The Company's headquarters are located in Green Bay, Wisconsin, in a 400,000 square foot office building owned by the Company and used by both of its business segments. The property is pledged as collateral to the Company's commercial lender pursuant to a mortgage that continues until January 1, 2004. The Company also leases property at approximately 50 locations throughout the United States for its field sales and provider network offices.
The following selected financial data as of and for the years ended December 31, 1995 through 1999 has been derived from the Company's consolidated financial statements. The following data should be read in conjunction with the Company's consolidated financial statements, the related notes thereto, and "Management's Discussion and Analysis of Financial Condition and Results of Operations."
During 1997 and 1998, the Company acquired the following blocks of business:
- - In the fourth quarter of 1997, the Company acquired from Pan American Life Insurance Company ("Pan American") most of the health insurance business which is marketed to individuals and small employer groups. - - Effective July 1, 1998, the Company assumed most of Pan American's remaining domestic health insurance business. - - Effective January 1, 1999, the Company acquired the majority of the fully insured group health business from Continental Assurance Company ("CNA").
The Company continues to actively seek opportunities for growth through acquisition. Management believes that as industry consolidation occurs, the Company is in a position to take advantage of its operational efficiencies. Management will continue to evaluate potential targets for acquisition.
The Company experienced a difficult and challenging year with disappointing 1999 financial results. Reserve strengthening charges totaling $16.0 million after-tax were recorded primarily relating to adverse medical loss ratio trends in its small group health business. Factors which significantly contributed to the reserve strengthening charges include rapidly rising medical costs, higher than anticipated claims utilization in certain markets, and development of prior years' claim reserves.
Although management is disappointed with the turn of events in 1999, the combined effect of the unfavorable developments is considered a short-term setback for the Company principally affecting 1999. Management remains confident in the underlying earnings potential of the Company and has implemented action plans, described above, which should contribute to improved financial performance starting in early 2000.
While the Company faced challenges with its small group health products, its ancillary products were profitable. The MedOne product, combined with the Company's group dental, group life, and self funded products combined to produce net income of $15.0 million in 1999.
The Company reported a net loss of $25.9 million or $1.58 per share for 1999, compared to an after-tax loss from continuing operations of $3.0 million or $0.18 per share for 1998. Excluding non-recurring charges and excluding interest on debt assumed by Newco/UWS, the Company reported a loss of $12.2 million or $0.74 per share for 1999, compared to income of $8.4 million or $0.51 per share for 1998. The decline in income from 1998 to 1999 is primarily the result of a higher loss ratio and lower investment gains, partially offset by a lower expense ratio and lower amortization of goodwill and other intangible assets.
The health loss ratio, excluding non-recurring items, was 80.4% for 1999, compared to 76.7% for 1998. The increase in the health loss ratio is due to reserve strengthening charges recorded in 1999 and adverse medical cost trends as discussed previously in greater detail. The Company reported a health loss ratio of 78.6% in the fourth quarter of 1999. Management believes the impact of its actions will continue to have a positive impact on the health loss ratio in 2000. The life loss ratio increased to 39.2% for the year ended December 31, 1999, compared to 31.5% for 1998. The life loss ratio tends to fluctuate from period to period. The Company experienced higher than usual life claims experience during certain months in 1999, which caused the year-end life loss ratio to be above historical trends. Management expects the life loss ratio to improve in 2000.
The expense ratio includes commissions, administrative expenses and premium taxes and assessments, but excludes non-recurring charges. The expense ratio for health products was 23.0% for 1999, an improvement from the prior year expense ratio of 23.9%. The administrative expense ratio decreased in 1999 as a result of successfully leveraging the Company's expenses over a larger premium base. Management believes the health expense ratio will increase slightly in 2000 due to the implementation of certain administrative initiatives. Management believes the cost of these initiatives will be more than offset by reduced claim costs. The health commission expense ratio increased slightly from 1998 as a result of growth in new business.
Interest expense decreased to $3.6 million in 1999 from $4.3 million in 1998, excluding interest on the $70.0 million debt assumed by Newco/UWS in conjunction with the spin-off. In July 1998, the Company refinanced its debt replacing its subordinated notes with a bank line of credit at a lower interest rate, which accounts for the decrease in interest expense from 1998 to 1999.
During 1998, other revenue declined to $22.6 million from $24.2 million in 1997. The decrease was primarily due to lower administrative fee revenue from self funded business in 1998 offset by additional fees related to the Pan American business acquired beginning in the third quarter 1998.
The Company's cash flows from operations were positive at $26.4 million for 1999, and negative at $3.7 million and $31.8 million for the years ended 1998, and 1997, respectively. Positive cash flows from operations in 1999 are principally the result of a leveling of the claims inventory, growth in membership and lower debt service costs as a result of the assumption of $70.0 million in debt by Newco/UWS in September 1998. Cash flows from operations were negative in 1998 and 1997, due mainly to a decline in business and a reduction in the inventory of claims pending adjudication. Management believes that cash flows for 2000 will be positive but may decline from 1999 due to an expected decline in business in force.
