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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________________ to __________________
COMMISSION FILE NUMBER 1-13154
AMERICAN MEDICAL SECURITY GROUP, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
WISCONSIN 39-1431799
(State of incorporation) (I.R.S. Employer Identification No.)
3100 AMS BOULEVARD
GREEN BAY, WISCONSIN 54313
(Address of principal executive offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (920) 661-1111
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
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Common Stock, no par value New York Stock Exchange
Preferred Share Purchase Rights New York Stock Exchange
(associated with the Common Stock)
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Registration S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
As of February 28, 2002, there were outstanding 13,955,439 shares of
Common Stock. The aggregate market value of the shares of such stock held by
non-affiliates of the registrant was $99,475,946 as of the same date, assuming
solely for purposes of this calculation that all directors and executive
officers of the Registrant are "affiliates." This determination of affiliate
status is not necessarily a conclusive determination for other purposes.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of American Medical Security Group, Inc. Proxy Statement dated
April 8, 2002 (Part III)
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AMERICAN MEDICAL SECURITY GROUP, INC.
INDEX TO
ANNUAL REPORT ON FORM 10-K
For the Year Ended December 31, 2001
PAGE
PART I
Item 1. Business...............................................................................................3
Item 2. Properties............................................................................................10
Item 3. Legal Proceedings.....................................................................................10
Item 4. Submission of Matters to a Vote of Security Holders...................................................11
Executive Officers of the Registrant.............................................................................12
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.................................13
Item 6. Selected Financial Data...............................................................................14
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.................15
Item 7A. Quantitative and Qualitative Disclosures about Market Risk ...........................................24
Item 8. Financial Statements and Supplementary Data...........................................................25
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure..................48
PART III
Item 10. Directors and Executive Officers of the Registrant....................................................49
Item 11. Executive Compensation................................................................................49
Item 12. Security Ownership of Certain Beneficial Owners.......................................................49
Item 13. Certain Relationships and Related Transactions........................................................49
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K......................................49
Schedule II - Condensed Financial Information of Registrant..........................................51
Schedule III - Supplementary Insurance Information....................................................54
Schedule IV - Reinsurance.............................................................................55
Schedule V - Valuation and Qualifying Accounts........................................................56
Signatures ......................................................................................................57
Exhibit Index..................................................................................................EX-1
PART I
ITEM 1. BUSINESS
FORWARD-LOOKING STATEMENTS
This document includes "forward-looking" statements within the meaning
of the safe harbor provisions of the Private Securities Litigation Reform Act of
1995. When used, the terms "anticipate," "believe," "estimate," "expect,"
"forecast," "objective," "plan," "possible," "potential," "project" and similar
expressions are intended to identify forward-looking statements. Forward-looking
statements are subject to inherent risks, uncertainties and assumptions that may
cause actual results or events to differ materially from those that are
described. In addition to the assumptions and other factors referred to
specifically in connection with such statements, factors that may cause actual
results or events to differ are described in Item 7, "Management's Discussion
and Analysis of Financial Condition and Results of Operations - Cautionary
Factors." The Company does not undertake any obligation to update or revise such
statements as a result of new information, future events or otherwise.
GENERAL
American Medical Security Group, Inc. is a provider of individual and
small employer group insurance products. As used herein, "the Company" refers to
American Medical Security Group, Inc. and its subsidiaries. The Company's
principal product offering is health insurance for individuals and small
employer groups. The Company also offers life, dental, prescription drug,
disability and accidental death insurance, and provides self-funded benefit
administration. See the Company's Notes to Consolidated Financial Statements,
Note 12, "Segments of the Business" for information concerning the Company's two
reportable segments: health insurance products (which accounted for 97% of the
Company's revenue for the year ended December 31, 2001, compared to 94% for the
year ended December 31, 2000) and life insurance products.
The Company's products are sold through independent licensed agents in
32 states and the District of Columbia. The Company specializes in providing
health and other insurance products designed to maximize choice and control
costs. The Company principally markets health benefit products that provide
discounts to insureds that utilize preferred provider organizations ("PPOs").
PPO plans differ from health maintenance organization ("HMO") plans in that they
typically provide a wider choice of health professionals, fewer benefit
restrictions and increased access to specialists at a somewhat higher premium
cost.
American Medical Security Group, Inc. is a Wisconsin corporation
organized in 1983. The Company's principal executive offices are located at 3100
AMS Boulevard, Green Bay, Wisconsin 54313 and its telephone number at that
address is (920) 661-1111.
In September 1998, the Company, then known as United Wisconsin
Services, Inc., spun off its managed care companies and specialty products
business to its shareholders. The Company contributed all of its subsidiaries
comprising the managed care and specialty products business to a newly created
subsidiary named "Newco/UWS, Inc.," a Wisconsin corporation ("Newco/UWS") and
distributed 100% of the issued and outstanding shares of common stock of
Newco/UWS to the Company's shareholders (the "Spin-off"). In connection with the
Spin-off, the Company adopted its current name of American Medical Security
Group, Inc. and Newco/UWS changed its name to United Wisconsin Services, Inc.,
which has since changed its name to Cobalt Corporation ("Cobalt"). As of
February 28, 2002, Blue Cross & Blue Shield United of Wisconsin ("BCBSUW"),
Cobalt's wholly owned subsidiary, owned 45.2% of the outstanding common stock of
the Company. Cobalt has filed a Schedule 13D, and amendments thereto, with the
Securities and Exchange Commission indicating its desire to reduce BCBSUW's
investment in the Company and its intent to nominate four persons for election
to the Company's Board of Directors at the 2002 annual meeting of shareholders.
To date the Company has been engaged in discussions with Cobalt concerning how
to address Cobalt's need to dispose of its shares in a manner that is favorable
to all of the Company's shareholders. This could include a possible repurchase
by the Company of a limited portion of the shares owned by Cobalt and/or a
possible secondary offering of Cobalt's shares.
3
PRODUCTS
The Company is a provider of insurance products tailored to meet the
varied health benefits needs of its primary markets, including individuals and
families, small employer groups and employers that choose to self insure a
portion of their health benefits. In providing these products and services, the
Company specializes in designing products to maximize choice and control costs.
The Company's primary small group product is GroupMedChoice. The
Company customizes employee benefit packages for businesses to allow them to
offer employees multiple health plan options in a single package. For example,
this strategy allows an employer with four employees to offer four different and
distinct health plans, one for each employee. Although the premium cost of the
plans may vary, the ability to offer different plans is without additional cost
to the employer. In 2001, the Company redesigned its product portfolio to serve
a shifting consumer trend where consumers appear to be willing to bear more of
the financial risk for their health care needs in exchange for lower premiums
and protection from major medical bills. The new GroupMedChoice products offer
more limited plan designs, including higher copayments and deductibles. The
Company began introducing the new products to new clients in several markets in
late 2001 and will continue introductions in additional markets in 2002.
Through its MedOne(SM) medical insurance products marketed to
individuals and families ("MedOne" products), the Company provides coverage to
fit the various health care needs and budgets of consumers. During 2001, the
Company continued to focus on increasing sales of its MedOne products. As a
result, at December 31, 2001, MedOne membership represented 45% of the Company's
medical membership, compared to 34% at the end of 2000. In October 2001, the
Company introduced a new MedOne product, called AMSMedOne, which is designed for
cost-conscious consumers and features more attractive premium rates, protection
from catastrophic medical costs and more patient responsibility for routine
health care expenses. The Company also offers custom, private label products for
individuals and families that are sold through arrangements with select general
agents.
The Company augments its core business with a select line of
complementary products and services. Ancillary benefits available in conjunction
with the Company's plans include dental, short-term disability, short-term
medical, term life and accidental death, and dependent life insurance. Voluntary
dental and term life insurance products may be elected by employees with no
employer contribution requirements. The Company also offers self-funded benefit
administration services for employers that want to assume a portion of the
financial risk for their own health plans. In conjunction with its benefit
administration services, the Company offers excess of loss reinsurance to cover
catastrophic losses. Additionally, the Company offers COBRA administration
services to groups subject to regulations of the Consolidated Omnibus Budget
Reconciliation Act of 1985, as amended.
The Company provides insureds and plan participants with toll-free,
personal customer service 24 hours a day, seven days a week. In addition,
through the Company's wholly owned subsidiary, Nurse Healthline, Inc. ("Nurse
Healthline"), insureds and plan participants have access to a toll-free, 24-hour
medical information line staffed by registered nurses.
MARKETING
The Company currently markets its products in 32 states and the
District of Columbia. The leading states with respect to medical membership
during 2001 were Florida, Illinois, Michigan, Texas, Arizona and Wisconsin,
which accounted for 53% of the Company's medical membership. The Company's small
group products are primarily marketed to employers with less than 50 employees.
The Company's average group size is six employees. During 2001, the Company
focused its marketing efforts on shifting resources to more profitable small
group markets, expanding distribution of MedOne products and growing dental
sales.
4
Product sales are conducted through licensed independent agents. During
2001, the Company continued to increase the number of agents selling its
products to support its initiative to grow MedOne sales. As of December 31,
2001, the Company marketed products through approximately 25,000 independent
agents, a 25% increase in the number of agents from the prior year. Custom
private label products for individuals and families are marketed under
arrangements with select general agents. Distribution of these products is
limited to the general agent and their contracted agent force. Agents are paid
commissions on premiums generated from new and renewal sales. The Company offers
an attractive incentive and service package to agents, creating an environment
as an "agent friendly" company.
The Company divides its sales territory into two regions, each of which
is the responsibility of a Regional Vice President ("RVP"). The RVPs work with
approximately 75 sales managers in offices located throughout the United States
in coordinating the Company's sales and marketing efforts. Sales office staff
provide product training to agents and support local agent needs. In addition,
the Company's Vice President, Sales and Marketing, Special Markets, oversees
proprietary marketers that together accounted for premium production of
approximately 7% of total premium revenue in 2001. Proprietary marketers are
independent agents that produce business through lead generation and independent
sub-agents located throughout the Company's sales territory.
The Company markets, on a limited basis, a MedOne medical insurance
product for individuals over the Internet through several online insurance
agencies. In 2001, the Company introduced EAMS.COM, a secured website
exclusively for agents designed to support their sales activities in marketing
the Company's products. The website allows agents to track their business, get
news from the home and field offices, print forms and promotional material, and
track commissions and incentives.
COMPETITION
The market for the Company's health care products is highly
competitive. The major competition for the Company's products comes from
national and regional firms. Many of the Company's competitors have larger
membership in regional markets or greater financial resources. The small group,
agency-controlled market is highly price sensitive, and the business is put out
for bid more frequently than larger group business. In addition, because most of
the Company's products are marketed primarily through independent agencies, most
of which represent more than one company, the Company experiences competition
within each agency. The Company and other insurers in the small group health
insurance market compete primarily on the basis of price, benefit plan design,
strength of provider networks, quality of customer service, reputation and
quality of agency relations.
PROVIDERS
The Company's wholly owned subsidiary, Accountable Health Plans of
America, Inc. ("Accountable Health Plans"), operates a commercial PPO network
that contracts with providers primarily in Texas, Florida, Iowa, Nebraska,
Wisconsin, Arizona, North Dakota and South Dakota. Approximately 20% of the
Company's members utilized this network in 2001. This network is also offered to
other insurers, third party administrators and employers that self insure their
benefit plans. This provides additional revenue to the Company and increases the
volume of business used to leverage provider contract pricing concessions, which
are largely volume related. Approximately 33% of Accountable Health Plan's
membership is derived from the Company.
The Company also contracts with approximately 60 commercial provider
networks for its fully insured and self-funded product offerings. A master
"payor" agreement is in place for each provider network that allows the Company
to access each network's provider contracts for the Company's PPO and exclusive
provider organization products.
The Company contracts with Merck-Medco Managed Care, LLC for management
of prescription benefits offered with the Company's products. This arrangement
allows members to access their prescription benefits at thousands of retail
outlets nationwide or through a mail-order service and is designed to provide
cost and efficiency benefits to the Company.
5
UTILIZATION REVIEW AND OTHER SERVICES
The Company provides substantially all of the utilization management
services for its members. The Company's utilization review program, which is
accredited by the American Accreditation HealthCare Commission/URAC to meet
national standards, is designed to ensure that services are being provided at an
appropriate level and meeting members' needs. As part of its utilization review
program, the Company performs case management for members who may benefit from
close review due to the severity and complexity of the member's medical
condition. Case management is performed by Company staff with the assistance of
a combination of internally developed and commercially purchased software
packages used to prompt, guide and record medical management decisions. In
addition, the Company has developed a series of software programs that enhance
its utilization management effort.
The Company has developed a demand management telephonic service
through its Nurse Healthline subsidiary. Members can access Nurse Healthline
registered nurses 24 hours a day, seven days a week. By using a computerized
algorithm based system, Nurse Healthline is able to provide information to
members to assist them in gauging the severity of a problem and accessing
appropriate health care.
The Company's subrogation department investigates potential injury
claims prior to final claims adjudication to determine if other insurance
coverage is available. The Company also pursues recoveries post-adjudication
when it learns that the insured has other insurance coverage that is considered
primary. In addition, the Company's special investigation unit proactively
searches for fraud and abuse on questionable claims submitted by providers and
insureds.
INFORMATION TECHNOLOGY
The Company's administrative needs for its products and provider
arrangements are met utilizing a single, custom-built, integrated management
information system. The system includes underwriting, billing, enrollment,
claims processing, utilization management, sales reporting, network analysis,
and service and status reporting.
The Company regularly evaluates, upgrades and enhances its management
information system to further improve its operating efficiencies and services.
An artificial intelligence system assists in claims processing, eligibility and
enrollment tasks. The Company has integrated software into its system with
specific functionality for case management and for the repricing of claims in
accordance with PPO contracts. The Company has the ability to perform data
analysis of the business to analyze trends in utilization, product mix, claim
costs, product pricing and other business factors. The Company uses extensive
personal computer-based network and software solutions that are integrated with
its mainframe system, which allows for continuous enhancement with technology
upgrades and other software solutions.
The Company provides an Internet portal for its independent contracted
sales agents. The website provides agents with account activity, provider
network information, forms access, communications, consumer quotes and other
information.
REINSURANCE
The Company has entered into a variety of reinsurance arrangements
under which it (1) cedes business to other insurance companies to mitigate large
claim risk, and (2) assumes risk from other insurance carriers in connection
with certain acquisitions and other business. See the Company's Notes to
Consolidated Financial Statements, Note 1, "Organization and Significant
Accounting Policies - Reinsurance" for a summary of reinsurance assumed and
ceded.
The Company cedes, through excess of loss arrangements, certain of its
risks on the small group health business and life business. This reinsurance
allows for greater diversification of risk to control exposure to potential
losses arising from large claims. In addition, it permits the Company to enhance
its premium and asset growth while maintaining favorable risk-based capital
ratios. All excess of loss reinsurers with which the Company contracts are rated
"A- (Excellent)" or better by A.M. Best.
6
INVESTMENTS
The Company attempts to minimize its business risk through conservative
investment policies. Investment guidelines set quality, concentration and return
parameters. Individual fixed income issues must carry an investment grade rating
at the time of purchase, with an ongoing average portfolio rating of "A-" or
better, based on ratings of Standard & Poor's Corporation or another nationally
recognized securities rating organization. Investment grade debt securities made
up 97% of the Company's total investment portfolio at December 31, 2001. Below
investment grade debt securities in the Company's investment portfolio were
investment grade when purchased and subsequently downgraded. The Company invests
in securities authorized by applicable state laws and regulations and follows
investment policies designed to maximize yield, preserve principal and provide
liquidity. The Company's portfolio contains no investments in mortgage loans,
non-publicly traded securities (except for principal only strips of U.S.
government securities), real estate held for investment or financial
derivatives.
With the exception of short-term investments and securities on deposit
with various state regulators, investment responsibilities have been delegated
to external investment managers. Such investment responsibilities, however, must
be carried out within the investment parameters established by the Company,
which are amended from time to time. See Item 7, "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Market Risk
Exposure" and the Company's Notes to Consolidated Financial Statements, Note 4,
"Investments," for additional information on the Company's investments.
REGULATION
Government regulation of employee benefit plans, including health care
coverage and health plans, is a changing area of law that varies from
jurisdiction to jurisdiction and generally gives responsible state and federal
administrative agencies broad discretion with respect to the regulation of
health plans, health insurers and related entities. The Company strives to
maintain compliance in all material respects with all federal and state
regulations applicable to its current operations. To maintain such compliance,
it may be necessary for the Company to make changes from time to time in its
services, products, structure or operations. Additional governmental regulation
or future interpretation of existing regulations could increase the cost of the
Company's compliance or otherwise affect the Company's operations, products,
profitability or business prospects.
The Company is unable to predict what additional government
regulations, if any, affecting its business may be enacted in the future or how
existing or future regulations might be interpreted. Most jurisdictions have
enacted small group insurance and rating reforms that generally limit the
ability of insurers and health plans to use risk selection as a method of
controlling costs for the small group business. These laws may generally limit
or eliminate use of pre-existing condition exclusions, experience rating and
industry class rating, and limit the amount of rate increases from year to year.
Under these laws, cost control through provider contracting and managing care
may become more important, and the Company believes its experience in these
areas will allow it to compete effectively. The Company regularly monitors state
and federal legislative and regulatory activity as it affects the Company's
business.
FEDERAL INSURANCE REGULATION
In recent years, federal legislation significantly expanded federal
regulation of small group health plans and health care coverage. The Health
Insurance Portability and Accountability Act of 1996 ("HIPAA") placed
restrictions on the use of pre-existing conditions and eligibility restrictions
based upon health status, and prohibited cancellation of coverage due to claims
experience or health status. HIPAA also prohibits insurance companies from
declining coverage to small employers. Additional federal laws that took effect
in 1998 include prohibitions against separate, lower dollar maximums for mental
health benefits and requirements relating to minimum coverage for maternity
inpatient hospitalization. Many requirements of the federal legislation are
similar to small group reforms that have been in place for many years.
7
HIPAA also established new requirements regarding the confidentiality
of patient health information and standard formats for the electronic
transmission of health care data, including code sets. Final privacy rules
adopted in 2001 will require changes in the way health information is handled.
The privacy regulations become effective in April 2003. Final regulations
regarding the standard formats for the transmission of health care information
have also been released and require compliance by October 2003. The Company is
taking administrative action to be in compliance with the privacy and
stardardization regulations. The regulations will have the effect of increasing
the Company's expenses. During 2001, the Company implemented procedures to
comply with the privacy standards for personal information required by the
"Gramm-Leach-Bliley Act."
The U. S. Department of Labor has published regulations that revise
claims procedures for employee benefit plans governed by ERISA effective for
claims filed on or after July 1, 2002. The regulations govern the time frame for
making benefit decisions for claims and appeals, and notification of claimants'
rights under the regulations. The Company is taking administrative action to be
in compliance with the claims procedure regulations.
Congress has proposed numerous other health care reform measures in
recent years. Congress continues to consider legislation referred to as a
"Patients' Bill of Rights" which could affect various aspects of the Company's
business. The Company is unable to predict when or whether such legislation or
any additional federal proposals will be enacted (see Item 7, "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Cautionary Factors").
STATE INSURANCE REGULATION
The Company's insurance subsidiaries are subject to regulation by
various insurance regulatory bodies in each state in which the respective
entities are licensed. Regulatory authorities exercise extensive supervisory
power over insurance companies in regard to (1) the licensing of insurance
companies, (2) the approval of forms and insurance policies used, (3) the nature
of, and limitation on, an insurance company's investments, (4) periodic
examination of the operations of insurance companies, (5) the form and content
of annual financial statements and other reports required to be filed on the
financial condition of insurance companies, (6) capital adequacy, and (7)
transactions with affiliates and changes in control. The Company's insurance
subsidiaries are required to file periodic statutory financial statements in
each jurisdiction in which they are licensed.
On an ongoing basis, states consider various health care reform
measures relating to network management, mandated benefits, underwriting,
appeals and administrative procedures and other matters. The Company is unable
to predict what reforms, if any, may be enacted or how these reforms would
affect the Company's operations.
The National Association of Insurance Commissioners has adopted
Risk-Based Capital ("RBC") requirements for life and health insurers to evaluate
the adequacy of statutory capital and surplus in relation to investment and
insurance risks associated with (1) asset quality, (2) mortality and morbidity,
(3) asset and liability matching, and (4) other business factors. The RBC
formula is used by state insurance regulators as an early warning tool to
identify insurance companies that potentially are inadequately capitalized. At
December 31, 2001, the Company's insurance subsidiaries had RBC ratios
substantially above the levels that would require Company or regulatory action.
Dividends paid by the Company's insurance subsidiaries to the parent
company are limited by state insurance regulations. For additional information
on dividend restrictions, see the Company's Notes to Consolidated Financial
Statements, Note 9, "Shareholders' Equity - Restrictions on Dividends From
Subsidiaries."
8
INSURANCE HOLDING COMPANY SYSTEMS
The Company is an insurance holding company system under applicable
state laws. As such, the Company and its insurance subsidiaries are subject to
regulation under state insurance holding company laws and regulations in the
states in which the insurance subsidiaries are domiciled. The insurance holding
company laws and regulations generally require annual registration with the
state departments of insurance and the filing of reports describing capital
structure, ownership, financial condition, certain intercompany transactions and
general business operations. Various notice and reporting requirements often
apply to transactions between an insurer and its affiliated companies, depending
on the size and nature of the transactions. Certain state insurance holding
company laws and regulations also require prior regulatory approval or notice of
certain material intercompany transactions. Acquisition of control of an
insurance company requires the prior approval of state regulators in the
insurer's state of domicile and sometimes other jurisdictions as well.
Acquisition of a controlling interest of the Company would constitute an
acquisition of a controlling interest in each of its insurance subsidiaries.
Under applicable state law, control is generally presumed to exist when greater
than 10% of a company's shares are controlled by an entity.
OTHER STATE REGULATIONS
Certain of the Company's subsidiaries are licensed as third party
administrators ("TPAs"). TPA regulations, although differing greatly from state
to state, generally contain requirements for administrative procedures, periodic
reporting obligations and minimum financial requirements. Certain of the
operations of the Company's subsidiaries are also subject to laws and/or
regulations governing PPO, managed care and utilization review activities. PPO
and managed care regulations generally contain requirements pertaining to
provider networks, provider contracting and reporting requirements that vary
from state to state. Utilization review regulations generally require compliance
with specific standards for the performance of utilization review services
including confidentiality, staffing, appeals and reporting requirements. In some
cases, the regulated PPO, managed care and utilization review activities are
delegated by the Company's subsidiaries to a third party.
ERISA
The provision of goods and services to or through certain types of
employee health benefit plans is subject to the Employee Retirement Income
Security Act of 1974, as amended ("ERISA"). ERISA is a complex set of laws and
regulations that are subject to periodic interpretation by the United States
Department of Labor and the Internal Revenue Service. ERISA governs how the
Company's business units may do business with employers whose employee benefit
plans are covered by ERISA, particularly employers that self fund benefit plans.
There have been legislative attempts to limit ERISA's preemptive effect on state
laws. If such limitations were to be enacted, they might increase the Company's
liability exposure under state law-based suits relating to employee health
benefits offered by the Company's health plans and could permit greater state
regulation of other aspects of those businesses' operations.
EMPLOYEES
As of December 31, 2001, the Company had 1,702 employees, 1,467 of
which are located at its home office facility in Green Bay, Wisconsin. None of
its employees are represented by a union.
TRADEMARKS
The Company has filed for and maintains various service marks,
trademarks and trade names at the federal level and in various states. Although
the Company considers its registered service marks, trademarks and trade names
important in the operation of its business, the business of the Company is not
dependent on any individual service mark, trademark or trade name.
9
ITEM 2. PROPERTIES
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 30 locations throughout the
United States primarily for its field sales and provider network offices.
ITEM 3. LEGAL PROCEEDINGS
REGULATORY ACTION
In May 2001, the Florida Department of Insurance issued a complaint
against the Company challenging the Company's rating and other practices in
Florida relating to its MedOne policies. The MedOne policies sold by the Company
in Florida are written pursuant to a group master policy issued to an
association domiciled in a state other than Florida. Therefore, management
believes the Company is exempt from most of Florida rating requirements and that
it has not violated rating or other regulations applicable to the Company. An
administrative hearing was held in January 2002 and the Company has not received
a ruling from the Administrative Law Judge. The complaint seeks penalties or
other administrative actions including possible suspension or revocation of the
Company's certificate of authority to do business in Florida.
SKILSTAF LITIGATION
In August 1999, a $6.9 million verdict was entered against American
Medical Security, Inc. ("AMS"), the Company's third party administrator
subsidiary, in the United States District Court for the Middle District of
Alabama. The decision was made in a lawsuit brought against the Company by
Skilstaf, Inc. ("Skilstaf"), an Alabama employee leasing company, in January
1998 alleging that the Company delayed claims payments under a contract with
Skilstaf. Skilstaf sought unspecified damages. The contract, which was entered
into in 1992 and terminated by Skilstaf in 1996, was a third party administrator
contract for Skilstaf's self funded employee benefit plan. The Company argued
that this case was governed by ERISA, which preempts all state law causes of
action and limits damages to contract damages. The Company's post-trial motion
to set aside the jury's finding was denied by the court on March 20, 2000. As a
result, the Company filed a notice of appeal with the Eleventh Circuit Federal
Appeals Court. On March 12, 2001, the Company received the Court of Appeal's
decision affirming the decision of the District Court. The Company then filed a
petition with the Court of Appeals for a rehearing by the full Court of Appeals,
which was denied in May 2001. At the direction of the District Court, the
Company paid the full amount of the verdict plus interest in July 2001. The
Company filed a petition with the United States Supreme Court for a writ of
certiorari to review the decision of the Court of Appeals. The writ was denied
by the Supreme Court in October 2001 and the case is closed.
HEALTH ADMINISTRATORS LITIGATION
In February 2000, a $5.4 million verdict was entered against AMS and
United Wisconsin Life Insurance Company ("UWLIC"), one of the Company's
insurance subsidiaries, in the Common Pleas Court of Delaware County, Ohio,
Civil Division, in a lawsuit brought against AMS and UWLIC in 1996 by Health
Administrators of America, Inc. ("Health Administrators"), an insurance agency
owned and operated by a former agent of AMS. The lawsuit alleges breach of
written and oral contracts involving commission amounts and fraud. The case was
heard and decided by a magistrate who awarded damages to Health Administrators,
based on breach of written commission and agent contracts and ruled in favor of
the Company on breach of oral contracts and fraud. The Company filed objections
with the Common Pleas Court requesting that the magistrate's decision against
the Company be reversed. The Common Pleas Court approved the magistrate's
decision in April 2000. As a result, the Company filed a notice of appeal with
the Court of Appeals, Delaware County, Ohio, Fifth Appellate District. On March
29, 2001, the Court of Appeals affirmed a portion of the verdict, with
modifications, representing approximately $3.0 million in damages, and reversed
and remanded the remaining issues in the case representing approximately $2.4
million in damages. The Company appealed the $3.0 million portion of the damages
to the Ohio Supreme Court, which, in July 2001, declined to take the appeal. The
Company paid substantially all of the approximately $3.0 million judgment in
December 2001. Briefs have been submitted for the remanded portion of the case,
and the parties are awaiting the trial court's decision.
10
FLORIDA CLASS ACTION LITIGATION
In February 2000, a complaint was filed against AMS and UWLIC in the
Circuit Court for Palm Beach County, Florida, by Evelyn Addison and others
seeking certification of a statewide class action on behalf of certain
individuals insured by or formerly insured by UWLIC. Plaintiffs allege the
Company did not follow Florida law when it discontinued writing certain health
insurance policies and offered new policies in 1998. Plaintiffs claim the
Company wrongfully terminated policies, improperly notified insureds of
conversion rights and charged improper premiums for the new policies. Plaintiffs
also assert that the Company's renewal rating methodology violates Florida law.
Plaintiffs are seeking unspecified damages. A motion for class certification was
granted by the Circuit Court and appealed to the Fourth District Court of
Appeals of the State of Florida, which upheld the class certification in October
2001. The Company has an appeal pending with the Florida Supreme Court with the
ultimate objective of seeking to vacate the finding of a certifiable class. The
Company and plaintiffs filed cross motions for summary judgment in Circuit Court
that were heard and denied in February 2002. A memorandum filed by plaintiffs in
January 2002 in support of their motion for summary judgment raised new
arguments that expanded the legal theory, scope and potential damages of the
case. The parties have agreed to a bifurcated trial, with the liability portion
of the trial tentatively scheduled to commence as a bench trial in March 2002.
Management believes the Company acted in compliance with applicable Florida law
with regard to the termination of and conversion of insurance policies and with
regard to its renewal rating practices. Although it cannot predict the outcome
of this case, management believes this suit is without merit and is defending
its position vigorously.
The Company is involved in various legal and regulatory actions
occurring in the normal course of business. Based on current information
including consultation with outside counsel, management believes any ultimate
liability that may arise from the above-mentioned and all other legal and
regulatory actions would not materially affect the Company's consolidated
financial position, results of operations or cash flow. However, management's
evaluation of the likely impact of these actions could change in the future and
an unfavorable outcome could have a material effect on the Company's
consolidated financial position, results of operations or cash flow of a future
period.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the
fourth quarter of 2001.
11
EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers of the Company, who are elected for one year
terms, are as follows:
Name Age Title
Samuel V. Miller 56 Chairman of the Board, President and Chief
Executive Officer
Gary D. Guengerich 56 Executive Vice President, Chief Financial
Officer and Treasurer
James C. Modaff 44 Executive Vice President and Chief Actuary
Thomas G. Zielinski 54 Executive Vice President, Operations
Timothy J. Moore 50 Senior Vice President of Corporate Affairs,
General Counsel and Secretary
Timothy F. O'Keefe 47 Senior Vice President and Chief Marketing
Officer
Clifford A. Bowers 50 Vice President, Corporate Communications
John R. Wirch 48 Vice President, Human Resources
Samuel V. Miller has been Chairman of the Board, President and Chief
Executive Officer of the Company since September 1998. Prior to that time, he
was an Executive Vice President of the Company since December 1995. During 1994
and 1995, Mr. Miller was a member of the executive staff planning group with the
Travelers Group, serving as Chairman and Group Chief Executive of National
Benefit Insurance Company and Primerica Financial Services Ltd. of Canada. Prior
to 1994, Mr. Miller spent 10 years as President and Chief Executive Officer of
American Express Life Assurance Company.
Gary D. Guengerich has been Executive Vice President and Chief
Financial Officer of the Company since November 1997. He has also served as
Treasurer of the Company since August 2001 and at certain other times during his
employment with the Company. Prior to joining the Company, Mr. Guengerich was
Senior Vice President and Comptroller of First Colony Life Insurance where he
was employed since 1981.
James C. Modaff has been Executive Vice President and Chief Actuary of
the Company since August 1999. Prior to joining the Company, he was a principal
of Milliman & Robertson, Inc. (a national actuarial and consulting firm) for the
majority of his 14-year career with the firm.
Thomas G. Zielinski has been Executive Vice President of Operations of
the Company since August 1999. Prior to joining the Company, he was a Vice
President of Humana, Inc. (a health services company) where he served as
Executive Director of the Wisconsin Service Center of Humana, Inc. and in
various other capacities, including Vice President, with a predecessor company
of Humana, Inc. since 1981.
Timothy J. Moore has been Senior Vice President of Corporate Affairs,
General Counsel and Corporate Secretary of the Company since March 1997. Prior
to that time, Mr. Moore was a partner with the national law firm of Katten
Muchin & Zavis, practicing at the firm from 1987 to 1997.
Timothy F. O'Keefe has been Senior Vice President and Chief Marketing
Officer of the Company since January 2002. Prior to joining the Company, he was
President of the Major Medical Division of Conseco, Inc.'s Insurance Operations,
having served in other senior management positions from 1997 until he became
President in 1998. From 1991 to 1997 he held various positions, including Chief
Marketing Officer, with various subsidiaries of Pioneer Financial Services.
Clifford A. Bowers has been Vice President of Corporate Communications
of the Company since October 1997. From 1988 to 1997, Mr. Bowers was Director of
Communications with Fort Howard Corporation (a paper manufacturer). Prior to
that time, Mr. Bowers held management positions with Tenneco, Manville and
Brunswick corporations.
John R. Wirch has been Vice President of Human Resources of the Company
since February 1996. Prior to that time, Mr. Wirch was Vice President of Human
Resources for Little Rapids Corporation (a manufacturer of specialty papers)
from 1993 to 1996, having served as Director of Human Resources of Little Rapids
Corporation from 1980 to 1993.
12
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The common stock of the Company is traded on the New York Stock
Exchange ("NYSE") under the symbol "AMZ". The following table sets forth the per
share high and low sales prices for the common stock as reported on the NYSE. No
cash dividends were paid during the periods indicated.
2001 2000
------------------------- -------------------------
Share Price Share Price
High Low High Low
------------------------- -------------------------
Quarter Ended:
March 31 $ 7.00 $ 4.75 $ 7.75 $ 5.38
June 30 6.96 5.00 7.25 5.00
September 30 6.85 4.80 8.50 6.25
December 31 12.45 5.60 6.38 4.25
The Company's line of credit agreement contains a debt covenant
restriction that prohibits the Company from declaring or paying any cash
dividends. In addition, dividends paid by the Company's insurance subsidiaries
to the parent Company are limited by state insurance regulations. See Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources" for a detailed discussion of
insurance subsidiary dividend limitations.
As of February 28, 2002, there were 252 shareholders of record of
common stock. Based on information obtained from the Company's transfer agent
and from participants in security position listings and otherwise, the Company
has reason to believe there are approximately 2,300 beneficial owners of shares
of common stock.
13
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data as of and for the years ended
December 31, 1997 through 2001 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."
As of and for the years ended December 31,
2001 2000 1999 1998(a) 1997
---------------------------------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENT OF OPERATIONS DATA:
Revenues:
Premium revenue $ 838,672 $ 951,071 $ 1,056,107 $ 914,017 $ 957,204
Net investment income 17,443 19,007 19,766 20,550 22,217
Net realized investment gains (losses) (779) (325) (854) 3,670 1,854
Other revenue 21,285 20,112 22,361 22,632 24,249
---------------------------------------------------------------
Total revenues 876,621 989,865 1,097,380 960,869 1,005,524
Expenses:
Medical and other benefits 601,942 724,613 860,473 691,767 733,491
Selling, general and administrative 257,742 251,767 268,059 242,073 252,160
Interest 2,877 3,584 3,564 7,691 9,311
Amortization of goodwill and other intangibles 3,628 3,785 4,273 8,781 7,975
Write-off of intangible assets and related charges - - - 15,453 -
---------------------------------------------------------------
Total expenses 866,189 983,749 1,136,369 965,765 1,002,937
---------------------------------------------------------------
Income (loss) from continuing operations,
before income taxes 10,432 6,116 (38,989) (4,896) 2,587
Income tax expense (benefit) 6,257 3,447 (13,043) (1,868) 1,032
---------------------------------------------------------------
Income (loss) from continuing operations 4,175 2,669 (25,946) (3,028) 1,555
Income from discontinued operations,
less applicable income taxes - - - 10,003 16,595
---------------------------------------------------------------
Net income (loss) $ 4,175 $ 2,669 $ (25,946) $ 6,975 $ 18,150
===============================================================
Earnings (loss) per common share - basic
Continuing operations $ 0.30 $ 0.18 $ (1.58) $ (0.18) $ 0.10
Discontinued operations - - - 0.60 1.01
---------------------------------------------------------------
Net income (loss) per common share - basic $ 0.30 $ 0.18 $ (1.58) $ 0.42 $ 1.11
===============================================================
Earnings (loss) per common share - diluted
Continuing operations $ 0.29 $ 0.18 $ (1.58) $ (0.18) $ 0.10
Discontinued operations - - - 0.60 1.00
---------------------------------------------------------------
Net income (loss) per common share - diluted $ 0.29 $ 0.18 $ (1.58) $ 0.42 $ 1.10
===============================================================
Weighted average common shares outstanding 14,049 14,899 16,470 16,559 16,423
Cash dividends per common share $ - $ - $ - $ 0.36 $ 0.48
BALANCE SHEET DATA:
Cash and investments $ 300,253 $ 284,982 $ 293,539 $ 309,562 $ 316,858
Total assets 473,015 471,923 503,094 498,722 648,136
Notes payable 40,058 41,258 42,523 55,064 124,578
Total shareholders' equity 229,400 221,177 220,280 266,451 326,377
(a) Discontinued operations include the operations of Newco/UWS through
September 25, 1998, the spin-off distribution date. Continuing operations
includes interest on debt assumed by Newco/UWS through September 11, 1998,
the spin-off effective date.
14
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
American Medical Security Group, Inc., together with its subsidiary
companies (the "Company"), is a provider of individual and small employer group
insurance products. The Company's principal product offering is health insurance
for small employer groups and health insurance for individuals and families
("MedOne"). The Company also offers life, dental, prescription drug, disability
and accidental death insurance, and provides self-funded benefit administration.
The Company's products are marketed in 32 states and the District of Columbia
through independent agents. Approximately 75 Company sales managers located in
sales offices throughout the United States support the independent agents. The
Company's products generally provide discounts to insureds that utilize
preferred provider organizations ("PPOs"). The Company owns a preferred provider
network and also contracts with other networks to ensure cost-effective health
care choices to its customers.
SUMMARY OF 2001 RESULTS
The Company's financial performance improved considerably in 2001. The
key factor in the improvement was the health loss ratio, which by year-end had
dropped to its lowest point in over three years. This positive momentum is
attributed to strategic decisions made in late 1999 including (1) aggressively
raising prices on new and renewal business, (2) focusing marketing efforts for
small group products in markets with the best prospects for profitability and
future growth, (3) redesigning products to meet the changing needs of today's
consumers, and (4) expanding the distribution of the Company's MedOne products.
During the first quarter of 2001, the Company received an adverse
decision by the Eleventh Circuit Federal Court of Appeals affirming a 1999 jury
verdict in a lawsuit brought against the Company by Skilstaf, Inc., an employee
leasing company. As a result, the Company's 2001 reported results reflect an
after-tax charge of $5.8 million or $0.41 per share. See Item 3, "Legal
Proceedings" for more detailed information regarding this case. Management has
characterized this charge as a nonrecurring item in the following discussion of
results of operations due to the unusual nature and size of the lawsuit and
because it relates to a contract inforce between 1992 and 1996.
Following is a discussion of management's strategic decisions made in
late 1999 and their effect on the Company's 2001 operations:
PRODUCT PRICING
Significant technological advancements in the health care field have
continued in the past few years. As a result of this and other factors, the
costs associated with health care have also increased. In the face of escalating
claims cost trends that emerged in late 1998 and 1999, management implemented
significant premium rate increases on the Company's existing block of business.
This action contributed greatly to the improvement in the health loss ratio and
resulting earnings performance. After the effect of buydowns in coverage and
terminations, average medical premium per member per month increased 14% from
2000 to 2001. In comparison, average medical claims costs increased only 7% for
the same period. Management is committed to a pricing strategy intended to
maintain premium rate increases at a level necessary to achieve the Company's
target profit margins.
FOCUSED SMALL GROUP MARKETING
Management continues to analyze the Company's geographic markets and is
focusing its marketing efforts in those areas that offer the greatest potential
for appropriate returns. As a consequence of government regulations and rapidly
rising health care inflation resulting from advances in technology and drug
treatments, the Company's small group business experienced losses in 1998 and
1999. Since that time, management has taken steps to return the Company's small
group business to profitability. Those steps included exiting from certain
unprofitable markets, shifting sales and marketing energies away from
underperforming markets and realigning the Company's small group agent force to
producers with a commitment to the Company.
15
As a result of these actions and the premium rate increases previously
discussed, the Company's small group business has improved significantly over
the past two years and is currently contributing to the Company's improved
financial performance. As anticipated, these focused efforts to improve
profitability resulted in a decline in membership and revenues throughout 2001.
Management is currently taking steps to return the Company's small group
business to a growth mode while continuing to protect its margins. Management
remains committed to this business and believes that this large and growing
sector of the economy has significant revenue and earnings potential.
PRODUCT REDESIGN
A significant portion of the Company's product portfolio was redesigned
during 2001 to keep pace with changes in the marketplace and to maximize the
Company's competitiveness. Consumers seem to be willing to accept higher
co-payments and deductibles in exchange for affordable premiums and protection
from major medical bills. The Company's new products for small groups and
individuals are designed to provide more affordable coverage for major medical
expenses by shifting the financial responsibility for routine day-to-day health
care to the patient. These new products feature attractive rates, real choice
and protection from catastrophic medical costs. The Company has been introducing
these products to its sales force for the past several months, and the agent
reaction has been enthusiastic. In markets where the products have been fully
launched, management has seen a positive trend in orders and quote requests.
MEDONE EXPANSION
Recognizing the significant earnings potential of the MedOne product
line, management continues to take steps to expand the distribution of this
business. There are a number of key factors that make MedOne a strategic focus
and an attractive product line to sell. The general regulatory environment
allows the Company expanded flexibility in pricing, risk selection and plan
design. The product line features higher deductibles and co-payments, thereby
increasing consumers' involvement in health care cost decisions. In addition,
the MedOne business is well positioned in a slowing economy in which employers
are faced with reducing their workforce or dropping their group health coverage.
MedOne represented 45% of the Company's medical membership at the end of 2001,
compared with 34% at the end of 2000. This shift in the Company's product mix
contributed to the improvement in the health loss ratio. While MedOne products
are more costly to sell and administer than small group products, the increased
underwriting and risk management flexibility results in a lower loss ratio. The
lower loss ratio was somewhat offset by the increase in the expense ratio during
2001. Management expects this product line to represent about half of the
Company's revenues by 2003.
OUTLOOK FOR 2002
Increasing premium rates and realigning marketing efforts caused a drop
in the Company's new member enrollment and an increase in existing membership
terminations resulting in decreased revenues throughout 2001. While this
consequence was anticipated, management believes membership and revenues in 2002
will remain flat with 2001 with some further decline during the first half of
2002 before starting to improve by mid-year. Premium rate increases will
moderate considerably during 2002, which should improve persistency of small
group membership. In addition, the introduction and roll out of new products is
expected to have a positive impact on new sales. The Company is currently
conducting significant marketing campaigns to recruit new MedOne and dental
agents. These efforts are also attracting agents who want to sell the Company's
full line of products causing the Company's force of professional, licensed
agents selling small group products to grow. Management also believes that
competitive pressures should ease in 2002 as other small group insurance
carriers either exit the small group market or implement significant rate
increases. Management expects the health loss ratio to continue to improve, but
at a more moderate rate during 2002.
Based on the Company's significantly improved financial performance in
the last two quarters of 2001, management anticipates 2002 earnings per share to
be between $1.15 and $1.25, including the effect of the nonamortization
provisions of a new accounting standard. See "Recent Accounting Pronouncements"
below for a detailed discussion of new accounting standards and the related
impact on the Company. While there may be material upside potential to these
estimates, the guidance is based on rapidly emerging positive trends, tempered
by inherent variables in this business. See "Cautionary Factors" below for a
detailed description of inherent risks and uncertainties that may cause actual
results or events to differ materially from those described.
16
COMPARISON OF RESULTS OF OPERATIONS
The Company experienced unrelated nonrecurring charges during 2001 and
1999. As these nonrecurring items were not reflective of the ongoing operations
of the Company, management has chosen to exclude their effects from the
"Comparison of Results of Operations" and to describe each item separately. The
following table illustrates the effect of nonrecurring items on the Company's
results:
Year ended December 31,
2001 2000 1999
-------------------------------------------
(IN THOUSANDS)
Income (loss) before nonrecurring item $ 10,025 $ 2,669 $ (12,241)
Nonrecurring item, net of tax (5,850) - (13,705)
-------------------------------------------
Net income (loss) $ 4,175 $ 2,669 $ (25,946)
===========================================
A summary description of each of the nonrecurring items is as follows:
During the third quarter of 1999, the Company ceased marketing and
terminated all small group business in Florida, all small group and individual
health business in Maryland and all remaining business in Minnesota over a
period of 18 months. This decision was made after it became clear to management
that certain regulatory challenges existed that made it impossible to return
these markets to profitability. The Company recorded a $13.7 million after-tax
charge in 1999 for a premium deficiency reserve to recognize expected losses
related to highly regulated markets.
During the first quarter of 2001, the Company received an adverse
decision by the Eleventh Circuit Federal Court of Appeals affirming a 1999 jury
verdict in a lawsuit brought against the Company by Skilstaf, Inc., an employee
leasing company. The Company recognized an after-tax charge of $5.8 million or
$0.41 per share during the first quarter of 2001 representing the full loss
including punitive damages and other expenses. In July 2001, at the direction of
the district court, the Company paid the full amount of the verdict plus
interest. This case is now closed.
YEARS ENDED DECEMBER 31, 2001 AND 2000
Insurance premiums decreased 11.8% to $838.7 million in 2001 from
$951.1 million in 2000. Premium revenues have decreased as a result of the
Company's membership decline. As discussed above, membership reductions have
resulted from product repricing, market exits and focusing marketing efforts in
profitable markets. Medical membership declined by 126,000 members during 2001.
The Company's change in its product mix has also impacted premium revenue. The
MedOne business, which has become a larger percentage of the Company's total
business, has a smaller premium per member compared with the declining small
group business. Partially offsetting the membership decline and the change in
the product mix is the effect of increasing premium rates.
The health segment loss ratio improved 460 basis points to 72.6% for
2001 compared to 77.2% for 2000. The 2001 health loss ratio is at its lowest
point in over three years. The improvement in the health loss ratio is due in
part to improved performance on the Company's small group business resulting
from repricing efforts. In 2001, average premiums per member per month increased
at a higher rate than average claims costs per member resulting in a lower loss
ratio. The health loss ratio also benefited, to a lesser degree, from the change
in product mix to a larger percentage of MedOne business, which has a lower loss
ratio. The life segment loss ratio remained relatively stable with the prior
year at 36.4% for 2001 compared with 34.5% for 2000.
Net investment income decreased to $17.4 million in 2001 from $19.0
million in 2000. The decrease resulted mainly from a decrease in the annual
investment yield. The annual investment yield was 6.4% for 2001 compared to 6.7%
for the prior year. Investment gains and losses are realized in the normal
investment process in response to market opportunities.
17
Other revenue, which primarily consists of administrative fee income
from claim processing on self funded business and other administrative services,
increased slightly to $21.3 million in 2001 from $20.1 million in 2000. The
increase resulted from a general increase in fees charged during 2001.
The expense ratio includes commissions, general and administrative
expenses, premium taxes and assessments. As anticipated, the health segment
expense ratio, excluding the first quarter litigation charge, increased to 26.6%
in 2001 from 24.2% in 2000. The increase largely reflected the change in the
Company's product mix. MedOne business has higher agent commissions and issue
costs than small group products, but lower claim costs. The decrease in premium
volume also contributed to the increase in the health expense ratio. For 2002,
management expects the health segment expense ratio to increase slightly
primarily as the result of investments in the Company's distribution system and
other selling costs and a continued expansion of the MedOne business.
The health segment combined ratio, which represents the sum of the
health loss and expense ratios, improved 220 basis points to 99.2% for 2001 from
101.4% for 2000. The 2.2% improvement in the combined ratio resulted in an
improvement in pre-tax income of $18.1 million to the Company in 2001.
Interest expense on the outstanding balance of the Company's line of
credit decreased to $2.9 million in 2001 from $3.6 million in 2000. The interest
rate charged on the line of credit is tied to the short-term borrowing rate,
which declined throughout most of 2001 resulting in decreased interest expense
for the Company. Amortization of goodwill and other intangible assets remained
relatively stable at $3.6 million for 2001 compared to $3.8 million for the
prior year. As discussed in detail below under the caption "Recent Accounting
Pronouncements," the Company will apply new accounting rules for goodwill and
intangibles effective January 1, 2002.
The effective tax rate for 2001 was 60.0%. Excluding the effect of the
first quarter litigation charge, the effective tax rate was 48.4% for 2001
compared to 56.4% for 2000. The change in the effective tax rate relates to the
amortization of non-deductible goodwill and other permanent items in relation to
pre-tax income. The Company had deferred tax assets recorded, net of valuation
allowances, of $2.9 million related to state net operating loss carryforwards at
December 31, 2001. State net operating loss carryforwards begin to expire in
2008. Management believes that the deferred tax assets will be realized
primarily through future state taxable income.
YEARS ENDED DECEMBER 31, 2000 AND 1999
Insurance premiums decreased 9.9% to $951.1 million for 2000 from
$1,056.1 million reported for 1999. The Company acquired the majority of the
fully insured group health business of Continental Assurance Company ("CNA") on
January 1, 1999. Premiums on the CNA block of business declined approximately
$70.0 million from 1999 to 2000, which accounted for the majority of the
decrease in premium. The remainder of the decline in premiums from the prior
year resulted from declining small group membership due to the exit from
unprofitable markets. Partially offsetting the impact of the declining
membership was the continued increase in premiums per member per month. The
Company's average fully insured medical premium per member per month increased
7% to $136, compared to $127 for 1999.
The health segment loss ratio improved 320 basis points to 77.2% in
2000 from 80.4% reported in 1999, excluding the nonrecurring charge. The
significant improvement was due to management's actions and strategies
implemented during 2000 to manage medical inflation. These actions included
premium increases, claims cost control initiatives and the exit from
unprofitable small group markets and the related release of premium deficiency
reserves. The improvement also reflected increased sales of MedOne products,
which are priced for a lower loss ratio due to its increased deductibles and
co-payments. The life segment loss ratio improved to 34.5% for 2000 from 39.2%
in 1999.
Net investment income decreased to $19.0 million in 2000 from $19.8
million in 1999. The decrease resulted from a slight decrease in average
invested assets from 1999 to 2000. Average invested assets at cost decreased
from $294.7 million at the end of 1999 to $283.8 million at the end of 2000.
Investment gains and losses are realized in the normal investment process in
response to market opportunities.
18
Other revenue, which primarily consists of administrative fee income
from claim processing on self funded business and other administrative services,
decreased slightly to $20.1 million in 2000 from $22.4 million in 1999. The
decrease resulted from a decline in administrative fee revenue from blocks of
business acquired in prior years.
The expense ratio includes commissions, general and administrative
expenses, premium taxes and assessments. As anticipated, the health segment
expense ratio increased to 24.2% in 2000 from 23.0% in 1999. The increase
largely reflected the change in the Company's product mix. MedOne business,
which expanded significantly during 2000, has higher agent commissions and issue
costs than small group products, but lower claim costs. In addition, in the
third quarter of 2000, the Company received a one-time assessment from the State
of Minnesota related to the Company's exit from the MedOne health insurance
market in that state in early 1999. The assessment was $1.2 million in excess of
the Company's original provision for the assessment. Management expects no
similar assessments from other exited markets. The decrease in premium volume
also contributed to the increase in the health expense ratio.
The health segment combined ratio, which represents the sum of the
health loss and expense ratios, improved 200 basis points to 101.4% for 2000
from 103.4% for 1999. The 2.0% improvement in the combined ratio resulted in an
improvement in pre-tax income of $18.2 million to the Company in 2000.
Interest expense on the outstanding balance on the Company's line of
credit agreement remained flat compared to 1999 at $3.6 million. Amortization of
goodwill and other intangible assets declined from 1999 to 2000 to $3.8 million
from $4.3 million.
The effective tax rate for 2000 was 56.4% compared with 33.5% for 1999.
The change in the effective tax rate relates to the amortization of
non-deductible goodwill and other permanent items in relation to pre-tax income.
The Company reported pre-tax income of $6.1 million in 2000 compared to a
pre-tax loss of $39.0 million in 1999.
CRITICAL ACCOUNTING POLICIES
LIABILITIES FOR UNPAID CLAIMS
The Company's liabilities for unpaid claims are based on an estimation
process that is complex and uses information obtained from both company specific
and industry data, as well as general economic information. These estimates are
developed using actuarial methods based upon historical data for payment
patterns, cost trends, product mix, seasonality, utilization of health care
services and other relevant factors. The amount recorded for unpaid claims
liabilities is sensitive to judgments and assumptions made in the estimation
process. The most significant assumptions used in the estimation process include
determining claims cost trends, the expected consistency in the frequency and
severity of claims incurred but not yet reported, changes in the timing of
claims submission patterns from providers, changes in the Company's speed of
processing claims and expected costs to settle unpaid claims.
Actual conditions could differ from those assumed in the estimation
process given the general economic and regulatory environment of the Company's
operations. Due to the uncertainties associated with the factors used in these
assumptions, materially different amounts could be reported in the Company's
statement of operations for a particular period under different conditions or
using different assumptions. As is common in the health insurance industry, the
Company believes that actual results may vary within a reasonable range of
possible outcomes. Management believes that the recorded liabilities for unpaid
claims at December 31, 2001 is in the higher end of a reasonable range of
outcomes. Management closely monitors and evaluates developments and emerging
trends in claims costs to determine the reasonableness of judgments made. A
retrospective test is performed on prior period claims liabilities and, as
adjustments to the liabilities become necessary, the adjustments are reflected
in current operations. Management believes that the amount of medical and other
benefits payable is adequate to cover the Company's liabilities for unpaid
claims as of December 31, 2001.
19
In determining the liability for unpaid claims at December 31, 2001,
management considered the potential impact of the September 11, 2001 events.
Although the events of September 11, 2001 did not have a direct material effect
on the Company, management anticipates an indirect impact including, but not
limited to, increased utilization by the general population of mental health
services for stress, anxiety, depression and similar conditions in the fourth
quarter. Also, subsequent bio-terrorism threats and attacks may result in
increased utilization of health care services including office visits,
laboratory tests and prescription drugs for flu-like symptoms in the fourth
quarter. While the impact of these claims cannot be predicted with certainty,
management believes adequate provision has been made for such claims as of
December 31, 2001. Accordingly, the outcome of these matters is not expected to
have a material adverse effect on the financial position of the Company. Should
the outcome be that minimal health benefits are incurred, the result would be
positive to the earnings of the Company.
LITIGATION
The Company is involved in various legal and regulatory actions
occurring in the normal course of business. The liabilities recorded for
litigation are generally determined on a case-by-case basis and typically relate
to disputes over policy coverage and benefits. In determining the amount to be
recorded, judgments are made by management based on the facts and the merits of
the case, advice from outside legal counsel, the general legal and regulatory
environment of the originating state, historical results of similar cases and
other relevant factors. The average cost for the settlement of the actions
occurring in the normal course of the Company's business approximates $30,000.
However, inherent uncertainties surround legal proceedings and actual results
could differ from those assumed in determining the liabilities. The possibility
exists that a decision could be rendered against the Company including punitive
or other damage awards, which may have a material impact on the results of the
Company's operations. In estimating the liabilities for litigation as of
December 31, 2001, the Company considered the recent unfavorable litigation
environment it has experienced in certain states. Management's evaluation of the
likely impact of these actions could change in the future and an unfavorable
outcome could have a material effect on the Company's financial condition,
results of operations or cash flow of a future period. See Item 3, "Legal
Proceedings" for a detailed discussion of the Company's material pending
litigation.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board issued
Statements of Financial Accounting Standards No. 141, BUSINESS COMBINATIONS, and
No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS (the "Statements"), effective for
fiscal years beginning after December 15, 2001. The new rules will impact the
Company in two ways. First, goodwill and intangible assets deemed to have
indefinite lives will no longer be amortized. Other intangible assets will
continue to be amortized over their useful lives. Second, goodwill and
intangible assets with indefinite lives will be subject to an initial impairment
test in accordance with the Statements, and any remaining balance of goodwill
and intangible assets will be subject to future annual impairment testing.
The Company will apply the new rules on accounting for goodwill and
other intangible assets beginning in the first quarter of 2002. Application of
the nonamortization provisions of the Statements is expected to result in an
increase in net income of approximately $2.7 million per year. The Company will
perform the first of the required impairment tests of goodwill and intangible
assets deemed to have indefinite lives in 2002, effective as of January 1, 2002,
by comparing the fair value of the Company's reporting units to their carrying
amounts (book value), including goodwill. In determining the fair value of the
Company's reporting units, management will consider valuation techniques such as
the quoted market price of the Company's stock, the present value of future cash
flows and market comparison of similar assets and liabilities.
At December 31, 2001, the Company's book value per share was $16.30 and
was significantly higher than the $12.45 quoted market price per share. The
Company has not yet determined what the effect of these tests will be on the
earnings and financial position of the Company. If management determines that
the quoted market price per share is the appropriate measure of the Company's
fair value, the resulting impairment would be greater than 50% of the amount of
goodwill and other intangibles on the Company's December 31, 2001 balance sheet.
If it is determined that an impairment exists as of January 1, 2002, the charge
would be reported as the cumulative effect of a change in accounting principle
in the Company's consolidated financial statements and would have no impact on
cash flows or the statutory-basis capital and surplus of the Company's insurance
subsidiaries.
20
LIQUIDITY AND CAPITAL RESOURCES
The Company's sources of cash flow consist primarily of insurance
premiums, administrative fee revenue and investment income. The primary uses of
cash include payment of medical and other benefits, selling, general and
administrative expenses and debt service costs. Positive cash flows are invested
pending future payments of medical and other benefits and other operating
expenses. The Company's investment policies are designed to maximize yield,
preserve principal and provide liquidity to meet anticipated payment
obligations.
The Company's cash provided by operations was $17.6 million for 2001
and cash used in operations was $3.2 million for the year ended 2000. Excluding
the payment for the Skilstaf litigation, cash provided by operations was $25.2
million for 2001. The increase in cash flows from operations is primarily the
result of improved underwriting margins in 2001 over 2000. Consistent with the
Company's earnings, cash flows increased significantly during the last half of
2001.
The Company is well capitalized with a debt to total capital ratio of
14.9% at December 31, 2001, which is low by industry standards.
The Company's insurance subsidiaries operate in states that require
certain levels of regulatory capital and surplus and may restrict dividends to
their parent companies. The insurance regulator in the insurer's state of
domicile may disapprove any dividend which, together with other dividends paid
by an insurance company in the prior 12 months, exceeds the regulatory maximum,
computed as the lesser of 10% of statutory surplus or total statutory net gain
from operations as of the end of the preceding calendar year. Based upon the
results of operations and capital position of the Company's insurance
subsidiaries as of December 31, 2001, as filed with the insurance regulators,
dividends are limited to $7.0 million without prior regulatory approval until
September 2002, at which time the aggregate amount available without regulatory
approval is $15.0 million. In February 2002, a $5.0 million dividend was paid to
the parent Company by an insurance subsidiary.
The National Association of Insurance Commissioners has adopted
risk-based capital ("RBC") standards for life and health insurers designed to
evaluate the adequacy of statutory capital and surplus in relation to various
business risks faced by such insurers. The RBC formula is used by state
insurance regulators as an early warning tool to identify insurance companies
that potentially are inadequately capitalized. At December 31, 2001, each of the
Company's insurance subsidiaries had RBC ratios substantially above the levels
that would require Company or regulatory action.
During 2001, the Company purchased 367,000 shares of its outstanding
common stock at an aggregate purchase price of $2.2 million. In October 2001,
the Company reached its maximum authorized purchase threshold, bringing the
total purchased under the program to 2.7 million shares at an aggregate purchase
price of $18.0 million.
As described in Item 1, "Business - General," the Company has been in
discussions with Cobalt regarding Cobalt's desire to reduce its investment in
the Company. Cobalt's wholly owned subsidiary, BCBSUW owned 45.2% of the
outstanding common stock of the Company at February 28, 2002. The outcome of
these discussions could result in a limited share repurchase and secondary
offering of the Company's shares owned by BCBSUW.
The Company maintains a revolving bank line of credit agreement with a
maximum commitment of $35.2 million. At December 31, 2001, the outstanding
balance of advances under the credit agreement was $35.2 million. As collateral
for the outstanding balance, the Company is required to maintain a minimum cash
deposit of $2.5 million in an account at the lender's institution. The credit
agreement contains customary covenants which, among other matters, require the
Company to achieve certain minimum financial results and restrict the Company's
ability to incur additional debt, pay future cash dividends and dispose of
assets outside the ordinary course of business. The Company was in compliance
with all such covenants at December 31, 2001 and anticipates continued
compliance in the foreseeable future. The Company believes that the
implementation of FAS 142 will not adversely impact its compliance with debt
covenants.
21
The credit agreement was amended in January 2001 and April 2001 to
revise the minimum financial requirements of certain covenants. The April 2001
amendment also revised the Company's applicable interest rate on outstanding
loans and the schedule of mandatory future commitment reductions including a
$4.8 million maximum commitment reduction from $40.0 million to $35.2 million.
Annual principal amounts that mature related to the credit agreement
are $5.0 million in 2002, $10.0 million in 2003, $10.0 million in 2004 and $10.2
million in 2005. The Company anticipates using future cash flows from operations
and existing capital and surplus, if necessary, to fund these capital resource
needs.
The Company does not expect to pay any cash dividends in the
foreseeable future and intends to employ its earnings in the continued
development of its business. The Company's future dividend policy will depend on
its earnings, capital requirements, debt covenant restrictions, financial
condition and other factors considered relevant by the Board of Directors.
MARKET RISK EXPOSURE
The primary investment objective of the Company is to maximize
investment income while controlling risks and preserving principal. The Company
seeks to meet this investment objective through diversity of coupon rates,
liquidity, investment type, industry, issuer, duration and geographic location.
Investment grade debt securities made up 97% of the Company's total investment
portfolio at December 31, 2001. The below investment grade debt securities were
investment grade when purchased and subsequently downgraded. None of the below
investment grade securities were in default at December 31, 2001. The Company
uses outside investment managers who seek to maximize return on the portfolio
within the Company's investment guidelines. At December 31, 2001, $274.6 million
or 99.7% of the Company's total investment portfolio was invested in debt
securities.
The bond portfolio had an average quality rating of Aa2 and Aa3 at
December 31, 2001 and 2000, respectively, as measured by Moody's Investor
Service. Almost the entire portfolio was classified as available for sale. The
Company had no investment mortgage loans, nonpublicly traded securities (except
for principal only strips of U.S. government securities), real estate held for
investment or financial derivatives. The market value of the total investment
portfolio exceeded amortized cost by $2.9 million at December 31, 2001 as
compared with December 31, 2000 when the amortized cost of the total investment
portfolio exceeded market value by $6.1 million. Management believes that cash
flow from operations will be sufficient for its cash flow needs and that
liquidation of its investment portfolio will not be necessary.
The primary market risk affecting the Company is interest rate risk.
Assuming an immediate increase of 100 basis points in interest rates, the net
hypothetical decline in fair value of shareholders' equity is estimated to be
$5.6 million after-tax at December 31, 2001. This amount represents
approximately 2.4% of the Company's shareholders' equity.
At December 31, 2001, the fair value of the Company's borrowings under
the line of credit facility approximated the carrying value. Market risk was
estimated as the potential increase in the fair value resulting from a
hypothetical 1% decrease in the Company's weighted average short-term borrowing
rate at December 31, 2001, and was not materially different from the year-end
carrying value.
INFLATION
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.
22
CAUTIONARY FACTORS
This report and other documents or oral presentations prepared or
delivered by and on behalf of the Company contain or may contain
"forward-looking statements" within the meaning of the safe harbor provisions of
the United States Private Securities Litigation Reform Act of 1995.
Forward-looking statements are statements based upon management's expectations
at the time such statements are made and are subject to risks and uncertainties
that could cause the Company's actual results to differ materially from those
contemplated in the statements. Readers are cautioned not to place undue
reliance on the forward-looking statements. When used in written documents or
oral presentations, the terms "anticipate," "believe," "estimate," "expect,"
"forecast," "objective," "plan," "possible," "potential," "project" and similar
expressions are intended to identify forward-looking statements. In addition to
the assumptions and other factors referred to specifically in connection with
such statements, factors that could cause the Company's actual results to differ
materially from those contemplated in any forward-looking statements include,
among others, the following:
o Unexpected increases in health care costs resulting from the aging of the
population, advances in medical technology, increased utilization of
medical services and prescription drugs resulting from bioterrorism or
otherwise, possible epidemics and natural or man-made disasters and other
factors affecting the delivery and cost of health care that are beyond the
Company's control.
o The Company's ability to profitably distribute and sell its products,
including, changes in its business relationships with independent agents
who sell the Company's products, the Company's ability to retain key
producing sales agents, the Company's ability to expand its distribution
network, competitive factors such as the entrance of additional competitors
into the Company's markets, competitive pricing practices, the Company's
ability to generate new sales, sell new products and retain existing
customers, the Company's ability to predict future health care cost trends
and adequately price its products, and the Company's ability to control
expenses during a time of declining revenue and membership.
o Federal and state laws adopted in recent years, currently proposed (such as
the "Patients' Bill of Rights") or that may be proposed in the future,
which affect or may affect the Company's operations, products,
profitability or business prospects. Reform laws adopted in recent years
generally limit the ability of insurers and health plans to use risk
selection as a method of controlling costs for small group business.
o Regulatory factors, including delays in regulatory approvals of rate
increases and policy forms; regulatory action resulting from market conduct
activity and general administrative compliance with state and federal laws;
restrictions on the ability of the Company's subsidiaries to transfer funds
to the Company or its other subsidiaries in the form of cash dividends,
loans or advances without prior approval or notification; the granting and
revoking of licenses to transact business; the amount and type of
investments that the Company may hold; minimum reserve and surplus
requirements; and risk-based capital requirements.
o Factors related to the Company's efforts to deal with adverse medical loss
ratio in its small group health business (which included implementing
significant rate increases, terminating business in unprofitable markets,
and introducing redesigned products), including the willingness of
employers and individuals to accept rate increases, premium repricing and
redesigned products.
o The development of and changes in claims reserves.
o The effectiveness of the Company's strategy to expand sales of its MedOne
products for individuals and families, to focus its small group health
product sales in core markets and to grow its ancillary products, including
its life, dental and self-funded benefit administration business.
o The cost and other effects of legal and administrative proceedings,
including the expense of investigating, litigating and settling any claims
against the Company, and the general increase in litigation involving
managed care and medical insurers.
o Adverse outcomes of litigation in excess of provisions made by the Company.
23
o Restrictions imposed by financing arrangements that limit the Company's
ability to incur additional debt, pay future cash dividends and transfer
assets.
o 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.
o General economic conditions, including changes in employment, interest
rates and inflation that may impact the performance on the Company's
investment portfolio or decisions of individuals and employers to purchase
the Company's products.
o The Company's ability to maintain attractive preferred provider networks
for its insureds.
o Factors affecting the Company's ability to hire and retain key executive,
managerial, professional and technical employees.
o Changes in accounting principles and the effects related to such changes.
o Other business or investment considerations that may be disclosed from time
to time in the Company's Securities and Exchange Commission filings or in
other publicly disseminated written documents.
The Company undertakes no obligation to publicly update or revise any
forward-looking statements, whether as a result of new information, future
events or otherwise.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See Item 7, "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Market Risk Exposure" for information
concerning potential market risks related to the Company's investment portfolio.
24
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
Board of Directors and Shareholders
American Medical Security Group, Inc.
We have audited the accompanying consolidated balance sheets of
American Medical Security Group, Inc. and its subsidiaries, (the "Company") as
of December 31, 2001 and 2000, 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, 2001.
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.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
the Company as of December 31, 2001 and 2000, and the consolidated results of
its operations and its cash flows for each of the three years in the period
ended December 31, 2001, in conformity with accounting principles generally
accepted in the United States. Also, in our opinion, the related financial
statement schedules, when considered in relation to the basic financial
statements taken as a whole, present fairly in all material respects the
information set forth therein.
/s/Ernst & Young LLP
Milwaukee, Wisconsin
January 31, 2002
25
AMERICAN MEDICAL SECURITY GROUP, INC.
CONSOLIDATED BALANCE SHEETS
December 31,
2001 2000
----------------------------
(IN THOUSANDS)
ASSETS:
Investments:
Securities available for sale, at fair value:
Fixed maturities $ 269,753 $ 262,428
Equity securities - preferred 722 2,368
Fixed maturity securities held to maturity, at amortized cost 4,286 4,320
Trading securities, at fair value 517 260
----------------------------
Total investments 275,278 269,376
Cash and cash equivalents 24,975 15,606
Other assets:
Property and equipment, net 33,381 32,451
Goodwill and other intangibles, net 103,934 107,562
Other assets 35,447 46,928
----------------------------
Total other assets 172,762 186,941
----------------------------
Total assets $ 473,015 $ 471,923
============================
LIABILITIES AND SHAREHOLDERS' EQUITY:
Liabilities:
Medical and other benefits payable $ 135,504 $ 145,310
Advance premiums 16,737 17,568
Payables and accrued expenses 28,032 25,902
Notes payable 40,058 41,258
Other liabilities 23,284 20,708
----------------------------
Total liabilities 243,615 250,746
Redeemable preferred stock - Series A adjustable rate
Nonconvertible, $1,000 stated value, 25,000 shares authorized - -
Shareholders' equity:
Preferred stock (no par value, 475,000 shares authorized) - -
Common stock (no par value, $1 stated value, 50,000,000 shares authorized,
16,654,315 issued and 13,955,439 outstanding at December 31, 2001,
16,654,315 issued and 14,270,945 outstanding at December 31, 2000) 16,654 16,654
Paid-in capital 187,927 187,956
Retained earnings 40,470 36,295
Accumulated other comprehensive income (loss) (net of tax expense
of $1,024,000 in 2001 and tax benefit of $2,126,000 in 2000) 1,903 (3,948)
Treasury stock (2,698,876 shares at December 31, 2001
and 2,383,370 shares at December 31, 2000, at cost) (17,554) (15,780)
----------------------------
Total shareholders' equity 229,400 221,177
----------------------------
Total liabilities and shareholders' equity $ 473,015 $ 471,923
============================
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
26
AMERICAN MEDICAL SECURITY GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Year ended December 31,
2001 2000 1999
-------------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
REVENUES:
Insurance premiums $ 838,672 $ 951,071 $ 1,056,107
Net investment income 17,443 19,007 19,766
Net realized investment losses (779) (325) (854)
Other revenue 21,285 20,112 22,361
-------------------------------------------
Total revenues 876,621 989,865 1,097,380
EXPENSES:
Medical and other benefits 601,942 724,613 860,473
Selling, general and administrative 257,742 251,767 268,059
Interest 2,877 3,584 3,564
Amortization of goodwill and other intangibles 3,628 3,785 4,273
-------------------------------------------
Total expenses 866,189 983,749 1,136,369
-------------------------------------------
Income (loss) before income taxes 10,432 6,116 (38,989)
Income tax expense (benefit) 6,257 3,447 (13,043)
-------------------------------------------
Net income (loss) $ 4,175 $ 2,669 $ (25,946)
===========================================
Earnings (loss) per common share - basic $ 0.30 $ 0.18 $ (1.58)
===========================================
Earnings (loss) per common share - diluted $ 0.29 $ 0.18 $ (1.58)
===========================================
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
27
AMERICAN MEDICAL SECURITY GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended December 31,
2001 2000 1999
-------------------------------------------
(IN THOUSANDS)
OPERATING ACTIVITIES:
Net income (loss) $ 4,175 $ 2,669 $ (25,946)
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Depreciation and amortization 10,493 9,762 11,038
Net realized investment losses 779 325 854
Net change in trading securities (257) (260) -
Deferred income tax expense (benefit) 609 6,029 (7,112)
Changes in operating accounts:
Other assets 7,722 9,119 (12,945)
Medical and other benefits payable (9,806) (23,807) 55,984
Advance premiums (831) 291 (880)
Payables and accrued expenses 2,130 858 1,605
Other liabilities 2,576 (8,145) 3,830
-------------------------------------------
Net cash provided by (used in) operating activities 17,590 (3,159) 26,428
INVESTING ACTIVITIES:
Purchases of available for sale securities (143,148) (14,512) (190,834)
Proceeds from sale of available for sale securities 129,038 25,460 172,086
Proceeds from maturity of available for sale securities 15,417 4,045 20,805
Purchases of held to maturity securities - - (686)
Proceeds from maturity of held to maturity securities - 630 770
Purchases of property and equipment (6,546) (4,584) (2,976)
Proceeds from sale of property and equipment 21 13 1,049
-------------------------------------------
Net cash provided by (used in) investing activities (5,218) 11,052 214
FINANCING ACTIVITIES:
Issuance of common stock 413 4 5
Purchase of treasury stock (2,216) (8,292) (7,488)
Proceeds from notes payable borrowings - 39,158 5,000
Repayment of notes payable (1,200) (40,423) (17,541)
-------------------------------------------
Net cash used in financing activities (3,003) (9,553) (20,024)
-------------------------------------------
Cash and cash equivalents:
Net increase (decrease) during year 9,369 (1,660) 6,618
Balance at beginning of year 15,606 17,266 10,648
-------------------------------------------
Balance at end of year $ 24,975 $ 15,606 $ 17,266
===========================================
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
28
AMERICAN MEDICAL SECURITY GROUP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
AND COMPREHENSIVE INCOME (LOSS)
Accumulated
Common Stock Other
------------------------ Paid-In Retained Comprehensive Treasury
Shares Amount Capital Earnings Income (Loss) Stock Total
--------------------------------------------------------------------------------------
(IN THOUSANDS, EXCEPT SHARE DATA)
Balance at January 1, 1999 16,653,179 $ 16,653 $ 188,981 $ 59,572 $ 1,245 $ - $ 266,451
Comprehensive loss:
Net loss (25,946) (25,946)
Change in net unrealized gain (loss) on
securities, net of taxes of $6,304,000 (11,709) (11,709)
------------
Comprehensive loss (37,655)
------------
Issuance of common stock 467 1 4 5
Stock option forfeiture (1,033) (1,033)
Purchase of treasury stock
(1,121,500 shares, at cost) (7,488) (7,488)
--------------------------------------------------------------------------------------
Balance at December 31, 1999 16,653,646 16,654 187,952 33,626 (10,464) (7,488) 220,280
Comprehensive income:
Net income 2,669 2,669
Change in net unrealized gain (loss) on
securities, net of taxes of $3,508,000 6,516 6,516
------------
Comprehensive income 9,185
------------
Issuance of common stock 669 4 4
Purchase of treasury stock
(1,261,870 shares, at cost) (8,292) (8,292)
--------------------------------------------------------------------------------------
Balance at December 31, 2000 16,654,315 16,654 187,956 36,295 (3,948) (15,780) 221,177
Comprehensive income:
Net income 4,175 4,175
Change in net unrealized gain (loss) on
securities, net of taxes of $3,150,000 5,851 5,851
------------
Comprehensive income 10,026
------------
Issuance of common stock (29) 442 413
Purchase of treasury stock
(367,262 shares, at cost) (2,216) (2,216)
--------------------------------------------------------------------------------------
Balance at December 31, 2001 16,654,315 $ 16,654 $ 187,927 $ 40,470 $ 1,903 $ (17,554) $ 229,400
=========================================================================================
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
29
AMERICAN MEDICAL SECURITY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION
American Medical Security Group, Inc., together with its subsidiary
companies (the "Company"), is a provider of individual and small employer group
insurance products. The Company's principal product offering is health insurance
for small employer groups and health insurance for individuals and families
("MedOne"). The Company also offers life, dental, prescription drug, disability
and accidental death insurance, and provides self-funded benefit administration.
The Company's products are marketed in 32 states and the District of Columbia
through independent agents. Approximately 75 Company sales managers located in
sales offices throughout the United States support the independent agents. The
Company's products generally provide discounts to insureds that utilize
preferred provider organizations ("PPOs"). The Company owns a preferred provider
network and also contracts with other networks to ensure cost-effective health
care choices to its customers.
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of the
Company and all of its majority-owned subsidiaries. Significant intercompany
accounts and transactions have been eliminated. The accompanying consolidated
financial statements have been prepared in accordance with accounting principles
generally accepted in the United States ("GAAP"). The preparation of financial
statements in conformity with GAAP requires management to make estimates and
assumptions that affect the amounts reported in the consolidated financial
statements and accompanying notes. These estimates are based on knowledge of
current events and anticipated future events, and accordingly, actual results
may differ from those estimates.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include operating cash and short-term
investments with original maturities of three months or less. These amounts are
recorded at cost, which approximates market value.
INVESTMENTS
The Company's investments are classified in three categories.
Investments that the Company has the positive intent and ability to hold to
maturity are classified as held-to-maturity securities and are reported at
amortized cost. Assets which are invested for the purpose of supporting the
Company's nonqualified executive retirement plan are classified as trading
securities and reported at fair value, with unrealized gains and losses included
in earnings as net investment income. All other investments are classified as
available-for-sale securities and are reported at fair value based on quoted
market prices. Unrealized gains and losses on available-for-sale securities are
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 or write-down for
other-than-temporary impairments of available-for-sale debt and equity
securities are calculated using the specific identification method.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair values of investments are reported in Note 4. The fair values
of all other financial instruments approximate their December 31, 2001 and 2000
carrying values.
30
PROPERTY AND EQUIPMENT
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.
GOODWILL AND OTHER INTANGIBLES
Goodwill represents the excess of cost over the fair market value of
net assets acquired. Goodwill and other intangible assets are currently being
amortized on a straight-line basis over a period of 40 years or less.
Accumulated amortization was $20,089,000 and $16,461,000 at December 31, 2001
and 2000, respectively. The Company periodically evaluates whether events and
circumstances have occurred that may affect the estimated useful life or the
recoverability of the remaining balance of its intangibles. Based on accounting
standards in effect at December 31, 2001, the Company measures impairment of
goodwill and other intangibles using undiscounted cash flows, and on that basis,
believes that no impairment of goodwill or other intangible assets exists at
December 31, 2001. As discussed in more detail in Note 2, "Recent Accounting
Pronouncements," the Financial Accounting Standards Board issued new statements
during 2001, which will impact the Company's accounting for goodwill and other
intangibles in future periods.
POLICY ACQUISITION COSTS
Policy acquisition costs consist of commissions and other
administrative costs that the Company incurs to acquire new business. The
Company currently does not defer policy acquisition costs. Premium is collected
and billed and commissions and other administrative costs are incurred on a
month-to-month basis. Policy acquisition costs are expensed in the period
incurred.
REINSURANCE
Reinsurance premiums, commissions and expense reimbursements on
reinsured business are accounted for on a basis consistent with those used in
accounting for the original policies issued and the terms of the reinsurance
contracts. Premiums and benefits ceded to other companies have been reported as
a reduction of premium revenue and benefits. Reinsurance receivables and prepaid
reinsurance premium amounts are reported as assets.
The Company limits the maximum net loss that can arise from certain
lines of business by reinsuring (ceding) a portion of these risks with other
insurance organizations (reinsurers) on an excess of loss or quota share basis.
The Company's retention limit per covered life is $500,000 per policy year for
medical claims and $50,000 for life claims. The Company is liable on reinsurance
ceded in the event that the reinsurers do not meet their contractual
obligations.
A summary of reinsurance assumed and ceded is as follows:
Year ended December 31,
2001 2000 1999
-------------------------------------------
(IN THOUSANDS)
Reinsurance assumed:
Insurance premiums $ 1,515 $ 8,725 $ 58,924
Medical and other benefits 1,395 9,921 52,137
Reinsurance ceded:
Insurance premiums $ 2,532 $ 2,523 $ 4,916
Medical and other benefits 1,910 3,250 7,897
31
MEDICAL AND OTHER BENEFITS PAYABLE
The liabilities for medical and other benefits represent estimates of
the ultimate net cost of all reported and unreported claims that are unpaid at
year end. These estimates are developed using actuarial methods based upon
historical data for payment patterns, cost trends, product mix, seasonality,
utilization of health care services and other relevant factors. The estimates
are reviewed periodically and, as adjustments to the liabilities become
necessary, the adjustments are reflected in current operations. Management
believes that the amount of medical and other benefits payable is adequate to
cover the Company's liability for unpaid claims as of December 31, 2001.
PREMIUM DEFICIENCY RESERVES
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 used in the premium deficiency reserve analysis and records
or adjusts premium deficiency reserves as necessary.
During 1999, the Company established a premium deficiency reserve of
$19,200,000 for its highly regulated markets. Premium deficiency reserves are
included in medical and other benefits payable in the Company's consolidated
balance sheets. At December 31, 2000, the Company had a remaining recorded
premium deficiency reserve of $1,142,000, which was fully amortized during 2001
leaving no remaining recorded premium deficiency reserve at December 31, 2001.
INCOME TAXES
Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for financial
statement purposes and the amounts used for income tax purposes. A valuation
allowance is recognized when, based on available evidence, it is more likely
than not that the deferred tax asset may not be realized.
REVENUE RECOGNITION
Premiums for health and life policies are recognized ratably over the
period that insurance coverage is provided. Other revenue, including
administrative fee income from claim processing and other administrative
services, is recognized in the period the service is provided.
RELATED PARTIES
The Company has deferred compensation payable to employees of
$3,167,000 and $3,388,000 at December 31, 2001 and 2000, respectively.
COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) is defined as net income (loss) plus or
minus other comprehensive income (loss). For the Company, under existing
accounting standards, other comprehensive income (loss) 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).
32
EARNINGS (LOSS) PER COMMON SHARE
A reconciliation of the numerator and denominator of the basic and
diluted earnings (loss) per common share ("EPS") is as follows:
Year ended December 31,
2001 2000 1999
-------------------------------------------
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
Numerator:
Net income (loss) $ 4,175 $ 2,669 $ (25,946)
===========================================
Denominator:
Denominator for basic EPS - weighted average shares 14,048,545 14,898,652 16,470,096
Effect of dilutive securities - employee stock options 179,143 150,651 -
-------------------------------------------
Denominator for diluted EPS 14,227,688 15,049,303 16,470,096
===========================================
Earnings (loss) per common share:
Basic $ 0.30 $ 0.18 $ (1.58)
Diluted $ 0.29 $ 0.18 $ (1.58)
Options to purchase 3,243,767 and 3,460,130 shares of common stock were
outstanding at December 31, 2001 and 2000, respectively. Of those shares,
1,914,313 and 2,030,170 were excluded from the computation of diluted earnings
(loss) per common share for the respective years because the option's exercise
price was greater than the average market price of common shares and, therefore,
the effect would be antidilutive. There was no effect of dilutive securities for
1999 because employee stock options were antidilutive during that year.
2. RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board issued
Statements of Financial Accounting Standards No. 141, BUSINESS COMBINATIONS, and
No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS (the "Statements"), effective for
fiscal years beginning after December 15, 2001. The new rules will impact the
Company in two ways. First, goodwill and intangible assets deemed to have
indefinite lives will no longer be amortized. Other intangible assets will
continue to be amortized over their useful lives. Second, goodwill and
intangible assets with indefinite lives will be subject to an initial impairment
test in accordance with the Statements, and any remaining balance of goodwill
and intangible assets will be subject to future annual impairment testing.
The Company will apply the new rules on accounting for goodwill and
other intangible assets beginning in the first quarter of 2002. Application of
the nonamortization provisions of the Statements is expected to result in an
increase in net income of approximately $2,700,000 per year. The Company will
perform the first of the required impairment tests of goodwill and intangible
assets deemed to have indefinite lives in 2002, effective as of January 1, 2002,
by comparing the fair value of the Company's reporting units to their carrying
amounts (book value), including goodwill. In determining the fair value of the
Company's reporting units, management will consider valuation techniques such as
the quoted market price of the Company's stock, the present value of future cash
flows and market comparison of similar assets and liabilities.
At December 31, 2001, the Company's book value per share was $16.30 and
was significantly higher than the $12.45 quoted market price per share. The
Company has not yet determined what the effect of these tests will be on the
earnings and financial position of the Company. If management determines that
the quoted market price per share is the appropriate measure of the Company's
fair value, the resulting impairment would be greater than 50% of the amount of
goodwill and other intangibles on the Company's December 31, 2001 balance sheet.
If it is determined that an impairment exists as of January 1, 2002, the charge
would be reported as the cumulative effect of a change in accounting principle
in the Company's consolidated financial statements and would have no impact on
cash flows or the statutory-basis capital and surplus of the Company's insurance
subsidiaries.
33
3. MEDICAL AND OTHER BENEFITS PAYABLE
Activity related to liabilities for unpaid claims included in medical
and other benefits payable is summarized as follows:
December 31,
2001 2000 1999
-------------------------------------------
(IN THOUSANDS)
Balance at January 1 $ 134,690 $ 141,177 $ 101,700
Less reinsurance recoverables 476 992 1,058
-------------------------------------------
Net balance at January 1 134,214 140,185 100,642
Incurred related to:
Current year 612,491 720,897 792,105
Prior years (12,026) (3,397) 10,398
-------------------------------------------
Total incurred 600,465 717,500 802,503
Paid related to:
Current year 487,400 587,828 651,941
Prior years 120,300 135,643 111,019
-------------------------------------------
Total paid 607,700 723,471 762,960
-------------------------------------------
Net balance at December 31 126,979 134,214 140,185
Plus reinsurance recoverables 1,351 476 992
-------------------------------------------
Balance at December 31 $ 128,330 $ 134,690 $ 141,177
===========================================
The incurred amounts related to prior years represent the differences
between the Company's estimated medical and other benefits payable for prior
years' claims and the actual amounts required to satisfy such claims. Actual
amounts differ from previously recorded liabilities due to inherent
variabilities associated with estimating health insurance benefits payable. The
liabilities for unpaid claims at December 31, 2000 and 1999 developed redundant
in subsequent years by $12,026,000 and $3,397,000, respectively. The developed
redundancy on the liability as of December 31, 2000 was due to an improvement in
the Company's average medical claims cost per member in late 2000. The liability
for unpaid claims at December 31, 1998, developed deficient by $10,398,000 in
the subsequent year as a result of an increase in medical claims trends that was
higher than anticipated in late 1998. No additional premiums are collected or
returned as a result of incurred claims from prior years.
In determining the liability for unpaid claims at December 31, 2001,
management considered the potential impact of the September 11, 2001 events.
Although the events of September 11, 2001 did not have a direct material effect
on the Company, management anticipates an indirect impact including, but not
limited to, increased utilization by the general population of mental health
services for stress, anxiety, depression and similar conditions in the fourth
quarter. Also, subsequent bio-terrorism threats and attacks may result in
increased utilization of health care services including office visits,
laboratory tests and prescription drugs for flu-like symptoms in the fourth
quarter. While the impact of these claims cannot be predicted with certainty,
management believes adequate provision has been made for such claims as of
December 31, 2001. Accordingly, the outcome of these matters is not expected to
have a material adverse effect on the financial position of the Company.
34
4. INVESTMENTS
Net investment income and net realized investment losses include the
following:
Year ended December 31,
2001 2000 1999
-------------------------------------------
(IN THOUSANDS)
Net investment income:
Interest on fixed maturities $ 15,728 $ 17,867 $ 18,731
Dividends on equity securities 148 148 134
Unrealized loss on trading securities (34) (21) -
Interest on cash equivalents and other investment income 2,223 1,629 1,581
Investment expenses (622) (616) (680)
-------------------------------------------
Net investment income $ 17,443 $ 19,007 $ 19,766
===========================================
Net realized investment losses:
Realized investment losses $ (2,323) $ (436) $ (2,205)
Realized investment gains 1,544 111 1,351
-------------------------------------------
Net realized investment losses $ (779) $ (325) $ (854)
===========================================
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 change in
unrealized gains (losses), which is included in accumulated other comprehensive
income (loss), is as follows:
Year ended December 31,
2001 2000 1999
-------------------------------------------
(IN THOUSANDS)
Fixed maturities $ 8,847 $ 9,854 $ (17,753)
Equity securities 154 170 (260)
-------------------------------------------
Net change in unrealized gains (losses) $ 9,001 $ 10,024 $ (18,013)
===========================================
Changes in accumulated other comprehensive income (loss) related to
changes in unrealized gains and losses on securities are as follows:
Year ended December 31,
2001 2000 1999
-------------------------------------------
(IN THOUSANDS)
Change in net unrealized gain (loss) on securities, net of taxes $ 6,357 $ 6,727 $ (12,264)
Less: reclassification adjustment for losses included in net
income (loss), net of tax benefit of $273,000, $114,000
and $299,000 in 2001, 2000 and 1999 respectively (506) (211) (555)
-------------------------------------------
Change in net unrealized gain (loss) on securities, net of taxes $ 5,851 $ 6,516 $ (11,709)
===========================================
35
The amortized cost and estimated fair values of investments are as
follows:
Gross Gross
Amortized Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
---------------------------------------------------------
(IN THOUSANDS)
AT DECEMBER 31, 2001:
Available for sale:
Fixed maturities:
U.S. Treasury securities $ 47,869 $ 283 $ (1) $ 48,151
Corporate debt securities 115,263 2,447 (1,068) 116,642
Foreign government securities 12,391 442 (2) 12,831
Government agency mortgage-backed securities 77,966 691 (101) 78,556
Municipal securities 13,351 223 (1) 13,573
---------------------------------------------------------
266,840 4,086 (1,173) 269,753
Equity securities - preferred 708 14 - 722
Held to maturity:
U.S. Treasury securities 4,286 73 - 4,359
---------------------------------------------------------
$ 271,834 $ 4,173 $ (1,173) $ 274,834
=========================================================
Gross Gross
Amortized Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
---------------------------------------------------------
(IN THOUSANDS)
AT DECEMBER 31, 2000:
Available for sale:
Fixed maturities:
U.S. Treasury securities $ 51,657 $ 160 $ (340) $ 51,477
Corporate debt securities 145,817 213 (5,142) 140,888
Foreign government securities 15,614 82 (356) 15,340
Government agency mortgage-backed securities 37,718 45 (513) 37,250
Municipal securities 17,556 6 (89) 17,473
---------------------------------------------------------
268,362 506 (6,440) 262,428
Equity securities - preferred 2,508 - (140) 2,368
Held to maturity:
U.S. Treasury securities 4,320 10 (16) 4,314
---------------------------------------------------------
$ 275,190 $ 516 $ (6,596) $ 269,110
=========================================================
36
The amortized cost and estimated fair values of debt securities at
December 31, 2001 by contractual maturity are shown below. Expected maturities
will differ from contractual maturities because borrowers may have the right to
call or prepay obligations.
Available-for-Sale Held-to-Maturity
Amortized Estimated Amortized Estimated
Cost Fair Value Cost Fair Value
---------------------------------------------------------
(IN THOUSANDS)
Due in one year or less $ 9,370 $ 9,515 $ 2,228 $ 2,244
Due after one through five years 99,796 101,646 755 775
Due after five through ten years 56,392 56,559 1,303 1,340
Due after ten years 23,316 23,477 - -
---------------------------------------------------------
188,874 191,197 4,286 4,359
Government agency mortgage-backed securities 77,966 78,556 - -
---------------------------------------------------------
$ 266,840 $ 269,753 $ 4,286 $ 4,359
=========================================================
At December 31, 2001, the insurance subsidiaries had fixed securities
and cash equivalents on deposit with various state insurance departments with
carrying values of approximately $4,500,000.
5. PROPERTY AND EQUIPMENT
Property and equipment are stated at cost and are summarized as
follows:
December 31,
2001 2000
---------------------------
(IN THOUSANDS)
Land and land improvements $ 3,893 $ 3,890
Building and building improvements 24,315 24,301
Computer equipment and software 18,121 13,024
Furniture and other equipment 13,559 13,495
---------------------------
59,888 54,710
Less accumulated depreciation (26,507) (22,259)
----------------------------
$ 33,381 $ 32,451
============================
The Company recognized depreciation expense on property and equipment
of $5,555,000, $4,656,000 and $4,544,000 in 2001, 2000 and 1999, respectively.
37
6. DEBT
Notes payable consists of the following:
December 31,
2001 2000
---------------------------
(IN THOUSANDS)
Line of credit, commercial banks, adjusted periodically,
interest payments due quarterly through February 2005 $ 35,158 $ 35,158
Mortgage payable, commercial bank, 9.05% interest, monthly
principal payments of $100,000 plus interest through January 1, 2004 4,900 6,100
---------------------------
$ 40,058 $ 41,258
===========================
The Company maintains a revolving bank line of credit agreement with a
maximum commitment of $35,158,000. At December 31, 2001, the outstanding balance
of advances under the credit agreement was $35,158,000. Interest is charged on
the outstanding balance based upon an indexed floating rate of interest. As
collateral for the outstanding balance, the Company is required to maintain a
minimum cash deposit of $2,500,000 in an account at the lender's institution.
The credit agreement contains customary covenants which, among other matters,
require the Company to achieve certain minimum financial results and restrict
the Company's ability to incur additional debt, pay future cash dividends and
dispose of assets outside the ordinary course of business. The Company was in
compliance with all such covenants at December 31, 2001.
The credit agreement was amended in January 2001 and April 2001 to
revise the minimum financial requirements of certain covenants. The April 2001
amendment also revised the Company's applicable interest rate on outstanding
loans and the schedule of mandatory future commitment reductions including a
$4,842,000 maximum commitment reduction from $40,000,000 to $35,158,000.
Future annual principal amounts due for all of the Company's debt,
including the credit agreement, as of December 31, 2001 are $6,200,000 for 2002,
$11,200,000 for 2003, $12,500,000 for 2004, and $10,158,000 for 2005. During
2001, 2000 and 1999, interest paid totaled $2,931,000, $4,005,000 and
$3,547,000, respectively.
The mortgage payable is collateralized by the Company's home office
property located in Green Bay, Wisconsin. The Company believes the carrying
value of all notes payable approximates fair value.
38
7. INCOME TAXES
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 had a net current federal income tax payable of $4,012,000
and a net current federal income tax receivable of $2,094,000 at December 31,
2001 and 2000, respectively. The Company and its subsidiaries had state net
business loss carryforwards totaling $92,327,000 at December 31, 2001, which
will begin to expire in the year 2008. The Company received net federal and
state income tax refunds of $466,000 and $6,910,000 in 2001 and 2000,
respectively and paid net federal and state income taxes of $1,496,000 in 1999.
The components of income tax expense (benefit) are as follows:
Year ended December 31,
2001 2000 1999
-------------------------------------------
(IN THOUSANDS)
Current:
Federal $ 5,410 $ (3,077) $ (5,965)
State 238 495 34
-------------------------------------------
5,648 (2,582) (5,931)
Deferred:
Federal 313 5,673 (6,244)
State 296 356 (868)
-------------------------------------------
609 6,029 (7,112)
-------------------------------------------
Income tax expense (benefit) $ 6,257 $ 3,447 $ (13,043)
===========================================
The differences between taxes computed at the federal statutory rate
and recorded income taxes are as follows:
Year ended December 31,
2001 2000 1999
-------------------------------------------
(IN THOUSANDS)
Income tax expense (benefit) at federal statutory rate $ 3,651 $ 2,141 $ (13,658)
Goodwill amortization 829 829 879
State income and franchise taxes, net of federal benefit 571 415 (565)
Other, net 1,206 62 301
-------------------------------------------
Income tax expense (benefit) $ 6,257 $ 3,447 $ (13,043)
===========================================
39
Significant components of the Company's federal and state deferred tax
liabilities and assets are as follows:
December 31, 2001 December 31, 2000
Federal State Federal State
---------------------------------------------------------
(IN THOUSANDS)
Deferred tax assets:
Insurance liabilities $ 1,231 $ 63 $ 2,031 $ 137
Unearned income 782 56 1,348 82
Unrealized losses on investments - - 2,126 -
Employee compensation and benefits 2,561 440 2,977 538
Accrued expenses 4,289 611 2,087 371
Specified policy acquisition costs 765 39 874 45
Net business loss carryforwards 1,082 6,384 1,082 6,176
Other deductible temporary differences 2,428 586 2,584 492
---------------------------------------------------------
13,138 8,179 15,109 7,841
Valuation allowances (1,963) (3,431) (1,082) (2,779)
---------------------------------------------------------
11,175 4,748 14,027 5,062
Deferred tax liabilities:
Intangibles 6,457 1,459 6,790 1,533
Prepaid assets 1,145 115 1,346 151
Depreciation and amortization 1,889 361 1,462 278
Unrealized gain on investments 1,024 - - -
Other taxable temporary differences 1,815 11 2,112 26
---------------------------------------------------------
12,330 1,946 11,710 1,988
---------------------------------------------------------
Net deferred tax assets (liabilities) $ (1,155) $ 2,802 $ 2,317 $ 3,074
=========================================================
The federal deferred benefit arising from the deductibility of state
deferred tax is included as a component of other federal deferred taxes. The net
deferred taxes are included in other assets in the accompanying consolidated
balance sheets.
8. COMMITMENTS AND CONTINGENCIES
On August 26, 1999, a $6,900,000 verdict was entered against the
Company in a lawsuit involving allegations regarding the Company's
administration of a self-funded benefit plan for Skilstaf, Inc., an employee
leasing company. The Company appealed the verdict and expected the verdict to be
reversed or substantially reduced following appeal. Based upon management's
evaluation of the merits of the appeal, the facts of the case and consultation
with outside legal counsel, management concluded that the likelihood of the
appellate court affirming the verdict was not probable. As a result, the
Company's accrual related to this case at the end of 1999 and 2000 was not
material. Following an adverse decision from the Court of Appeals on March 12,
2001, the Company recognized an additional accrual during the first quarter of
2001 representing the full potential loss including punitive damages and other
expenses. In July 2001, at the direction of the district court, the Company paid
the full amount of the verdict plus interest and the case is closed.
40
On February 7, 2000, a $5,400,000 verdict was entered against the
Company in a lawsuit filed by Health Administrators, Inc., an insurance agency
owned and operated by a former agent of the Company, which alleged breach of
contract involving commission amounts due to such agent. The Company appealed
the verdict and on March 29, 2001, the Ohio Court of Appeals affirmed a portion
of the verdict, with modifications, representing approximately $3,000,000 in
damages. The affirmed portion of the verdict was paid by the Company during 2001
and is considered closed. The appeals court reversed and remanded the remaining
issue in the case representing approximately $2,400,000 in damages. Briefs have
been submitted for the remanded portion of the case and the parties are awaiting
the trial court's decision.
In February 2000, a complaint was filed against the Company in the
Circuit Court for Palm Beach County, Florida, seeking certification of a
statewide class action on behalf of certain individuals insured by or formerly
insured by the Company. Plaintiffs allege the Company did not follow Florida law
when it discontinued writing certain health insurance policies and offered new
policies in 1998. Plaintiffs claim the Company wrongfully terminated policies,
improperly notified insureds of conversion rights and charged improper premium
for the new policies. Plaintiffs also assert that the Company's renewal rating
methodology violates Florida law. Plaintiffs are seeking unspecified damages. A
motion for class certification was granted by the Circuit Court and appealed to
the Fourth District Court of Appeals of the State of Florida, which upheld the
class certification in October 2001. The Company has an appeal pending with the
Florida Supreme Court with the ultimate objective of seeking to vacate the
finding of a certifiable class. The Company and plaintiffs filed cross motions
for summary judgment in Circuit Court that were heard and denied in February
2002. A memorandum filed by plaintiffs in January 2002 in support of their
motion for summary judgment raised new arguments that expanded the legal theory,
scope and potential damages of the case. The trial is tentatively scheduled to
commence as a bench trial in March 2002. Management believes the Company acted
in compliance with applicable Florida law with regard to the termination of and
conversion of insurance policies and with regard to its renewal rating
practices. Although the outcome of the case cannot be predicted with certainty,
management believes this suit is without merit and is defending its position
vigorously.
The Company is involved in various legal and regulatory actions
occurring in the normal course of business. Based on current information
including consultation with outside counsel, management believes any ultimate
liability that may arise from the above-mentioned and all other legal and
regulatory actions would not materially affect the Company's consolidated
financial position, results of operations or cash flow. However, management's
evaluation of the likely impact of these actions could change in the future and
an unfavorable outcome could have a material effect on the Company's
consolidated financial position, results of operations or cash flow of a future
period.
9. SHAREHOLDERS' EQUITY
STATUTORY FINANCIAL INFORMATION
State insurance laws and regulations prescribe accounting practices for
determining statutory net income and equity for insurance companies. 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 capital and surplus of
the Company's insurance subsidiaries, United Wisconsin Life Insurance Company
and American Medical Security Insurance Company of Georgia, at December 31, 2001
and 2000, was $161,789,000 and $153,912,000, respectively. The combined
statutory net income of the Company's insurance subsidiaries was $18,052,000 and
$7,808,000 for the years ended December 31, 2001 and 2000, respectively, and the
combined statutory net loss was $20,782,000 for the year ended December 31,
1999.
State insurance regulations also require the maintenance of a minimum
compulsory surplus based on a percentage of premiums written. At December 31,
2001, the Company's insurance subsidiaries were in compliance with these
compulsory regulatory requirements.
41
Effective January 1, 2001, the National Association of Insurance
Commissioners revised the Accounting Practices and Procedures Manual in a
process referred to as Codification. Codification has changed certain prescribed
statutory accounting practices resulting in changes to the accounting practices
that the insurance subsidiaries of the Company use to prepare their
statutory-basis financial statements. The impact of Codification to the
Company's insurance subsidiaries' statutory-basis capital and surplus was not
material.
RESTRICTIONS ON DIVIDENDS FROM SUBSIDIARIES
Dividends paid by the insurance subsidiaries to the parent Company are
limited by state insurance regulations. The insurance regulator in the insurer's
state of domicile may disapprove any dividend which, together with other
dividends paid by an insurance company in the prior 12 months, exceeds the
regulatory maximum, computed as the lesser of 10% of statutory surplus or total
statutory net gain from operations as of the end of the preceding calendar year.
Based upon the financial statements of the Company's insurance subsidiaries as
of December 31, 2001, as filed with the insurance regulators, dividends are
limited to $6,963,000 without prior regulatory approval until September 2002, at
which time the aggregate amount available without regulatory approval is
$14,963,000. In February 2002, a $5,000,000 dividend was paid to the parent
Company by an insurance subsidiary.
SHAREHOLDERS' RIGHTS AGREEMENT
In August 2001, the Board of Directors of the Company adopted a
shareholders' rights agreement (the "rights agreement") and declared a dividend
of one preferred share purchase right for each outstanding share of common stock
of the Company. When exercisable, each right entitles the registered holder to
purchase from the Company a unit consisting of one ten-thousandth of a share of
Series B Junior Cumulative Preferred Stock of the Company at a price of $30.00.
The rights agreement, as amended, is designed to deter takeover initiatives not
considered to be in the best interests of the Company's shareholders. In the
event that a person or a group has become the beneficial owner of 12% or more of
the common shares then outstanding, in certain circumstances the rights become
exercisable, and each holder of a right will have the right to receive, upon
exercise, common shares having a value equal to two times the exercise price of
the right. The rights are redeemable by action of the Company's Board of
Directors at any time prior to their becoming exercisable. The rights expire on
August 20, 2011.
10. EMPLOYEE BENEFIT PLANS
RETIREMENT SAVINGS PLAN
The Company's employees are included in a qualified defined
contribution plan (the "Retirement Savings Plan") with profit sharing and
discretionary savings provisions covering all eligible salaried and hourly
employees. Participant contributions up to 6% of the participant's compensation
are matched 60% by the Company. Effective January 1, 2002, participant
contributions up to 6% of the participant's compensation are matched 70% by the
Company. Profit sharing contributions to the Retirement Savings Plan are
determined annually by the Company. Participants vest in Company contributions
in three years. The Company recognized expense associated with the Retirement
Savings Plan of $1,881,000, $1,944,000 and $1,610,000 in 2001, 2000 and 1999,
respectively.
NONQUALIFIED EXECUTIVE RETIREMENT PLAN
During 2000, the Company adopted a nonqualified executive retirement
plan (the "Nonqualified Plan") to provide key management with the opportunity to
accumulate deferred compensation which cannot be accumulated under the
Retirement Savings Plan due to compensation limitations imposed by the Internal
Revenue Service. The Nonqualified Plan is funded through a rabbi trust and has
contribution and investment options similar to those of the Retirement Savings
Plan. The Company recognized expense associated with the Nonqualified Plan of
$53,000 and $77,000 during 2001 and 2000, respectively.
42
STOCK BASED COMPENSATION PLANS
The Company has a stock-based compensation plan, the Equity Incentive
Plan (the "Plan"), for the benefit of eligible employees and directors of the
Company. The Plan permits the grant of nonqualified stock options ("NQSO"),
incentive stock options, stock appreciation rights, restricted stock awards and
performance awards. Persons eligible to participate in the Plan include all
full-time active employees and outside directors of the board of directors. The
Plan allows for the granting of up to 4,000,000 shares of which 472,297 shares
are available for grant as of December 31, 2001. The Company's 1995 Director
Stock Option Plan also permits the grant of NQSOs. The plan allows for the
granting of up to 75,000 shares of which 14,000 shares are available for grant,
as of December 31, 2001.
The terms of incentive stock options and nonqualified stock options
granted under the Plan cannot exceed more than 10 and 12 years, respectively,
and the option exercise price generally cannot be less than the fair market
value of the Company's common stock on the date of grant. Incentive stock
options and NQSOs are not exercisable in any event prior to six months following
the grant date.
Stock appreciation rights generally have a grant price at least equal
to 100% of the fair market value of the Company's common stock. The term of the
stock appreciation rights cannot exceed 12 years. Stock appreciation rights are
not exercisable prior to six months following the grant date.
Restricted stock generally may not be sold or otherwise transferred for
certain periods based on the passage of time, the achievement of performance
goals or the occurrence of other events. However, participants may exercise full
voting rights and are entitled to receive all dividends and other distributions
with respect to restricted stock. Restricted stock does not vest prior to six
months following the date of grant.
During 1998, the Company and a key executive entered into a deferred
stock agreement. Under the agreement the Company has an obligation to issue
73,506 shares of the Company's common stock provided the executive remains
continuously employed with the Company through November 17, 2002. The Company
incurred expense of $225,000 in each of the three years ended 2001, 2000 and
1999 related to this agreement.
On July 9, 2001, the Company and a key executive entered into a
restricted stock agreement. Under the agreement, the Company granted the
executive 25,000 shares of common stock, subject to certain rights and
restrictions, in exchange for the surrender for cancellation of 443,857 shares
of the executive's nonqualified stock options. The 25,000 shares of restricted
stock vested in December 2001 upon the occurrence of certain triggering events,
as specified under the restricted stock agreement. The Company incurred expense
of $139,000 during 2001 related to this agreement.
Effective January 1, 2000, the Company adopted a deferred compensation
plan for the benefit of certain outside directors of the Company who wish to
defer the receipt of eligible compensation which they may otherwise be entitled
to receive from the Company. Directors who choose to participate in the plan may
elect to have their deferred compensation credited to, in whole or in part,
either an interest account or a Company stock unit account.
43
Stock option activity for all plans is as follows:
December 31,
2001 2000 1999
----------------------------------------------------
TOTAL NUMBER OF NQSOS
Outstanding at beginning of year 3,460,130 2,809,143 2,918,893
Granted 426,000 715,000 999,000
Exercised (26,756) - -
Forfeited (615,607) (64,013) (1,108,750)
----------------------------------------------------
Outstanding at end of year 3,243,767 3,460,130 2,809,143
====================================================
Exercisable at end of year 1,826,017 1,807,963 1,504,976
Available for grant at end of year 486,297 296,690 947,677
WEIGHTED AVERAGE EXERCISE PRICE OF NQSOS
Outstanding at beginning of year $9.86 $11.10 $15.18
Granted - Exercise price equals market price on grant date 9.97 5.28 7.33
Granted - Exercise price is less than market price on grant date - - -
Granted - Exercise price exceeds market price on grant date - - -
Exercised 5.15 - -
Forfeited 14.09 13.14 18.45
Outstanding at end of year 9.11 9.86 11.10
Exercisable at end of year 10.33 12.60 13.68
NQSOS BY EXERCISE PRICE RANGE
Range of exercise prices $ 3.01 - $8.88 $ 3.01 - $8.88 $ 3.01 - $8.88
Weighted average exercise price $5.75 $5.71 $6.07
Weighted average remaining contractual life (years) 10.08 11.03 11.34
Exercisable at end of year 605,954 260,877 47,960
Outstanding at end of year 1,471,454 1,571,960 856,960
Weighted average exercise price of options exercisable at end of year $5.77 $5.64 $3.01
Range of exercise prices $10.20 - $14.38 $10.25 - $14.38 $10.25 - $14.38
Weighted average exercise price $11.07 $11.54 $11.53
Weighted average remaining contractual life (years) 8.78 8.75 9.79
Exercisable at end of year 964,984 848,151 734,848
Outstanding at end of year 1,517,234 1,189,234 1,230,015
Weighted average exercise price of options exercisable at end of year $11.48 $11.66 $11.76
Range of exercise prices $15.76 - $22.74 $15.76 - $22.74 $15.76 - $22.74
Weighted average exercise price $16.83 $16.33 $16.33
Weighted average remaining contractual life (years) 6.45 7.48 8.50
Exercisable at end of year 255,079 698,936 722,168
Outstanding at end of year 255,079 698,936 722,168
Weighted average exercise price of options exercisable at end of year $16.83 $16.33 $16.33
44
The Black-Scholes option valuation model is commonly used in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions including the expected stock price volatility.
Since the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimates, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
The Company follows Accounting Principles Board Opinion No. 25 under
which no compensation expense is recorded when the exercise price of the
Company's employee stock options equals the market price of the underlying stock
on the date of grant. The Company's pro forma information regarding net income
and net income per share has been determined as if these options had been
accounted for since January 1, 1995, in accordance with the fair value method of
Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for
Stock-Based Compensation".
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:
Year ended December 31,
2001 2000 1999
-------------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net income (loss) $ 4,175 $ 2,669 $ (25,946)
Compensation expense in accordance with SFAS No. 123 (1,119) (933) (483)
-------------------------------------------
Pro forma net income (loss) $ 3,056 $ 1,736 $ (26,429)
===========================================
Earnings (loss) per common share:
Basic $ 0.30 $ 0.18 $ (1.58)
Diluted $ 0.29 $ 0.18 $ (1.58)
Pro forma earnings (loss) per common share:
Basic $ 0.22 $ 0.12 $ (1.60)
Diluted $ 0.21 $ 0.12 $ (1.60)
The pro forma disclosures only include the effect of options granted
subsequent to January 1, 1995. Accordingly, the effects of applying the SFAS No.
123 pro forma disclosures to future periods may not be indicative of future
effects.
In determining compensation expense in accordance with 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:
Year ended December 31,
2001 2000 1999
-------------------------------------------
Expected life of options 6.00 years 6.00 years 6.00 years
Risk-free interest rate 4.67% 5.73% 6.13%
Expected dividend yield 0.00% 0.00% 0.00%
Expected volatility factor 53% 56% 45%
Grant date fair value of options:
Exercise price equals market price $ 5.51 $ 3.09 $ 3.84
Exercise price is less than market price $ - $ - $ -
Exercise price exceeds market price $ - $ - $ -
45
11. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Selected quarterly financial data for the years ended December 31, 2001
and 2000 are as follows:
Quarter
-----------------------------------------------------------------------
First Second Third Fourth Total
-----------------------------------------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
2001
Total revenues $ 232,258 $ 223,306 $ 213,388 $ 207,669 $ 876,621
Net income (loss) (5,140) 1,466 3,504 4,345 4,175
Earnings (loss) per common share:
Basic (0.36) 0.10 0.25 0.31 0.30
Diluted (0.36) 0.10 0.25 0.30 0.29
2000
Total revenues $ 257,677 $ 250,326 $ 241,756 $ 240,106 $ 989,865
Net income (loss) 1,659 2,260 (1,376) 126 2,669
Earnings (loss) per common share:
Basic 0.11 0.15 (0.09) 0.01 0.18
Diluted 0.11 0.15 (0.09) 0.01 0.18
12. SEGMENTS OF THE BUSINESS
The Company has two reportable segments: 1) health insurance products;
and 2) life insurance products. The Company's health insurance products consist
of the following coverages related to small group PPO products: MedOne and small
group medical, self-funded medical, dental and short-term disability. Life
products consist primarily of group term life insurance. The "All Other"
category includes operations not directly related to the business segments and
unallocated corporate items (i.e., corporate investment income, interest expense
on corporate debt, amortization of goodwill and intangibles and unallocated
overhead expenses). The reportable segments are managed separately because they
differ in the nature of the products offered and in profit margins.
The Company evaluates segment performance based on income or loss
before income taxes, excluding gains and losses on the Company's investment
portfolio. The accounting policies of the reportable segments are the same as
those described in the summary of significant accounting policies. Significant
intercompany transactions have been eliminated prior to reporting reportable
segment information.
46
Selected financial data for the Company by segment is as follows:
YEAR ENDED DECEMBER 31, 2001: Health Life Total
Insurance Insurance All Other Consolidated
---------------------------------------------------------
(IN THOUSANDS)
REVENUES:
Insurance premiums $ 820,658 $ 17,424 $ 590 $ 838,672
Net investment income 9,197 656 7,590 17,443
Net realized investment losses - - (779) (779)
Other revenue 17,272 154 3,859 21,285
---------------------------------------------------------
Total revenues 847,127 18,234 11,260 876,621
EXPENSES:
Medical and other benefits 595,811 6,334 (203) 601,942
Selling, general and administrative 244,453 5,446 7,843 257,742
Interest - - 2,877 2,877
Amortization of goodwill and other intangibles - - 3,628 3,628
---------------------------------------------------------
Total expenses 840,264 11,780 14,145 866,189
---------------------------------------------------------
Income (loss) before income taxes (a) $ 6,863 $ 6,454 $ (2,885) $ 10,432
=========================================================
As of December 31, 2001:
Segment assets $ 147,889 $ 3,958 $ 321,168 $ 473,015
=========================================================
(a) Excluding the first quarter 2001 litigation charge, pre-tax income for the
health segment would have been $15,863,000 and consolidated pre-tax income
would have been $19,432,000.
YEAR ENDED DECEMBER 31, 2000: Health Life Total
Insurance Insurance All Other Consolidated
---------------------------------------------------------
(IN THOUSANDS)
REVENUES:
Insurance premiums $ 907,722 $ 22,578 $ 20,771 $ 951,071
Net investment income 9,513 638 8,856 19,007
Net realized investment losses - - (325) (325)
Other revenue 16,115 217 3,780 20,112
---------------------------------------------------------
Total revenues 933,350 23,433 33,082 989,865
EXPENSES:
Medical and other benefits 700,511 7,781 16,321 724,613
Selling, general and administrative 235,649 6,581 9,537 251,767
Interest - - 3,584 3,584
Amortization of goodwill and other intangibles - - 3,785 3,785
---------------------------------------------------------
Total expenses 936,160 14,362 33,227 983,749
---------------------------------------------------------
Income (loss) before income taxes $ (2,810) $ 9,071 $ (145) $ 6,116
=========================================================
As of December 31, 2000:
Segment assets $ 180,683 $ 4,292 $ 286,948 $ 471,923
=========================================================
47
YEAR ENDED DECEMBER 31, 1999: Health Life Total
Insurance Insurance All Other Consolidated
---------------------------------------------------------
(IN THOUSANDS)
REVENUES:
Insurance premiums $ 985,322 $ 26,183 $ 44,602 $1,056,107
Net investment income 9,254 202 10,310 19,766
Net realized investment losses - - (854) (854)
Other revenue 17,857 258 4,246 22,361
---------------------------------------------------------
Total revenues 1,012,433 26,643 58,304 1,097,380
EXPENSES:
Medical and other benefits 805,768 10,270 44,435 860,473
Selling, general and administrative 245,676 7,640 14,743 268,059
Interest - - 3,564 3,564
Amortization of goodwill and other intangibles - - 4,273 4,273
---------------------------------------------------------
Total expenses 1,051,444 17,910 67,015 1,136,369
---------------------------------------------------------
Income (loss) before income taxes (a) $ (39,011) $ 8,733 $ (8,711) $ (38,989)
=========================================================
As of December 31, 1999:
Segment assets $ 186,611 $ 4,229 $ 312,254 $ 503,094
=========================================================
(a) Excluding the third quarter 1999 premium deficiency charge, pre-tax loss
for the health segment would have been $23,926,000 and consolidated pre-tax
loss would have been $17,904,000.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
None.
48
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information required by this item with respect to directors and
executive officers is incorporated herein by reference to the information
included under the headings "Election of Directors" and "Section 16(a)
Beneficial Ownership Reporting Compliance" in the Company's definitive Proxy
Statement, expected to be dated April 8, 2002, relating to the 2002 Annual
Meeting of Shareholders currently scheduled for May 23, 2002 (the "2002 Proxy
Statement") and the information under the heading "Executive Officers of the
Registrant" in Part I of this report. The 2002 Proxy Statement will be filed
with the Securities and Exchange Commission not later than 120 days after the
end of the Company's fiscal year.
ITEM 11. EXECUTIVE COMPENSATION
Information required by this item is included under the headings
"Executive Compensation" and "Election of Directors -- Compensation of
Directors" in the 2002 Proxy Statement, which section is hereby incorporated by
reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information required by this item is included under the heading
"Security Ownership of Certain Beneficial Owners and Management" in the 2002
Proxy Statement, which section is hereby incorporated by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information required by this item is included under the heading "Certain
Transactions" in the 2002 Proxy Statement, which section is hereby incorporated
by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1 and 2. FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
PAGE IN
FORM 10-K
REPORT
The following consolidated financial statements of American Medical Security Group, Inc.
and subsidiaries are included in Item 8:
Report of Independent Auditors..................................................................... 25
Consolidated Balance Sheets at December 31, 2001 and 2000.......................................... 26
Consolidated Statements of Operations for the years ended December 31, 2001, 2000 and 1999......... 27
Consolidated Statements of Cash Flows for the years ended December 31, 2001, 2000 and 1999......... 28
Consolidated Statements of Changes in Shareholders' Equity and Comprehensive Income (Loss)
for the years ended December 31, 2001, 2000 and 1999............................................ 29
Notes to Consolidated Financial Statements......................................................... 30
49
PAGE IN
FORM 10-K
REPORT
The following financial statement schedules of American Medical
Security Group, Inc. and subsidiaries are included in Item 14(d):
Schedule II - Condensed Financial Information of Registrant................................. 51
Schedule III - Supplementary Insurance Information.......................................... 54
Schedule IV - Reinsurance................................................................... 55
Schedule V - Valuation and Qualifying Accounts.............................................. 56
All other schedules for which provision is made in applicable accounting
regulations of the Securities and Exchange Commission are not required under the
related instructions or are inapplicable, and therefore have been omitted.
3. EXHIBITS
See the Exhibit Index following the Signature page of this report, which
is incorporated herein by reference. Each management contract and compensatory
plan or arrangement required to be filed as an exhibit to this report is
identified in the Exhibit Index by an asterisk following its exhibit number.
(b) REPORTS ON FORM 8-K
No reports on Form 8-K were filed during the fourth quarter of 2001.
(c) EXHIBITS
See the Exhibit Index following the Signature page of this report.
(d) FINANCIAL STATEMENT SCHEDULES
The financial statement schedules referenced in Item 14(a) are as follows.
50
SCHEDULE II
AMERICAN MEDICAL SECURITY GROUP, INC.
(PARENT COMPANY ONLY)
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED BALANCE SHEETS
December 31,
2001 2000
----------------------------
(IN THOUSANDS)
ASSETS:
Cash and cash equivalents $ 3,137 $ 1,671
Other assets:
Investment in consolidated subsidiaries 250,794 240,784
Goodwill and other intangibles, net 19,666 20,229
Due from affiliates - 1,761
Other assets 239 309
----------------------------
Total other assets 270,699 263,083
----------------------------
Total assets $ 273,836 $ 264,754
============================
LIABILITIES AND SHAREHOLDERS' EQUITY:
Liabilities:
Notes payable $ 35,158 $ 35,158
Taxes payable 7,821 7,019
Payables and accrued expenses 5 50
Due to affiliates 634 -
Other liabilities 818 1,350
----------------------------
Total liabilities 44,436 43,577
Shareholders' equity:
Common stock 16,654 16,654
Paid-in capital 187,927 187,956
Retained earnings 40,470 36,295
Accumulated other comprehensive gain (loss) 1,903 (3,948)
Treasury stock (17,554) (15,780)
----------------------------
Total shareholders' equity 229,400 221,177
----------------------------
Total liabilities and shareholders' equity $ 273,836 $ 264,754
============================
51
SCHEDULE II
AMERICAN MEDICAL SECURITY GROUP, INC.
(PARENT COMPANY ONLY)
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED STATEMENTS OF OPERATIONS
Year ended December 31,
2001 2000 1999
-------------------------------------------
(IN THOUSANDS)
REVENUES:
Fees from consolidated subsidiaries $ 4,427 $ 4,139 $ 3,199
Other revenue 103 140 92
-------------------------------------------
Total revenues 4,530 4,279 3,291
EXPENSES:
General and administrative 563 430 1,071
Interest 2,377 2,972 2,802
Amortization of goodwill and other intangibles 563 563 563
-------------------------------------------
Total expenses 3,503 3,965 4,436
-------------------------------------------
Income (loss) before income tax expense (benefit) and equity
in net income (loss) of subsidiaries 1,027 314 (1,145)
Income tax expense (benefit) 874 154 (347)
-------------------------------------------
Income (loss) before equity in net income (loss) of subsidiaries 153 160 (798)
Equity in net income (loss) of subsidiaries 4,022 2,509 (25,148)
-------------------------------------------
Net income (loss) $ 4,175 $ 2,669 $ (25,946)
===========================================
52
SCHEDULE II
AMERICAN MEDICAL SECURITY GROUP, INC.
(PARENT COMPANY ONLY)
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED STATEMENTS OF CASH FLOWS
Year ended December 31,
2001 2000 1999
-------------------------------------------
(IN THOUSANDS)
OPERATING ACTIVITIES:
Net income (loss) $ 4,175 $ 2,669 $ (25,946)
Adjustments to reconcile net income (loss)
to net cash provided by operating activities:
Equity in net (income) loss of subsidiaries (4,022) (2,509) 25,148
Dividends received from subsidiaries - 16,400 15,250
Amortization of intangibles 563 563 563
Deferred income tax expense (benefit) 72 186 (399)
Changes in operating accounts:
Net other assets and liabilities 2,481 (7,622) 3,011
-------------------------------------------
Net cash provided by operating activities 3,269 7,018 17,627
INVESTING ACTIVITIES:
Net cash used in investing activities - - -
FINANCING ACTIVITIES:
Issuance of common stock 413 4 5
Purchase of treasury stock (2,216) (8,292) (7,488)
Proceeds from notes payable borrowings - 39,158 5,000
Repayment of notes payable - (39,158) (15,000)
-------------------------------------------
Net cash used in financing activities (1,803) (8,288) (17,483)
Cash and cash equivalents:
Net increase during year 1,466 1,399 144
Balance at beginning of year 1,671 272 128
-------------------------------------------
Balance at end of year $ 3,137 $ 1,671 $ 272
===========================================
53
SCHEDULE III
AMERICAN MEDICAL SECURITY GROUP, INC.
SUPPLEMENTARY INSURANCE INFORMATION
Deferred Medical and
Policy Other Other
Acquisition Benefits Advance Policyholder
SEGMENT Costs Payable Premiums Funds
----------------------------------------------------------------------------------------
(IN THOUSANDS)
DECEMBER 31, 2001:
Health $ - $ 125,834 $ 15,472 $ -
Life - 9,480 816 -
All Other - 190 449 -
--------------------------------------------------------
Total $ - $ 135,504 $ 16,737 $ -
========================================================
DECEMBER 31, 2000:
Health $ - $ 133,001 $ 16,367 $ -
Life - 9,924 745 -
All Other - 2,385 456 -
--------------------------------------------------------
Total $ - $ 145,310 $ 17,568 $ -
========================================================
DECEMBER 31, 1999:
Health $ - $ 150,201 $ 16,171 $ -
Life - 9,328 530 -
All Other - 9,588 576 -
--------------------------------------------------------
Total $ - $ 169,117 $ 17,277 $ -
========================================================
Amortization of
Medical and Deferred
Net Other Policy Other
Premium Investment Benefit Acquisition Operating Premiums
SEGMENT Revenue Income Expenses Costs Expenses Written
--------------------------------------------------------------------------------------------------------------------
(IN THOUSANDS)
DECEMBER 31, 2001:
Health $ 820,658 $ 9,197 $ 595,811 $ - $ 244,453 $ 819,763
Life 17,424 656 6,334 - 5,446
All Other 590 6,811 (203) - 7,843 583
-----------------------------------------------------------------------
Total $ 838,672 $ 16,664 $ 601,942 $ - $ 257,742
=======================================================================
DECEMBER 31, 2000:
Health $ 907,722 $ 9,513 $ 700,511 $ - $ 235,649 $ 907,918
Life 22,578 638 7,781 - 6,581
All Other 20,771 8,531 16,321 - 9,537 20,651
-----------------------------------------------------------------------
Total $ 951,071 $ 18,682 $ 724,613 $ - $ 251,767
=======================================================================
DECEMBER 31, 1999:
Health $ 985,322 $ 9,254 $ 805,768 $ - $ 245,676 $ 984,715
Life 26,183 202 10,270 - 7,640
All Other 44,602 9,456 44,435 - 14,743 44,726
-----------------------------------------------------------------------
Total $ 1,056,107 $ 18,912 $ 860,473 $ - $ 268,059
=======================================================================
54
SCHEDULE IV
AMERICAN MEDICAL SECURITY GROUP, INC.
REINSURANCE
Percentage
Ceded to Assumed Of Amount
Direct Other from Other Net Assumed
Business Companies Companies Amount to Net
--------------------------------------------------------------------------
(IN THOUSANDS)
YEAR ENDED DECEMBER 31, 2001:
Life insurance in force $ 9,351,321 $ 6,913,662 $ - $ 2,437,659 0.0%
Premiums:
Accident and Health 821,994 2,259 1,513 821,248 0.2%
Life 17,695 273 2 17,424 0.0%
-------------------------------------------------------------
Total Premiums 839,689 2,532 1,515 838,672 0.2%
YEAR ENDED DECEMBER 31, 2000:
Life insurance in force $ 14,839,256 $ 11,412,772 $ 1,942 $ 3,428,426 0.1%
Premiums:
Accident and Health 922,087 2,236 8,642 928,493 0.9%
Life 22,782 287 83 22,578 0.4%
-------------------------------------------------------------
Total Premiums 944,869 2,523 8,725 951,071 0.9%
YEAR ENDED DECEMBER 31, 1999:
Life insurance in force $ 14,355,089 $ 12,731,969 $ 9,455 $ 1,632,575 0.6%
Premiums:
Accident and Health 976,457 4,309 57,776 1,029,924 5.6%
Life 25,642 607 1,148 26,183 4.4%
-------------------------------------------------------------
Total Premiums 1,002,099 4,916 58,924 1,056,107 5.6%
55
SCHEDULE V
AMERICAN MEDICAL SECURITY GROUP, INC.
VALUATION AND QUALIFYING ACCOUNTS
Additions
Balance at Charged to
Beginning Costs and Balance at
of Period Expenses Deductions End of Period
---------------------------------------------------------
(IN THOUSANDS)
YEAR ENDED DECEMBER 31, 2001:
Allowance for bad debts $ 344 $ 1,250 $ 302 $ 1,292
Valuation allowance for deferred taxes 3,861 1,810 277 5,394
---------------------------------------------------------
Total $ 4,205 $ 3,060 $ 579 $ 6,686
=========================================================
YEAR ENDED DECEMBER 31, 2000:
Allowance for bad debts $ 651 $ 7 $ 314 $ 344
Valuation allowance for deferred taxes 3,549 398 86 3,861
---------------------------------------------------------
Total $ 4,200 $ 405 $ 400 $ 4,205
=========================================================
YEAR ENDED DECEMBER 31, 1999:
Allowance for bad debts $ 1,118 $ 14 $ 481 $ 651
Valuation allowance for deferred taxes 2,654 1,029 134 3,549
---------------------------------------------------------
Total $ 3,772 $ 1,043 $ 615 $ 4,200
=========================================================
56
57
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
AMERICAN MEDICAL SECURITY GROUP, INC.
Date: March 6, 2002 By: /s/ SAMUEL V. MILLER
Samuel V. Miller, Chairman, President,
and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.*
SIGNATURE TITLE
/s/ SAMUEL V. MILLER Chairman of the Board, President and Chief
Samuel V. Miller Executive Officer; Director
/s/ GARY D. GUENGERICH Executive Vice President and Chief Financial
Gary D. Guengerich Officer (Principal Financial Officer and
Principal Accounting Officer)
/s/ ROGER H. BALLOU Director
Roger H. Ballou
/s/ W. FRANCIS BRENNAN Director
W. Francis Brennan
/s/ MARK A. BRODHAGEN Director
Mark A. Brodhagen
/s/ WILLIAM R. JOHNSON Director
William R. Johnson
/s/ EUGENE A. MENDEN Director
Eugene A. Menden
/s/ EDWARD L. MEYER, JR Director
Edward L. Meyer, Jr.
/s/ MICHAEL T. RIORDAN Director
Michael T. Riordan
/s/ H.T. RICHARD SCHREYER Director
H.T. Richard Schreyer
/s/ FRANK L. SKILLERN Director
Frank L. Skillern
/s/ J. GUS SWOBODA Director
J. Gus Swoboda
*Each of the above signatures is affixed as of March 6, 2002.
57
AMERICAN MEDICAL SECURITY GROUP, INC.
(COMMISSION FILE NO. 1-13154)
EXHIBIT INDEX
TO
FORM 10-K ANNUAL REPORT
FOR THE YEAR ENDED DECEMBER 31, 2001
EXHIBIT INCORPORATED HEREIN FILED
NUMBER DOCUMENT DESCRIPTION BY REFERENCE TO HEREWITH
2.1 Distribution and Indemnity Agreement Exhibit 2.1 to Newco/UWS'
between the United Wisconsin Registration Statement on Form 10,
Services, Inc., now known as as amended (File No. 1-14177)
American Medical Security Group,
Inc. ("AMSG f/k/a UWS or
Registrant") and Newco/UWS, Inc.
("Newco/UWS") dated as of September
11, 1998
2.2 Employee Benefits Agreement dated as Exhibit 10.1 to Newco/UWS'
of September 11, 1998, by and Registration Statement on Form 10,
between AMSG f/k/a UWS and Newco/UWS as amended (File No. 1-14177)
2.3 Tax Allocation Agreement, entered Exhibit 10.2 to Newco/UWS'
into as of September 11, 1998, by Registration Statement on Form 10,
and between AMSG f/k/a UWS and as amended (File No. 1-14177)
Newco/UWS
3.1(a) Restated Articles of Incorporation Exhibit 3.1 to the Registrants Form
of Registrant dated as February 17, 10-K for the year ended
1999 December 31, 1998 (the "1998 10-K")
3.1(b) Articles of Amendment to Restated Exhibit 3 to the Registrant's Form
Articles of Incorporation with 10-Q for the quarter ended June 30,
Respect to Designation, Preferences, 2001.
Limitations and Relative Rights of
Series B Junior Cumulative Preferred
Stock
3.2 Bylaws of Registrant as amended and Exhibit 3.2 to the Registrant's
restated November 17, 1999 Form 10-K for the year ended
December 31, 1999 (the "1999 10-K")
4.1(a) Credit Agreement dated as of Exhibit 4 to the Registrant's Form
March 24, 2000, (the "Credit 10-Q for the quarter ended
Agreement") among the Registrant, March 31, 2000 (the "3/31/00 10-Q")
LaSalle Bank National Association
and other Lenders (replacing prior
credit agreement with Bank One, NA)
EX-1
EXHIBIT INCORPORATED HEREIN FILED
NUMBER DOCUMENT DESCRIPTION BY REFERENCE TO HEREWITH
4.1(b) First Amendment dated as of July 18, Exhibit 4 to the Registrant's Form
2000 to Credit Agreement 10-Q for the quarter ended June 30,
2000
4.1(c) Second Amendment dated as of Exhibit 4 to the Registrant's Form
November 10, 2000 to Credit Agreement 10-Q for the quarter ended
September 30, 2000 (the "9/30//00
10-Q")
4.1(d) Third Amendment dated as of January Exhibit 4.4 to the Registrant's
29, 2001 to Credit Agreement Form 10-K for the year ended
December 31, 2000 (the "2000 10-K")
4.1(e) Fourth Amendment dates as of April Exhibit 4 to the Registrant's Form
27, 2001 to Credit Agreement dated 10-Q for the quarter ended March
as of March 24, 2000 among the 31, 2001
Registrant, LaSalle Bank National
Association and other Lenders
4.2(a) Rights Agreement, dated as of August Exhibit 1 to the Registrant's
9, 2001, between American Medical Registration Statement on Form 8-A
Security Group, Inc. and Firstar filed August 14, 2001 and Exhibit 4
Bank, N.A., as Rights Agents (the to the Registrant's Current Report
"Rights Agreement') including the on Form 8-K dated August 9, 2001,
form of Rights Certificate as and filed on August 14, 2001
Exhibit B thereto
4.2(b) Amendment dated as of February 1, Exhibit 4.1 to the Registrant's
2002, to the Rights Agreement Form 8-K dated February 1, 2002
(the "2/1/02 8-K")
4.2(c) Appointment and Assumption Agreement Exhibit 4.2 to the 2/1/02 8-K
dated December 17, 2001, between the
Registrant and Firstar Bank, N.A.,
appointing LaSalle Bank, N.A. as
Rights Agent for the Rights Agreement
10.1* Equity Incentive Plan as amended and X
restated November 29, 2001
10.2* Form of Nonqualified Stock Option Exhibit 10.2 to 1998 10-K
Award Agreement for Officers
10.3* Form of Nonqualified Stock Option Exhibit 10.3 to 1999 10-K
Award Agreement for Directors
10.4* Deferred Stock Agreement between the Exhibit 10.3 to 1998 10-K
Registrant and Samuel V. Miller
EX-2
EXHIBIT INCORPORATED HEREIN FILED
NUMBER DOCUMENT DESCRIPTION BY REFERENCE TO HEREWITH
10.5* 1995 Director Stock Option Plan as X
amended November 29, 2001
10.6* Directors Deferred Compensation Plan Exhibit 10.6 to 1999 10-K
adopted November 17, 1999
10.7* Voluntary Deferred Compensation Plan Exhibit 10.7 to 1999 10-K
as Amended and Restated effective
September 25, 1998
10.8(a)* Deferred Compensation Trust Exhibit 10.48 to the Registrant's
Form 10-K for the year ended
December 31, 1997
10.8(b)* First Amendment to the Deferred Exhibit 10.9 to 1999 10-K
Compensation Trust
10.9* Restricted Stock Agreement with Exhibit 10 to the Registrant's Form
Chief Executive Officer dated July 10-Q for the quarter ended
9, 2001 September 30, 2001
10.10* Executive Reimbursement Group Exhibit 10.8 to 1998 10-K
Insurance Policy
10.11(a)* Change of Control Severance Benefit Exhibit 10.11 to 2000 10-K
Plan as amended and restated
November 15, 2000
10.11(b)* Change of Control Severance Benefit X
Plan as amended and restated
November 29, 2001
10.12* Severance Benefit for Certain Exhibit 10.10 to 1998 10-K
Executive Officers
10.13* Executive Management Incentive Plan Exhibit 10.14 to 2000 10-K
effective January 1, 2001
10.14* Executive Annual Incentive Plan Exhibit 10.15 to 2000 10-K
10.15(a)* Employment Agreement of Chief Exhibit 10 to 9/30/00 10-Q
Executive Officer ("CEO") dated
September 28, 2000
10.15(b)* Amendment dated as of November 29, X
2001 to Employment Agreement of CEO
10.16* Nonqualified Executive Retirement Exhibit 10 to 3/31/00 10-Q
Plan effective April 1, 2000
EX-3
EXHIBIT INCORPORATED HEREIN FILED
NUMBER DOCUMENT DESCRIPTION BY REFERENCE TO HEREWITH
10.17 Registration Rights Agreement Exhibit 10.19 to 1998 10-K
between the Registrant and Blue
Cross Blue Shield United of
Wisconsin ("BCBSUW") dated as of
September 1, 1998
10.18 Agreement dated February 1, 2002, Exhibit 10.1 to the 2/1/02 8-K
among the Company, Cobalt
Corporation and Blue Cross & Blue
Shield United of Wisconsin
concerning the Rights Agreement
21 Subsidiaries of the Registrant X
23 Consent of Ernst & Young LLP X
* Indicates compensatory plan or arrangement.
EX-4