment of the IM Agreement provide that AOL shall receive immediately exercisable warrants to purchase 300,000 shares of HealthAxis's or PAMCO's common stock, or any combination thereof, for an aggregate of 300,000 shares. The exercise price of the warrant to purchase shares of PAMCO's common stock is $3.38 per share and is exercisable for a period of nine years commencing November 13, 1998. The warrants to purchase shares of HealthAxis's common stock has an exercise price of $1.77 per share and are exercisable for a period of nine years commencing November 13, 1998. The fair value of these warrants (approximately $2,651) was accounted for as a capital contribution from PAMCO and a prepaid interactive marketing expense. If HealthAxis renews the IM Agreement, then PAMCO will issue warrants to AOL for the purchase of up to 300,000 additional shares of PAMCO's common stock at an exercise price of $5.15. These warrants shall be exercisable for a period of seven years commencing April 1, 2000, vesting quarterly. HealthAxis and PAMCO also granted AOL (including any transferee or successor thereof) certain registration rights with respect to shares of HealthAxis' and PAMCO's common stock acquired upon the exercise of the warrants granted to AOL.
Since signing the original agreement CNet and Snap.Com have become separate entities. Consequently, CNet and Snap.Com have extended an offer whereby they are requesting HealthAxis to separate the CNet agreement into two agreements with CNet and Snap.Com. If the agreement is split, the payments as discussed above will remain substantially the same. HealthAxis is currently negotiating with both companies and has a verbal agreement to suspend the payments due in 1999 until such time as the new arrangement can be mutually agreed upon.
HealthAxis's amended agreement with Lycos provides that Lycos will make HealthAxis the exclusive provider of medical, HMO, PPO, indemnity, dental, vision, prescription, long term care, and long term disability insurance through the Internet, for total payments approximating $9,060 (of which $800 has been paid and accounted for as prepaid interactive marketing expense) during the term of the agreement which shall extend for twenty-four months from the launch of the co-branded version of HealthAxis's site expected to be on or about May 31, 1999. Of the remaining $8,260 payments to Lycos, $1,275, $5,345 and $1,640 are due in 1999, 2000 and 2001, respectively. In addition, HealthAxis shall pay to Lycos certain fees based upon the success of sales from the co-branded web site.
Under the terms of the E-Commerce Agreement, HealthAxis is required to pay HPS 4% of the transaction fee revenue (the "License Fees") generated from insurance companies whose products are available for sale through HealthAxis ("Carrier Partners") for various services to be provided, including but not limited to, a transaction fee on each item of e-commerce transacted through HealthAxis web site, excluding docking, advertising, front holding fees and other fees for the right to participate in the sale of insurance products over the HealthAxis web site or any other form of e-commerce, during the term of the E-Commerce Agreement.
As described in Notes F, G and H HealthAxis has made payments and issued warrants aggregating $12,240 which have been charged to prepaid interactive marketing expense. These payments and warrants issued under the terms of the respective agreements with AOL, Cnet and Lycos represent exclusivity and impression advertising costs of $3,527 and $8,713, respectively. Included in advertising and promotional expense is amortization of prepaid interactive marketing expense of $585 consisting of exclusivity expense and impression advertising of $381 and $204, respectively.
Effective December 31, 1998, all remaining unamortized policy acquisition costs for the Company's group medical products sold or reinsured during 1998 was netted against the ceding commission received as described in Note W. Accordingly, deferred policy acquisition costs as of December 31, 1998 and 1997 relate only to the Company's individual life business. Based on an analysis by the Company's appointed actuary, management believes the estimated future profitability of the individual life business exceeds the unamortized deferred policy acquisition costs for life products.
Note L - Loans Receivable - Officer and Director and Shareholder
Loans receivable, of related parties interest at rates ranging from 5.33% to 9.5%, are generally due in April 2000 and collateralized primarily by the Company's common stock.
The Company has a bank line of credit aggregating $1,000 and bearing interest at 1% above the prime rate. Average borrowings approximated $83 and $131 in 1998 and 1997, respectively, and the weighted average interest rate was approximately 5.0% and 6.7% in 1998 and 1997, respectively. The maximum amount borrowed was $1,000 in both years.
As described in Note Z, the Company received $5,000 from HPS, which has been accounted for as a loan payable discounted at the Company's recent historical borrowing rate of 9.25%. The net discounted loan of $3,865 is payable in 60 monthly installments of $95 including principal and interest commencing in March 1998.
The Company and its subsidiaries have a net operating loss carryforward ("NOLs") approximating $18,400, of which is available to offset future taxable income through 2013. Approximately $4,100 of the NOLs result from a 1989 acquisition and expire between 1999 and 2004 and are subject to annual limitations approximating $100, thereby significantly reducing their ultimate utilization. The NOLs included as deferred tax assets have been reduced to exclude the estimated amount of carryforwards that are unavailable due to certain limitations.
In accordance with the Life Insurance Company Income Tax Act of 1959, a portion of the Insurance Subsidiaries' statutory income was not subject to current income taxation but was accumulated in an account designated Policyholders' Surplus. Under the Tax Reform Act of 1984, no further additions may be made to the Policyholders' Surplus Account for tax years ending after December 31, 1983. The balance in the account of approximating $2,400 at December 31, 1998 would result in a tax liability of $840 (at a 35% rate), only if distributed to shareholders or if the account balance exceeded a prescribed maximum. No income taxes have been provided on this account because, in management's opinion, the likelihood that these conditions will be met is remote. "Shareholders' Surplus" represents an accumulation of taxable income (net of tax thereon) plus the dividends-received deduction, tax-exempt interest, and certain other special deductions as provided by the Act. At December 31, 1998, the balance in the "Shareholders' Surplus" account amounted to approximately $3,500. There is no present intention to make distributions in excess of "Shareholders' Surplus".
As of December 31, 1998, 16,172,760 shares of HealthAxis common stock were issued and outstanding. Of this amount, 13,807,395 or approximately 85% were held by PAMCO and 2,365,365 or approximately 15% were held by HPS. The minority interest in HealthAxis represents HPS' approximate 15% of HealthAxis' equity.
Note P - HealthAxis.com, Inc. Series B Cumulative Convertible Preferred Stock
Shares of Series B Preferred Stock are convertible at any time, at the option of the holder, into Common Stock at a price equal to the original issuance price ($4.40 per share) divided by the Conversion Price which is defined as the original issuance price adjusted for future issuances of common stock as defined in the preferred stock agreement.
All of the outstanding shares of Series B Preferred Stock shall be converted into a number of shares of Common Stock at the Conversion Price (as defined above) upon the consummation of an underwritten public offering of the Common Stock of HealthAxis at a net offering price per share that represents a pre-offering market capitalization of not less than $200,000 and aggregate proceeds (net of underwriting commissions and discounts) to HealthAxis of not less than $25,000.
The Stock Purchase Agreement, dated November 13, 1998, related to AOL's purchase of the Series B Preferred Stock (the "Stock Purchase Agreement") provides that HealthAxis with certain exceptions as outlined in the agreement may not issue, sell, exchange or reserve or set aside for issuance any Common Stock, any other equity security of HealthAxis, or any convertible debt security or debt security with equity features or any option, warrant or right to subscribe for, or purchase any equity or debt security of HealthAxis unless HealthAxis offers to sell AOL its proportionate interest (as defined in the Stock Purchase Agreement) of such securities at a price and terms specified by HealthAxis, which offer is required to remain open for 30 days. These above-described rights granted to AOL do not apply to and terminate upon an underwritten public offering with a pre-offering market capitalization of $150,000 which results in aggregate net cash proceeds of not less than $25,000.
HealthAxis and PAMCO also agreed that, provided AOL owned or possessed the right to acquire at least 1% of HealthAxis's outstanding Common Stock, HealthAxis would be precluded from certain transactions without the prior consent of AOL.
The Stockholders' Agreement dated, November 13, 1998 (the "Stockholders' Agreement") between HealthAxis, AOL, HPS, PAMCO, PILIC and Messrs. Ashker and Clemens provides that in the event a Selling Group Stockholder, which includes all parties to the Stockholders' Agreement other than AOL and HealthAxis, intends to sell or transfer any shares of capital stock of HealthAxis, such Selling Group Stockholder shall give notice to AOL of the name and terms offered by the proposed purchaser and provide AOL with the right to purchase such shares at the same price offered by the proposed purchaser for a period of 30 days. If AOL does not elect to purchase such shares within 30 days, the Selling Group Stockholder may sell such shares to the proposed purchaser within 90 days on the same terms, including price, contained in the notice to AOL. If the sale is not effective within 90 days, additional notice to AOL is required. A purchaser of the shares held by any Selling Group Stockholder must agree to be bound by the terms of the Stockholders' Agreement as a condition to the transfer. If any Selling Group Stockholder receives any bona fide offer from a third party to purchase any shares of stock covered by the Stockholders' Agreement, such stockholder shall provide notice of such offer to AOL and shall not sell any stock of HealthAxis unless the terms of the offer are extended to AOL. See Note BB.
The Stockholders' Agreement terminates upon: (i) an underwritten public offering by HealthAxis which generates net cash proceeds of $25,000 and has a pre-offering market capitalization of not less than $150,000; or (ii) with respect to a particular party to such agreement, upon the transfer of all of the stock owned by such stockholder.
Series A Cumulative Convertable Preferred stock, $1 par value, entitles its holder to vote on an "as-converted" basis at a rate of four common votes per one share of Preferred Stock, to receive an annual cash dividend of $.25 per share, to convert after March 1995 into either common voting stock or Class A Common Stock on a share-for-share basis (each Class A Common Share has four votes) adjusted for future dilution and to receive $3.65 per share plus all accrued and unpaid dividends in the event of voluntary or involuntary liquidation and may be redeemed at the option of the Company on June 30, 1998, at the greater of (a) the current market price of the Class A Common Stock or the common stock or (b) $5.45 per share, plus in each case all accrued and unpaid dividends. Redemption payments shall be payable in up to three annual installments, with interest at the then-current prime rate. However, no redemption shall be made unless, immediately thereafter, the Company and all of its subsidiaries shall be in compliance with the applicable laws, rules and regulations relating to insurance companies in the various states in which a subsidiary of the Company may be licensed to do business. During the fourth quarter of 1998, 23,650 shares of Series A Cumulative Convertible Preferred stock were converted to common stock on a share-for-share basis.
Dividend restrictions: Dividends paid by the Company over and above the financial assets of PAMCO are dependent on the ability of PILIC and HealthAxis to pay dividends to PAMCO. The payment of dividends by PILIC is dependent upon a number of factors including earnings and financial condition, business needs and capital and surplus requirements as well as applicable regulatory restrictions. Under Pennsylvania law, PILIC is currently unable to pay dividends without the prior approval of the Pennsylvania Insurance Commissioner as a result of PILIC's statutory unassigned deficit of $20,139 which excludes common stock and additional paid-in capital amounts. Dividends paid by HealthAxis to PAMCO and HPS are subject to restrictions set forth in the Certificate of Designation related to HealthAxis' Series A and Series B Preferred Stock and subject to restrictions set for in HealthAxis' Certificate of Designation related to the Series C Preferred Stock once issued (see note). PAMCO, PILIC and HealthAxis individually neither has paid nor anticipates paying a cash dividend in the foreseeable future.
(1) PILIC's total capital and surplus, adjusted capital and surplus and company action level Risk Based Capital includes amounts for its subsidiaries including PALHIC in 1997 and 1996.
The Incentive Stock Option Plan for Employees authorized the granting of options for up to 650,000 shares of the Company's common stock to key managerial employees of the Company, which are exercisable for up to five years at a price not less than the fair market value of the shares on the date of grant. All options granted under the Incentive Stock Option Plan have been granted at 100% of the fair market value of the shares on the date of grant. The Incentive Stock Option Plan for Employees expired during 1996 and the Company adopted the 1996 Employee Incentive Stock Option Plan ("1996 Employee Plan"), which was amended in 1997 to increase the number of shares issuable thereunder from 950,000 shares to 1,250,000 shares of the Company's common stock to key employees of the Company and its subsidiaries and affiliates, exercisable for up to five years from the effective date of the grant at a price not less than the fair market value of the shares on the effective date of grant. All options granted under the 1996 Employee Plan have been granted at 100% of the fair market value of the shares on the effective date of the grant, with the exception of an option granted Mr. Clemens, which was granted at 110% of the fair market value.
Also during 1997, the Company approved the adoption of a Military Stock Option Plan and a 1997 Insurance Agent Stock Option Plan ("Agents Plan"), designed to replace and supercede all previous stock option plans for non-employee agents. Each Plan is administered by the Option Administration Committee. Options are granted at fair market value and subject to certain other vesting or performance conditions, and the Company has reserved 750,000 shares of the Company's common stock for issuance under each Plan. Options will be issued under each Plan only to insurance agents who are licensed to sell insurance by a life insurance subsidiary of the company, and are exercisable for up to five years from the effective date of the grant.
The following table lists changes in outstanding stock options for all of PAMCO Option Plans:
In addition, Mr. Clemens directly owns options to purchase 253,376 shares of the Company's Common Stock at $ .9091 per share expiring from time to time between November 1999 through December 2004. Mr. Clemens indirectly owns options to purchase 82,080 shares of the Company's common stock at $.9091 per share expiring from time to time between November 1999 and December 2004. Mr. Clemens disclaims beneficial ownership of all other options of any partnership in which Mr. Clemens directly or indirectly is a partner.
The Stock Option Plan for Executives ("Executive Plan") was amended in 1996 and authorizes the granting of options to purchase up to 3,850,000 shares of the Company's Series A Cumulative Convertible Preferred Stock ("Series A Preferred Stock"), which are exercisable for up to ten years from the effective date of grant at a price not less than the fair market value of the shares on the date of grant. Also in 1997, the Company granted Mr. Clemens an option to purchase shares of the Company's Series A Preferred Stock successively upon each exercise by Mr. Clemens of his existing option and each subsequently granted option to purchase shares of Series A Preferred Stock from time-to-time, limited in the aggregate to (i) that the number shares of Series A Preferred Stock which, when exercised, shall permit Mr. Clemens to acquire the right to vote not more than 55% of the shares of the Company's common stock owned, either directly or beneficially, by Mr. Clemens at such time, (ii) the shares of Series A Preferred Stock which are, as of the date of any such exercise, authorized and unissued; and (iii) an option to purchase more than 550,000 shares of Series A Preferred Stock in any six month period shall be prohibited except upon the occurrence of a "change of control" (within the meaning of the Securities Exchange Act of 1934, as amended).
Warrants: On June 6, 1996, the Company issued 100,000 stock purchase warrants to an unaffiliated party at $9.00 per share and are exercisable through June 6, 2001. The Company issued a warrant to an exclusive consultant of the Company to purchase 100,000 shares of the Company's Common Stock at the market price per share as of each of January 1, 1996, January 1, 1997, and January 1, 1998, provided PILIC has realized new annualized premium sales production of at least $35,000, $45,000, and $50,000, respectively, for each of these calendar years. PILIC has realized the annualized premium threshold for the years ending December 31, 1996 and 1997, and accordingly, the consultant is entitled to exercise 100,000 warrants at $7.375 per share for 1996, 100,000 at $14.00 per share for 1997 and 100,000 at $2.81 per share for 1998.
Commitments: The Company has various agreements with AOL, CNet and Lycos containing future cash and other commitments described in notes F, G and H.
Litigation: The Company is involved in litigation in the customary settlement of insurance claims. Management is of the opinion that neither the litigation nor these claims will have a material adverse effect on the results of operations or financial position of the Company.
Government Legislation and Regulation: Unfavorable economic conditions have contributed to an increase in the number of insurance companies that are under regulatory supervision. This is expected to result in an increase in mandatory assessments by state guaranty funds of solvent insurance companies to cover losses to policyholders of insolvent or rehabilitated companies. Mandatory assessments, which are subject to statutory limits, can be partially recovered through a reduction in future premium taxes in some states. Although the Company is not able to reasonably estimate the potential effect on it of any such future assessments, such amounts charged against operations for 1998, 1997 and 1996 have not been material.
Under the CRLC Agreement, PALHIC reinsured 100% of its business to PILIC, which in turn reinsured through a 100% coinsurance agreement all of the Company's group medical and group life business to Reassurance Company of Hannover ("RCH"). In addition, PILIC sold all of the outstanding shares of PALHIC and NIA to CRLC for an amount equal to PALHIC's capital and surplus. The Company transferred all rights and control regarding the Company's licensed insurance agents and entered into a non-compete and non-solicitation agreements with CRLC regarding the Company's licensed insurance agents with respect to the future sale of health insurance products for a three year period.
Under the CRLC Agreement, PILIC has the right to assume new business written by PILIC's agents for five years after the effective date of the CRLC Agreement. PILIC may assume up to 20% of the new business written by PILIC's agents during 1999 and up to 50% for the remaining four years via a new quota share reinsurance agreement with PALHIC. For the purpose of computing profit and loss of the reinsured business, CRLC, through PALHIC, will charge not more than 43% of first year premium and 28% of renewal premium, plus an administrative fee of 3%, which will be reduced to 2% if total policies under administration exceed $100 million of premium inforce. In its 1999 forecast, PILIC has not projected any such reinsurance with PALHIC.
Pursuant to the terms of the CRLC Agreement, PILIC may also assume 50% of the new business sold through HealthAxis and directly underwritten by PALHIC commencing January 1, 1999 via a new quota share reinsurance agreement with PALHIC for a period of 3 years. For the purpose of computing profit and loss of the reinsured business, CRLC, through PALHIC, will charge not more than 28% of first year premium and 21% of renewal premium, plus an administrative fee of 3%. PALHIC will pay HealthAxis commissions of 15% of first year premium and 8% of renewal premium, plus all administrative fees until HealthAxis has recovered all payments made to initiate its Internet program. After such time, the fees will be subject to the quota share agreement between PALHIC and PILIC. CRLC will work to develop additional health insurance products for sale by HealthAxis and enter into comparable reinsurance agreements with PILIC. Such transactions are subject to regulatory approval. In its 1999 forecast, PILIC has not projected any such reinsurance with PALHIC.
Under the terms of Quota Share Reinsurance Agreements, the Company ceded 47.5% of the liability on its accident and health insurance business. The Company received ceding commissions of: 45.5% on all first year business, and 25.5% or 30.5% on renewal business, depending on product, in 1998; 45.5% on all first year business, and 25.5% to 30.5% on renewal business, depending on product in 1997; 41.5% on all first year business, and 26.5% to 30.5% on renewal business, depending on product, in 1996. The combined ceding commissions amounted to approximately 36.9%, 37% and 38.9% of ceded earned premium for 1998, 1997, and 1996, respectively.
The Company's medical quota share and excess reinsurance agreements with Swiss Re were terminated effective December 31, 1997. Swiss Re's obligation to assume its proportionate share of medical paid losses incurred prior to January 1, 1998 remains in effect. The amount of reinsurance recoverable from Swiss Reis currently in dispute. Although the amount of loss, if any, cannot be determined with any certainty at this time, the Company believes that such amounts are due and collectible and has asserted its rights under the Reinsurance Contract.
In October 1997 the Company and HealthPlan Services Corporation ("HPS") entered into a 5 year agreement under which the Company outsourced to HPS all of its health insurance policy issuance, billing, and claims, effective February 1998 for certain claim processing and February 1998 for all remaining outsourced functions (the "Outsourcing Agreement"). The Company's life and stop-loss operations are unaffected by the Agreement.
$5.0 million due on February 1, 2000; $5.9 million due on May 1, 2000; $5.9 million due on August 1, 2000; $8.4 million due on January , 2001; and $8.4 million due on April 1, 2001.
In connection with the issuance of Series C Preferred Stock (see Note D, P, and Q) HealthAxis has amended the terms of the Series A and Series B Preferred Stock to, among other things, provide for the preference of Series C Preferred Stock over the Series A Preferred Stock, to clarify the priorities of the Series A, B and C Preferred Stock in the event of a liquidation, to delete the dividend currently payable on the Series A and B Preferred Stock, to delete the optional redemption provision related to the Series A Preferred Stock, to revise the optional and mandatory conversion provisions applicable to the Series A and B Preferred Stock and to revise the definition of excluded Shares applicable to the Series A Preferred Stock.