Health care costs have been rising and are expected to continue to rise at a rate that exceeds the consumer price index. The Company's cost control measures and premium rate increases are designed to reduce the adverse effect of medical cost inflation on its operations. In addition, the Company uses its underwriting and medical management capabilities to help control inflation in health care costs. However, there can be no assurance that the Company's efforts will fully offset the impact of inflation or that premium revenue increases will equal or exceed increasing health care costs.
The Company experienced no known significant Year 2000 issues or disruptions during the first part of 2000, and anticipates no future significant problems relating to the Year 2000 issue. While the Company currently believes that the Year 2000 project was a success and that future material operational problems are unlikely, there can be no guarantee that future Year 2000 related issues will not arise. Given the uncertainties surrounding unlikely possible future events relating to the Year 2000 issue, the Company will continue to monitor its applications and business processes.
- - Increasing health care costs resulting from the aging of the population, advances in medical technology, increased utilization of medical services and drugs, health care inflation (particularly pharmacy costs), possible epidemics and natural disasters and other factors affecting the delivery and cost of health care that are beyond the Company's control.
- - The Company's ability to profitably distribute and sell its products, including changes in business relationships with independent agents who sell the Company's products, competitive factors such as the entrance of additional competitors into the Company's markets, competitive pricing practices, demand for the Company's existing and new products, and the Company's ability to predict future health care cost trends and adequately price its products.
- - Adverse outcomes of litigation against the Company, including the inability of the Company to prevail in having the verdicts in the Skilstaf litigation and the Health Administrators litigation reversed or substantially reduced.
- - Restrictions imposed by financing arrangements that limit the Company's ability to incur additional debt, pay future cash dividends and transfer assets.
- - Changes in rating agency policies and practices and the ability of the Company's insurance subsidiaries to maintain or exceed their A- (Excellent) rating by A.M. Best.
- - The Company's ability to integrate effectively the operational, managerial and financial aspects of future acquisitions.
- - Other business or investment considerations that may be disclosed from time to time in the Company's Securities & Exchange Commission filings or in other publicly disseminated written documents.
We have audited the accompanying consolidated balance sheets of American Medical Security Group, Inc. and its subsidiaries, (the "Company") as of December 31, 1999 and 1998, and the related consolidated statements of operations, changes in shareholders' equity and comprehensive income (loss) and cash flows for each of the three years in the period ended December 31, 1999. Our audits also included the financial statement schedules listed in the Index at Item 14(a). These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
Investments are classified as either held-to-maturity or available-for-sale. Investments which the Company has the positive intent and ability to hold to maturity are designated as held-to-maturity and are stated at amortized cost. All other investments are classified as available-for-sale and are stated at fair value based on quoted market prices, with unrealized gains and losses excluded from earnings and reported as a separate component of shareholders' equity as accumulated other comprehensive income or loss, net of income tax effects. Realized gains and losses from the sale of available-for-sale debt securities and equity securities are calculated using the specific identification method.
Goodwill represents the excess of cost over the fair market value of net assets acquired. Goodwill and other intangible assets are being amortized on a straight-line basis over a period of 40 years or less. Accumulated amortization was $12,676,000 and $8,403,000 at December 31, 1999 and 1998, respectively.
The liabilities for medical and other benefits are determined using statistical analyses and represent estimates of the ultimate net cost of all reported and unreported claims that are unpaid at year end. The Company's year-end claim liabilities are substantially satisfied through claim payments in the subsequent year. Management believes that the liabilities for insurance claims are adequate. The liability for unpaid claims of $101,721,000 at December 31, 1998, developed deficient in the subsequent year by $10,398,000. At December 31, 1997, the liability for unpaid claims of $123,907,000, developed deficient by $1,228,000 in the subsequent year. The estimates are reviewed periodically and, as adjustments to the liabilities become necessary, the adjustments are reflected in current operations.
The Company recognizes premium deficiency reserves on an existing group of insurance contracts when the sum of expected future claim costs, claim adjustment expenses and related maintenance expenses exceeds the expected future premium revenue and investment income. Insurance contracts are grouped as relating to highly regulated markets or all other markets consistent with the Company's manner of acquiring, servicing and measuring the profitability of its business. Highly regulated markets are identified based on significant rating restrictions, states' general legislative and regulatory environments, and the Company's ability to effectively underwrite risk. The Company continues to evaluate assumptions and updates the premium deficiency reserve as necessary.
The Company has acquired certain business from other carriers through reinsurance transactions. A summary of reinsurance assumed and ceded related to acquired business is as follows:
Property and equipment are recorded at cost. Depreciation and amortization are provided using the straight-line method over the estimated useful lives, which are 20 to 30 years for land improvements, 10 to 40 years for buildings and building improvements, three to five years for computer equipment and software and three to 10 years for furniture and other equipment.
The Company has deferred compensation payable to employees of $3,597,000 and $1,421,000 at December 31, 1999 and 1998, respectively.
There was no effect of dilutive securities for the years ended 1999 and 1998 because employee stock options were antidilutive during such periods. Options to purchase 1,908,449 shares of common stock were outstanding and exercisable at the end of 1997 and all but 147,715 were excluded from the computation of diluted earnings per share because the options' exercise price was greater than the average market price of common shares and, therefore, the effect would be antidilutive.
Comprehensive income (loss) is defined as net income (loss) plus or minus other comprehensive income (loss), which for the Company, under existing accounting standards, includes unrealized gains and losses, net of income tax effects, on certain investments in debt and equity securities. Comprehensive income (loss) is reported by the Company in the consolidated statements of changes in shareholders' equity and comprehensive income (loss).
The net assets of Newco/UWS consisted of assets and liabilities of the managed care and specialty management business along with $70,000,000 in debt that was assumed by Newco/UWS in conjunction with the Distribution. Newco/UWS was renamed United Wisconsin Services, Inc. The operations of Newco/UWS, along with direct costs of approximately $4,900,000 associated with the spin-off, are reflected in discontinued operations. All prior periods of the consolidated financial statements of AMSG have been restated to reflect Newco/UWS operations as discontinued operations in the accompanying consolidated financial statements of AMSG. Discontinued operations reported total revenues of $488,033,000 and $609,109,000 for 1998 and 1997, respectively. Interest expense on the $70,000,000 debt assumed by Newco/UWS is reflected in continuing operations only through September 11, 1998.
Unrealized gains (losses) are computed as the difference between estimated fair value and amortized cost for fixed maturities and equity securities classified as available for sale. A summary of the net decrease in unrealized gains, which is included in accumulated other comprehensive income (loss), is as follows:
Changes in accumulated other comprehensive income (loss) related to changes in unrealized gains and losses on securities are as follows:
At December 31, 1999, the insurance subsidiaries had fixed securities and cash equivalents on deposit with various state insurance departments with carrying values of approximately $3,275,000.
During 1998, the Company borrowed $45,158,000 on the bank line of credit to retire its subordinated notes outstanding. Effective November 5, 1999, the Company entered into an agreement to amend the line of credit to reduce the maximum commitment from $70,000,000 to $40,000,000. The maximum commitment will be further reduced to $30,000,000 on July 31, 2001. The stock of American Medical Security Holdings, Inc. and United Wisconsin Life Insurance Company, subsidiaries of the Company, has been pledged as collateral for the loan.
Future annual principal amounts due for all notes are $1,265,000 for 2000, $6,358,000 for 2001, $1,200,000 for 2002, $31,200,000 for 2003, and $2,500,000 for 2004. During 1999, 1998 and 1997, interest paid totaled $3,547,000, $6,971,000 and $9,320,000, respectively.
The Company and most of its subsidiaries file a consolidated federal income tax return. The Company and its subsidiaries file separate state franchise, income and premium tax returns as applicable.
The Company is involved in various legal and regulatory actions occurring in the normal course of its business. In the opinion of management, adequate provision has been made for losses which may result from the above-mentioned and other legal and regulatory actions and, accordingly, the outcome of these matters is not expected to have a material adverse effect on the consolidated financial statements.
Insurance companies are subject to state insurance regulations. These regulations require, among other matters, the filing of financial statements prepared in accordance with statutory accounting practices prescribed or permitted for insurance companies. The combined statutory surplus of the Company's insurance subsidiaries, United Wisconsin Life Insurance Company and American Medical Security Insurance Company of Georgia, at December 31, 1999 and 1998, was $155,937,000 and $183,288,000, respectively.
State insurance regulations also require the maintenance of a minimum compulsory surplus based on a percentage of premiums written. At December 31, 1999, the Company's insurance subsidiaries were in compliance with these compulsory regulatory requirements.
Dividends paid by the insurance subsidiaries to the Company are limited by state insurance regulations. The insurance regulator in the state of domicile may disapprove any dividend which, together with other dividends paid by an insurance company in the prior twelve months, exceeds the regulatory maximum as computed for the insurance company based on its statutory surplus and net income. Based upon the financial statements of the Company's insurance subsidiaries as of December 31, 1999, as filed with the insurance regulators, no dividends may be paid without prior regulatory approval in 2000.
For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The Company's pro forma information is as follows:
In determining compensation cost pursuant to SFAS No. 123, the fair value for these options was estimated at the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions:
Selected continuing operations quarterly financial data for the years ended December 31, 1999 and 1998 are as follows: