UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2003.
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 NO. 001-14953
---------------
UICI
(Exact name of registrant as specified in its charter)
Delaware 75-2044750
------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
9151 Grapevine Highway, North Richland Hills, Texas 76180
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(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code (817) 255-5200
Not Applicable
--------------------------------------------------------------------------------
Former name, former address and former fiscal year, if changed since last
report.
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 whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ].
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date. Common Stock, $.01
Par Value, 46,313,310 shares as of November 7, 2003.
INDEX
UICI AND SUBSIDIARIES
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated condensed balance sheets-September 30, 2003 (unaudited) and December
31, 2002............................................................................. 3
Consolidated condensed statements of income (loss) (unaudited) - Three months
ended September 30, 2003 and 2002 and nine months ended September 30, 2003 and 2002.. 4
Consolidated condensed statements of comprehensive income (loss) (unaudited) -
Three months ended September 30, 2003 and 2002 and nine months ended September 30,
2003 and 2002........................................................................ 5
Consolidated condensed statements of cash flows (unaudited) - Nine months
ended September 30, 2003 and 2002.................................................... 6
Notes to consolidated condensed financial statements (unaudited) - September 30,
2003................................................................................. 7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations........................................................................... 28
Item 3. Quantitative and Qualitative Disclosures about Market Risk........................... 37
Item 4. Controls and Procedures.............................................................. 38
PART II. OTHER INFORMATION 39
Item 1. Legal Proceedings.................................................................... 39
Item 2. Changes in Securities and Use of Proceeds............................................ 39
Item 6. Exhibits and Reports on Form 8-K..................................................... 39
SIGNATURES............................................................................................ 40
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
UICI AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
SEPTEMBER 30, DECEMBER 31,
2003 2002
------------- ------------
(UNAUDITED)
ASSETS
Investments
Securities available for sale --
Fixed maturities, at fair value (cost:
2003--$1,189,631; 2002--$1,051,710)..................... $1,232,790 $1,088,126
Equity securities, at fair value (cost:
2003--$23,572; 2002--$52,526)........................... 67,793 81,240
Mortgage and collateral loans.............................. 6,090 7,322
Policy loans............................................... 18,433 19,191
Investment in Healthaxis, Inc. ............................ -- 4,929
Short-term investments..................................... 99,283 138,854
---------- ----------
Total Investments................................... 1,424,389 1,339,662
Cash......................................................... 32,881 16,256
Student loans................................................ 99,814 95,449
Restricted cash.............................................. 47,219 77,777
Reinsurance receivables...................................... 51,395 59,155
Due premiums and other receivables........................... 79,413 57,771
Investment income due and accrued............................ 22,403 20,756
Federal income tax assets.................................... 2,416 5,881
Deferred acquisition costs................................... 85,436 89,310
Goodwill and other intangible assets......................... 45,765 30,735
Property and equipment, net.................................. 75,989 77,528
Other assets................................................. 8,950 8,451
AMS assets held for sale..................................... 1,910,245 1,842,773
---------- ----------
$3,886,315 $3,721,504
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Policy liabilities
Future policy and contract benefits........................ $ 431,102 $ 423,218
Claims..................................................... 518,090 466,295
Unearned premiums.......................................... 143,295 121,750
Other policy liabilities................................... 16,671 17,706
Accounts payable............................................. 22,031 18,098
Other liabilities............................................ 118,977 125,149
Debt......................................................... 3,951 7,922
CFLD student loan credit facility............................ 150,000 150,000
AMS liabilities held for sale................................ 1,872,818 1,787,069
Net liabilities of discontinued operations, including reserve
for losses on disposal.................................... 28,495 19,247
---------- ----------
3,305,430 3,136,454
Commitments and Contingencies
Stockholders' Equity
Preferred stock, par value $0.01 per share................. -- --
Common stock, par value $0.01 per share.................... 516 509
Additional paid-in capital................................. 254,907 236,082
Accumulated other comprehensive income .................... 56,832 42,337
Retained earnings.......................................... 338,625 364,032
Treasury stock, at cost.................................... (69,995) (57,910)
---------- ----------
580,885 585,050
---------- ----------
$3,886,315 $3,721,504
========== ==========
NOTE: The balance sheet data as of December 31, 2002 have been derived from the
audited financial statements at that date.
See Notes to Consolidated Condensed Financial Statements.
3
UICI AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF INCOME (LOSS) (UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- -----------------------
2003 2002 2003 2002
--------- --------- ---------- --------
REVENUE
Premiums:
Health (includes amounts received from related parties of $3,619 and $2,317
for the three months ended September 30, 2003 and 2002,
respectively, and $8,939 and $5,673 for the nine months ended
September 30, 2003 and 2002, respectively)................................. $ 395,809 $ 309,744 $1,135,235 $ 829,356
Life premiums and other considerations........................................ 7,953 7,924 23,991 23,397
--------- --------- ---------- ---------
403,762 317,668 1,159,226 852,753
Investment income (includes amounts received from related parties of $9
and $2 for the three months ended September 30, 2003 and 2002,
respectively, and $14 and $3 for the nine months ended September 30, 2003
and 2002, respectively)...................................................... 19,380 21,005 58,173 60,383
Other income (includes amounts received from related parties of $343 and
$1,927 for the three months ended September 30, 2003 and 2002,
respectively and $3,051 and $7,244 for the nine months ended September
30, 2003 and 2002, respectively)............................................. 28,564 23,981 76,425 64,999
Gains (losses) on investments................................................. 1,861 (398) 1,674 (6,231)
--------- --------- ---------- ---------
453,567 362,256 1,295,498 971,904
BENEFITS AND EXPENSES
Benefits, claims, and settlement expenses..................................... 269,114 200,891 753,297 547,021
Underwriting, acquisition, and insurance expenses (includes amounts paid to
related parties of $3,434 and $2,946 for the three months ended September
30, 2003 and 2002, respectively and $9,086 and $17,319 for the nine months
ended September 30, 2003 and 2002, respectively)............................. 142,686 112,275 402,857 294,666
Variable stock-based compensation expense (benefit)........................... (1,211) 3,890 (1,663) 14,258
Other expenses (includes amounts paid to related parties of $380 and $726
for the three months ended September 30, 2003 and 2002, respectively, and
$783 and $2,493 for the nine months ended September 30, 2003 and 2002,
respectively)................................................................ 16,539 16,201 52,088 45,871
Depreciation (includes expense on assets purchased from related parties of
$557 and $438 for the three months ended September 30, 2003 and 2002,
respectively, and $1,742 and $1,260 for the nine months ended September
30, 2003 and 2002, respectively)............................................. 3,606 3,579 12,296 10,887
Interest expense.............................................................. 332 193 771 1,276
Interest expense--student loan credit facilities.............................. 433 756 1,456 2,004
Losses in Healthaxis, Inc. investment......................................... 1,266 796 2,211 8,895
--------- --------- ---------- ---------
432,765 338,581 1,223,313 924,878
--------- --------- ---------- ---------
INCOME FROM CONTINUING OPERATIONS BEFORE
FEDERAL INCOME TAXES.......................................................... 20,802 23,675 72,185 47,026
Federal income taxes.......................................................... 6,996 7,875 24,876 14,965
--------- --------- ---------- ---------
INCOME FROM CONTINUING OPERATIONS............................................... 13,806 15,800 47,309 32,061
DISCONTINUED OPERATIONS
Income (loss) from operations (net of income tax benefit of $10,660 and
$4,900 for the three months ended September 30, 2003 and 2002,
respectively, and $13,547 and $3,100 for the nine months ended September
30, 2003 and 2002, respectively).............................................. (67,101) 422 (72,716) 1,970
--------- --------- ---------- ---------
INCOME (LOSS) BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE (53,295) 16,222 (25,407) 34,031
Cumulative effect of accounting change (net of income tax benefit of
$1,742 for the nine months ended September 30, 2002)......................... -- -- -- (5,144)
--------- --------- ---------- ---------
NET INCOME (LOSS).............................................................. $ (53,295) $ 16,222 $ (25,407) $ 28,887
========= ========= ========== =========
Earnings (loss) per share:
Basic earnings
Income from continuing operations............................................ $ 0.30 $ 0.33 $ 1.02 $ 0.68
Income (loss) from discontinued operations................................... (1.45) 0.01 (1.57) 0.04
--------- --------- ---------- ---------
Income (loss) before cumulative effect of accounting change.................. (1.15) 0.34 (0.55) 0.72
Cumulative effect of accounting change....................................... -- -- -- (0.11)
--------- --------- ---------- ---------
Net income (loss)............................................................ $ (1.15) $ 0.34 $ (0.55) $ 0.61
========= ========= ========== =========
Diluted earnings
Income from continuing operations............................................ $ 0.29 $ 0.32 $ 0.99 $ 0.66
Income (loss) from discontinued operations................................... (1.40) 0.01 (1.52) 0.04
--------- --------- ---------- ---------
Income (loss) before cumulative effect of accounting change.................. (1.11) 0.33 (0.53) 0.70
Cumulative effect of accounting change....................................... -- -- -- (0.11)
--------- --------- ---------- ---------
Net income (loss)............................................................ $ (1.11) $ 0.33 $ (0.53) $ 0.59
========= ========= ========== =========
See Notes to Consolidated Condensed Financial Statements.
4
UICI AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(UNAUDITED) (DOLLARS IN THOUSANDS)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ -----------------------
2003 2002 2003 2002
-------- -------- -------- --------
Net income (loss)..................................... $(53,295) $ 16,222 $(25,407) $ 28,887
Other comprehensive income (loss):
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising during
period............................................. (5,789) 9,699 28,349 23,176
Reclassification adjustment for losses included in
net income (loss).................................. (5,494) (2,121) (6,100) (9,492)
-------- -------- -------- --------
Other comprehensive income (loss) before tax.... (11,283) 7,578 22,249 13,684
Income tax provision related to items of other
comprehensive income (loss)........................ 3,982 (2,652) (7,754) (4,786)
-------- -------- -------- --------
Other comprehensive income (loss) net of tax
provision..................................... (7,301) 4,926 14,495 8,898
-------- -------- -------- --------
Comprehensive income (loss)........................... $(60,596) $ 21,148 $(10,912) $ 37,785
======== ======== ======== ========
See Notes to Consolidated Condensed Financial Statements.
5
UICI AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED)
(DOLLARS IN THOUSANDS)
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------------
2003 2002
--------- ---------
OPERATING ACTIVITIES
Net income (loss) ............................................................... $ (25,407) $ 28,887
Adjustments to reconcile net income to cash provided by operating activities:
Increase in policy liabilities ................................................. 86,779 64,453
Increase in other liabilities and accrued expenses ............................. 13,741 17,869
Decrease (increase) in income taxes ............................................ (4,353) 99
Decrease (increase) in deferred acquisition costs .............................. 4,181 (11,917)
Increase in accrued investment income .......................................... (1,647) (902)
Decrease (increase) in reinsurance and other receivables ....................... (20,559) 17,451
Stock appreciation expense (benefit) ........................................... (1,663) 15,812
Depreciation and amortization .................................................. 23,548 20,188
Losses in Healthaxis, Inc investment ........................................... 2,211 2,395
(Gains) losses on sale of investments .......................................... (1,674) 6,231
Decrease in AMS net assets held for sale ....................................... 116,296 124,061
Amounts charged to loss on disposal of discontinued operations ................. (5,460) (6,774)
Other items, net ............................................................... (1,849) (2,910)
--------- ---------
Cash Provided by Operating Activities ......................................... 184,144 274,943
--------- ---------
INVESTING ACTIVITIES
Increase in student loans ....................................................... (5,899) (6,383)
Increase in other investments ................................................... (49,896) (52,027)
Decrease (increase) in restricted cash .......................................... 8,528 (41,762)
Increase in AMS net assets held for sale ........................................ (133,114) (330,771)
Decrease (increase) in agents' receivables ...................................... 15,727 (9,969)
Proceeds from sale of subsidiary net of cash disposal of $701 in 2002 ........... -- 3,242
Purchase of subsidiaries net of cash acquired of $2,649 in 2002 ................. -- (30,783)
Increase in property and equipment .............................................. (28,433) (26,774)
--------- ---------
Cash Used in Investing Activities ............................................. (193,087) (495,227)
--------- ---------
FINANCING ACTIVITIES
Deposits from investment products ............................................... 9,862 10,133
Withdrawals from investment products ............................................ (18,364) (18,413)
Proceeds from CFLD student loan facility ........................................ -- 50,000
Repayment of debt ............................................................... (3,972) (15,568)
Issue shares to Employee Stock Plan ............................................. -- 3,292
Exercise of stock options ....................................................... 9,434 10,773
Purchase of treasury shares ..................................................... (16,036) (1,336)
Exercise of Onward and Upward option ............................................ -- (10,129)
Repayment of notes receivable from stock sale ................................... 1,582 --
Decrease in AMS net assets held for sale ........................................ 42,131 207,053
Other items, net ................................................................ 931 1,044
--------- ---------
Cash Provided by Financing Activities ......................................... 25,568 236,849
--------- ---------
Net increase in Cash .......................................................... 16,625 16,565
Cash and cash equivalents at Beginning of Period .............................. 16,256 13,142
--------- ---------
Cash and cash equivalents at End of Period .................................... $ 32,881 $ 29,707
========= =========
See Notes to Consolidated Condensed Financial Statements.
6
UICI AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (UNAUDITED)
September 30, 2003
NOTE A - BASIS OF PRESENTATION
The accompanying unaudited consolidated condensed financial statements
for UICI and its subsidiaries (the "Company" or "UICI") have been prepared in
accordance with accounting principles generally accepted in the United States of
America ("GAAP") for interim financial information and the instructions to Form
10-Q and Rule 10-01 of Regulation S-X. Accordingly, such financial statements do
not include all of the information and notes required by GAAP for complete
financial statements. In the opinion of management, all adjustments considered
necessary for a fair presentation have been included. All such adjustments,
except as otherwise described herein, consist of normal recurring accruals.
Operating results for the nine-month period ended September 30, 2003 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 2003. For further information, refer to the consolidated financial
statements and notes thereto included in the Company's Annual Report on Form
10-K for the year ended December 31, 2002. Certain amounts in the 2002 financial
statements have been reclassified to conform to the 2003 financial statement
presentation.
CHANGE IN RESERVING METHODOLOGY - SELF EMPLOYED AGENCY DIVISION
Effective January 1, 2003, the Company's Self Employed Agency ("SEA")
Division made adjustments to its reserve methodology and certain changes in
accounting estimates, the net effect of which decreased reserves and
correspondingly increased operating income reported by the SEA Division in the
amount of $4.8 million in the first quarter of 2003. Set forth below is a
summary of the adjustments and changes in accounting estimates made by the
Company.
Claim Reserve Changes
The SEA Division utilizes the developmental method to estimate claim
reserves. Under the developmental method, completion factors are applied to paid
claims in order to estimate the ultimate claim payments. These completion
factors are derived from historical experience and are dependent on the
"incurred dates" of the paid claims. Prior to January 1, 2003, the Company
utilized the "original incurred date" coding method to establish the date a
policy claim is incurred under the developmental method. Under the original
incurred date coding method, prior to the end of the period in which a health
policy claim was made, the Company estimated and recorded a liability for the
cost of all medical services related to the accident or sickness relating to the
claim, even though the medical services associated with such accident or
sickness might not be rendered to the insured until a later financial reporting
period.
Effective January 1, 2003, the Company has determined to utilize a
"modified incurred date" coding method to establish incurred dates under the
developmental method. Under this modified incurred date coding method, a break
in service of more than six months will result in the establishment of a new
"incurred date" for subsequent services. In addition, under the modified
incurred date coding method, prior to the end of the period in which a health
policy claim is made, the Company estimates and records a liability for the cost
of medical services to be rendered to the insured for at most the succeeding
three years following the date the policy claim is initially made. If in fact a
particular claim extends past the three year period following the date the
policy claim is initially made, an incurred date more recent than the original
incurred date is utilized in future reserve calculations. The Company believes
that this modified incurred date coding method will provide for a more direct
and accurate reflection of actual experience in the pricing of the Company's
insurance products. This change in methodology resulted in a reduction in the
claim reserves of $12.3 million during the first quarter of 2003.
Changes in Estimate
Several changes in accounting estimates resulted in a further reduction
of the claim reserve in the amount of $5.4 million during the first quarter of
2003. This reduction in the claim reserve was attributable primarily to the
effects of a change in estimate of the reserve for excess pending claims. This
change was necessary to maintain consistency with the historical data underlying
the calculation of the new completion factors used in the claim development
reserve. These completion factors are based on more recent experience with
claims payments than the previous factors. This more recent experience has a
greater number of pending claims. As a result, the new completion
7
factors have built in a higher level of reserves for pending claims. The release
of a portion of the excess pending claims reserve reflects the additional
pending claims included in the completion factors.
ROP Reserve Changes
The Company has issued certain health policies with a
"return-of-premium" (ROP) rider, pursuant to which the Company undertakes to
return to the policyholder on or after age 65 all premiums paid less claims
reimbursed under the policy. The ROP rider also provides that the policyholder
may receive a portion of the benefit prior to age 65. Historically, the Company
has established a reserve for future ROP benefits, which reserve has been
calculated by applying factors (based on 2 year preliminary term, a 5% interest
assumption, 1958 CSO mortality termination assumption, and level future gross
premiums) to the current premium on a contract-by-contract basis. A claims
offset was applied, on a contract-by-contract basis, solely with respect to an
older closed block of policies. The ROP reserve is reflected in future policy
and contract benefits on the Company's consolidated balance sheet.
The Company records an ROP reserve to fund longer-term obligations
associated with the ROP rider. This reserve is impacted both by the techniques
utilized to calculate the reserve and the many assumptions underlying the
calculation, including interest rates, policy lapse rates, premium rate
increases on policies and assumptions with regard to claims paid. The Company
has previously utilized a simplified reserving methodology that it believed
generated an appropriate ROP reserve in the aggregate. However, the Company
recently reviewed its ROP reserving methodology in order to determine if
refinements to the methodology were appropriate. As a result of such review,
effective January 1, 2003, the ROP reserving methodology was refined to utilize
new factors (based on a net level premium basis, 4.5% interest, 1958 CSO
mortality, and, where appropriate, 10% annual increases in future gross
premiums) and to apply these factors to the historical premium payments on a
contract-by-contract basis. The claim offset is now applied on all material
blocks of policies with ROP riders. As a result of these changes, the ROP
reserve for the Company increased by $12.9 million during the first quarter of
2003.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In April 2003, the FASB issued Statement No. 149, Amendment of
Statement 133 on Derivative Instruments and Hedging Activities. Statement 149 is
effective for contracts entered into or modified after June 30, 2003. This
statement amends and clarifies financial accounting and reporting for derivative
instruments embedded in other contracts and for hedging activities under FASB
Statement No. 133. Effective June 30, 2003, the Company adopted this
pronouncement. Adoption of this pronouncement did not have a material effect
upon the financial condition or results of operations of the Company.
In May 2003, the FASB issued Statement No. 150, Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity.
Statement 150 is effective for financial instruments entered into or modified
after May 31, 2003. This Statement establishes standards for how an issuer
classifies and measures certain financial instruments with characteristics of
both liabilities and equity. Effective July 1, 2003, the Company adopted this
pronouncement. Adoption of this pronouncement did not have a material effect
upon the financial condition or results of operations of the Company.
In June 2002, the FASB issued Statement No. 146, Accounting for Costs
Associated with Exit or Disposal Activities. Statement 146 is effective for exit
or disposal activities initiated after December 31, 2002. Effective January 1,
2003, the Company adopted this pronouncement. Adoption of this pronouncement did
not have a material effect upon the financial condition or results of operations
of the Company.
In November 2002, the FASB issued Interpretation No. 45, Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others. The interpretation elaborates on the
disclosures to be made by a guarantor in its interim and annual financial
statements about its obligations under certain guarantees that it has issued. It
also clarifies that a guarantor is required to recognize, at the inception of a
guarantee, a liability for the fair value of the obligation undertaken in
issuing the guarantee. The initial recognition and initial measurement
provisions of this Interpretation are applicable on a prospective basis to
guarantees issued or modified after December 31, 2002, irrespective of the
guarantor's fiscal year end. The disclosure requirements in this Interpretation
are effective for financial statements of interim or annual periods ending after
December 15, 2002. Effective January 1, 2003, the Company adopted this
pronouncement. Adoption of this pronouncement did not have a material effect
upon the financial condition or results of operations of the Company.
8
In December 2002, the FASB issued Statement No. 148, Accounting for
Stock-Based Compensation-Transition and Disclosure. Statement 148 amends FASB
Statement No. 123, Accounting for Stock-Based Compensation, to provide
alternative methods of transition for a voluntary change to the fair value based
method of accounting for stock-based employee compensation. In addition,
Statement 148 amends the disclosure requirements of Statement 123 to require
prominent disclosures in both annual and interim financial statements about the
method of accounting for stock-based employee compensation and the effect of the
method used on reported results. The amendments to Statement 123 are effective
for financial statements for fiscal years ending after December 15, 2002.
Earlier application of the transition provisions is permitted for entities with
a fiscal year ending prior to December 15, 2002. The Company has historically
accounted for the stock-based compensation plans under Accounting Principles
Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees. On January
1, 2003, the Company adopted Statement No. 123 for all employee awards granted
or modified on or after January 1, 2003, and began measuring the compensation
cost of stock-based awards under the fair value method. The Company adopted the
transition provisions that require expensing options prospectively in the year
of adoption. Existing awards will continue to follow the intrinsic value method
prescribed by APB 25. Assuming award levels and fair values similar to past
years, the impact of adoption is not material on results of operations. This
change will primarily impact the accounting for stock options.
The following table illustrates the effect on net income (loss) as if
the fair-value-based method had been applied to all outstanding and unvested
awards in each period.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------- ----------- -----------------------
2003 2002 2003 2002
--------- --------- --------- --------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Net income (loss), as reported...................... $ (53,295) $ 16,222 $ (25,407) $ 28,887
Add stock-based employee compensation expense
included in reported net income, net of tax....... 42 55 126 165
Deduct total stock-based employee compensation
expense determined under fair-value-based method
for all rewards, net of tax....................... (94) (392) (415) (2,903)
--------- --------- --------- --------
Pro forma net income (loss) ........................ $ (53,347) $ 15,885 $ (25,696) $ 26,149
========= ========= ========= ========
Earnings (loss) per share:
Basic-as reported................................. $ (1.15) $ 0.34 $ (0.55) $ 0.61
========= ========= ========= ========
Basic-pro forma................................... $ (1.15) $ 0.33 $ (0.55) $ 0.55
========= ========= ========= ========
Diluted-as reported............................... $ (1.11) $ 0.33 $ (0.53) $ 0.59
========= ========= ========= ========
Diluted-pro forma................................. $ (1.11) $ 0.32 $ (0.53) $ 0.53
========= ========= ========= ========
NOTE B - DISCONTINUED OPERATIONS
For financial reporting purposes, the Company has classified as
discontinued operations its former sub-prime credit card unit, its Special Risk
Division, its Senior Market Division and its Academic Management Services Corp.
("AMS") subsidiary. The Company's results in the three and nine months ended
September 30, 2003 included losses from discontinued operations in the amount of
$(67.1) million and $(72.7) million, net of tax, respectively. For the three and
nine months ended September 30, 2002, the Company's results from discontinued
operations reflected income in the amount of $422,000 and $2.0 million (net of
tax), respectively.
As previously reported, on October 29, 2003, UICI executed a definitive
agreement with SLM Corporation ("Sallie Mae"), pursuant to which UICI will sell
its entire equity interest in AMS. (See Note C - Academic Management Services
Corp.).
In May 2003, the Company determined to exit the businesses of its
Senior Market Division by sale or wind-down, and as a result the Company
designated and has classified its Senior Market Division as a discontinued
operation for financial reporting purposes. The Company's Senior Market Division
formerly specialized in the development of long-term care and Medicare
Supplement insurance products for the senior market.
For the three and nine months ended September 30, 2003, the Senior
Market Division reported losses (net of tax) in the amount of $(161,000) and
$(9.1) million, respectively, compared to losses of $(1.4) million and $(3.5)
million in the three and nine months ended September 30, 2002, respectively. A
significant portion of such losses in the
9
three and nine months ended September 30, 2003 was attributable to a loss in the
amount of $(5.5) million (net of tax) recognized upon sale, effective June 30,
2003, of the Company's interest in the agency through which the Company formerly
marketed and distributed insurance products to the senior market.
NOTE C - ACADEMIC MANAGEMENT SERVICES CORP.
On October 29, 2003, UICI executed a definitive agreement with SLM
Corporation ("Sallie Mae"), pursuant to which UICI will sell its entire equity
interest in Academic Management Services Corp. ("AMS"). The Company has
estimated that the sale of AMS to Sallie Mae, when completed, will generate net
cash proceeds to UICI of approximately $25.3 million. At closing, UICI will also
receive uninsured student loan assets currently held by AMS' special purpose
financing subsidiaries with a face amount of approximately $44.7 million
(including accrued interest). The fair value of the uninsured loans is expected
to be significantly less than the face amount of the loans.
Closing of the transaction is anticipated to occur in November 2003 and
is subject to satisfaction of several closing conditions, including expiration
or earlier termination of the applicable waiting period under the
Hart-Scott-Rodino Antitrust Improvements Act of 1976. While the Company believes
that it will be able to satisfy all conditions to closing, there can be no
assurance that the conditions to closing will be satisfied or that the
transaction contemplated by the definitive agreement will in fact be completed.
The Company has classified AMS as a discontinued operation for
financial reporting purposes as of September 30, 2003. Reflecting the fair
market value of AMS implied by the proposed transaction with Sallie Mae, UICI
recorded in the three and nine months ended September 30, 2003 a pre-tax loss
(consisting of an estimated loss upon disposal of AMS and AMS' operating results
in the periods) in the amount of $(77.5) million ($(66.9) million net of tax)
and $(75.3) million ($(65.6) million net of tax), respectively. Exclusive of the
estimated loss upon disposal of AMS in the amount of $(61.2) million (net of
tax), in the three and nine months ended September 30, 2003 AMS reported
operating losses (net of tax) in the amount of $(5.7) million and $(4.4)
million, respectively, compared to operating income (net of tax) of $1.8 million
and $5.4 million in the corresponding periods of the prior year.
AMS historically financed its student loan origination activities
through seven special purpose subsidiaries ("Special Purpose Subsidiaries")
(EFG-II LP, EFG-III LP, EFG Funding LLC, EFG-IV LP, AMS-I 2002 LP, AMS-II 2002
LP and AMS-III 2003 LP), through which it has outstanding six secured student
loan financing facilities that issue debt securities secured by student loans
and other qualified collateral. At December 31, 2002 and September 30, 2003, AMS
had indebtedness outstanding under such facilities in the aggregate amount of
$1,644.9 million and $1,602.6 million, respectively. All such indebtedness
issued by the AMS Special Purpose Subsidiaries is included in "AMS liabilities
held for sale" on the Company's consolidated balance sheet; and all student
loans pledged to secure such indebtedness and all such cash, cash equivalents
and qualified investments specifically pledged under the student loan credit
facilities are included in "AMS assets held for sale" on the Company's
consolidated balance sheet.
One of AMS' Special Purpose Subsidiaries (EFG-II LP) was liquidated in
September 2003 when substantially all of the loans owned by the Special Purpose
Subsidiary were sold (approximately $105.5 million of principal and accrued
interest) and the associated debt was repaid. The Company recorded a net gain of
$2.0 million from the liquidation of this facility.
On July 21, 2003, UICI reported the discovery of a shortfall in the
type and amount of collateral supporting two of the securitized student loan
financing facilities entered into by three Special Purpose Subsidiaries of AMS.
The problems at one of the financing facilities (the EFG-III LP commercial paper
conduit facility) are of three types: insufficient collateral, a higher
percentage of alternative loans (i.e., loans that are privately guaranteed as
opposed to loans that are guaranteed by the federal government) included in the
existing collateral than permitted by the loan eligibility provisions of the
financing documents and failure to provide timely and accurate reporting to each
of the various financial institutions that are parties to the financings,
including the indenture trustee, the commercial paper liquidity providers and
the financial guaranty insurer. The problems related to the second financing
subsidiary (AMS-1 2002, LP) consist primarily of a higher percentage of
alternative loans included in the existing collateral than permitted by the loan
eligibility provisions of the financing documents and the failure to provide
timely and accurate reporting to interested parties. In addition, AMS and the
other four special financing subsidiaries of AMS have failed to comply with
their respective reporting obligations owed to the indenture trustee under the
financing documents.
10
On July 24, 2003, AMS obtained waivers and releases from interested
third parties, as described more fully below, with respect to four of the six
securitized student loan financing facilities. The waiver and release agreements
were entered into with Bank of America and Fleet Bank (the providers of a
liquidity facility that supports the EFG-III, LP commercial paper facility),
Bank One (the trustee under the indentures that govern the terms of the debt
securities issued by each of AMS' Special Purpose Subsidiaries) and MBIA
Insurance Corporation (the financial guaranty insurer of debt securities issued
by four of the six AMS student loan financing facilities).
The waiver and release agreement for the EFG-III, LP commercial paper
securitized student loan facility required UICI's contribution to the capital of
AMS of $48.25 million ($1.75 million on July 24, 2003, $36.5 million on July 31,
2003 and $10.0 million on August 15, 2003) in cash, all of which, as of July 31,
2003, UICI had contributed to AMS.
The financial institutions agreed to waive all existing defaults under
the relevant financing documents with respect to EFG-III, LP and EFG Funding LLC
(both of which are exclusively involved in the commercial paper program) until
January 1, 2004, which date will be automatically extended for successive 90-day
periods through September 30, 2004 if the outstanding amount of commercial paper
is reduced to agreed-upon levels from its current outstanding amount
(approximately $440.0 million). AMS agreed to partially address the
under-collateralization problem by transferring to EFG-III, LP approximately
$189 million of federally-guaranteed student loan and other assets that meet
loan eligibility requirements under the financing documents and by transferring
approximately $34.4 million of uninsured student loans that do not meet loan
eligibility requirements under the financing documents. In addition, AMS agreed
to contribute to EFG-III LP $46.5 million of the $48.25 million in cash
contributed to AMS by UICI, either in the form of cash or federally guaranteed
student loans. These various transfers by AMS eliminated the shortfall in
collateral amount with respect to the EFG-III LP commercial paper conduit
facility.
With respect to the AMS-1 2002, LP facility, as of July 24, 2003, the
interested parties agreed to waive, for a period of 90 days, all defaults,
amortization events and events of default based solely on defaults arising prior
to July 24, 2003 resulting from non-federally insured student loans included in
the collateral in excess of the maximum percentage limit for such loans as set
forth in the documents governing the financing, which waiver is not extendable.
In addition, with respect to four other student loan financing facilities, the
interested parties agreed to waive, as of July 24, 2003, all immaterial
previously-existing defaults resulting from inaccurate or untimely reporting to
interested parties or any other reporting deficiency by the applicable issuer
under each such facility, AMS or any other affiliate of AMS, for a period of 90
days, which period is not extendable.
Effective October 17, 2003, the interested parties agreed to extend the
initial 90-day waiver period under the AMS-1 2002, LP waiver to February 6,
2004, unless (a) UICI failed to execute a purchase agreement with Sallie Mae on
or before October 31, 2003 (in which case the waiver shall expire ten days
thereafter) or (b) UICI fails to close a transaction with Sallie Mae on or
before December 1, 2003 (in which case the waiver shall expire ten days
thereafter). Effective October 17, 2003, the interested parties agreed to extend
the initial 90-day waiver period under the EFG-IV, LP waiver to March 31, 2004,
unless (a) UICI fails to execute a purchase agreement with Sallie Mae on or
before October 31, 2003 (in which case the waiver shall expire ten days
thereafter) or (b) UICI fails to close a transaction with Sallie Mae on or
before December 1, 2003 (in which case the waiver shall expire ten days
thereafter). As discussed above, on October 29, 2003, UICI executed a definitive
agreement with Sallie Mae to sell AMS, and pursuant to the agreement Sallie Mae
has agreed to assume responsibility for liquidating and terminating all of the
remaining special purpose financing facilities through which AMS previously
securitized student loans.
UICI believes that it has no obligations with respect to the
indebtedness of AMS' Special Purpose Subsidiaries or with respect to the
obligations of AMS relating to such financings. Nonetheless, in exchange for
UICI's capital contribution to AMS as described above, the financial
institutions named above have agreed to release UICI from any and all existing
claims or suits (other than claims for fraud at the UICI level) that could arise
relating to the AMS student loan financing facilities.
11
On August 7, 2003, AMS entered into a master repurchase facility with a
financial institution, the obligations under which are partially (to the extent
of $13.3 million) guaranteed by the Company. The proceeds of the facility are
used by AMS from time to time to initially fund AMS' student loan originations.
The repurchase facility provides for the purchase of student loans by the
financial institution at 96% of par, and the financial institution may put the
student loans back to AMS on the last day of each month. AMS, in turn, has the
right to require the financial institution to repurchase the student loans on
such date, with the interest rate on the repurchase facility reset on such date.
The lender under the facility is committed to provide up to $275.0 million of
financing. Amounts outstanding under the facility will bear interest at a
variable annual rate of LIBOR plus 75 basis points and are secured by student
loans made under the Federal Family Education Loan Program. The master
repurchase facility terminates on November 20, 2003 and is subject to monthly
extensions upon the mutual agreement of the financial institution and AMS.
The Audit Committee of UICI's Board of Directors, with the assistance
of independent counsel, conducted an investigation into the matters and events
leading to the announcement of the collateral shortfalls at AMS' student loan
financing facilities. Based on that investigation, the Company believes that
UICI's previously published consolidated financial statements have been fairly
presented.
Set forth below is a summary of the operating results of AMS for the
nine months ended September 30, 2003 and 2002:
NINE MONTHS ENDED SEPTEMBER 30,
------------------------------
2003 2002
--------- ----------
(UNAUDITED)
(IN THOUSANDS)
Revenues:
Student loan spread income:
Interest income -- student loans............ $ 41,122 $ 51,454
Interest expense -- student loans........... (27,304) (29,701)
--------- ----------
Net student loan spread income............ 13,818 21,753
Gain on sale of student loans.................. 3,868 3,866
Tuition payment program revenue:
Fee income.................................. 9,328 9,975
Investment income on trust balances......... 1,577 2,899
--------- ----------
Total tuition payment program revenue..... 10,905 12,874
Fee income -- loan servicing and other......... 8,914 9,595
--------- ----------
Net revenues:............................. 37,505 48,088
Operating expenses:
Interest expense -- other indebtedness......... 40 60
Other operating expenses....................... 44,272 42,829
--------- ----------
Total operating expenses.................... 44,312 42,889
--------- ----------
Income (loss) from operations............... (6,807) 5,199
Estimated loss from disposal................ (68,518) --
--------- ----------
Total pre-tax income (loss)...................... $ (75,325) $ 5,199
========= ==========
Set forth below is a summary of the financial condition of AMS as of
September 30, 2003 and December 31, 2002:
SEPTEMBER 30, DECEMBER 31,
2003 2002
----------- -----------
(UNAUDITED)
(IN THOUSANDS)
Assets:
Student loans.................................. $ 1,406,175 $ 1,335,540
Cash........................................... 5,712 38,660
Restricted cash................................ 427,834 332,407
Investment income due and accrued.............. 40,664 38,371
Other assets................................... 29,860 97,795
----------- -----------
Total assets.............................. 1,910,245 1,842,773
Liabilities:
Collections payable............................ 205,979 155,908
Other liabilities.............................. 21,940 28,559
Student loan credit facilities................. 1,644,899 1,602,602
----------- -----------
Total liabilities........................... 1,872,818 1,787,069
----------- -----------
Net assets held for sale.................... $ 37,427 $ 55,704
=========== ===========
12
In April 2003, AMS completed the sale to institutional investors of
$366.7 million principal amount of student loan asset-backed notes issued by a
Special Purpose Subsidiary of AMS, consisting of a series of senior notes in the
aggregate principal amount of $330.0 million and a series of subordinated notes
in the aggregate principal amount of $36.7 million. The notes are secured by a
pledge of federally guaranteed student loans and alternative (i.e.,
non-federally guaranteed) student loans. As of August 18, 2003, the senior notes
were rated AAA by Standard & Poor's and Fitch, Inc. and Aaa by Moody's Investor
Service, and the subordinated notes were rated A by Standard & Poor's, A2 by
Moody's Investor Service and A+ by Fitch, Inc. The final scheduled payment date
of the senior and subordinated notes is May 2042. The notes are prepayable by
the Special Purpose Subsidiary at any time and from time to time at 100% of the
principal amount thereof. Interest on the senior notes is payable and reset
every 28 days at a rate equal to the 90-day LIBOR plus 1.25%, and interest on
the subordinated notes is payable and reset every 28 days at a rate equal to the
90-day LIBOR plus 2.25%.
AMS has a note payable in the outstanding principal amount of $1.5
million and $1.6 million at September 30, 2003 and December 31, 2002,
respectively. The note bore interest at approximately 2.8% at September 30,
2003, matures on June 30, 2004, requires principal and interest payments
quarterly and is secured by a first mortgage on real estate held by AMS. The
note is classified on the Company's balance sheet under the caption "AMS
liabilities held for sale."
NOTE D - INVESTMENT IN HEALTHAXIS, INC.
At July 1, 2003, the Company held 26,382,702 shares of common stock of
Healthaxis, Inc. (HAXS: Nasdaq) ("HAI"), which at such date represented
approximately 49.25% of the issued and outstanding shares of HAI. Effective
September 30, 2003, the Company sold to Healthaxis, Inc. (HAXS: Nasdaq) ("HAI")
its then entire 48.27% equity interest in HAI for a total sale price of $3.9
million, of which $500,000 was paid in cash at closing, and the balance was paid
by delivery of a promissory note payable to the Company in the amount of $3.4
million. The Company recognized a nominal loss for financial reporting purposes
in connection with the sale.
NOTE E - GOODWILL AND OTHER INTANGIBLE ASSETS
The Company adopted FASB Statements No. 141, Business Combinations, and
No. 142, Goodwill and Other Intangible Assets on January 1, 2002. In accordance
with Statement No. 142, the Company tested for goodwill impairment as of January
1, 2002. As a result of the transitional impairment testing, completed during
the quarter ended September 30, 2002, the Company determined that goodwill
recorded in connection with the acquisitions of AMS and Barron Risk Management
Services ("Barron") was impaired in the aggregate amount of $6.9 million ($5.1
million net of tax). AMS is classified as a discontinued operation for financial
reporting purposes at the end of the third quarter of 2003. The Company has
reflected this impairment charge in its financial statements as a cumulative
effect of a change in accounting principle as of January 1, 2002 in accordance
with Statement No. 142.
Effective February 28, 2002, UICI acquired STAR HRG for an initial cash
purchase price of $25.0 million, plus additional contingent consideration based
on the future annualized premium of STAR HRG measured over the three-month
period ended May 31, 2003. In June 2003, the Company recorded on its
consolidated balance sheet the additional consideration plus interest from date
of acquisition through May 31, 2003 ($16.1 million) as goodwill and established
a corresponding liability reflecting the obligation to pay the additional
consideration (see Note G).
Set forth in the table below is a summary of the goodwill and other
intangible assets by operating segment as of September 30, 2003 and December 31,
2002:
SEPTEMBER 30, 2003
-------------------------------------------------------------
(IN THOUSANDS)
OTHER
INTANGIBLE ACCUMULATED
GOODWILL ASSETS AMORTIZATION NET
-------- ---------- ------------ --------
Self Employed Agency Division............. $ 9,405 $ -- $ (3,972) $ 5,433
Group Insurance Division.................. 33,640 8,858 (2,525) 39,973
Life Insurance Division................... 552 -- (193) 359
-------- -------- -------- --------
$ 43,597 $ 8,858 $ (6,690) $ 45,765
======== ======== ======== ========
13
DECEMBER 31, 2002
-------------------------------------------------------------
(IN THOUSANDS)
OTHER
INTANGIBLE ACCUMULATED
GOODWILL ASSETS AMORTIZATION NET
-------- ---------- ------------ --------
Self Employed Agency Division............. $ 9,405 $ -- $ (3,972) $ 5,433
Group Insurance Division.................. 17,513 8,858 (1,428) 24,943
Life Insurance Division................... 552 -- (193) 359
-------- -------- -------- --------
$ 27,470 $ 8,858 $ (5,593) $ 30,735
======== ======== ======== ========
Other intangible assets consist of customer lists, trademark and
non-compete agreements related to the acquisition of Star Human Resources Group,
Inc. and STAR Administrative Services, Inc. (collectively referred by the
Company as its "STAR HRG" unit) completed in the three months ended March 31,
2002. (See Note G).
Set forth in the table below is a summary of the estimated amortization
expense for the next five years and thereafter for other intangible assets:
(IN THOUSANDS)
--------------
Remainder of 2003..... $ 365
2004.................. 1,270
2005.................. 1,082
2006.................. 948
2007.................. 722
2008 and thereafter... 1,946
--------
$ 6,333
========
NOTE F - DEBT
HOLDING COMPANY DEBT
At September 30, 2003 and December 31, 2002, the Company had
outstanding consolidated short and long-term indebtedness (exclusive of
indebtedness secured by student loans) in the amount of $4.0 million and $7.9
million, respectively, all of which constituted indebtedness of the holding
company.
On January 25, 2002, the Company entered into a three-year bank credit
facility with Bank of America, NA and LaSalle Bank National Association. Under
the facility, the Company may borrow from time to time up to $30.0 million on a
revolving, unsecured basis. The Company intends to utilize the proceeds of the
facility for general working capital purposes. At September 30, 2003, the
Company had no borrowings outstanding under the facility.
On June 22, 1994, the Company authorized an issue of its 8.75% Senior
Notes due June 2004 in the aggregate amount of $27.7 million. In accordance with
the agreement governing the terms of the notes (the "Note Agreement"),
commencing on June 1, 1998 and on each June 1 thereafter to and including June
1, 2003, the Company was required to pay approximately $4.0 million aggregate
principal together with accrued interest thereon to the date of such repayment.
The principal amount of the notes outstanding was $4.0 million and $7.9 million
at September 30, 2003 and December 31, 2002, respectively. The Company incurred
$403,000 and $663,000 of interest expense on the notes in the nine months ended
September 30, 2003 and 2002, respectively. The Note Agreement contains
restrictive covenants that include certain financial ratios, limitations on
additional indebtedness as a percentage of certain defined equity amounts and
the disposal of certain subsidiaries, including primarily the Company's
regulated insurance subsidiaries.
In full payment of all contingent consideration payable in connection
with UICI's February 2002 acquisition of STAR HRG, on November 10, 2003 UICI
delivered to the sellers UICI's 6% convertible subordinated notes in the
aggregate principal amount of $15.0 million, together with cash interest in the
aggregate amount of approximately $1.5 million. The subordinated notes are
convertible into UICI Common Stock at a conversion price of $20.06 per common
share. See Note G of Notes to Condensed Consolidated Financial Statements.
STUDENT LOAN DEBT
At each of September 30, 2003 and December 31, 2002, the Company,
through its former College Fund Life Division, had outstanding an aggregate of
$150.0 million of indebtedness issued by a special purpose entity ("Special
Purpose Subsidiary") under a secured student loan credit facility. The accounts
of the Company's Special Purpose Subsidiary are included in the Company's
Consolidated Financial Statements. At September 30, 2003 and
14
December 31, 2002, the indebtedness issued by the Special Purpose Entity was
secured by privately guaranteed and alternative (i.e., non-federally guaranteed)
student loans and by a pledge of cash, cash equivalents and other qualified
investments. All such indebtedness issued by the Special Purpose Subsidiary is
reflected as student loan indebtedness on the Company's consolidated balance
sheet; all such student loans pledged to secure such indebtedness are reflected
as student loan assets on the Company's consolidated balance sheet; and all such
cash, cash equivalents and qualified investments specifically pledged under the
student loan credit facility are reflected as restricted cash on the Company's
consolidated balance sheet.
The notes represent obligations solely of the Special Purpose Entity
and not of the Company or any other subsidiary of the Company. For financial
reporting and accounting purposes, the College Fund Life Division structured
finance facility has been classified as a financing. Accordingly, in connection
with the financing the Company recorded no gain on sale of the assets
transferred to the Special Purpose Entity and, on a consolidated basis, the
Company continues to carry on its consolidated balance sheet the alternative
student loans ($99.6 million and $95.2 million principal amount at September 30,
2003 and December 31, 2002, respectively) and cash and cash equivalents held by
the Special Purpose Entity ($44.9 million and $48.2 million at September 30,
2003 and December 31, 2002, respectively, classified as restricted cash) and the
associated indebtedness ($150.0 million and $150.0 million at September 30, 2003
and December 31, 2002, respectively, which is included on the Company's
consolidated balance sheet as student loan credit facility) arising from the
transaction.
During the three months ended September 30, 2003 and 2002, the Company
incurred total interest on borrowings associated with the College Fund Life
Division securitization in the amount of $433,000 and $756,000, respectively.
At December 31, 2002 and September 30, 2003, AMS had indebtedness outstanding
under six secured student loan financing facilities that issue debt securities
secured by student loans and other qualified collateral in the aggregate
outstanding amount of $1,644.9 million and $1,602.6 million, respectively. All
such indebtedness is included in "AMS liabilities held for sale" on the
Company's consolidated balance sheet. See Note C of Notes to Condensed
Consolidated Financial Statements for additional information concerning AMS
securitized student loan facilities.
NOTE G - ACQUISITIONS AND DISPOSALS
In February 2002 UICI acquired STAR HRG for an initial cash purchase
price of $25.0 million, plus additional contingent consideration based on the
amount of annualized premium of STAR HRG measured over the three-month period
ended May 31, 2003. The contingent consideration was established as an amount
not to exceed $15.0 million and is payable, at the Company's option, in cash or
by delivery of UICI's 6.0% convertible subordinated notes due March 1, 2012
plus, in each case, interest payable in cash computed at a rate of 6% from the
initial closing. UICI and the sellers of STAR determined that the full
contingent consideration of $15.0 million was payable during the three months
ended June 30, 2003. In full settlement of the contingent portion of the
purchase price, on November 10, 2003, the Company issued to the sellers UICI's
6% convertible subordinated notes in the aggregate principal amount of $15.0
million, together with cash interest in the aggregate amount of approximately
$1.5 million. The subordinated notes are convertible into UICI Common Stock at a
conversion price of $20.06 per common share.
In connection with the acquisition, in the first quarter of 2002 the
Company recorded non-amortizable goodwill in the amount of $17.5 million and
amortizable intangible assets in the amount of $8.9 million. During the three
months ended June 30, 2003, the Company recorded on its consolidated balance
sheet the additional consideration plus interest from date of acquisition
through May 31, 2003 ($16.1 million) as goodwill and established a corresponding
liability reflecting the obligation to pay the additional contingent
consideration. In the period commencing June 1, 2003 through September 30, 2003,
the Company recorded $300,000 of interest expense related to this contingent
consideration.
NOTE H - INCOME TAXES
The Company's effective tax rate on continuing operations for the three
and nine month periods ended September 30, 2003 was 33.6% and 34.5%,
respectively, compared to 33.3% and 31.8% respectively, in the corresponding
2002 periods. Comparable low-income housing tax credits for 2003 and 2002, when
expressed as a percentage of each year's anticipated taxes, resulted in a lower
effective tax rate for the nine-months ended September 30, 2002 compared to the
corresponding 2003 period.
15
The tax benefit on the losses from discontinued operations for the 2003
periods varied from the expected benefit (at the statutory rate of 35%)
primarily as a result of the non-deductible portion of the AMS impairment
charge. For the 2002 periods, the tax benefit is primarily attributable to the
release of a valuation allowance associated with the net operating loss
carryforward of AMS.
NOTE I - EARNINGS (LOSS) PER SHARE
The following table sets forth the computation of basic and diluted
earnings (loss) per share:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------- ----------------------------
2003 2002 2003 2002
---------- ---------- ---------- ----------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Income (loss) available to common shareholders:
Income from continuing operations available to
common shareholders......................... $ 13,806 $ 15,800 $ 47,309 $ 32,061
Income (loss) from discontinued operations... (67,101) 422 (72,716) 1,970
---------- ---------- ---------- ----------
Income (loss) before cumulative effect of
accounting change........................... (53,295) 16,222 (25,407) 34,031
Cumulative effect of accounting change....... -- -- -- (5,144)
---------- ---------- ---------- ----------
Net income (loss)............................ $ (53,295) $ 16,222 $ (25,407) $ 28,887
========== ========== ========== ==========
Weighted average shares outstanding -- basic
earnings (loss) per share.................... 46,396 47,874 46,487 47,437
Effect of dilutive securities:
Employee stock options and other shares........ 1,528 667 1,490 1,417
---------- ---------- ---------- ----------
Weighted average shares outstanding -- dilutive
earnings (loss) per share.................... 47,924 48,541 47,977 48,854
========== ========== ========== ==========
Basic earnings (loss) per share
From continuing operations................... $ 0.30 $ 0.33 $ 1.02 $ 0.68
From discontinued operations................. (1.45) 0.01 (1.57) 0.04
---------- ---------- ---------- ----------
Income (loss) before cumulative effect of
accounting change......................... (1.15) 0.34 (0.55) 0.72
Cumulative effect of accounting change....... -- -- -- (0.11)
---------- ---------- ---------- ----------
Net income (loss)............................ $ (1.15) $ 0.34 $ (0.55) $ 0.61
========== ========== ========== ==========
Diluted earnings (loss) per share
From continuing operations................... $ 0.29 $ 0.32 $ 0.99 $ 0.66
From discontinued operations................. (1.40) 0.01 (1.52) 0.04
---------- ---------- ---------- ----------
Income (loss) before cumulative effect of
accounting change........................... (1.11) 0.33 (0.53) 0.70
Cumulative effect of accounting change....... -- -- -- (0.11)
---------- ---------- ---------- ----------
Net income (loss)............................ $ (1.11) $ 0.33 $ (0.53) $ 0.59
========== ========== ========== ==========
NOTE J - LEGAL PROCEEDINGS
The Company is a party to the following material legal proceedings:
ASSOCIATION GROUP LITIGATION
Introduction
The health insurance products issued by the Company's insurance
subsidiaries in the self-employed market are primarily issued to members of
various independent membership associations that jointly market the products
with the insurance subsidiaries. The associations provide their membership with
a number of endorsed benefits and products, including the opportunity to apply
for health insurance underwritten by the Company's health insurance
subsidiaries. The Company and/or its insurance company subsidiaries have
recently been named a party to several lawsuits challenging the nature of the
relationship between the Company's insurance companies and the associations that
have endorsed the insurance companies' health insurance products.
Mississippi Individual Litigation
The MEGA Life and Health Insurance Company (a wholly owned subsidiary
of the Company) ("MEGA") is currently a defendant in eight separate lawsuits in
Mississippi (Tomlin et al. v. MEGA Life and Health Insurance Company, et al.,
filed on January 28, 2003 in the Circuit Court of Monroe County, Mississippi;
Bailey et al. v. MEGA Life, et al., filed on February 13, 2003 in the Circuit
Court of Chickasaw County, Mississippi; Pride, et al. v. MEGA Life, et al.,
filed on December 31, 2002 in the Circuit Court of Panola County, Mississippi;
Bishop v. John
16
Doe, MEGA Life and Health Insurance Company, et al., filed on April 15, 2003 in
the Circuit Court of Lafayette County, Mississippi; Clark, et al. v. MEGA Life
and Health Insurance Company, et al., filed on April 16, 2003 in the Circuit
Court of Tate County, Mississippi; Webster, et al. v. The MEGA Life and Health
Insurance Company, et al., filed on June 18, 2003 in the Circuit Court of the
First Judicial District of Chickasaw County, Mississippi; Mathis et al. v. MEGA
Life and Health Insurance Company, et al. filed on October 2, 2003 in the
Circuit Court of the First Judicial District of Hinds County, Mississippi; and
McCommon, et al. v. MEGA Life and Health Insurance Company, et al., filed on May
23, 2003, in the Circuit Court for Hinds County, et al. Mississippi).
Each of the Mississippi cases contains certain allegations regarding
the relationships between MEGA and the National Association for the
Self-Employed (NASE), the membership association that has endorsed MEGA's health
insurance products. Plaintiffs specifically allege, among other things, that
MEGA pursued a scheme of deceptive sales practices designed to create the
impression that the NASE is an independent entity; that in fact the NASE and
MEGA are "under common ownership and control;" that the benefits of the NASE
membership are negligible and membership is intended to permit MEGA to control
the insurer/insured relationship; and that the arrangement was intended to allow
MEGA to eliminate insureds with health problems from its block of business by
raising premiums. Plaintiffs demand punitive and economic damages in an
indeterminate amount, including excess premiums, association dues and charges,
administrative fees, and accrued interest.
The Tomlin, Bailey, Pride, Bishop, Clark, Webster and McCommon cases
have been removed to the United States District Court for the Northern District
of Mississippi. The plaintiffs in the Tomlin, Bailey, Pride and Bishop cases
have moved to remand the matters to state court. MEGA has moved to dismiss the
Tomlin, Bailey, Bishop and Pride cases, but has not answered or otherwise
responded in the Clark, Webster, Mathis or McCommon cases. No discovery has been
undertaken in any of the cases.
Mississippi Class Action Litigation
UICI, MEGA and UICI Marketing, Inc. have been named in a purported
nationwide class action suit filed on October 30, 2003 in federal court (Eugene
A. Golebiowski, individually and on behalf of others similarly situated, v.
MEGA, UICI, the National Association for the Self-Employed et al, pending in the
United States District Court for the Northern District of Mississippi, Eastern
Division). Plaintiffs have alleged, among other things, that the relationship
between NASE and MEGA constitutes an improper marketing scheme devised by the
defendants to sell insurance, and that the "scheme" involves the non-disclosure
of relationships between the defendants, the undisclosed transfer of association
membership dues and fees to MEGA, and the utilization of "teaser rates" that are
artificially low and established at an amount below that which would be
actuarially recommended. Plaintiff, individually and on behalf of similarly
situated class members, has asserted several causes of action, including
fraudulent concealment, breach of contract, common law liability for
non-disclosure, breach of fiduciary and trust duties, civil conspiracy, unjust
enrichment and violation of state deceptive and trade practice acts. Plaintiffs
seek declaratory judgment, injunctive, and other equitable relief. UICI, MEGA
and UICI Marketing have not been formally served or otherwise pled or responded
in the case.
California Litigation
As previously disclosed, UICI and Mid-West National Life Insurance
Company of Tennessee (a wholly owned subsidiary of the Company) ("Mid-West")
have been named as defendants in a suit filed on April 2, 2003 (Correa v. UICI,
et al.) in the Superior Court for the State of California, County of Los
Angeles, in which plaintiff has alleged, among other things, that defendants
have engaged in illegal marketing practices in connection with the sale of
health insurance. The plaintiff has asserted several causes of action, including
breach of contract, violation of California Business and Professions Code
Section 17200, false advertising, and negligent and intentional
misrepresentation. On July 3, 2003, the Correa case was removed to the United
States District Court for the Central District of California. The Company has
moved to dismiss plaintiff's second amended complaint or, in the alternative, to
require the Plaintiff to state the particulars of the alleged fraud and to
strike certain portions of the complaint as inconsistent with California law. A
hearing on such motions is scheduled for November 24, 2003.
As previously disclosed, UICI, MEGA, and Mid-West were named as
defendants in an action filed on April 22, 2003 (Lacy v. The MEGA Life and
Health Insurance Company, et al.) in Superior Court of California, County of
Alameda, Case No. RG03-092881. Plaintiff, purportedly on behalf of the "general
public," has alleged that all of the defendants are under common control and
operate as a unified business arrangement established for the purpose
17
of, among other things, generating profits through association dues and
bypassing and circumventing more stringent state insurance regulations
applicable to other California insurance companies. Plaintiff has further
alleged that defendants have knowingly and intentionally failed to disclose the
common ownership and control of the defendant group, the amount and character of
association dues administrative fees and other costs of obtaining insurance from
MEGA and Mid-West and that initial premium rates are below the amount
actuarially calculated for the purpose of inducing purchases of MEGA and
Mid-West policies. Plaintiffs assert that defendants' actions constitute a
violation of California Business and Professions Code Section 17200, for which
plaintiff is entitled to injunctive, disgorgement, and monetary relief in an
unspecified amount.
The Lacy case was removed on June 18, 2003 to the United States
District Court for the Northern District of California. The Company moved to
dismiss the case on July 15, 2003. The plaintiffs filed a motion to remand the
case to state court on August 15, 2003. The Court has taken both motions under
advisement. The Company also recently filed a motion requesting transfer to the
Central District of California for coordination with the Correa matter.
As previously disclosed, UICI and Mid-West were named in a lawsuit
filed on May 28, 2003 (Startup et al. v. UICI, et al.) in the Superior Court for
the State of California, County of Los Angeles, Case No. BC296476). Plaintiffs
have alleged, among other things, that UICI and Mid-West breached their duty of
good faith and fair dealing in failing to pay medical claims submitted under a
Mid-West policy issued to plaintiffs. Plaintiffs also alleged that the
relationship between Alliance and Mid-West constitutes an illegal marketing
"scheme" and asserted several causes of action, including breach of contract,
violation of California Business and Professions Code Section 17200, false
advertising, and negligent and intentional misrepresentation. Plaintiffs seek
injunctive relief and monetary damages in an unspecified amount. On October 28,
2003, the Court granted defendants' motion to compel arbitration and stayed the
case pending arbitration.
UICI and Mid-West were named as defendants in a lawsuit filed on July
25, 2003 (Portune, et. al. v. UICI, et al.), in the Superior Court of the State
of California, County of San Bernadino, Case No. RCV 074062. Plaintiffs have
alleged, among other things, that UICI and Mid-West breached their duty of good
faith and fair dealing in failing to pay medical claims submitted under a
Mid-West policy issued to plaintiffs. Plaintiffs also alleged that the
relationship between Alliance and Mid-West constitutes an illegal marketing
"scheme" and asserted several causes of action, including breach of contract,
violation of California Business and Professions Code Section 17200, false
advertising, and negligent and intentional misrepresentation. Plaintiffs seek
injunctive relief and monetary damages in an unspecified amount. On September
16, 2003, UICI and Mid-West removed the Portune case to the United States
District Court, Central District of California, Eastern Division. On October 15,
2003, the matter was transferred to the Western Division of the Central District
of California on the grounds that the case is related to the Correa matter. On
October 15, 2003, the Plaintiffs also moved to remand the case to state court.
On October 14, 2003, the Company moved to dismiss the Complaint, or in the
alternative, to require the plaintiffs to state the particulars of the alleged
fraud and strike certain portions of the Complaint as inconsistent with
California law.
On September 26, 2003, UICI and MEGA were named as cross defendants in
a lawsuit initially filed on July 30, 2003 (Retailers' Credit Association of
Grass Valley, Inc. v. Henderson, et al. v. UICI, et al. pending in the Superior
Court of the State of California for the County of Nevada, Case No. L69072). In
the suit, cross-plaintiffs allege, among other things, that UICI and MEGA
breached their duty of good faith and fair dealing in failing to pay medical
claims submitted under a MEGA policy issued to plaintiffs and that UICI and MEGA
failed to properly disclose the relationship between MEGA and the NASE. Cross
plaintiffs have asserted several causes of action, including breach of implied
covenant of good faith and fair dealing, fraud, violation of California Business
and Professions Code Section 17200, and negligent and intentional
misrepresentation. Cross-plaintiffs seek injunctive relief and monetary damages
in an unspecified amount and allege that MEGA denied insurance claims in an
amount exceeding $158,000.
UICI and MEGA were named as defendants in a lawsuit filed on October
29, 2003 (Dan Liebscher v. UICI, The MEGA Life and Health Insurance Company,
National Association for the Self Employed, et al pending in the Superior Court
of the State of California, County of Los Angeles, Case No. BC 305194).
Plaintiffs have alleged, among other things, that the failure to disclose the
relationship between MEGA and NASE served to fraudulently induce plaintiff into
joining NASE in order to acquire a health insurance policy and that UICI and
MEGA breached their duty of good faith and fair dealing in failing to pay
medical claims submitted under a MEGA policy issued to plaintiffs. Plaintiffs
have asserted several causes of action, including breach of contract, violation
of California
18
Business and Professions Code Section 17200, false advertising, and negligent
and intentional misrepresentation. Defendants have not responded or otherwise
pled in the case.
Texas Litigation
As previously disclosed, UICI and MEGA have been named as defendants in
a purported class action suit filed on April 22, 2003 (Garcia v. UICI, et al.)
in the District Court of Starr County, Texas, 381st Judicial District, Case No.
DC-03-135. Plaintiff, on behalf of himself and a purported class of similarly
situated individuals, has asserted, among other things, that MEGA, NASE Group
Trust and NASE are under common control and ownership and operate as a "unified
business arrangement" which is used solely for the purpose of generating profits
through association dues and avoiding state insurance regulations. Plaintiffs
have alleged that defendants have used false and deceptive advertising and sales
practices in connection with the sale of insurance in Texas in violation of the
Texas Insurance Code, and plaintiffs further allege conversion and breach of
contract, for which they have asked for a return of all association dues and
administrative fees collected by the defendants. MEGA, UICI, and NASE responded
to initial written discovery requests. Neither UICI nor MEGA has answered or
otherwise responded in the case. The Garcia case was removed on July 18, 2003 to
the United States District Court for the Southern District of Texas, McAllen
Division. The Plaintiffs have moved to remand the case back to state court.
Oklahoma Litigation
As previously disclosed, UICI and MEGA were named as defendants in a
lawsuit filed on May 2, 2003 (Grigsby, et al. v. The MEGA Life and Health
Insurance Company, et al.) in the District Court of Oklahoma County, Oklahoma,
Case No. CJ-2003-3759. Plaintiffs have alleged that the defendants defrauded
them into purchasing a health insurance policy and an association membership and
that MEGA acted in bad faith and in breach of its contractual obligations in
processing their health claims. Plaintiffs further allege that the defendants
knowingly misrepresented, among other things, their relationship with the NASE
and that plaintiffs were purchasing "true group insurance." Plaintiffs seek
actual and punitive damages. UICI and MEGA moved to dismiss the case on July 16,
2003.
In Re Association Group Insurance Litigation
On September 22, 2003, UICI, MEGA, and Mid-West petitioned the Judicial
Panel on Multidistrict Litigation to transfer and consolidate the Garcia,
Grigsby, Portune, Correa, Bishop, Lacy, Tomlin, Bailey, Pride, Clark, and
Webster cases for purposes of discovery and other pre-trial matters (In re
Association Group Insurance Litigation, MDL Docket No. 1578). UICI requested
transfer to the United States District Court for the Northern District of Texas.
The Correa, Portune, Garcia, Lacy, Bailey, and Tomlin plaintiffs have opposed
the motion to transfer and consolidate on the grounds that the underlying cases
did not have common fact and legal issues and that transfer and consolidation
would be inefficient and more costly. The Webster, Clark, Bishop, and Pride
plaintiffs, the NASE, and the Alliance for Affordable Services joined in the
motion to transfer and consolidate.
Idaho Litigation
The Company and Mid-West are currently named as defendants in five
pending suits in Idaho state court (Skinner, et al. v. Mid-West, UICI, et al.,
and Hansen v. Mid-West, UICI, et al., each filed on August 22, 2002 in pending
in the District Court for the County of Lemhi, Idaho; and Petersen, et al. v.
Mid-West, et al., filed on August 2, 2002, Murphy, et al. v. Mid-West, et al.,
filed January 25, 2002, and Graybeal, et al. v. Mid-West, et al., filed December
20, 2002, each pending in the District Court for the County of Twin Falls,
Idaho).
Plaintiffs in the Skinner and Hansen cases allege that the insurance
products they purchased were more expensive and provided less coverage than
represented by the agent who sold the policies and that they have not been paid
on claims submitted pursuant to those policies. Plaintiffs in Skinner and Hansen
claim damages, including punitive damages, and attorneys' fees. The Company
moved for partial summary judgment with respect to plaintiffs' breach of
contract and bad faith claims in both cases. Mid-West also filed motions to
dismiss certain of the plaintiffs' claims in both cases. Those motions are
pending before the Court. Mid-West answered the complaints on September 30,
2002. Discovery has commenced in each case, and both cases are currently
scheduled for trial in August 2004.
19
Plaintiffs in Peterson, Murphy, and Graybeal allege, among other
things, that the Mid-West policies they purchased were of a lesser quality than
represented and that they have not been paid for certain claims submitted under
the policies. Plaintiffs in Peterson purport to represent a class of similarly
situated persons. Plaintiffs in each of the actions claim damages, including
punitive damages, and attorneys' fees. The Idaho Supreme Court recently ruled
that the Murphy plaintiffs were not required to arbitrate their disputes with
Mid-West. Both the Petersen and Murphy cases are currently stayed. Mid-West has
not answered the complaint in either Petersen or Murphy. Mid-West answered the
complaint in Graybeal on March 24, 2003. Discovery has commenced in Graybeal,
and trial is currently scheduled to begin in October 2004.
The Company believes that plaintiffs' claims in all of these cases are
without merit, and the Company intends to vigorously contest the claims.
INSURANCE REGULATORY MATTERS
The Company's insurance subsidiaries are subject to extensive
regulation in their states of domicile and the other states in which they do
business under statutes that typically delegate broad regulatory, supervisory
and administrative powers to state insurance departments and agencies. The
method of regulation varies, but the subject matter of such regulation covers,
among other things, the amount of dividends and other distributions that can be
paid by the Company's insurance subsidiaries without prior approval or
notification; the granting and revoking of licenses to transact business; trade
practices, including with respect to the protection of consumers; disclosure
requirements; privacy standards; minimum loss ratios; premium rate regulation;
underwriting standards; approval of policy forms; methods and timing of claims
payment; licensing of insurance agents and the regulation of their conduct; the
amount and type of investments that the Company's subsidiaries may hold; minimum
reserve and surplus requirements; risk-based capital requirements; and compelled
participation in, and assessments in connection with, risk sharing pools and
guaranty funds. Such regulation is intended to protect policyholders rather than
investors.
The Company's insurance subsidiaries are required to file detailed
annual statements with the state insurance regulatory departments, and state
insurance departments have also periodically conducted and continue to conduct
periodic financial and market conduct examinations of UICI's insurance
subsidiaries. As of September 30, 2003, either or both MEGA and Mid-West were
subject to ongoing market conduct examinations in 12 states. State insurance
regulatory agencies have broad authority to levy monetary fines and penalties
resulting from findings made during the course of such financial and market
conduct examinations. Historically, the Company's insurance subsidiaries have
from time to time been assessed such fines and penalties, none of which
individually or in the aggregate have had a material adverse effect on the
results of operations or financial condition of the Company.
The Company provides health insurance products to consumers in the
self-employed market in 44 states. A substantial portion of such products is
issued to members of various independent membership associations that endorse
the products and act as the master policyholder for such products. The two
principal membership associations in the self-employed market for which the
Company underwrites insurance are the NASE and the Alliance for Affordable
Services ("AAS"). The associations provide their membership with a number of
endorsed benefits and products, including health insurance underwritten by the
Company. Subject to applicable state law, individuals generally may not obtain
insurance under an association's master policy unless they are also members of
the associations. UGA agents and Cornerstone agents also act as field service
representatives on behalf of the associations, in which capacity the agents act
as enrollers of new members for the associations and provide field support
services, for which the agents receive compensation. Specialized Association
Services, Inc. (a company controlled by the adult children of the Chairman of
the Company) provides administrative and benefit procurement services to the
associations, and a subsidiary of the Company sells new membership sales leads
to the enrollers and video and print services to the associations and to
Specialized Association Services, Inc. In addition to health insurance premiums
derived from the sale of health insurance, the Company receives fee income from
the associations, including fees associated with the enrollment of new members,
fees for association membership marketing and administrative services and fees
for certain association member benefits. The agreements with these associations
requiring the associations to continue as the master policyholder and to endorse
the Company's insurance products to their respective members are terminable by
the Company and the associations upon not less than one year's advance notice to
the other party.
Articles in the press have been critical of association group coverage.
In December 2002, the NAIC convened a special task force to review association
group coverage, and the Company is aware that selected states are reviewing the
laws and regulations under which association group policies are issued. As
discussed above, the Company
20
and/or its insurance subsidiaries have also recently been named a party to
several lawsuits challenging the nature of the relationship between the
Company's insurance companies and the principal membership associations that
have endorsed the insurance companies' health insurance products. While the
Company believes it is providing association group coverage in full compliance
with applicable law, changes in the relationship between the Company and the
membership associations and/or changes in the laws and regulations governing
so-called "association group" insurance (particularly changes that would subject
the issuance of policies to prior premium rate approval and/or require the
issuance of policies on a "guaranteed issue" basis) could have a material
adverse impact on the financial condition, results of operations and/or business
of the Company.
OTHER LITIGATION MATTERS
The Company and its subsidiaries are parties to various other pending
legal proceedings arising in the ordinary course of business, including some
asserting significant damages arising from claims under insurance policies,
disputes with agents and other matters. Based in part upon the opinion of
counsel as to the ultimate disposition of such lawsuits and claims, management
believes that the liability, if any, resulting from the disposition of such
proceedings will not be material to the Company's financial condition or results
of operations.
NOTE K - RELATED PARTY TRANSACTIONS
SALE OF HEALTHAXIS, INC. EQUITY STAKE
Effective September 30, 2003, the Company sold to Healthaxis, Inc.
("HAI") its 49.25% equity interest in HAI for a sale price of $3.9 million, of
which $500,000 was paid in cash at closing, and the balance was paid by an
unsecured promissory note issued by HAI to the Company in the principal amount
of $3.4 million. The note will be amortized by credits against amounts otherwise
payable by UICI for data and imaging services provided from time to time by
Healthaxis Imaging Services (a subsidiary of HAI), to The MEGA Life and Health
Insurance Company, in accordance with an existing service agreement. The note
has a three year term and is payable monthly in the amount of 50% of the service
fees due pursuant to the service agreement or $65,000 per month, whichever is
greater. The Company recognized a nominal loss for financial reporting purposes
in connection with the sale.
RICHLAND STATE BANK TRANSACTION
Richland State Bank ("RSB") is a state-chartered bank in which Ronald
L. Jensen (the Company's Chairman) holds a 100% equity interest. In accordance
with the terms of a loan origination agreement with Academic Management Services
Corp., RSB has historically provided to AMS certain loan origination and
underwriting services with respect to an AMS student loan program for students
in post-secondary education (primarily graduate health curricula). In accordance
with the origination agreement, RSB originated the student loans and resold such
loans to AMS at par plus an origination fee of 31 basis points (0.31%). In
addition, the agreement provided that AMS was required to prefund all loans
originated by RSB by depositing on account at RSB cash sufficient to fund the
loans. All obligations of AMS under the loan origination agreement have been
guaranteed by UICI.
Following announcement of collateral deficiencies at AMS in July 2003,
AMS terminated the uninsured alternative student loan program for which RSB acts
as originator. However, loans and loan commitments in process prior to July 16,
2003 have been and will continue to be funded. In an effort to free up cash to
be used for operations at AMS, on September 25, 2003, AMS and RSB entered into
an amendment to the loan origination agreement, pursuant to which RSB has agreed
to release to AMS restricted cash on deposit (approximately $2.0 million) and
hold the student loans until December 31, 2003 (in the case of fully funded
loans) and May 20, 2004 (in the case of second disbursements).
AMENDMENT TO UICI - SPECIAL INVESTMENT RISKS, LTD. AGREEMENT
As previously disclosed, from the Company's inception through 1996,
Special Investment Risks, Ltd. ("SIR") (formerly United Group Association, Inc.)
(a company owned by the Company's Chairman) sold health insurance policies that
were issued by AEGON USA and coinsured by the Company or policies that were
issued directly by the Company. Effective January 1, 1997, the Company acquired
the agency force of SIR and certain tangible assets of SIR for a price equal to
the net book value of the tangible assets acquired and assumed certain agent
commitments of $3.9 million. The tangible assets acquired consisted primarily of
agent debit balances, a building, and related furniture and fixtures having a
net book value of $13.1 million.
21
In accordance with the terms of an amendment, dated July 22, 1998, to
the terms of the initial sale agreement governing the sale of the UGA assets to
the Company, SIR was granted the right to retain 10% of net renewal commissions
(computed at the UGA -- Association Field Services agency level) on any new
business written by the UGA agency force after January 1, 1997. During the year
ended December 31, 2002 and nine months ended September 30, 2003, the Company
paid to SIR the amount of $1.9 million and $2.9 million, respectively, pursuant
to this override arrangement.
In an effort to simplify the calculation of the payments to be made to
Mr. Jensen and to clarify with specificity the business subject to the override
arrangement, the Company and SIR have entered into an amendment to the asset
sale agreement, the principal effect of which is to change the basis of the
override calculation from a multiple of renewal commissions received by UGA -
Association Field Services to a multiple of commissionable renewal premium
received. Based on management's projections of future business, the Company
estimates that the absolute amount of future override commission to be paid to
SIR pursuant to the amendment will not vary in any material respect from that
expected to be paid in accordance with the existing arrangement.
PURCHASE OF MINORITY INTEREST IN U.S. MANAGERS LIFE INSURANCE LTD.
As previously disclosed, UICI formerly held a 79% equity interest in
U.S. Managers Life Insurance Company Ltd, a Turks and Caicos Islands domiciled
insurer ("U.S. Managers"). The remaining 21% minority interest in U.S. Managers
was held by Onward and Upward, Inc. ("OUI"), a corporation owned by the adult
children of Ronald L. Jensen (the Company's Chairman). The shares held by OUI
were subject to the terms of a Stock Agreement, dated as of January 3, 1992, as
amended (the "Stock Agreement"), between UICI and OUI, pursuant to which OUI had
a put, and UICI had a corresponding obligation to purchase, the minority
interest in U.S. Managers at a formula price generally equal to the cost of such
minority interest plus (or minus) cumulative earnings (losses) of U.S. Managers.
OUI notified UICI of its intent to exercise its put and sell its 21%
minority interest in U.S. Managers at the formula price calculated as of July
31, 2003, and UICI and OUI entered into a Purchase Agreement governing the terms
of the exercise of the put and sale to UICI of the minority interest. In
accordance with the terms of the Purchase Agreement, on August 26, 2003, UICI
purchased the 21% minority interest in U.S. Managers from OUI for a purchase
price of $863,000, representing the formula price at July 31, 2003.
SALE OF SHARES BY MR. MUTZ
On May 6, 2003, the Company completed the purchase of 207,104 shares of
UICI common stock from Gregory T. Mutz (the President and Chief Executive
Officer of the Company until July 1, 2003). The shares were purchased for a
total purchase price of $2.8 million, or $13.67 per share, which was the closing
price of UICI shares on the New York Stock Exchange on May 5, 2003. Part of the
proceeds from the sale was used to retire indebtedness owing by Mr. Mutz to the
Company in the amount of $1.3 million, which indebtedness had initially been
incurred by Mr. Mutz in 1998-99 to acquire shares of UICI stock pursuant to the
Company's Executive Stock Purchase Program.
In a separate transaction, on May 8, 2003, Mr. Mutz sold 265,507 shares of
UICI common stock to Ronald L. Jensen (Chairman of the Company). All of the
proceeds of such sale were used by Mr. Mutz to pay in full indebtedness owing to
Mr. Jensen, which indebtedness had initially been incurred to acquire shares of
UICI stock in 1998.
TRANSFER OF MINORITY INTEREST IN SUNTECH PROCESSING SYSTEMS, LLC
On May 13, 2003, the Company, Mr. Jensen and the plaintiffs reached
agreement on a full and final settlement of litigation (Sun Communications, Inc.
v. SunTech Processing Systems, LLC, UICI, Ronald L. Jensen, et al) concerning
the distribution of the cash proceeds from the sale and liquidation of SunTech
Processing Systems, LLC ("STP") assets in February 1998 (the "Sun Litigation").
As previously disclosed, effective April 2, 2002, the Company and Mr.
Jensen entered into an Assignment and Release Agreement, which, among other
things, transferred UICI's financial and other rights and obligations in STP to
Mr. Jensen and effectively terminated the Company's active participation in, and
limited the Company's financial exposure associated with, the Sun Litigation. In
accordance with the terms of the Assignment and Release Agreement, on April 2,
2002 Mr. Jensen made a total payment to UICI of $15.6 million and granted to
UICI various indemnities against possible losses which UICI might incur
resulting from the Sun Litigation. In addition, as part of
22
the terms of the Assignment and Release Agreement UICI granted to Mr. Jensen an
irrevocable option to purchase and to receive an assignment of UICI's membership
interests, including without limitation all of UICI's Class A Interests and
Class B Interests (constituting an 80% economic interest) in STP for an exercise
price of $100.
Following settlement of the Sun Litigation, and pursuant to the terms
of an agreement dated as of June 17, 2003, by and between UICI and Mr. Jensen,
Mr. Jensen exercised his option to purchase UICI's membership interests in STP,
and UICI assigned and transferred to Mr. Jensen all of the Company's right,
title and interest in and to such STP membership interests. For financial
reporting purposes the Company recognized no gain or loss in connection with
this transaction.
NOTE L - SEGMENT INFORMATION
The Company's operating segments included in operations are: (i)
Insurance, which includes the businesses of the Self Employed Agency Division,
the Group Insurance Division (formerly the Company's Student Insurance Division,
which includes the operations of the Company's recently-acquired STAR HRG
business unit effective February 28, 2002), and the Life Insurance Division
(formerly the Company's OKC Division, which includes the Company's College Fund
Life Division), (ii) Financial Services, which included (until its sale
effective September 30, 2003) the Company's investment in Healthaxis, Inc., and
(iii) Other Key Factors.
Effective January 1, 2003, the Company began to allocate to the
Company's operating business segments certain general expenses relating to
corporate operations (consisting primarily of technology related expenses and
expenses associated with the operations of the Company's insurance company
subsidiaries), which expenses had been formerly reflected in the Other Key
Factors segment. All business segment results for all periods presented have
been restated to reflect such allocation of these expenses. The Company believes
that this allocation of certain general expenses relating to corporate
operations results in a more accurate portrayal of the financial results of its
core insurance and other operations. The Other Key Factors segment now includes
investment income not allocated to the other business segments, realized gains
or losses on sale of investments, the operating results at the Company's former
Barron Risk Management Services, Inc. unit until its sale in September 2002, the
operations of the Company's AMLI Realty Co. subsidiary, certain other general
expenses related to corporate operations, minority interest, interest expense on
corporate debt and variable stock-based compensation.
Allocations of investment income and certain general expenses are based
on a number of assumptions and estimates, and the business segments reported
operating results would change if different methods were applied. Certain assets
are not individually identifiable by segment and, accordingly, have been
allocated by formulas. Segment revenues include premiums and other policy
charges and considerations, net investment income, fees and other income.
Management does not allocate income taxes to segments. Transactions between
reportable operating segments are accounted for under respective agreements,
which provide for such transactions generally at cost.
Revenues from continuing operations, income from continuing operations
before federal income taxes, and assets by operating segment are set forth in
the tables below:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ ----------------------
2003 2002 2003 2002
---------- --------- --------- -------
(IN THOUSANDS)
Revenues
Insurance:
Self Employed Agency Division............... $344,999 $273,794 $ 982,715 $741,158
Group Insurance Division.................... 87,730 65,406 254,031 164,676
Life Insurance Division..................... 16,295 17,773 48,188 56,385
-------- -------- ---------- --------
449,024 356,973 1,284,934 962,219
-------- -------- ----------- --------
Other Key Factors............................ 4,557 5,283 11,118 9,685
Intersegment Eliminations.................... (14) -- (554) --
-------- -------- ---------- ---------
Total revenues from continuing operations...... $453,567 $362,256 $1,295,498 $ 971,904
======== ======== ========== =========
23
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ----------------------
2003 2002 2003 2002
------- ------- ------- -------
(IN THOUSANDS)
Income (loss) from continuing operations before federal
income taxes:
Insurance:
Self Employed Agency Division........................ $ 32,517 $23,128 $80,819 $58,547
Group Insurance Division............................. (12,075) 3,030 (3,969) 8,088
Life Insurance Division.............................. (296) 1,243 (3,196) 6,675
-------- ------- ------- -------
20,146 27,401 73,654 73,310
-------- ------- ------- -------
Financial Services:
Losses in Healthaxis, Inc. investment................ (1,266) (796) (2,211) (8,895)
-------- ------- ------- -------
(1,266) (796) (2,211) (8,895)
-------- ------- ------- -------
Other Key Factors:
Investment income on equity, realized gains and losses,
general corporate expenses and other (including
interest expense on non-student loan indebtedness).. 711 960 (921) (3,131)
Variable stock-based compensation (expense) benefit.. 1,211 (3,890) 1,663 (14,258)
-------- ------- ------- -------
1,922 (2,930) 742 (17,389)
-------- ------- ------- -------
Total income from continuing operations before federal
income taxes.......................................... $ 20,802 $23,675 $72,185 $47,026
======== ======= ======= =======
SEPTEMBER 30, DECEMBER 31,
2003 2002
------------- -------------
(IN THOUSANDS)
Assets
Insurance:
Self Employed Agency Division........... $ 742,140 $ 665,938
Group Insurance Division................ 223,122 152,858
Life Insurance Division................. 612,280 630,238
------------- -------------
1,577,542 1,449,034
------------- -------------
Financial Services:
AMS assets held for sale................ 1,910,245 1,842,773
Investment in Healthaxis, Inc........... -- 4,929
------------- -------------
1,910,245 1,847,702
Other Key Factors:
General corporate and other............. 398,528 424,768
------------- -------------
Total assets............................... $ 3,886,315 $ 3,721,504
============= =============
NOTE M - STOCK OPTIONS
The Company has historically accounted for the stock-based compensation
plans under Accounting Principles Board (APB) Opinion No. 25, Accounting for
Stock Issued to Employees. Under APB 25, because the exercise price of the
Company's employee stock options has been equal to the market price of
underlying stock on the date of grant, no compensation expense has to date been
recognized. On January 1, 2003, the Company adopted Statement No. 123 for all
employee awards granted or modified on or after January 1, 2003, and will begin
measuring the compensation cost of stock-based awards under the fair value
method. The Company adopted Statement No. 148 on January 1, 2003 and has adopted
the transition provisions that require expensing options prospectively in the
year of adoption. Existing awards will continue to follow the intrinsic value
method prescribed by APB 25. The impact of implementation on the Company's
financial position or results of operations was not material.
Pro forma information regarding net income and earnings per share is
required by Statement No. 123, and has been determined as if the Company had
accounted for its employee stock options under the fair value method of that
Statement. The fair value for all options was estimated at the date of grant
using a Black-Scholes option pricing model with the following weighted-average
assumptions for 2003: risk-free interest rate 2.00%; dividend yield of 0%,
volatility factor of the expected market price of the Company's common stock of
0.58; and a weighted-average expected life of the option of 3.00 years. The
weighted average grant date fair value per share of stock options issued in 2003
was $4.54. The weighted-average assumptions for 2002: risk-free interest rate
3.53%; dividend yield of 0%, volatility factor of the expected market price of
the Company's common stock of 0.65; and a weighted-average expected life of the
option of 4.26 years. The weighted average grant date fair value per share of
stock options issued in 2002 was $4.46.
24
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The effect on
net income of the stock compensation amortization for the periods presented
above is not likely to be representative of the effects on reported net income
for future periods. The Company's pro forma information is set forth below (in
thousands except for earnings per share information):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- ------------------------
2003 2002 2003 2002
---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
Pro forma income (loss):
Income from continuing operations..................... $ 13,754 $ 15,463 $ 47,020 $ 29,323
Income (loss) from discontinued operations............ (67,101) 422 (72,716) 1,970
Loss from cumulative effect of accounting change...... -- -- -- (5,144)
---------- ---------- ---------- ----------
Net income.......................................... $ (53,347) $ 15,885 $ (25,696) $ 26,149
========== ========== ========== ==========
Pro forma earnings (loss) per common share:
Basic earnings:
Income from continuing operations.................... $ 0.30 $ 0.32 $ 1.02 $ 0.62
Income (loss) from discontinued operations........... (1.45) 0.01 (1.57) 0.04
Loss from cumulative effect of accounting change..... -- -- -- (0.11)
---------- ---------- ---------- ----------
Net income (loss)................................... $ (1.15) $ 0.33 $ (0.55) $ 0.55
========== ========== ========== ==========
Diluted earnings:
Income from continuing operations.................... $ 0.29 $ 0.31 $ 0.98 $ 0.60
Income (loss) from discontinued operations........... (1.40) 0.01 (1.51) 0.04
Loss from cumulative effect of accounting change..... -- -- -- (0.11)
---------- ---------- ---------- ----------
Net income (loss)................................... $ (1.11) $ 0.32 $ (0.53) $ 0.53
========== ========== ========== ==========
NOTE N - EMPLOYEE AND AGENT STOCK ACCUMULATION PLANS
UICI EMPLOYEE STOCK OWNERSHIP AND SAVINGS PLAN
The Company maintains for the benefit of its and its subsidiaries'
employees the UICI Employee Stock Ownership and Savings Plan (the "Employee
Plan").
During the three and nine months ended September 30, 2002, the Company
recorded an expense of $2.5 million and $5.7 million, respectively, related to
stock appreciation expense with respect to the Employee Plan. This expense
represented the incremental compensation expense associated with the allocation
to participants' accounts during the respective period of shares, previously
purchased in 2000 by the Employee Plan from the Company at $5.25 per share
("$5.25 ESOP Shares") to fund the Company's matching and supplemental
contributions to the ESOP. The allocated $5.25 ESOP Shares were considered
outstanding for purposes of the computation of earnings per share. The Employee
Plan initially purchased in 2000 an aggregate of 1,610,000 $5.25 ESOP Shares,
and as of December 31, 2002 all such shares had been allocated to participants'
accounts. During the fourth quarter of 2002, the Company allocated the remaining
unallocated shares to participants' accounts.
AGENT STOCK ACCUMULATION PLANS
The Company sponsors a series of stock accumulation plans (the "Agent
Plans") established for the benefit of the independent insurance agents and
independent sales representatives associated with its field force agencies,
including UGA -- Association Field Services, New United Agency and Cornerstone
Marketing of America.
The Agent Plans generally combine an agent-contribution feature and a
Company-match feature. The agent-contribution feature generally provides that
eligible participants are permitted to allocate a portion (subject to prescribed
limits) of their commissions or other compensation earned on a monthly basis to
purchase shares of UICI common stock at the fair market value of such shares at
the time of purchase. Under the Company-match feature of the Agent Plans,
participants are eligible to have posted to their respective Agent Plan accounts
book credits in the form of equivalent shares based on the number of shares of
UICI common stock purchased by the participant under the agent-contribution
feature of the Agent Plans. The "matching credits" vest over time (generally in
prescribed increments over a ten-year period, commencing the plan year following
the plan year during which contributions are first made under the
agent-contribution feature), and vested matching credits in a participant's plan
account in January of each year are converted from book credits to an equivalent
number of shares of UICI common stock. Matching credits forfeited by
participants no longer eligible to participate in the Agent Plans are
reallocated each year among eligible participants and credited to eligible
participants' Agent Plan accounts.
The Agent Plans do not constitute qualified plans under Section 401(a)
of the Internal Revenue Code of 1986 or employee benefit plans under the
Employee Retirement Income Security Act of 1974 ("ERISA"), and the Agent Plans
are not subject to the vesting, funding, nondiscrimination and other
requirements imposed on such plans by the Internal Revenue Code and ERISA.
Prior to July 1, 2000, the Company granted matching credits in an
amount equal to the number of shares of UICI common stock purchased by the
participant under the agent-contribution feature of the Agent Plans. Effective
July 1, 2000, the Company modified the formula for calculating the number of
matching credits to be posted to participants' accounts. During the period
beginning July 1, 2000 and ending on the earlier of June 30, 2002 or the date
that an aggregate of 2,175,000 share equivalents had been granted under this
revised formula, the number of matching credits issued to an individual
participant will be the greater of (a) the number of matching credits
25
determined each month by dividing the dollar amount of the participant's
contribution for that month by $5.25, or (b) the actual number of shares
acquired, at then-current fair market value, by the participant's contribution
amount.
Prior to July 1, 2000, the Company purchased UICI shares in the open
market from time to time to satisfy its commitment to issue its shares upon
vesting of matching credits under the Agent Plans. During the period beginning
July 1, 2000 and ending July 31, 2002, the Company agreed to utilize up to
2,175,000 newly issued shares to satisfy its commitment to deliver shares that
will vest under the Company-match feature of the agent plans. Under the
arrangement effective July 1, 2000, the Company's subsidiaries transferred to
the holding company $5.25 per share for any newly issued shares utilized to fund
vested matching credits under the plans. In accordance with such arrangement,
during the period commencing July 1, 2000 and ending on July 31, 2002, the
Company issued to the subsidiaries an aggregate of 1,765,251 shares, for which
the Company's subsidiaries transferred to the Company at the holding company
level cash in the aggregate amount of $9.3 million. Subsequent to July 31, 2002,
the Company resumed purchasing UICI shares in the open market from time to time
to satisfy its commitment to issue its shares upon vesting of matching credits
under the Agent Plans.
For financial reporting purposes, the Company accounts for the
Company-match feature of its Agent Plans under EITF 96-18 "Accounting for Equity
Instruments that are issued to Other Than Employees for Acquiring or in
Connection with Selling Goods and Services," by recognizing compensation expense
over the vesting period in an amount equal to the fair market value of vested
shares at the date of their vesting and distribution to the participants. At
each quarter-end, the Company estimates its current liability for unvested
matching credits by reference to the number of unvested credits, the current
market price of the Company's common stock, and the Company's estimate of the
percentage of the vesting period that has elapsed up to the current quarter end.
Changes in the liability from one quarter to the next are accounted for as an
increase in, or decrease to, compensation expense, as the case may be. Upon
vesting, the Company releases the accrued liability (equal to the market value
of the vested shares at date of vesting) with a corresponding increase to
paid-in capital. Unvested matching credits are considered share equivalents
outstanding for purposes of the computation of earnings per share. For the three
months ended September 30, 2003 and 2002, the Company recorded total
compensation expense associated with these agent plans in the amount of $(1.2)
million and $(3.0) million, respectively, of which a $1.2 million benefit and
$(1.3) million expense, respectively, represent the non-cash stock based
compensation associated with the adjustment to the liability for future unvested
benefits. For the nine months ended September 30, 2003 and 2002, the Company
recorded total compensation expense associated with these agent plans in the
amount of $(5.8) million and $(11.9) million, respectively, of which a $1.7
million benefit and $(7.1) million expense, respectively, represented the
non-cash stock based compensation benefit (expense) associated with the
adjustment to the liability for future unvested benefits.
At December 31, 2002, the Company had recorded approximately 1.9
million unvested matching credits associated with the Agent Plans, of which
697,000 vested in January 2003. At September 30, 2003, the Company had recorded
approximately 1.8 million unvested matching credits.
The accounting treatment of the Company's Agent Plans will result in
unpredictable stock-based compensation expense charges, dependent upon
fluctuations in the quoted price of UICI common stock. These unpredictable
fluctuations in stock based compensation charges may result in material non-cash
fluctuations in the Company's results of operations. In periods of general
decline in the quoted price of UICI common stock, if any, the Company will
recognize less stock based compensation expense than in periods of general
appreciation in the quoted price of UICI common stock. In addition, in
circumstances where increases in the quoted price of UICI common stock are
followed by declines in the quoted price of UICI common stock, negative
compensation expense may result as the Company adjusts the cumulative liability
for unvested stock-based compensation expense.
NOTE O - CORPORATE OVERHEAD ALLOCATION
Effective January 1, 2003, the Company began to allocate to the
Company's operating business segments certain general expenses relating to
corporate operations (consisting primarily of technology related expenses and
expenses associated with the operations of the Company's insurance company
subsidiaries), which expenses had been formerly reflected in the Other Key
Factors segment. The Company believes that this allocation of certain general
expenses relating to corporate operations results in a more accurate portrayal
of the financial results of its core insurance and other operations. The Other
Key Factors segment now includes investment income not allocated to the other
business segments, realized gains or losses on sale of investments, the
operating results at the Company's former Barron Risk Management Services, Inc.
unit until its sale in September 2002, the operations of the Company's AMLI
Realty Co. subsidiary, certain other general expenses related to corporate
operations, minority
26
interest, interest expense on corporate debt and variable stock-based
compensation.
Following is a summary of the Company's quarterly segment results for
the year ended December 31, 2002, adjusted to reflect the allocation to the
Company's operating business segments of certain general expenses relating to
corporate operations as discussed above:
THREE MONTHS ENDED
MAR 31, JUN 30, SEP 30, DEC 31, TOTAL
2002 2002 2002 2002 2002
--------- --------- --------- --------- ---------
(IN THOUSANDS)
Income (loss) from continuing operations before
federal income taxes:
Insurance:
Self Employed Agency Division.................. $ 15,748 $ 19,671 $ 23,127 $ 25,647 $ 84,193
Group Insurance Division....................... 1,747 3,311 3,030 5,067 13,155
Life Insurance Division........................ 2,615 2,817 1,243 1,421 8,096
--------- --------- --------- --------- ---------
20,110 25,799 27,400 32,135 105,444
--------- --------- --------- --------- ---------
Financial Services:
Losses in Healthaxis, Inc. investment.......... (174) (7,925) (796) (744) (9,639)
--------- --------- --------- --------- ---------
(174) (7,925) (796) (744) (9,639)
--------- --------- --------- --------- ---------
Other Key Factors:
Investment income on equity, realized gains and
losses, general corporate expenses and other
(including interest expense on non-student loan
indebtedness)................................. (337) (3,754) 961 398 (2,732)
Variable stock-based compensation expense...... (4,251) (6,117) (3,890) (2,225) (16,483)
--------- --------- --------- --------- ---------
(4,588) (9,871) (2,929) (1,827) (19,215)
--------- --------- --------- --------- ---------
Total income from continuing operations before
federal income taxes............................ $ 15,348 $ 8,003 $ 23,675 $ 29,564 $ 76,590
========= ========= ========= ========= =========
NOTE P - SUBSEQUENT EVENTS
As further discussed in Note C, on October 29, 2003, UICI executed a
definitive agreement with SLM Corporation ("Sallie Mae"), pursuant to which UICI
will sell its entire equity interest in AMS. The Company has estimated that the
sale of AMS to Sallie Mae, if and when completed, will generate net cash
proceeds to UICI of approximately $25.3 million. At closing, UICI will also
receive uninsured student loan assets currently held by AMS' special purpose
financing subsidiaries with a face amount of approximately $44.7 million
(including accrued interest). The fair value of the uninsured loans is expected
to be significantly less than the face amount of the loans.
Closing of the transaction is anticipated to occur in November 2003 and
is subject to satisfaction of several closing conditions, including expiration
or earlier termination of the applicable waiting period under the
Hart-Scott-Rodino Antitrust Improvements Act of 1976. While the Company believes
that it will be able to satisfy all conditions to closing, there can be no
assurance that the conditions to closing will be satisfied or that the
transaction contemplated by the definitive agreement will in fact be completed.
In full payment of all contingent consideration payable in connection
with UICI's February 2002 acquisition of STAR HRG, on November 10, 2003 UICI
delivered to the sellers UICI's 6% convertible subordinated notes in the
aggregate principal amount of $15.0 million, together with cash interest in the
aggregate amount of approximately $1.5 million. The subordinated notes are
convertible into UICI Common Stock at a conversion price of $20.06 per common
share. See Note G of Notes to Condensed Consolidated Financial Statements.
In November 2003, the Company's wholly owned subsidiary, The MEGA Life
and Health Insurance Company ("MEGA") sold an aggregate of 1,722,086 shares of
beneficial interest in AMLI Residential Properties Trust ("AML") in a series of
privately negotiated transactions. In connection with the sales, the Company
will recognize a gain in the amount of $39.8 million ($25.9 million, or $0.54
per share, net of tax) in the quarter ending December 31, 2003. The Company
effected such sales to diversify its portfolio and to generate taxable capital
gains that may be used to offset capital losses from other investments. The
Company through its various subsidiaries continues to hold 828,900 AML shares
with an aggregate cost basis of $18.6 million ($22.41 average cost per share).
These remaining AML shares are subject to various resale restrictions imposed by
federal and state securities laws.
27
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
INTRODUCTION
The Company's operating segments include: (i) Insurance, which includes
the businesses of the Self Employed Agency Division, the Group Insurance
Division (formerly the Company's Student Insurance Division, which includes the
operations of the Company's STAR HRG business unit effective February 28, 2002),
and the Life Insurance Division (formerly the Company's OKC Division), (ii)
Financial Services, which includes the Company's investment in Healthaxis, Inc.,
and (iii) Other Key Factors.
Effective January 1, 2003, the Company began to allocate to the
Company's operating business segments certain general expenses relating to
corporate operations (consisting primarily of technology related expenses and
expenses associated with the operations of the Company's insurance company
subsidiaries), which expenses had been formerly reflected in the Other Key
Factors segment. The Company believes that this allocation of certain general
expenses relating to corporate operations results in a more accurate portrayal
of the financial results of its core insurance and other operations. The Other
Key Factors segment now includes investment income not allocated to the other
business segments, realized gains or losses on sale of investments, the
operating results at the Company's former Barron Risk Management Services, Inc.
unit until its sale in September 2002, the operations of the Company's AMLI
Realty Co. subsidiary, certain other general expenses related to corporate
operations, minority interest, interest expense on corporate debt and variable
stock-based compensation.
RECENT DEVELOPMENTS
Academic Management Services Corp.
On October 29, 2003, UICI executed a definitive agreement with SLM
Corporation ("Sallie Mae"), pursuant to which UICI will sell its entire equity
interest in AMS. The Company has estimated that the sale of AMS to Sallie Mae,
when completed, will generate net cash proceeds to UICI of approximately $25.3
million. At closing, UICI will also receive uninsured student loan assets
currently held by AMS' special purpose financing subsidiaries with a face amount
of approximately $44.7 million (including accrued interest). The fair value of
the uninsured loans is expected to be significantly less than the face amount of
the loans.
Closing of the transaction is anticipated to occur in November and is
subject to satisfaction of several closing conditions, including expiration or
earlier termination of the applicable waiting period under the Hart-Scott-Rodino
Antitrust Improvements Act of 1976. While the Company believes that it will be
able to satisfy all conditions to closing, there can be no assurance that the
conditions to closing will be satisfied or that the transaction contemplated by
the definitive agreement will in fact be completed.
The Company has classified AMS as a discontinued operation for
financial reporting purposes as of September 30, 2003. Reflecting the fair
market value of AMS implied by the proposed transaction with Sallie Mae, UICI
recorded in the three and nine months ended September 30, 2003 a pre-tax loss
(consisting of an estimated loss upon disposal of AMS and AMS' operating results
in the periods) in the amount of $(77.5) million ($(66.9) million net of tax)
and $(75.3) million ($(65.6) million net of tax), respectively. Exclusive of the
estimated loss upon disposal of AMS in the amount of $(61.2) million (net of
tax), in the three and nine months ended September 30, 2003 AMS reported
operating losses (net of tax) in the amount of $(5.7) million and $(4.4)
million, respectively, compared to operating income (net of tax) of $1.8 million
and $5.4 million in the corresponding periods of the prior year.
AMS historically financed its student loan origination activities
through seven special purpose subsidiaries ("Special Purpose Subsidiaries")
(EFG-II LP, EFG-III LP, EFG Funding LLC, EFG-IV LP, AMS-I 2002 LP, AMS-II 2002
LP and AMS-III 2003 LP), through which it has outstanding six secured student
loan financing facilities that issue debt securities secured by student loans
and other qualified collateral. EFG-II LP was liquidated in September 2003 when
substantially all of the loans owned by the special purpose subsidiary were sold
(approximately $105.5 million of principal and accrued interest) and the
associated debt was repaid. The Company recorded a gain of $2.0 million from the
liquidation of this facility.
On July 21, 2003, UICI reported the discovery of certain defaults under
the documents governing AMS' six secured student loan financing facilities. The
defaults consisted of insufficient collateral, a higher percentage of
alternative loans (i.e., loans that are privately guaranteed as opposed to loans
that are guaranteed by the federal government) included in the existing
collateral than permitted by the loan eligibility provisions of the financing
documents and failure to provide timely and accurate reporting to each of the
various financial institutions that are parties to the financings. On July 24,
2003, AMS obtained waivers and releases from interested third parties with
respect to four of the six securitized student loan financing facilities.
28
The waiver and release agreement with respect to the EFG-III, LP
commercial paper securitized student loan facility required UICI's contribution
to the capital of AMS of $48.25 million, which, as of July 31, 2003, UICI had
contributed to AMS. UICI believes that it has no obligations with respect to the
indebtedness of AMS' Special Purpose Subsidiaries or with respect to the
obligations of AMS relating to such financings. Nonetheless, in exchange for
UICI's capital contribution to AMS, the financial institutions agreed to release
UICI from any and all existing claims or suits (other than claims for fraud at
the UICI level) that could arise relating to the AMS student loan financing
facilities.
See Note C of Notes to Condensed Consolidated Financial Statements for
additional information with respect to the AMS securitized student loan
financing facilities, the defaults thereunder announced in July 2003 and the
waivers of such defaults obtained from the interested financing parties.
As discussed above, UICI has executed a definitive agreement with
Sallie Mae to sell AMS. Pursuant to the definitive agreement and if the
transaction contemplated thereby closes, Sallie Mae has agreed to assume
responsibility for liquidating and terminating all of the remaining special
purpose financing facilities through which AMS previously securitized student
loans.
In July and August 2003, the Audit Committee of UICI's Board of Directors,
with the assistance of independent counsel, conducted an investigation into the
matters and events leading to the announcement of the collateral shortfalls at
AMS' student loan financing facilities. Based on that investigation, the Company
believes that UICI's previously published consolidated financial statements have
been fairly presented.
Sale of AMLI Residential Properties Trust Shares
In November 2003, the Company's wholly-owned subsidiary, The MEGA Life
and Health Insurance Company ("MEGA") sold an aggregate of 1,722,086 shares of
beneficial interest in AMLI Residential Properties Trust ("AML") in a series of
privately negotiated transactions. In connection with the sales, the Company
will recognize a gain in the amount of $39.8 million ($25.9 million, or $0.54
per share, net of tax) in the quarter ending December 31, 2003. The Company
effected such sales to diversify its portfolio and to generate taxable capital
gains that may be used to offset capital losses from other investments. The
Company through its various subsidiaries continues to hold 828,900 AML shares
with an aggregate cost basis of $18.6 million ($22.41 average cost per share).
These remaining AML shares are subject to various resale restrictions imposed by
federal and state securities laws.
RESULTS OF OPERATIONS
Revenues and income from continuing operations before federal income
taxes ("operating income") by business segment are summarized in the tables
below.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ -----------------------
2003 2002 2003 2002
--------- -------- ---------- --------
(IN THOUSANDS)
Revenues
Insurance:
Self Employed Agency Division............... $344,999 $273,794 $ 982,715 $741,158
Group Insurance Division.................... 87,730 65,406 254,031 164,676
Life Insurance Division..................... 16,295 17,773 48,188 56,385
-------- -------- ---------- --------
449,024 356,973 1,284,934 962,219
-------- -------- ---------- --------
Other Key Factors............................ 4,557 5,283 11,118 9,685
Intersegment Eliminations.................... (14) -- (554) --
-------- -------- ---------- --------
Total revenues from continuing operations...... $453,567 $362,256 $1,295,498 $971,904
======== ======== ========== ========
29
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ----------------------
2003 2002 2003 2002
------- ------- ------- -------
(IN THOUSANDS)
Income (loss) from continuing operations before
federal income taxes:
Insurance:
Self Employed Agency Division.............................. $32,517 $23,128 $80,819 $58,547
Group Insurance Division................................... (12,075) 3,030 (3,969) 8,088
Life Insurance Division.................................... (296) 1,243 (3,196) 6,675
------- ------- ------- -------
20,146 27,401 73,654 73,310
------- ------- ------- -------
Financial Services:
Losses in Healthaxis, Inc. investment...................... (1,266) (796) (2,211) (8,895)
------- ------- ------- -------
(1,266) (796) (2,211) (8,895)
------- ------- -------- -------
Other Key Factors:
Investment income on equity, realized gains and losses,
general corporate expenses and other (including
interest expense on non-student loan indebtedness)........ 711 960 (921) (3,131)
Variable stock-based compensation (expense) benefit........ 1,211 (3,890) 1,663 (14,258)
------- ------- ------- -------
1,922 (2,930) 742 (17,389)
------- ------- ------- -------
Total income from continuing operations before federal
income taxes................................................ $20,802 $23,675 $72,185 $47,026
======= ======= ======= =======
---------------------------
(1) As discussed above, effective January 1, 2003, the Company began to
allocate to the Company's operating business segments certain general expenses
relating to corporate operations (consisting primarily of technology related
expenses and expenses associated with the operations of the Company's insurance
company subsidiaries), which expenses had been formerly reflected in the Other
Key Factors segment. All business segment results for all periods presented have
been restated to reflect the allocation of these expenses.
UICI's results of operations for the three and nine months ended
September 30, 2003 were particularly impacted by the following factors:
Self Employed Agency Division
The Company's Self Employed Agency ("SEA") Division enjoyed significant
continued period-over-period growth in both revenue and operating income.
Operating income increased to $32.5 million and $80.8 million in the three and
nine-month periods ended September 30, 2003, respectively, from $23.1 million
and $58.5 million in the corresponding 2002 periods. Earned premium revenue
increased from $245.7 million in the third quarter of 2002 to $311.3 million in
the third quarter of 2003 and from $664.3 million in the first nine months of
2002 to $890.5 million in the first nine months of 2003. Submitted annualized
premium volume (i.e., the aggregate annualized premium amount associated with
health insurance applications submitted by the Company's agents for underwriting
by the Company) decreased in the nine months ended September 30, 2003 to $691.4
million from $708.3 million in the corresponding 2002 period. Submitted
annualized premium volume decreased to $228.6 million in the third quarter of
2003 from $250.5 million in the corresponding period of the prior year.
Operating income as a percentage of earned premium revenue in the three
and nine months ended September 30, 2003 was 10.4% and 9.1%, respectively,
compared to 9.4% and 8.8% in the corresponding periods of the prior year. This
increase in operating margin was attributable primarily to lower commission
expense and a slightly lower loss ratio. The SEA Division's results for the
first nine months of 2003 included pre-tax income in the amount of $4.8 million
associated with the release of reserves resulting from an adjustment to the
Company's reserve methodology and certain changes in accounting estimates.
Group Insurance Division
The Company's Group Insurance Division (consisting of the Company's
Student Insurance and Star HRG business units) reported operating losses of
$(12.1) million and $(4.0) million in the three and nine months ended September
30, 2003, respectively, reflecting a previously reported increase in loss
reserves recorded in the third quarter in the amount of $13.1 million ($8.5
million net of tax, or ($0.18) per diluted share). In the three and nine months
ended September 30, 2002, the Company reported operating income at its Group
Insurance Division of $3.0 million and $8.1 million, respectively.
Substantially all of the operating losses in the 2003 periods at the
Group Insurance segment was attributable to results at the Company's Student
Insurance Division, which offers tailored health insurance programs that
generally provide single school year coverage to individual students at colleges
and universities. Results at the Company's Student Insurance Division also
reflected a significant amount of seasonal marketing and administrative costs
incurred in the third quarter related to policies written covering the full 2003
- 2004 school year. For the full 2003 calendar year, the Company currently
anticipates that its Group Insurance business segment will report an operating
loss in the amount of approximately $(4.0) million ($(2.6) million net of tax,
or $(0.05) per diluted share). Because Student Insurance policies are issued on
a school year basis and the 2003-2004 school year has just begun, the
30
Student Insurance Division will be limited in its ability to reprice its overall
book of business until August 2004. As a result, the Company currently
anticipates that results at Student Insurance for calendar year 2004 will be at
or near breakeven.
Life Insurance Division
For the three and nine months ended September 30, 2003, the Company's
Life Insurance Division reported operating losses of $(296,000) and $(3.2)
million, respectively, compared to operating income of $1.2 million and $6.7
million in the corresponding 2002 periods. The operating losses in the 2003
interim periods were primarily attributable to a reserve increase in the
Company's former workers compensation business, a previously announced charge
associated with the final resolution of litigation arising out of the close down
in 2001 of the Company's former workers compensation business, costs associated
with the closedown of the Company's College Fund Life Division operations, and a
decrease in investment income allocated to the segment.
Other Key Factors
In the three and nine months ended September 30, 2003, the Company's
Other Key Factors segment reported operating income of $1.9 million and
$742,000, respectively, compared to operating losses of $(2.9) million and
$(17.4) million, respectively, in the corresponding periods of 2002. The
increase in income in the Other Key Factors category in the three and nine
months ended September 30, 2003 as compared to 2002 was primarily attributable
to a decrease in variable stock-based compensation and net realized gains in
2003 compared to net realized losses in 2002, offset by a decrease in investment
income attributable to equity determined after allocation to operating segment
portfolios. For the three and nine months ended September 30, 2003, the Company
experienced a $5.1 million and $15.9 million decrease, respectively, in variable
stock-based compensation expense (as discussed more fully below), compared to
the corresponding periods of the prior year, and the Company recorded realized
gains in the amount of $1.9 million and $1.7 million, respectively, compared to
realized losses of $(398,000) and $(6.2) million in the corresponding 2002
periods. The continued lower prevailing interest rate environment in 2003
negatively affected investment income attributable to equity determined after
allocation to operating segment portfolios. Investment income after allocation
to the operating segments decreased by $2.0 million in the third quarter of 2003
and by $4.2 million in the first nine months of 2003, in each case as compared
to such income in the corresponding 2002 periods.
In connection with the Company's stock accumulation plans established
for the benefit of the independent insurance agents and independent sales
representatives associated with UGA -- Association Field Services, New United
Agency and Cornerstone America, the Company has recognized and will continue to
recognize non-cash variable stock-based compensation benefit (expense) in
amounts that depend and fluctuate based upon the market performance of the
Company's common stock. In the three and nine months ended September 30, 2003,
the Company recognized a non-cash variable stock-based benefit in the amount of
$1.2 million and $1.7 million, respectively, associated with its agent stock
accumulation plans. During the three and nine months ended September 30, 2002,
the Company recognized non-cash variable stock-based expense in the amount of
$(3.9) million and $(14.3) million, respectively, of which $(1.3) million and
$(7.1) million, respectively, was attributable to the Company's stock
accumulation plans established for the benefit of its independent agents, $(2.5)
million and $(5.7) million, respectively, was attributable to the allocation of
the $5.25 UICI shares under the UICI Employee Stock Ownership and Savings Plan
and $(100,000) and $(1.5) million, respectively, was attributable to other
stock-based compensation plans. As of December 31, 2002, all $5.25 UICI shares
had been allocated to participants' accounts under UICI's Employee Stock
Ownership and Savings Plan. Accordingly, in all periods commencing after
December 31, 2002 the Company will not recognize additional variable stock-based
compensation associated with the ESOP feature of the UICI Employee Stock
Ownership and Savings Plan.
Discontinued Operations
For financial reporting purposes, the Company has classified as
discontinued operations its former sub-prime credit card unit, its Special Risk
Division, its Senior Market Division and its Academic Management Services Corp.
("AMS") subsidiary. The Company's results in the three and nine months ended
September 30, 2003 included losses from discontinued operations in the amount of
$(67.1) million and $(72.7) million, net of tax ($(1.40) per diluted share and
$(1.52) per diluted share), respectively. For the three and nine months ended
September 30, 2002, the Company's results from discontinued operations reflected
income in the amount of $422,000 and $2.0 million (net of tax) ($0.01 per
diluted share and $0.04 per diluted share), respectively.
31
As previously reported, on October 29, 2003, UICI executed a definitive
agreement with SLM Corporation ("Sallie Mae"), pursuant to which UICI will sell
its entire equity interest in Academic Management Services Corp. The Company has
estimated that the sale of AMS to Sallie Mae, when completed, will generate net
cash proceeds to UICI of approximately $25.3 million. At closing, UICI will also
receive uninsured student loan assets currently held by AMS' special purpose
financing subsidiaries with a face amount of approximately $44.7 million
(including accrued interest). The fair value of the uninsured loans is expected
to be significantly less than the face amount of the loans.
Closing of the transaction is anticipated to occur in November 2003 and
is subject to satisfaction of several closing conditions, including expiration
or earlier termination of the applicable waiting period under the
Hart-Scott-Rodino Antitrust Improvements Act of 1976. While the Company believes
that it will be able to satisfy all conditions to closing, there can be no
assurance that the conditions to closing will be satisfied or that the
transaction contemplated by the definitive agreement will in fact be completed.
The Company has classified AMS as a discontinued operation for
financial reporting purposes at the end of the third quarter. Reflecting the
fair market value of AMS implied by the proposed transaction with Sallie Mae,
UICI recorded in the three and nine months ended September 30, 2003 a loss
(consisting of an estimated loss upon disposal of AMS and AMS' operating results
in the periods) in the amount of $(77.5) million ($(66.9) million net of tax,
and $(75.3) million ($(65.6) million net of tax, respectively. Exclusive of the
estimated loss upon disposal in the amount of $(61.2) million (net of tax) in
the three and nine months ended September 30, 2003 AMS reported operating losses
(net of tax) in the amount of $(5.7) million and $(4.4) million, respectively,
compared to operating income (net of tax) of $1.8 million and $5.4 million,
respectively, in the corresponding periods of the prior year.
The Company does not anticipate that the closing of the sale of AMS or
future operating results at AMS will have a material effect on UICI's future
consolidated results of operations.
Results from discontinued operations for all periods presented also
include the results of the Company's former Senior Market Division, which the
Company closed down in the quarter ended June 30, 2003. In the three and nine
months ended September 30, 2003, the Company reported losses associated with the
former Senior Market Division in the amount of $(161,000) and $(9.1) million
(net of tax), respectively, compared to losses in the amount of $(1.4) million
and $(3.5) million (net of tax), respectively, in the comparable periods in
2002. The losses in the 2003 periods were primarily attributable to a loss of
$(5.5) million (net of tax) recognized in the second quarter of 2003 upon sale
of the Company's interest in the agency through which the Company formerly
marketed and distributed insurance products to the senior market, a write off of
impaired assets, operating losses incurred at the Senior Market Division through
the close-down date and costs associated with the wind down and closing of the
operations.
Sale of Healthaxis, Inc. Equity Stake
Effective September 30, 2003, the Company sold to Healthaxis, Inc. its
entire 49.25% equity interest in Healthaxis, Inc. for a total sale price of $3.9
million, of which $500,000 was paid in cash at closing, and the balance was paid
by delivery of a promissory note payable to the Company in the amount of $3.4
million. The Company recognized a nominal loss for financial reporting purposes
in connection with the sale.
Self Employed Agency Division -- Reserve Adjustments
Effective January 1, 2003, the Company's SEA Division made adjustments
to its reserve methodology and certain changes in accounting estimates, the net
effect of which decreased reserves and correspondingly increased operating
income reported by the SEA Division in the amount of $4.8 million in the first
quarter of 2003. See Note A of Notes to Condensed Consolidated Financial
Statements for a summary of the adjustments and changes in accounting estimates
made by the Company.
32
LIQUIDITY AND CAPITAL RESOURCES
Historically, the Company's primary sources of cash on a consolidated
basis have been premium revenues from policies issued, investment income, fees
and other income, and borrowings to fund student loans. The primary uses of cash
have been payments for benefits, claims and commissions under those policies,
operating expenses and the funding of student loans. In the nine months ended
September 30, 2003, net cash provided by operations totaled approximately $184.1
million, compared to net cash provided by operations of $274.9 million in the
corresponding period of 2002.
As previously discussed (see "Recent Developments - - Academic
Management Services Corp." above), on July 31, 2003, UICI completed its
contribution to the capital of AMS of cash in the amount of $48.25 million in
accordance with the terms of the waiver and release agreements with the
interested third parties to the AMS financings. UICI is a holding company, the
principal assets of which are its investments in its separate operating
subsidiaries, including its regulated insurance subsidiaries. The holding
company's ability to fund its cash requirements is largely dependent upon its
ability to access cash, by means of interest income, loans or dividends or other
means, from its subsidiaries. The Company generated additional cash to fund its
$48.25 million obligations under the AMS waiver and release agreements from
loans and dividends from offshore insurance subsidiaries, reimbursements under
tax sharing agreements with subsidiaries and dividends from non-insurance
subsidiaries.
Payment by UICI of the capital contributions to AMS pursuant to the
terms of the waiver and release agreements had a material adverse effect during
the quarter ended September 30, 2003 upon the liquidity of the Company at the
holding company level. The Company currently anticipates that it will be able to
fund its future estimated cash requirements at the holding company level with
cash currently on hand and cash generated from the sources set forth above, plus
dividends from regulated domestic insurance subsidiaries. However, there can be
no assurance that the cash requirements at the holding company level will not
exceed current estimates.
On October 29, 2003, UICI executed a definitive agreement with SLM
Corporation ("Sallie Mae"), pursuant to which UICI will sell its entire equity
interest in AMS. The Company has estimated that the sale of AMS to Sallie Mae,
if and when completed, will generate net cash proceeds to UICI of approximately
$25.3 million. See Note C of Notes to Condensed Consolidate Financial
Statements.
The Company intends to adhere to its historical policy with regard to
dividends from its regulated domestic insurance company subsidiaries. The
Company's domestic insurance company subsidiaries have not paid cash dividends
in 2003. These subsidiaries will be able to pay $39.1 million in cash dividends
to the UICI holding company in December 2003 in the ordinary course of business
without prior approval of the regulatory authorities. However, as has been its
policy in the past, during the fourth quarter of 2003 the Company will assess
the results of operations of the regulated domestic insurance companies to
determine the prudent dividend capability of the subsidiaries, consistent with
UICI's practice of maintaining risk-based capital ratios at each of the
Company's domestic insurance subsidiaries significantly in excess of minimum
requirements. Historically, the Company has not received dividends from its
regulated domestic insurance subsidiaries in the full amount that it could
otherwise receive without prior regulatory approval.
During the nine months ended September 30, 2003, the Company at the
holding company level reduced its consolidated short and long-term indebtedness
(exclusive of indebtedness incurred to fund student loans) from $7.9 million at
December 31, 2002 to $4.0 million at September 30, 2003.
On January 25, 2002, the Company entered into a three-year bank credit
facility with Bank of America, NA and LaSalle Bank National Association. Under
the facility, the Company may borrow from time to time up to $30.0 million on a
revolving, unsecured basis. Loans outstanding under the facility will bear
interest at the option of the Company at prime plus 1% or LIBOR plus 1%. The
Company intends to utilize the proceeds of the facility for general working
capital purposes. The Company has not to date borrowed any funds under the
facility.
See Note C of Notes to Condensed Consolidated Financial Statements for
a discussion of various financing facilities entered into by AMS.
STOCK REPURCHASE PLAN
In November 1998, the Company's Board of Directors authorized the
repurchase of up to 4,500,000 shares of the Company's Common Stock. The shares
were authorized to be purchased from time to time on the open market or in
33
private transactions. As of December 31, 2000, the Company had repurchased
198,000 shares pursuant to such authorization, all of which were purchased in
1999. At its regular meeting held on February 28, 2001, the Board of Directors
of the Company reconfirmed the Company's 1998 share repurchase program.
Following reconfirmation of the program the Company had purchased an additional
3.3 million shares pursuant to the program (with the most recent purchase made
on March 12, 2003) at an aggregate cost of $43.2 million, or $12.98 per share.
The timing and extent of additional repurchases, if any, will depend on market
conditions and the Company's evaluation of its financial resources at the time
of purchase.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The Company's discussion and analysis of its financial condition and
results of operations are based upon the Company's consolidated financial
statements, which have been prepared in accordance with accounting principles
generally accepted in the United States of America. The preparation of these
financial statements requires the Company to make estimates and judgments that
affect the reported amounts of assets, liabilities, revenues and expenses, and
related disclosure of contingent assets and liabilities. On an on-going basis,
the Company evaluates its estimates, including those related to health and life
insurance claims and reserves, deferred acquisition costs, bad debts, impairment
of investments, intangible assets, income taxes, financing operations and
contingencies and litigation. The Company bases its estimates on historical
experience and on various other assumptions that are believed to be reasonable
under the circumstances, the results of which form the basis for making
judgments about the carrying values of assets and liabilities that are not
readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions.
Effective January 1, 2003, the Company's SEA Division made adjustments
to its reserve methodology and certain changes in accounting estimates, the net
effect of which decreased reserves and correspondingly increased operating
income in the amount of $4.8 million in the first quarter of 2003. See Note A of
Notes to Condensed Consolidated Financial Statements.
PRIVACY INITIATIVES
Recently-adopted legislation and regulations governing the use and
security of individuals' nonpublic personal data by financial institutions,
including insurance companies, may have a significant impact on the Company's
business and future results of operations.
Gramm-Leach-Bliley Act and State Insurance Laws and Regulations
The business of insurance is primarily regulated by the states and is
also affected by a range of legislative developments at the state and federal
levels. The Financial Services Modernization Act of 1999 (the so-called
Gramm-Leach-Bliley Act, or "GLBA") includes several privacy provisions and
introduces new controls over the transfer and use of individuals' nonpublic
personal data by financial institutions, including insurance companies,
insurance agents and brokers and certain other entities licensed by state
insurance regulatory authorities. Additional federal legislation aimed at
protecting the privacy of nonpublic personal financial and health information is
proposed and over 400 state privacy bills are pending.
GLBA provides that there is no federal preemption of a state's
insurance related privacy laws if the state law is more stringent than the
privacy rules imposed under GLBA. Accordingly, state insurance regulators or
state legislatures will likely adopt rules that will limit the ability of
insurance companies, insurance agents and brokers and certain other entities
licensed by state insurance regulatory authorities to disclose and use
non-public information about consumers to third parties. These limitations will
require the disclosure by these entities of their privacy policies to consumers
and, in some circumstances, will allow consumers to prevent the disclosure or
use of certain personal information to an unaffiliated third party. Pursuant to
the authority granted under GLBA to state insurance regulatory authorities to
regulate the privacy of nonpublic personal information provided to consumers and
customers of insurance companies, insurance agents and brokers and certain other
entities licensed by state insurance regulatory authorities, the National
Association of Insurance Commissioners has recently promulgated a new model
regulation called Privacy of Consumer Financial and Health Information
Regulation. Some states issued this model regulation before July 1, 2001, while
other states must pass certain legislative reforms to implement new state
privacy rules pursuant to GLBA. In addition, GLBA requires state insurance
regulators to establish standards for administrative, technical and physical
safeguards pertaining to customer records and information to (a) ensure their
security and confidentiality, (b) protect against anticipated threats and
hazards to their security and integrity, and (c) protect against unauthorized
access to and use of these records and information. However, no state insurance
34
regulators have yet issued any final regulations in response to such security
and confidentiality requirements. The privacy and security provisions of GLBA
will significantly affect how a consumer's nonpublic personal information is
transmitted through and used by diversified financial services companies and
conveyed to and used by outside vendors and other unaffiliated third parties.
Due to the increasing popularity of the Internet, laws and regulations
may be passed dealing with issues such as user privacy, pricing, content and
quality of products and services, and those regulations could adversely affect
the growth of the online financial services industry. If Internet use does not
grow as a result of privacy or security concerns, increasing regulation or for
other reasons, the growth of UICI's Internet-based business would be hindered.
It is not possible at this time to assess the impact of the privacy provisions
on UICI's financial condition or results of operations.
Health Insurance Portability and Accountability Act of 1996
The federal Health Insurance Portability and Accountability Act of 1996
("HIPAA") contains provisions requiring mandatory standardization of certain
communications between health plans (including health insurance companies),
electronic clearinghouses and health care providers who transmit certain health
information electronically. HIPAA requires health plans to use specific
data-content standards, mandates the use of specific identifiers (e.g., national
provider identifiers and national employer identifiers) and requires specific
privacy and security procedures. HIPAA authorized the Secretary of the federal
Department of Health and Human Services ("HHS") to issue standards for the
privacy and security of medical records and other individually identifiable
patient data.
In December 2000, HHS issued final regulations regarding the privacy of
individually-identifiable health information. This final rule on privacy applies
to both electronic and paper records and imposes extensive requirements on the
way in which health care providers, health plan sponsors, health insurance
companies and their business associates use and disclose protected information.
Under the new HIPAA privacy rules, the Company is required to (a) comply with a
variety of requirements concerning its use and disclosure of individuals'
protected health information, (b) establish rigorous internal procedures to
protect health information and (c) enter into business associate contracts with
other companies that use similar privacy protection procedures. The final rules
do not provide for complete federal preemption of state laws, but, rather,
preempt all contrary state laws unless the state law is more stringent. The
Company believes that it was in material compliance with the privacy
requirements imposed by HIPAA and the rules thereunder as of April 14, 2003, the
date the rules became effective.
Sanctions for failing to comply with standards issued pursuant to HIPAA
include criminal penalties of up to $250,000 per violation and civil sanctions
of up to $25,000 per violation. Due to the complex and controversial nature of
the privacy regulations, they may be subject to court challenge, as well as
further legislative and regulatory actions that could alter their effect.
In August 2000, HHS published for comment proposed rules related to the
security of electronic health data, including individual health information and
medical records, for health plans, health care providers, and health care
clearinghouses that maintain or transmit health information electronically. The
proposed rules would require these businesses to establish and maintain
responsible and appropriate safeguards to ensure the integrity and
confidentiality of this information. The standards embraced by these rules
include the implementation of technical and organization policies, practices and
procedures for security and confidentiality of health information and protecting
its integrity, education and training programs, authentication of individuals
who access this information, system controls, physical security and disaster
recovery systems, protection of external communications and use of electronic
signatures. The final HIPAA security rules were issued by the HHS in February
2003, and the compliance date for HIPAA covered entities is April 21, 2005.
UICI is currently reviewing the potential impact of the HIPAA privacy
regulations on its operations, including its information technology and security
systems. The Company cannot at this time predict with specificity what impact
(a) the recently adopted final HIPAA rules governing the privacy of
individually-identifiable health information and (b) the proposed HIPAA rules
for ensuring the security of individually-identifiable health information may
have on the business or results of operations of the Company. However, these new
rules will likely increase the Company's burden of regulatory compliance with
respect to its life and health insurance products and other information-based
products, and may reduce the amount of information the Company may disclose and
use if the Company's customers do not consent to such disclosure and use. There
can be no assurance that the restrictions and duties imposed by the recently
adopted final rules on the privacy of individually-identifiable health
information,
35
or the proposed rule on security of individually-identifiable health
information, will not have a material adverse effect on UICI's business and
future results of operations.
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
Certain statements set forth herein or incorporated by reference herein
from the Company's filings that are not historical facts are forward-looking
statements within the meaning of the Private Securities Litigation Reform Act.
Actual results may differ materially from those included in the forward-looking
statements. These forward-looking statements involve risks and uncertainties
including, but not limited to, the ability to resolve all of the collateral and
reporting issues associated with AMS' securitized student loan financings,
including compliance with waivers obtained from third parties with respect to
such student loan financings; AMS' ability to prevent similar future
occurrences; AMS' ability to meet future student loan funding obligations; the
Company's ability to maintain adequate liquidity to satisfy its obligations;
changes in general economic conditions, including the performance of financial
markets, and interest rates; competitive, regulatory or tax changes that affect
the cost of or demand for the Company's products; health care reform; the
ability to predict and effectively manage claims related to health care costs;
and reliance on key management and adequacy of claim liabilities.
The Company's future results will depend in large part on accurately
predicting health care costs incurred on existing business and upon the
Company's ability to control future health care costs through product and
benefit design, underwriting criteria, utilization management and negotiation of
favorable provider contracts. Changes in mandated benefits, utilization rates,
demographic characteristics, health care practices, provider consolidation,
inflation, new pharmaceuticals/technologies, clusters of high-cost cases, the
regulatory environment and numerous other factors are beyond the control of any
health plan provider and may adversely affect the Company's ability to predict
and control health care costs and claims, as well as the Company's financial
condition, results of operations or cash flows. Periodic renegotiations of
hospital and other provider contracts coupled with continued consolidation of
physician, hospital and other provider groups may result in increased health
care costs and limit the Company's ability to negotiate favorable rates. In
addition, the Company faces competitive and regulatory pressure to contain
premium prices. Fiscal concerns regarding the continued viability of
government-sponsored programs such as Medicare and Medicaid may cause decreasing
reimbursement rates for these programs. Any limitation on the Company's ability
to increase or maintain its premium levels, design products, implement
underwriting criteria or negotiate competitive provider contracts may adversely
affect the Company's financial condition or results of operations.
The Company's insurance subsidiaries are subject to extensive
regulation in their states of domicile and the other states in which they do
business under statutes that typically delegate broad regulatory, supervisory
and administrative powers to state insurance departments and agencies. State
insurance departments have also periodically conducted and continue to conduct
financial and market conduct examinations and other inquiries of UICI's
insurance subsidiaries. State insurance regulatory agencies have authority to
levy monetary fines and penalties resulting from findings made during the course
of such examinations and inquiries. Historically, the Company's insurance
subsidiaries have from time to time been subject to such regulatory fines and
penalties. While none of such fines or penalties individually or in the
aggregate have to date had a material adverse effect on the results of
operations or financial condition of the Company, the Company could be adversely
affected by increases in regulatory fines or penalties an/or changes in the
scope, nature and/or intensity of regulatory scrutiny and review.
The Company provides health insurance products to consumers in the
self-employed market in 44 states. A substantial portion of such products is
issued to members of various independent membership associations that endorse
the products and act as the master policyholder for such products. The two
principal membership associations in the self-employed market for which the
Company underwrites insurance are the National Association for the Self-Employed
("NASE") and the Alliance for Affordable Services ("AAS"). The associations
provide their membership with a number of endorsed benefits and products,
including health insurance underwritten by the Company. Subject to applicable
state law, individuals generally may not obtain insurance under an association's
master policy unless they are also members of the associations. UGA agents and
Cornerstone agents also act as field service representatives on behalf of the
associations, in which capacity the agents act as enrollers of new members for
the associations and provide field support services, for which the agents
receive compensation. Specialized Association Services, Inc. (a company
controlled by the adult children of the Chairman of the Company) provides
administrative and benefit procurement services to the associations, and a
subsidiary of the Company sells new membership sales leads to the enrollers and
video and print services to the associations and to Specialized Association
Services, Inc. In addition to health insurance premiums derived from the sale of
health insurance, the Company receives fee income from the associations,
including fees associated with the enrollment of new members,
36
fees for association membership marketing and administrative services and fees
for certain association member benefits. The agreements with these associations
requiring the associations to continue as the master policyholder and to endorse
the Company's insurance products to their respective members are terminable by
the Company and the associations upon not less than one year's advance notice to
the other party.
Articles in the press have been critical of association group coverage.
In December 2002, the National Association of Insurance Commissioners (NAIC)
convened a special task force to review association group coverage, and the
Company is aware that selected states are reviewing the laws and regulations
under which association group policies are issued. The Company has also recently
been named a party to several lawsuits challenging the nature of the
relationship between the Company's insurance companies and the associations that
have endorsed the insurance companies' health insurance products. While the
Company believes it is providing association group coverage in full compliance
with applicable law, changes in the relationship between the Company and the
membership associations and/or changes in the laws and regulations governing
so-called "association group" insurance (particularly changes that would subject
the issuance of policies to prior premium rate approval and/or require the
issuance of policies on a "guaranteed issue" basis) could have a material
adverse impact on the financial condition, results of operations and/or business
of the Company.
The Company's Academic Management Services Corp. business could be
adversely affected by changes in the Federal Higher Education Act of 1965, which
authorizes and governs most federal student aid and student loan programs,
and/or changes in other relevant federal or state laws, rules and regulations.
The Higher Education Act is subject to review and reauthorization by the
recently convened 108th Congress. Congress last reauthorized the Higher
Education Act in 1998. While the Company believes that the Higher Education Act
of 1965 will in fact be reauthorized, there can be no assurance of the form that
reauthorization will take or the changes that the reauthorization bill will
bring to the law and regulations governing student finance.
In addition, existing legislation and future measures by the federal
government may adversely affect the amount and nature of federal financial
assistance available with respect to loans made through the U.S. Department of
Education. Finally, the level of competition currently in existence in the
secondary market for loans made under the Federal Loan Programs could be
reduced, resulting in fewer potential buyers of the Federal Loans and lower
prices available in the secondary market for those loans.
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk of loss arising from adverse changes in market
rates and prices, such as interest rates, foreign currency exchange rates, and
other relevant market rate or price changes. Market risk is directly influenced
by the volatility and liquidity in the markets in which the related underlying
assets are traded.
The primary market risk to the Company's investment portfolio is
interest rate risk associated with investments and the amount of interest that
policyholders expect to have credited to their policies. The interest rate risk
taken in the investment portfolio is managed relative to the duration of the
policy liabilities. The Company's investment portfolio consists mainly of high
quality, liquid securities that provide current investment returns. The Company
believes that the annuity and universal life-type policies are generally
competitive with those offered by other insurance companies of similar size. The
Company does not anticipate significant changes in the primary market risk
exposures or in how those exposures are managed in the future reporting periods
based upon what is known or expected to be in effect in future reporting
periods.
The events at AMS occurring in July 2003 had the immediate effect of
increasing AMS' cost of borrowings used to fund AMS' student loan originations,
which increase has negatively impacted and will continue to negatively impact
the amount of student loan interest spread income that AMS may earn in future
periods. Accordingly, the Company has determined that, for the indefinite
future, AMS will originate and sell student loans rather than originate and hold
student loans in AMS' portfolio. Nevertheless, if and to the extent that AMS
continues to hold student loans in its portfolio, profitability of the student
loans will be affected by the spreads between the interest yield on the student
loans and the cost of the funds borrowed under the various credit facilities.
Although the interest rates on the student loans and the interest rate on the
credit facilities are variable, the gross interest earned by lenders on Stafford
student loans uses the results of 91-day T-bill auctions as the base rate while
the base rate on the credit facilities is LIBOR. The effect of rising interest
rates on earnings on Stafford loans is generally small, as both revenues and
costs adjust to new market levels. In addition to Stafford loans, the Company
holds PLUS loans on which the interest rate yield is set annually beginning July
1 through June 30 by regulation at a fixed rate. The Company held approximately
$152.1 million principal amount of PLUS loans at September 30, 2003. The fixed
37
yield on PLUS loans was 4.86% and 6.79% for the twelve months ended June 30,
2003 and 2002, respectively, and was reset to 4.22% for the twelve months
beginning July 1, 2003. These loans are financed with borrowings whose rates are
subject to reset, generally monthly. During the twelve months beginning October
1, 2003, the cost of borrowings to finance this portion of the student loan
portfolio could rise or fall while the rate earned on the student loans will
remain fixed.
Item 4 - Controls and Procedures
As of September 30, 2003, the Company's management, including William
J. Gedwed (the Chief Executive Officer) and Mark D. Hauptman (the Principal
Financial Officer), evaluated the effectiveness of the Company's "disclosure
controls and procedures," as such term is defined in Rules 13a-15(e) and
15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended.
Based on that evaluation and except as disclosed in the following paragraphs,
the Company's Chief Executive Officer and its Principal Financial Officer
concluded that the Company's disclosure controls and procedures were effective
in timely alerting management, including the Chief Executive Officer and the
Principal Financial Officer, to information about the Company required to be
included in periodic Securities and Exchange Commission filings. Except as
disclosed in the following paragraphs, there have been no significant changes in
the Company's internal control over financial reporting that occurred that have
materially affected, or are reasonably likely to materially affect, the
Company's internal control over financial reporting subsequent to the date of
evaluation.
As discussed above (see Note C of Notes to Condensed Consolidated
Financial Statements and "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Recent Developments - Academic Management
Services Corp."), during July 2003 the Company became aware of a shortfall in
the type and amount of collateral supporting two of the securitized student loan
financing facilities entered into by three Special Purpose Subsidiaries of AMS.
UICI determined (and has so advised the Audit Committee of its Board of
Directors and KPMG LLP, its independent auditors) that a significant deficiency
in AMS' internal control over financial reporting detracted from AMS' ability to
timely monitor and accurately assess the impact of certain transactions relating
to AMS' securitized student loan financing facilities, as would otherwise be
expected in an effective financial reporting control environment.
The Audit Committee of UICI's Board of Directors, with the assistance
of independent counsel, conducted an investigation into the matters and events
leading to the announcement of the collateral shortfalls at AMS' student loan
financing facilities. Based on that investigation, the Company believes that
UICI's previously published consolidated financial statements have been fairly
presented. Nevertheless, the Company and AMS have dedicated and will continue to
dedicate resources to make corrections to the control deficiency at AMS. The
Company has taken immediate steps to better integrate AMS' financial reporting
function and information reporting systems to assure that accurate and
consistent information concerning AMS's student loan funding facilities is
transmitted to interested parties in a timely fashion. In addition, on July 17,
2003 the former president of AMS was put on leave and relieved of all
responsibilities pending the completion of AMS' and UICI's ongoing investigation
into the matter, and on August 15, 2003, the employment of the former president
of AMS was terminated.
Notwithstanding the foregoing and as indicated in the certifications
filed as Exhibits 31.1 and 31.2 to this Quarterly Report on Form 10-Q, the
Company's Chief Executive Officer and the Principal Financial Officer have
certified that, to the best of their knowledge, the financial statements, and
other financial information included in this Quarterly Report on Form 10-Q,
fairly present in all material respects the financial condition, results of
operations and cash flows of the Company as of the dates, and for the periods
presented, in this Report.
PART II. OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS
The Company is a party to various material legal proceedings, all of
which are described in Note J of Notes to the Consolidated Condensed Financial
Statements included herein and in the Company's Annual Report on Form 10-K filed
for the year ended December 31, 2002 under the caption "Item 3 - Legal
Proceedings." The Company and its subsidiaries are parties to various other
pending legal proceedings arising in the ordinary course of business, including
some asserting significant damages arising from claims under insurance policies,
disputes with agents and other matters. Based in part upon the opinion of
counsel as to the ultimate disposition of such lawsuits and claims, management
believes that the liability, if any, resulting from the disposition of such
proceedings will not be material to the Company's financial condition or results
of operations.
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ITEM 2 - Changes in Securities and Use of Proceeds
During the nine months ended September 30, 2003, the Company issued
61,182 shares of unregistered common stock pursuant to its 2001 Restricted Stock
Plan.
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
10.82 -- Amendment No. 1 dated October 17, 2003 to EFG-IV
Waiver dated July 24, 2003, entered into by MBIA
Insurance Corporation, Bank One, National Association,
EFG-IV, LP, and Academic Management Services Corp.
10.83 -- Amendment No. 1 dated October 17, 2003 to AMS-I Waiver dated July 24, 2003, entered
into by MBIA Insurance Corporation, AMS-1 2002, LP, and Academic Management Services
Corp.
10.84 -- Amendment dated October 2, 2003 to Master Repurchase
Agreement dated August 7, 2003, between Lehman Brothers
Bank, FSB, and Academic Management Services Corp.
31.1 -- Principal Executive Officer's Certifications Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
31.2 -- Principal Financial Officer's Certifications Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
32 -- Certification Pursuant to 18 U.S.C. Section 1350 (Section 906 of Sarbanes-Oxley Act of 2002)
(b) Reports on Form 8-K.
1. Current Report on Form 8-K dated July 21, 2003
2. Current Report on Form 8-K dated August 4, 2003
3. Current Report on Form 8-K dated August 20, 2003
4. Current Report on Form 8-K dated September 15, 2003
5. Current Report on Form 8-K dated October 30, 2003
6. Current Report on Form 8-K dated November 6, 2003
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SIGNATURES
Pursuant to the requirements 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.
UICI
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(Registrant)
Date: November 14, 2003 /s/ William J. Gedwed
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William J. Gedwed, President,
Chief Executive Officer and Director
Date: November 14, 2003 /s/ Mark D. Hauptman
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Mark D. Hauptman, Vice President, Chief
Accounting Officer and Chief Financial Officer
40