Also during 1997, policy persistency declined in connection with the implementation of certain rate increases together with intensified competitor solicitation of the Company's policyholders. These events, including increased claim loss ratios, affected the future profit margins available to absorb amortization of Deferred Policy Acquisition Costs ("DPAC"). As a result of these adverse changes, the Company undertook a revaluation of the recoverability of DPAC in the fourth quarter of 1997. Based on the results of this review and the impact of future projected premium revenues and the discontinuance of certain lines of business, the Company determined that a premium deficiency existed for certain old lines of business as of December 31, 1997.
As a result of the Company's poor financial performance in 1997, current management has completed or is working toward completing the following strategic initiatives designed to restore profitability:
PRODUCT REVISION AND NEW PRODUCT DEVELOPMENT: The Company introduced a new Medical Expense product during the first quarter of 1998. Accordingly, management has focused on providing a reasonable level of policy benefits in relation to premiums and on reducing first-year commission rates on all of its Medical Expense products in order to enhance overall profitability of the business.
As of the Effective Date, the Company is obligated to pay dividends on its New Preferred Stock, when, as and if declared by the Board of Directors. Dividends on the New Preferred Stock accrue at an annual rate of $102.50 per share and are payable annually. The Company may pay dividends on the New Preferred in cash or in additional shares of New Preferred Stock having an aggregate liquidation preference equal to the amount of dividends being declared and paid. The Company expects to pay such dividends by issuing additional shares of New Preferred Stock for the foreseeable future.
PREMIUMS. The following table shows the premiums, in thousands, received by the Company as a result of direct sales and acquisitions. Certain reclassifications have been made to 1997 and 1996 amounts in order to conform to 1998 presentation.
(1) For a breakdown of premiums by product line, see ITEM 1 - "Business-Product Lines."
Generally, as a result of acquisitions of policies in force and the transfer of assets and liabilities relating thereto, the Company receives higher revenues in the form of premiums and net investment income and experiences higher expenses in the form of benefits and claims, amortization of DPAC, commissions and general and administrative expenses. The Company expects that premiums, net investment income, net realized gains on investments, benefits and claims, amortization of DPAC, commissions and general and administrative expenses attributable to these acquired policies will continue to decline over time as the acquired policies lapse.
YEAR ENDED DECEMBER 31, 1998 COMPARED WITH YEAR ENDED DECEMBER 31, 1997
PREMIUMS. Premiums decreased $25.4 million, or 15.8%, from $161.1 million to $135.7 million as a result of declining persistency of in force policies and a reduction in the Company's marketing results. This decrease resulted from a decrease in first-year premiums from Company-issued policies of $18.2 million, or 49.1%, a decrease in renewal premiums from Company-issued policies of $1.1 million, or 1.4%, a decrease in first-year premiums from acquired policies of $0.5 million, or 61.0%, and a decrease in renewal premiums from acquired policies of $5.6 million, or 12.4%.
The decrease in renewal premiums from acquired policies was attributable to a decrease of $2.2 million, or 10.5%, from the policies acquired in the NFIC and AICT acquisition, a decrease of $1.9 million, or 16.2%, from the policies acquired from FLICA, and a decrease of $1.5 million, or 12.0%, from the policies acquired from AII and other acquisitions.
FEE AND SERVICE INCOME. Fee and service income decreased $0.5 million, or 3.2%, from $16.7 million to $16.2 million for the year ended December 31, 1998. The Company's sales of unaffiliated managed care and senior products were lower in 1998 than 1997.
Amortization of DPAC decreased $26.5 million, or 85.9%, from $30.9 million to $4.4 million. This variance was attributable to decreases of $18.0 million, $7.9 million, $0.2 million, and $0.4 million, from Company-issued Medical Expense products, Medicare Supplement products, Specified Disease products and acquired policies, respectively.
RECOGNITION OF PREMIUM DEFICIENCY. During the third quarter of 1998, the Company recorded a non-cash charge to expense of approximately $5.0 million compared to a $65.0 million premium deficiency charge recognized in the fourth quarter of 1997. This adjustment has no impact on the Company's cash position and does not impact the statutory capital and surplus of the Insurance Subsidiaries. See "KEY EVENTS - Determination of Premium Deficiency".
TAXES, LICENSES AND FEES. Taxes, licenses and fees decreased $0.8 million, or 13.3%, from $6.0 million to $5.2 million for the year ended December 31, 1998. These decreases are attributable to the declining premium base for which premium taxes are levied.
INTEREST EXPENSE. Interest expense decreased $0.3 million, or 4.2%, from $7.1 million to $6.8 million for the year ended December 31, 1998. Commensurate with the filing of the Chapter 11 Case, interest on the Company's Convertible Notes ceased to accumulate. Accordingly, pre-petition non-cash accrued interest totaled approximately $7.3 million on such Convertible Notes as of December 31, 1998.
Under the terms of the Plan, interest on the Company's Senior Notes continued to accrue post-petition at the rate of 11% per annum through the Effective Date. Accordingly, pre-petition non-cash accrued interest totaled approximately $2.1 million and post-petition non-cash accrued interest totaled approximately $0.6 million on such Senior Notes for the year ended December 31, 1998.
During 1997, interest expense was computed from the date of the issuance of the Company's Convertible Notes in the second quarter of 1997.
PROVISION FOR INCOME TAXES. The change in the provision for income taxes during 1998 is directly attributable to the net loss recorded by the Company for the year ended December 31, 1998. As a result, net operating loss carryforwards ("NOLs") were generated that will be available for offset against taxable income generated in future reporting periods. The Company has determined that it is more likely than not that it will be unable to utilize all of these NOLs prior to the related expiration dates. Accordingly, the Company has recorded a valuation allowance that significantly reduces its benefit from income taxes for the current year from the amount that would have been derived by applying the 35% statutory federal tax rate to the Company's pre-tax loss for the year ended December 31, 1998. See NOTE 10 - "Income Taxes" to the Company's Consolidated Financial Statements.
PREFERRED STOCK DIVIDENDS. Commensurate with the filing of the Chapter 11 Case, dividends on the Company's Old Preferred Stock ceased to accumulate. Accordingly, the Company recorded approximately $1.3 million of pre-petition non-cash accrued dividends on such Old Preferred Stock for the year ended December 31, 1998.
YEAR ENDED DECEMBER 31, 1997 COMPARED WITH YEAR ENDED DECEMBER 31, 1996
The increase in renewal premiums from Company-issued policies was attributable to an increase of $20.8 million, or 118.9% in Medical Expense premiums, an increase of $13.0 million, or 91.9% in Medicare Supplement premiums, an increase in other premiums of $0.2 million, or 50.0%, and was offset by a decrease of $0.3 million, or 2.1%, in Specified Disease premiums.
NET INVESTMENT INCOME. Net investment income increased $2.3 million, or 26.4%, from $8.7 million to $11.0 million. This increase was attributable to a higher average investment base resulting from the net proceeds received from the Company's sale of its Convertible Notes during the second quarter.
FEE AND SERVICE INCOME. Fee and service income increased $7.2 million, or 75.8%, from $9.5 million to $16.7 million. The increase was primarily due to an increase of $6.4 million, or 81%, relating to commissions on managed care product sales earned by the Company's agency operations and an increase of $0.8 million, or 47.1%, in other fees.
The increase in benefits and claims expense from Company-issued policies was primarily attributable to an increase of $31.1 million, or 115.2%, from Medical Expense products, an increase of $6.4 million, or 25.3%, from Medicare Supplement products, an increase of $2.2 million, or 36.7%, from Specified Disease products, and was offset by a decrease of $0.5 million, or 35.7% from other products.
The increase in benefits and claims expense from acquired policies was primarily attributable to an increase of $2.9 million, or 72.5%, from the policies acquired in the FLICA acquisition, an increase of $0.3 million, or 1.4%, from the policies acquired in the NFIC and AICT acquisition, and an increase of $0.3 million, or 3.1% from the policies acquired from AII, LHI and DNL.
REORGANIZATION EXPENSE. As more fully described in "Key Events", in response to the losses sustained by the Company in the second and third quarters of 1997, the Company hired a financial advisor to explore its strategic alternatives. The Company was responsible for paying the fees of its financial advisor and legal counsel and agreed to pay the fees of the financial advisors and legal counsel for an ad hoc creditors' committee in connection with the efforts to formulate and evaluate transactional alternatives. During 1997, the Company incurred approximately $1.4 million in expenses during the fourth quarter of 1997 related to these efforts. In addition, the Company incurred approximately $3.0 million during the second quarter of 1997 in connection with a non-recurring internal reorganization.
EXTRAORDINARY ITEM. The Company recognized an extraordinary loss on the early extinguishment of debt in the amount of $1.0 million, net of taxes, for the year ended December 31, 1997. This extraordinary charge is comprised of (i) $0.4 million, net of taxes, related to the termination and recapture of a block of reinsured policies and (ii) $0.6 million, net of taxes, related to the recognition of unamortized financing fees associated with the repayment and refinancing of the Company's revolving credit facility with Fleet National Bank.
The primary sources of cash for the Insurance Subsidiaries are premiums and income on invested assets. Additional cash is periodically provided by capital contributions from the Company and from the sale of short-term investments and could, if necessary, be provided through the sale of long-term investments and blocks of business. The Insurance Subsidiaries' primary uses for cash are benefits and claims, commissions, general and administrative expenses, and taxes, licenses and fees.
During the year ended December 31, 1998, the Insurance Subsidiaries continued to experience adverse loss ratios and declining persistency on certain old Medical Expense and Medicare Supplement products. The Insurance Subsidiaries have developed new insurance products with more stringent underwriting procedures and lower agent commissions. In addition, the Insurance Subsidiaries are implementing rate increases to the extent approved by state regulatory authorities or offering higher deductible benefit options on certain old lines of business in order to mitigate the effect of adverse claims experience on such old lines. The Insurance Subsidiaries have also implemented a policyholder retention program designed to mitigate the impact of declining persistency on such old lines receiving rate increases. However, the Company expects that the Insurance Subsidiaries will continue to incur operating losses on these old lines of business (i) until such time as the necessary rate increases can be fully implemented and realized, and (ii) until sales of new products reach targeted production levels. There can be no assurance that the full extent of such rate increase requests will be approved, that the impact of these rate increases will result in profitability on such old lines, or that targeted production levels will be reached and sustained.
For the year ended December 31, 1998, the Insurance Subsidiaries received capital contributions totaling approximately $5.7 million from Westbridge. To the extent that the Insurance Subsidiaries experience further statutory operating losses, additional capital may be required.
In December 1992, the NAIC adopted the Risk-Based Capital for Life and/or Health Insurers Model Act ("the Model Act"). The Model Act provides a tool for insurance regulators to determine the levels of statutory capital and surplus an insurer must maintain in relation to its insurance and investment risks and whether there is a need for possible regulatory attention. The Model Act (or similar legislation or regulation) has been adopted in states where the Insurance Subsidiaries are domiciled. The Model Act provides four levels of regulatory attention, varying with the ratio of the insurance company's total adjusted capital (defined as the total of its statutory capital and surplus, asset valuation reserve and certain other adjustments) to its risk-based capital ("RBC"). If a company's total adjusted capital is less than 100 percent but greater than or equal to 75 percent of its RBC, or if a negative trend (as defined by the NAIC) has occurred and total adjusted capital is less than 125 percent of RBC (the "Company Action Level"), the company must submit a comprehensive plan aimed at improving its capital position to the regulatory authority proposing corrective actions. If a company's total adjusted capital is less than 75 percent but greater than or equal to 50 percent of its RBC (the "Regulatory Action Level"), the regulatory authority will perform a special examination of the company and issue an order specifying the corrective actions that must be followed. If a company's total adjusted capital is less than 50 percent but greater than or equal to 35 percent of its RBC (the "Authorized Control Level"), the regulatory authority may take any action it deems necessary, including placing the company under regulatory control. If a company's total adjusted capital is less than 35 percent of its RBC (the "Mandatory Control Level"), the regulatory authority must place the company under its control. The NAIC's requirements are effective on a state by state basis if, and when, they are adopted by the regulators in the respective states. The Insurance Departments of the States of Delaware and Mississippi have each adopted the NAIC's Model Act. At December 31, 1998, total adjusted capital for NFL, a Delaware domiciled company, and FLICA, a Mississippi domiciled company, exceeded the respective Company Action Levels.
As a result of the statutory losses sustained by the Insurance Subsidiaries during 1997, material transactions are subject to approval by the department of insurance in each domiciliary state.
Net cash provided by (used for) investing activities for the years ended December 31, 1998, 1997 and 1996 totaled $13.3 million, $(40.4) million and $6.3 million, respectively. Net cash provided by investing activities between 1998 and 1997 was primarily used to fund the Company's operating and financing activities for the same period. Further, the significant cash outflow to acquire investments in 1997 was related to the investment of the net proceeds from the issuance of Westbridge's Convertible Notes. Cash inflows for 1996 were utilized to fund operating cash requirements and were also attributable to the liquidation of investments to support the increase in new business production, which occurred during the first two quarters of 1996.
In the ordinary course of business, the Company advances commissions on policies written by its general agencies and their agents. The Company is reimbursed for these advances from the commissions earned over the respective policy's life. In the event that policies lapse prior to the time the Company has been fully reimbursed, the general agency or the individual agents, as the case may be, are responsible for reimbursing the Company for the outstanding balance of the commission advance. For the years ended December 31, 1998, 1997 and 1996, the Company has recorded a net provision for uncollectible commission advances totaling $0.6 million, $2.8 million and $0.5 million, respectively.
The Company finances the majority of its obligations to make commission advances through Westbridge Funding Corporation ("WFC"), an indirect wholly owned subsidiary of Westbridge. On June 6, 1997, WFC entered into a Credit Agreement (the "Credit Agreement") with LaSalle National Bank ("LaSalle"). This Credit Agreement provides WFC with a three-year, $20.0 million revolving loan facility (the "Receivables Financing"), the proceeds of which are used to purchase agent advance receivables from the Insurance Subsidiaries and certain affiliated marketing companies. WFC's obligations under the Credit Agreement are secured by liens upon substantially all of WFC's assets. In connection with this commission advancing program, at December 31, 1998, the Company's receivables from subagents totaled approximately $9.0 million and approximately $6.2 million was outstanding under the Credit Agreement. The Credit Agreement terminates on June 5, 2000, at which time the outstanding principal and interest thereunder will be due and payable.
The Company has initiated an enterprise-wide program designed to determine whether all of its Information Technology ("I/T"), such as computer systems and related software applications, and non-I/T systems, such as facsimile machines and copy machines, will function properly as the millennium (the "Year 2000") approaches. The Year 2000 problem is pervasive and complex as virtually every computer operation will be affected in some way by the rollover of the two-digit year value to 00. The issue is whether computer systems will properly recognize date-sensitive information when the year changes to 2000. Systems that do not properly recognize such information could generate erroneous data or cause a system to fail.
The Company's overall Year 2000 remediation effort has focused on preparing the computer systems, infrastructure and facilities for the Year 2000. The following phases encompass the Year 2000 plan: (i) assessment of all internal and external business critical systems, including I/T and non-I/T systems, (ii) remediation or upgrading of business critical systems, (iii) testing of remediated and updated systems, (iv) implementation of remediated and updated systems, and (v) contingency planning.
The Company has engaged certain outside vendors and dedicated certain employees on a full time basis to help in the full array of its Year 2000 efforts. This includes system assessment and monitoring advice, actual code remediation, communication and consultation with critical business partners and testing resources.
Under the Company's enterprise-wide remediation program, the most effective I/T systems solution was to purchase a new, more modern, Year 2000 compliant policyholder and claim administration system. This replacement effort is well underway and targeted for implementation in the third quarter of 1999.
The Company's contingency plan is to make the existing I/T systems, which are to be replaced, Year 2000 compliant. This effort is currently in the remediation and testing phases of the project and is scheduled to be completed during the second quarter of 1999. The Company's contingency plan has identified and prioritized the Year 2000 exposures within the existing I/T systems. By remediating these I/T exposures on a priority basis, the Company is working to limit its Year 2000 contingency risk to lower priority I/T exposures in the event that the Company's most reasonably likely worst case Year 2000 scenario were to occur.
The most reasonably likely worst case Year 2000 scenario would be that certain functions within the Company's existing I/T systems would incorrectly process policy information such as policy paid-to-dates, premium billings, commissions and claims. This scenario could have a material, adverse impact on the Company's ability to conduct its business.
The Company expects to incur approximately $4.0 to $5.0 million in charges related to computer hardware and software, infrastructure, and facilities enhancements necessary to prepare for the Year 2000, of which a portion may be capitalized. For the year ending December 31, 1998, the Company incurred approximately $0.6 million in expenses related to systems planning and consulting efforts associated with the development of the Company's Year 2000 remediation plans. The majority of the Company's Year 2000 costs relate to computer hardware and software purchases and consulting fees, which will occur primarily in the first and second quarters of 1999.
As discussed in NOTE 1 to the Consolidated Financial Statements, Westbridge Capital Corp. filed a voluntary petition for relief under Chapter 11 of the Bankruptcy Code with the United States Bankruptcy Court for the District of Delaware on September 16, 1998. The Bankruptcy Court confirmed the Plan on December 17, 1998, and, after the satisfaction of a number of conditions, the Plan became effective on March 24, 1999. In connection with its emergence from Chapter 11, Westbridge Capital Corp. changed its corporate name to Ascent Assurance, Inc.
WESTBRIDGE CAPITAL CORP. CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS. EXCEPT SHARE DATA)
Adjustments to reconcile net income to cash used for operating activities in the Company's Consolidated Statement of Cash Flows exclude increases relating to the acquired assets and liabilities of FHC. Accordingly, these adjustments do not correspond to the changes in the related line items on the Company's Consolidated Balance Sheets.
WESTBRIDGE CAPITAL CORP. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT) (IN THOUSANDS, EXCEPT SHARE DATA)
WESTBRIDGE CAPITAL CORP. CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME (IN THOUSANDS)
On September 16, 1998 (the "Petition Date"), Westbridge commenced a reorganization case (the "Chapter 11 Case") by filing a voluntary petition for relief under Chapter 11, Title 11 of the United States Code in the United States Bankruptcy Court for the District of Delaware (the "Bankruptcy Court"), along with a disclosure statement (as amended, the "Disclosure Statement") and a proposed plan of reorganization (as amended, the "Plan"). The filing of the Disclosure Statement and Plan culminated months of negotiations between Westbridge and an ad hoc committee of holders of its 11% Senior Subordinated Notes due 2002 (the "Senior Notes") and its 7-1/2% Convertible Subordinated Notes due 2004 (the "Convertible Notes"). The Disclosure Statement and the Plan were amended on October 28, 1998, and the Disclosure Statement was approved by entry of an order by the Bankruptcy Court on October 30, 1998. Following the approval of the Plan by the holders of allowed claims and equity interests, the Bankruptcy Court confirmed the Plan on December 17, 1998. The Plan became effective March 24, 1999 (the "Effective Date").
In connection with its emergence from Chapter 11, Westbridge changed its corporate name to "Ascent Assurance, Inc." Pursuant to the Plan, the Company's Board of Directors was reconstituted as of the Effective Date, and the Company's certificates of incorporation and by-laws were amended and restated in their entirety.
Westbridge's capital structure was realigned and deleveraged. Pursuant to the Plan, the following securities of Westbridge were canceled as of the Effective Date: (i) $23.3 million aggregate principal amount of, plus all accrued and unpaid interest on, the Senior Notes, (ii) $77.3 million aggregate principal amount of, plus all accrued and unpaid interest on, the Convertible Notes, (iii) $13.2 million aggregate liquidation preference of, plus all accrued and unpaid dividends on, Westbridge's Series A Convertible Redeemable Exchangeable Preferred Stock (the "Old Preferred Stock"), (iv) Westbridge's Common Stock, par value $.10 per share (the "Old Common Stock"), (v) all outstanding warrants to purchase Old Common Stock, (vi) all outstanding unexercised stock options to purchase Old Common Stock, and (vii) all unvested grants of restricted Old Common Stock.
Pursuant to the Company's Amended and Restated Certificate of Incorporation, the total number of shares of stock the Company shall have the authority to issue is 30,040,000, consisting of 30,000,000 shares of common stock, par value $.01 per share (the "New Common Stock") and 40,000 shares of preferred stock, par value $.01 per share, all of which are designated Series A Convertible Preferred Stock (the "New Preferred Stock")
To holders of general unsecured claims and Convertible Notes as of December 10, 1998 and current management, 6,110,000 shares, or 94%, of the New Common Stock issued on the Effective Date, subject to the completion of the exchange requirements as contemplated by the Plan. Holders of general unsecured claims and Convertible Notes will receive their first distribution of shares in partial satisfaction and discharge of their allowed claims beginning in April 1999. The remaining shares of New Common Stock are held for future distributions to such holders pending the final resolution of disputed claims.
To holders of Old Common Stock, 130,000 shares as of December 10, 1998, or 2%, of the New Common Stock issued on the Effective Date and New Warrants to purchase an additional 693,761 shares, or 5%, of the number of shares of New Common Stock issued and outstanding on the Effective Date, on a fully diluted basis, subject to the completion of the exchange of securities as contemplated by the Plan. Fractional shares of New Common Stock will not be issued in connection with the Plan. As a result of this provision, many holders of Old Common Stock will receive no distribution of New Common Stock or New Warrants under the Plan.
To the CSFB Affiliate, in respect of the Senior Notes owned by CSFB as of December 10, 1998, 8,090 shares of New Preferred Stock which, together with the 15,167 additional shares of New Preferred Stock purchased by the CSFB Affiliate as described above, are convertible into 4,765,165 shares of the New Common Stock at an initial conversion price of $4.88 per share. As a result of the New Preferred Stock received by the CSFB Affiliate, together with the 3,093,998 shares of New Common Stock to be received by the CSFB Affiliate in respect of the Convertible Notes owned by CSFB, the CSFB affiliate will own approximately 56.6% of the New Common Stock on an as converted basis.
In connection with the New Warrants described above, 971,266 shares of New Common Stock are reserved for issuance upon the exercise of New Warrants. The New Warrant are exercisable at an initial exercise price $9.04 per share of New Common Stock and will expire on March 24, 2004.
Pursuant to the Plan, up to 1,251,685 shares, or 10%, of the fully diluted number of shares of New Common Stock issued and outstanding on the Effective Date are reserved for issuance to employees and directors, and up to 387,119 shares, or 3%, of the fully diluted number of shares of New Common Stock issued and outstanding on the Effective Date are reserved for issuance to the Company's marketing agents under the Company's 1999 Stock Option Plan.
In connection with the reorganization, the Company will realize a non-taxable gain from the extinguishment of certain indebtedness for tax purposes, since the gain results from a reorganization under the Bankruptcy Code. However, the Company will be required during 1999 to reduce certain tax attributes related to Westbridge, exclusive of its operating subsidiaries, including (i) net operating loss carryforwards ("NOLs"), (ii) certain tax credits and (iii) tax bases in assets in an amount equal to such a gain on extinguishment.
In accordance with the American Institute of Certified Public Accountants' Statement of Position 90-7 ("SOP 90-7"), "Financial Reporting by Entities in Reorganization Under the Bankruptcy Code," the Company will adopt fresh start reporting. For accounting purposes, the Effective Date is deemed to be March 31, 1999. In fresh start reporting, a reorganization value will be assigned to the Company's New Preferred Stock and New Common Stock. The reorganization value will be allocated to the fair value of assets and liabilities similar to the purchase method of accounting under APB 16. As a result of the application of fresh start reporting, the Company's financial statements issued subsequent to the adoption of fresh start reporting will not be comparable with those prepared before emergence, including the historical financial statements in this annual report.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND OTHER MATTERS
ACCOUNTING PRINCIPLES AND REGULATORY MATTERS. The consolidated financial statements have been prepared in accordance with generally accepted accounting principles ("GAAP"). These principles differ from statutory accounting principles, which must be used by NFL, FLICA, NFIC and AICT (together, the "Insurance Subsidiaries") when reporting to state insurance departments. The Insurance Subsidiaries are subject to oversight by the state insurance departments of Delaware, Mississippi, Texas and other states in which they are authorized to conduct business. These regulators perform periodic examinations of the Insurance Subsidiaries' statutory financial statements and, as a result, may propose adjustment to such statements.
INVESTMENTS. The Company's fixed maturity portfolio is classified as available-for-sale and is carried at estimated market value. Equity securities (common and nonredeemable preferred stocks) are also carried at estimated market value. Changes in aggregate unrealized appreciation or depreciation on fixed maturities and equity securities are reported directly in stockholders' equity, net of applicable deferred income taxes and, accordingly, have no effect on current operations. The Company's 40% equity investment in FHC was accounted for on the equity basis (i.e., cost adjusted for equity in post-acquisition earnings and amortization of excess cost) until May 31, 1996 and on a consolidated basis for the periods subsequent to the acquisition of the remaining 60% of FLICA's parent FHC. Mortgage loans on real estate and policy loans are carried at the unpaid principal balance. Realized gains and losses on sales of investments are recognized in current operations on the specific identification basis.
LEASEHOLD IMPROVEMENTS AND EQUIPMENT. Leasehold improvements and equipment are stated at cost less accumulated depreciation and amortization. Depreciation of equipment is computed using the straight-line method over the estimated useful lives (three to seven years) of the assets. Leasehold improvements are amortized over the estimated useful lives of the related assets or the period of the lease, whichever is shorter. Maintenance and repairs are expensed as incurred, and renewals and betterments which materially extend the useful life of the underlying assets are capitalized.
EARNINGS PER SHARE. In February 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share," ("SFAS 128") that revises the standards for computing earnings per share previously found in APB Opinion No. 15, "Earnings Per Share." The SFAS 128 established two measures of earnings per share: "basic earnings per share" and "diluted earnings per share." Basic earnings per share is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were converted or exercised. The SFAS 128 requires dual presentation of basic and diluted earnings per share on the face of the income statement for all entities with potential dilutive securities outstanding. Diluted weighted average shares exclude all convertible securities for loss periods.
For the Company, comprehensive income (loss) equals its reported consolidated net income (loss) plus the change in the unrealized appreciation (depreciation) of marketable securities from the previously reported period. Currently, this accumulated other comprehensive income, net of tax, is reported in the Company's Consolidated Balance Sheets as a separate component of stockholders' equity.
Also in June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information" ("SFAS 131"). This pronouncement, also effective for calendar year 1998 financial statements, requires companies to report segment information consistent with the way executive management of an entity disaggregates its operations internally to assess performance and make decisions regarding resource allocations. Among the information to be disclosed, SFAS 131 requires an entity to report a measure of segment profit or loss, certain specific revenue and expense items and segment assets. SFAS 131 also requires reconciliations of total segment revenues, total segment profit or loss and total segment assets to the corresponding amounts shown in the entity's consolidated financial statements. Under SFAS 131, the Company will continue to have only one reportable segment, Accident and Health insurance.
In December 1997, the Accounting Standards Executive Committee ("AcSEC") issued Statement of Position ("SOP") 97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments," which provides guidance on accounting for insurance-related assessments. The Company will adopt SOP 97-3 on a prospective basis. The adoption of SOP 97-3 is not expected to have a material impact on the Company's results of operations, liquidity or financial position.
In March 1998, AcSEC issued SOP 98-1, "Accounting for the Costs of Software Developed or Obtained for Internal Use," which requires capitalization of certain costs after the date of adoption in connection with developing or obtaining software for internal use. The Company will adopt SOP 98-1 on a prospective basis. The Company has not yet determined the impact of adopting this SOP.
In 1998, the National Association of Insurance Commissioners ("NAIC") adopted the Codification of Statutory Accounting Principles guidance, which will replace the current Accounting Practices and Procedures manual as the NAIC's primary guidance on statutory accounting. The NAIC is now considering amendments to the Codification guidance that would also be effective upon implementation. The NAIC has recommended an effective date of January 1, 2001. The Codification provides guidance for areas where statutory accounting has been silent and changes current statutory accounting in certain areas. It is not known whether the insurance departments of the state of domicile of the Company's Insurance Subsidiaries will adopt the Codification or whether those insurance departments will make any changes to that guidance. The Company has not estimated the potential effect of the Codification guidance if adopted. However, the actual effect of adoption could differ as changes are made to the Codification guidance, prior to its recommended effective date of January 1, 2001.
RECLASSIFICATIONS. Certain reclassifications have been made to 1997 and 1996 amounts in order to conform to 1998 financial statement presentation.
Unrealized appreciation on investments is reflected directly in stockholders' equity as a component of accumulated other comprehensive income and is summarized as follows:
Estimated market values represent the closing sales prices of marketable securities. The amortized cost and estimated market values of investments in fixed maturities at December 31, 1998 and 1997, are summarized by category as follows:
A summary of unrealized appreciation on investments in fixed maturities available-for-sale, which is reflected directly in stockholders' equity as a component of accumulated other comprehensive income, is as follows:
Included in fixed maturities at December 31, 1998 and 1997, are high-yield, unrated or less than investment grade corporate debt securities comprising less than 3.2% and 1.6% of total cash and invested assets at December 31, 1998 and 1997, respectively.
Investment securities on deposit with insurance regulators in accordance with statutory requirements at December 31, 1998 and 1997 had a par value totaling $28.2 million and $28.3 million, respectively.
At December 31, 1998, the Company had restricted cash and investments totaling $2.5 million and $1.9 million, respectively, related to its receivables financing program (see NOTE 6 - "Financing Activities") and to a collateralized letter of credit ("LOC") for the purpose of potential future capital contributions to NFIC and AICT. The collateralized LOC expires in June 1999 and future draws upon this LOC are subject to certain provisions regarding NFIC's and AICT's statutory capital and surplus levels.
As of the Effective Date, there were no events of default under the Guaranty or Credit Agreements, which were amended to reflect the recapitalization of the Company.
Prior to the Effective Date of the Plan (see NOTE 1), the Company had the following debt securities outstanding:
During the first quarter of 1995, the Company issued $20.0 million aggregate principal amount of its Senior Notes, due 2002, in an underwritten public offering. The Senior Notes were issued at par, less an underwriting discount of 4%. Contractual interest on the Senior Notes was payable in monthly installments. In November 1997, the Company suspended the scheduled monthly interest payments on these Senior Notes.
The following table provides a reconciliation of the beginning and ending claim reserve balances, on a gross-of-reinsurance basis, for 1998, 1997 and 1996, to the amounts reported in the Company's balance sheet:
Pursuant to the Plan, the Company authorized 40,000 shares of non-voting New Preferred Stock, of which 23,257 shares are owned by CSFB (See NOTE 1).
The following summarizes the significant terms of the New Preferred Stock:
The right to designate one additional director prior to June 24, 1999, and the right to elect one director if dividends are in arrears.
Prior to the Effective Date of the Plan (see NOTE 1), the Company had the following preferred stock securities outstanding:
Seven thousand sixty-five (7,065) shares of the Old Preferred Stock were converted into shares of Old Common Stock during the year ended December 31, 1998. The converted shares of Old Preferred Stock had an aggregate liquidation preference of $7,065,000 and were converted into 840,071 shares of Old Common Stock. Old Preferred Stock was convertible into 1,419,144 shares of Common Stock as of December 31, 1998 at a conversion price of $8.41 per share.
In November 1997, the Company suspended the scheduled dividend payments on its Old Preferred Stock. The failure to declare and pay the scheduled dividend on the Old Preferred Stock constituted an event of non-compliance under the terms of the Old Preferred Stock Agreement and resulted in an immediate increase from 8.25% to 9.25% in the rate at which dividends accrued on the Old Preferred Stock. At the Petition Date, approximately $1.3 million of cumulative, unpaid dividends were accrued. The Company did not accrue dividends on its Old Preferred Stock after the Petition Date as it was unlikely such dividends would be paid under the Plan. The amount of contractual dividends that would have otherwise been accrued from the Petition Date to December 31, 1998 totaled $0.6 million, and such contractual dividends would have continued to accrue at $3,067 per day from January 1, 1999 until the Effective Date.
The cost of insurance purchased in 1996 is related to the acquisition of the remaining 60% ownership interest in FHC and its wholly owned insurance subsidiary, FLICA. This amount is being amortized in relation to premium revenue over the remaining life of the business. Interest accrues on the unamortized balance at 7% per year. Amortization of this cost of insurance purchased was approximately $0.8 million and $0.6 million in 1998 and 1997, respectively, net of interest accretion of $0.3 million and $0.2 million.
In connection with the Company's acquisition of NFIC and AICT in 1994 and prior to the recognition of a premium deficiency as described below, the related cost of insurance purchased was amortized in relation to premium revenues over the remaining life of the business. Interest accrued on the unamortized balance at 7% per year. Amortization of this cost of insurance purchased was approximately $0, $1.5 million and $1.8 million in 1998, 1997 and 1996, respectively, net of the respective interest accretion of $0, $0.3 million and $0.5 million.
A premium deficiency occurs when the projected present value of future premiums associated with these policies will not be adequate to cover the projected present value of future payments for benefits and related amortization of DPAC. GAAP requires the immediate recognition of a premium deficiency by charging the unamortized DPAC to expense. Accordingly, for the quarter and year ended December 31, 1997, the Company recorded a non-cash charge to expense of approximately $65.0 million and incurred a significant loss for the year ended December 31, 1997. This adjustment had no impact on the Company's cash position at December 31, 1997 nor did it affect the statutory capital and surplus of the Insurance Subsidiaries.
The provision for (benefit from) U.S. federal income taxes charged to continuing operations was as follows:
Under the provisions of pre-1984 life insurance tax regulations, NFL was taxed on the lesser of taxable investment income or income from operations, plus one-half of any excess of income from operations over taxable investment income. One-half of the excess (if any) of the income from operations over taxable investment income, an amount which was not currently subject to taxation, plus special deductions allowed in computing the income from operations, were placed in a special memorandum tax account known as the policyholders' surplus account. The aggregate accumulation in the account at December 31, 1998, approximated $2.5 million. Federal income taxes will become payable on this account at the then current tax rate when and to the extent that the account exceeds a specific maximum, or when and if distributions to stockholders, other than stock dividends and other limited exceptions, are made in excess of the accumulated previously taxed income. The Company does not anticipate any transactions that would cause any part of the amount to become taxable and, accordingly, deferred taxes which would approximate $0.9 million have not been provided on such amount.
At December 31, 1998, NFL has approximately $7.8 million in its shareholders surplus account from which it could make distributions to the Company without incurring any federal tax liability. The amount of dividends which may be paid by NFL to the Company is limited by statutory regulations.
The Texas Department of Insurance ("TDI") has adopted its own RBC requirements, the stated purpose of which is to require a minimum level of statutory capital and surplus to absorb the financial, underwriting and investment risks assumed by an insurer. Texas' RBC requirements differ from those adopted by the NAIC in two principal respects: (i) they use different elements to determine minimum RBC levels in their calculation formulas and (ii) they do not stipulate "Action Levels" (like those adopted by the NAIC) where corrective actions are required. However, the Commissioner of the TDI does have the power to take similar corrective actions if a company does not maintain the required minimum level of statutory capital and surplus. NFIC and AICT are domiciled in Texas and must comply with Texas RBC requirements. At December 31, 1998, AICT's RBC exceeded the minimum level prescribed by the TDI; however, NFIC's RBC was below the minimum level prescribed by the TDI.
In December 1990, the Company and NFL entered into an agreement under which NFL issued a surplus certificate to the Company in the principal amount of $2,863,000 in exchange for $2,863,000 of the Company's assets. The unpaid aggregate principal under the surplus certificate bears interest at an agreed upon rate not to exceed 10% and is repayable, in whole or in part, upon (i) NFL's surplus exceeding $7,000,000, exclusive of any surplus provided by any reinsurance agreements and (ii) NFL receiving prior approval for repayment from the Delaware Insurance Commissioner. During 1993 and 1994, NFL received such approval and repaid $2,086,000 to the Company. No principal payments have been made subsequent to 1994. The unpaid aggregate principal under this surplus certificate totaled $777,000 as of December 31, 1998 and 1997.
The Insurance Subsidiaries cede insurance to other insurers and reinsurers on both life and accident and health business. Reinsurance agreements are used to limit maximum losses and provide greater diversity of risk. The Company remains liable to policyholders to the extent the reinsuring companies are unable to meet their treaty obligations. Total accident and health premiums of $2.8 million, $3.6 million and $4.1 million, were paid to reinsurers in 1998, 1997, and 1996, respectively. Face amounts of life insurance in force approximated $37.5 million, $53.1 million and $87.0 million at December 31, 1998, 1997 and 1996, respectively. In 1998, NFL entered into an excess of loss reinsurance agreement on a closed block of annually renewable term life insurance. NFL's retention limit is $25,000 per year, and $22,046 of premiums were paid to the reinsurer for the year ended December 31, 1998. No other life insurance products were reinsured during 1998, 1997 or 1996.
The Company, through NFL and FLICA, entered into a 90% Coinsurance Funds Withheld Reinsurance Agreement (the "Agreement") with a reinsurer effective July 1, 1996 on the in force Specified Disease business. The Agreement provided an initial ceding commission of $10.5 million, of which $8.4 million was received in cash. This ceding commission allowance was to be repaid, inclusive of interest at 12.5%, as statutory profits emerged from the reinsured block of business. For the year ended December 31, 1996, the repayment was $1.9 million. The ceding allowance payable for the year ended December 31, 1996 was $8.6 million. The Company exercised its option to terminate and recapture this Agreement on April 1, 1997 consisting of approximately $9.0 million in total recapture costs calculated at an interest rate of 15% less approximately $2.0 million in unearned premium reserves due to NFL and FLICA. See NOTE 15 - "Extraordinary Item."
In May 1987, NFL entered into a coinsurance treaty with FLICA. Under the terms of the treaty, NFL assumed a 50% pro-rata share of all insurance business written by FLICA from January 1, 1987 through December 31, 1988. In November 1988, the coinsurance treaty was amended to extend through 1997. For the years ended December 31, 1998, 1997 and 1996, $0, $0 and $1.7 million, respectively, of assumed premiums under the coinsurance treaty are included as revenue in the consolidated financial statements. This coinsurance treaty was canceled subsequent to the acquisition of the remaining interest of FLICA's parent FHC, on May 31, 1996.
The Company's future minimum lease payments for non-cancelable operating leases, relating primarily to office facilities and data processing equipment having a remaining term in excess of one year, at December 31, 1998, aggregated $6.7 million. The amounts due by year are as follows: 1999-$2.3 million; 2000-$1.4 million; 2001-$1.1 million; 2002-$1.0 million; 2003-$0.4 million; and thereafter-$0.5 million. Aggregate rental expense included in the consolidated financial statements for all operating leases approximated $3.2 million, $4.4 million and $4.2 million in 1998, 1997 and 1996, respectively.
For the year ended December 31, 1997, the Company recognized an aggregate of $1.0 million in extraordinary losses, net of taxes. Of this amount, (i) $0.6 million resulted from the recognition of unamortized financing fees associated with the prepayment and refinancing of the Company's revolving credit facility with Fleet National Bank (See NOTE 6 "Financing Activities"); and (ii) $0.4 million resulted from the termination and recapture of the block of reinsured policies referred to in NOTE 13 - "Reinsurance."
The condensed financial information should be read in conjunction with the Westbridge Capital Corp. consolidated financial statements as of December 31, 1998 and notes thereto.