The following table sets forth selected financial and statistical data for the Company as of the dates and for the periods indicated. As a result of the 1998 fourth quarter acquisition of TPN, Inc. ("TPN") that was accounted for as a pooling of interests, the 1996 through 1998 periods have been restated to include the operating results of TPN. The 1998 balance sheet data contained herein reflects the December 30, 1998 acquisition of Universal Fidelity Life Insurance Company ("UFL") that was accounted for as a purchase transaction and accordingly, no operating results of UFL prior to 1999 are included in the income statement data. Beginning in 1999, UFL's operating results are included in the consolidated financial results. This information is not necessarily indicative of the Company's future performance. The following information should be read in conjunction with the Company's Consolidated Financial Statements and Notes thereto included elsewhere herein.
(1) The Membership benefits ratio, the Commissions expense ratio and the general and administrative expense ratio represent those costs as a percentage of Membership fees. The product cost ratio represents product costs as a percentage of product sales. These ratios do not measure total profitability because they do not take into account all revenues and expenses.
Membership Fees and Membership Benefit Costs The Company's principal revenues are derived from Membership fees, most of which are collected on a monthly basis. Memberships are generally guaranteed renewable and non-cancelable except for fraud, non-payment of Membership fees or upon written request. Membership fees are recognized in income when due in accordance with Membership terms, which generally require the holder of the Membership to remit fees on at least a monthly basis. Approximately 94% of our members remit their Membership fees to us on a monthly basis. The Company records any amount received in excess of that currently due as deferred revenue and recognizes such deferred amount as income when earned. For example, a payment received representing an annual payment would be recognized as income to the extent of one month and the remaining 11 months would be deferred in month one and then ratably recognized as income in each of the succeeding 11 months. The Company also charges new members, who are not part of an employee group, a $10 enrollment fee. This fee is deferred and recognized in income over the estimated life of a Membership .
More than 98% of active Memberships at December 31, 2000 have benefits delivered by a designated provider law firm with whom the Company has arranged for the services to be provided in a particular geographic area, typically a state or province. Provider law firms receive a fixed monthly payment for each member in their service area and are responsible for providing the Membership benefits without additional remuneration. The fixed cost aspect of this arrangement provides significant advantages to the Company in managing its claims risk. Pursuant to these Provider law firm arrangements, the Company has the ability to more effectively monitor the quality of legal services provided and, due to the volume of claims that may be directed to particular provider law firms, has access to larger, more diversified law firms.
Commission advance receivables as of December 31, 2000, 1999 and 1998 are as follows:
Cash Flow Considerations Relating to Sales of Memberships The Company generally advances significant commissions at the time a Membership is sold. Since approximately 94% of Membership fees are collected on a monthly basis, a significant cash flow deficit is created at the time a Membership is sold. This deficit is reduced as monthly Membership fees are remitted and no additional commissions are paid on the Membership until all previous commission advance receivables have been fully recovered. Since the cash advanced at the time of sale of a new Membership may be recovered over a multi-year period, cash flow from operations may be adversely affected depending on the number of new Memberships written in relation to the existing active base of Memberships and the composition of new or existing sales associates producing such Memberships.
(1) Excluding short-term investments with a fair value of $3.9 million and $3.3 million at December 31, 2000 and 1999, respectively.
The table above illustrates, for example, that an instantaneous 200 basis point increase in market interest rates at December 31, 2000 would reduce the estimated fair value of the Company's fixed-maturity investments by approximately $1.7 million at that date. At December 31, 1999, and based on the fair value of fixed-maturity investments of $22.9 million, an instantaneous 200 basis point increase in market interest rates would have reduced the estimated fair value of the Company's fixed-maturity investments by approximately $2.3 million at that date. The Company's decreased sensitivity to rising interest rates is due to the 25% reduction of investments with maturities over ten years. The definitive extent of the interest rate risk is not quantifiable or predictable due to the variability of future interest rates, but the Company does not believe such risk is material.
General and administrative expenses during 1999 and 1998 were $19.4 million and $21.9 million, respectively, and represented 12.3% and 19.9% of Membership fees for such years. Management expects further gradual decreases in general and administrative expenses when expressed as a percentage of total revenues as a result of certain economies of scale and the integration of TPN and UFL operations.
The Company may not be able to grow memberships and earnings at the same rate as it has historically experienced. The Company's year end active memberships have increased 28.6%, 37.3% and 41.8% in the years ended December 31, 2000, 1999 and 1998, respectively. Net income applicable to common stockholders for the same three years have increased 12.0%, 29.0% and 72.5%, respectively. The Company's ability to grow memberships and earnings is substantially dependent upon its ability to expand or enhance the productivity of its sales force, develop additional legal expense products, develop alternative marketing methods or expand geographically. There is no assurance that the Company will be able to achieve increases in membership and earnings growth comparable to its historical growth rates.
There is litigation pending with respect to certain of our accounting practices that may have a material adverse effect on the Company if adversely determined. There are numerous putative class actions pending against the Company in the United Stated District Court for the Western District of Oklahoma primarily alleging violations of the federal securities laws in connection with the Company's accounting policy with respect to commission advance receivables. If the class actions are resolved adversely to the Company, it could have a material adverse effect on the Company's financial condition and common stock price. See "Item 3. Legal Proceedings".
The Company is dependent upon the success of its marketing force. The Company's principal method of product distribution is through multi-level marketing. The success of a multi-level marketing force is highly dependent upon the Company's ability to offer a commission and organizational structure and sales training and incentive program that enable sales associates to recruit and develop other sales associates to create a "downline". There are a number of other products and services that use multi-level marketing as a distribution method and the Company must compete with these organizations to recruit, maintain and grow its multi-level marketing force. In order to do so, the Company may be required to increase its marketing costs through increases in commissions, sales incentives or other features, all of which could adversely affect the Company's future earnings. In addition, the level of confidence of the sales associates in the Company's ability to perform is an important factor in maintaining and growing a multi-level marketing force. Adverse financial developments concerning the Company, including negative publicity or common stock price declines, could adversely affect the ability of the Company to maintain the confidence of its sales force.
/s/ Deloitte & Touche LLP Deloitte & Touche LLP Tulsa, Oklahoma April 20, 2001
The contractual maturities of the Company's available-for-sale investments in debt securities and certificates of deposit at December 31, 2000 by maturity date follows:
December 31, ------------------------- 2000 1999 ----------- ----------- Available-for-sale investments (current)........... $ 2,448 $ 2,252 Available-for-sale investments (non-current)....... 21,207 19,628 Investments pledged................................ 6,105 5,288 ----------- ----------- Total.............................................. $ 29,760 $ 27,168 =========== ===========
The Company is required to pledge investments to various state insurance departments as a condition to obtaining authority to do business in certain states. The fair value of investments pledged to state regulatory agencies is as follows: