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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
[ X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____________ to _______________
COMMISSION FILE NUMBER 1-13154
AMERICAN MEDICAL SECURITY GROUP, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
WISCONSIN 39-1431799
(State of incorporation) (I.R.S. Employer Identification No.)
3100 AMS BOULEVARD
GREEN BAY, WISCONSIN 54313
(Address of principal executive offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (920) 661-1111
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
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Common Stock, no par value New York Stock Exchange
Preferred Share Purchase Rights New York Stock Exchange
(associated with the Common Stock)
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: None
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Registration S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes [X] No [ ]
The aggregate market value of the shares of outstanding Common Stock held by
non-affiliates of the registrant was approximately $259,000,000 as of June 28,
2002, assuming solely for purposes of this calculation that all directors and
executive officers of the Registrant are "affiliates." This determination of
affiliate status is not necessarily a conclusive determination for other
purposes.
As of February 28, 2003, there were outstanding 12,913,398 shares of Common
Stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of American Medical Security Group, Inc. Proxy Statement for its
Annual Meeting of Shareholders to be held on May 21, 2003 (Part III)
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AMERICAN MEDICAL SECURITY GROUP, INC.
INDEX TO
ANNUAL REPORT ON FORM 10-K
For the Year Ended December 31, 2002
PAGE
PART I
Item 1. Business...............................................................................................3
Item 2. Properties............................................................................................10
Item 3. Legal Proceedings.....................................................................................10
Item 4. Submission of Matters to a Vote of Security Holders...................................................11
Executive Officers of the Registrant.............................................................................12
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.................................13
Item 6. Selected Financial Data...............................................................................14
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.................15
Item 7A. Quantitative and Qualitative Disclosures about Market Risk ...........................................26
Item 8. Financial Statements and Supplementary Data...........................................................27
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure..................51
PART III
Item 10. Directors and Executive Officers of the Registrant....................................................52
Item 11. Executive Compensation................................................................................52
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters ..........................................................................52
Item 13. Certain Relationships and Related Transactions........................................................52
Item 14. Controls and Procedures...............................................................................52
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K......................................53
Schedule II - Condensed Financial Information of Registrant..........................................54
Schedule III - Supplementary Insurance Information....................................................57
Schedule IV - Reinsurance.............................................................................58
Schedule V - Valuation and Qualifying Accounts........................................................59
Signatures ......................................................................................................60
Certifications...................................................................................................61
Exhibit Index..................................................................................................EX-1
2
PART I
ITEM 1. BUSINESS
FORWARD-LOOKING STATEMENTS
This document includes "forward-looking" statements within the meaning of the
safe harbor provisions of the United States Private Securities Litigation Reform
Act of 1995. When used, the terms "anticipate," "believe," "estimate," "expect,"
"may," "objective," "plan," "possible," "potential," "project," "will" and
similar expressions are intended to identify forward-looking statements.
Forward-looking statements are subject to inherent risks, uncertainties and
assumptions that may cause actual results or events to differ materially from
those that are described. In addition to the assumptions and other factors
referred to specifically in connection with such statements, factors that may
cause actual results or events to differ are described in Item 7, "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Cautionary Factors." The Company does not undertake any obligation to update or
revise such statements as a result of new information, future events or
otherwise.
GENERAL
American Medical Security Group, Inc. is a provider of individual and small
employer group insurance products. As used herein, "the Company" refers to
American Medical Security Group, Inc. and its subsidiaries. The Company's
principal product offering is health insurance for individuals and small
employer groups. The Company also offers life, dental, prescription drug,
disability and accidental death insurance, and provides self-funded benefit
administration. See the Company's Notes to Consolidated Financial Statements,
Note 12, "Segments of the Business" for information concerning the Company's two
reportable segments: health insurance products (which accounted for
approximately 97% of the Company's revenue for the years ended December 31, 2002
and 2001) and life insurance products.
The Company's products are sold through independent licensed agents in 32 states
and the District of Columbia. The Company specializes in providing health and
other insurance products designed to maximize choice and control costs. The
Company principally markets health benefit products that provide discounts to
insureds that utilize preferred provider organizations ("PPOs"). PPO plans
differ from health maintenance organization ("HMO") plans in that they typically
provide a wider choice of health professionals, fewer benefit restrictions and
increased access to specialists at a somewhat higher premium cost.
American Medical Security Group, Inc. is a Wisconsin corporation organized in
1983. The Company's principal executive offices are located at 3100 AMS
Boulevard, Green Bay, Wisconsin 54313 and its telephone number at that address
is (920) 661-1111.
In September 1998, when the name of the Company was United Wisconsin Services,
Inc., the Company spun off its managed care companies and specialty products
business to the Company's shareholders. The Company transferred all of its
subsidiaries comprising the managed care and specialty products business to a
newly created subsidiary named Newco/UWS, Inc., a Wisconsin corporation, and
distributed 100% of the issued and outstanding shares of common stock of
Newco/UWS, Inc. to the Company's shareholders. In connection with the spin-off,
the Company adopted its current name of American Medical Security Group, Inc.,
and Newco/UWS, Inc. changed its name to United Wisconsin Services, Inc., which
has since changed its name to Cobalt Corporation.
AVAILABLE INFORMATION
The Company's annual report on Form 10-K, quarterly reports on Form 10-Q,
current reports on Form 8-K and amendments to those reports filed or furnished
pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are
available free of charge through the Company's website at http://www.eams.com as
soon as reasonably practicable after the Company electronically files such
reports with the Securities and Exchange Commission.
3
PRODUCTS
The Company provides tailored products to meet the varied health insurance needs
of its primary markets, including small employer groups, individuals and their
families. Features commonly found in the Company's products include:
o Choice of co-payment, deductible and coinsurance levels
o Choice of PPO networks
o Availability of comprehensive prescription drug coverage
o Wellness and routine care coverage
o Nurse Healthline, Inc., the Company's 24 hour-a-day health information line
SMALL EMPLOYER GROUP
Small employer group medical insurance products are targeted to employer groups
with 2 to 50 employees. The Company's average in-force group size was
approximately six employees as of December 31, 2002. Distributed through a
network of independent agents, small employer group products are customized for
businesses to offer their employees multiple health plan options in a single
package. For example, this strategy allows an employer with four employees to
offer four different and distinct health plans, one for each employee. Although
the premium cost of the plans may vary, the ability to offer different plans to
individual employees is without any additional cost to the employer. In 2002,
the Company continued the introduction of small employer group products that
were redesigned to provide for more patient responsibility for routine health
care.
MEDONE(SM)
MedOne(SM) medical insurance products are marketed to individuals and their
families. These products are designed to meet the various health insurance needs
and budgets of consumers. Sold through independent agents, MedOne(SM) insurance
products are designed for cost-conscious consumers and feature more attractive
premium rates, protection from catastrophic medical costs and increased patient
responsibility for routine health expenses. Individuals may select various
deductible and co-payment features to fit their needs and budgets. In addition,
the Company offers custom, private label products for individuals and families
that are sold through arrangements with select general agents. In 2002, the
Company consolidated the number of offerings for its MedOne(SM) plan options.
DENTAL
The Company's dental products offer members a choice in benefit plans, with
access to any dental provider in most markets, and coverage for a complete range
of dental services from preventative maintenance to major dental expenses. The
Company's dental products can be purchased through employer-sponsored plans or
on a voluntary basis with no employer contribution requirements. Dental coverage
can be purchased with the Company's group medical insurance or on a stand-alone
basis. Approximately 70% of the Company's dental members have stand-alone plans.
OTHER
The Company also sells fully insured products to employers having in excess of
50 employees. These products have the same features as the Company's products
sold to small employer groups. In addition, the Company offers self-funded
benefit administration services for employers that want to assume a portion of
the financial risk for their own health plans. In conjunction with the Company's
benefit administration services, the Company offers excess loss reinsurance to
cover catastrophic losses of the self-funded plan. Additionally, the Company
offers COBRA administration services to groups subject to regulations under the
Consolidated Omnibus Budget Reconciliation Act of 1985, as amended.
4
The Company augments its core business with a select line of products and
services. Ancillary benefits available with the Company's plans include term
life, short-term medical, short-term disability, accidental death and dependent
life insurance. Voluntary term life insurance products may be elected by
employees with no employer contribution requirements.
The Company provides members with toll-free, personal customer service 24 hours
a day, seven days a week. In addition, through the Company's wholly owned
subsidiary, Nurse Healthline, Inc., members have access to a toll-free 24
hour-a-day health information line staffed by registered nurses.
SALES AND MARKETING
The Company currently markets its products in 32 states and the District of
Columbia. At December 31, 2002, the Company's leading states with respect to
medical membership were Florida, Illinois, Texas and Michigan, each individually
representing approximately 10% of the Company's total medical membership.
Product sales are conducted through approximately 27,000 licensed independent
agents, an 8% increase in the number of agents from the prior year. During 2002,
the Company continued to increase the number of agents selling its products to
support the Company's initiative to grow MedOne(SM) sales. Agents are paid
commissions on premiums generated from new and renewal sales. The Company offers
an attractive incentive and service package to agents, establishing itself as an
agent-friendly company.
During 2002, the Company expanded and realigned its sales organization and
brought in new leadership in sales and support areas. The Company operates 17
regional sales offices located throughout the United States to coordinate the
Company's sales and marketing efforts for all of its products. The sales offices
are staffed by approximately 75 sales managers who manage the Company's
relationship with the independent agents. Sales office staff also provide
product training to agents and support local agent needs.
In late 2002, the Company enhanced its marketing approach for its small employer
group products with the introduction of a computer-based quoting tool that
allows agents to rapidly calculate both employer and employee contribution rates
for multiple plan designs.
The Company also utilizes select general agents to sell custom, private label
products for individuals and their families. These independent agents produce
business through lead generation and independent sub-agents located throughout
the Company's sales territory. In 2002, the Company began contracting with
regional marketing centers to focus on sales of the Company's MedOne(SM)
products. Regional marketing centers are independent agencies employing
broad-based, mass marketing techniques to sell health insurance to individuals
and families. The Company currently has contracts with seven regional marketing
centers. The Company also markets, on a limited basis, a MedOne(SM) medical
insurance product for individuals and their families over the Internet through
several online insurance agencies.
COMPETITION
The market for the Company's insurance products is highly competitive. The major
competition for the Company's products comes from national and regional firms.
Many of the Company's competitors have larger membership in regional markets or
greater financial resources. The small employer group and individual health
insurance business is typically agency-controlled, highly price sensitive and
put out for bid more frequently than larger group business. In addition, because
most of the Company's products are marketed primarily through independent
agencies, most of which represent more than one company, the Company experiences
competition within each agency. The Company and other insurers in the small
group health insurance market compete primarily on the basis of price, benefit
plan design, strength of provider networks, quality of customer service,
reputation and quality of agency relations.
5
PROVIDERS
The Company has arrangements with approximately 70 commercial preferred provider
networks for its fully insured and self-funded product offerings. The networks
recruit and maintain providers representing a wide variety of specialty areas.
Other than the commercial PPO network operated by the Company's wholly owned
subsidiary, Accountable Health Plans of America, Inc., the Company generally
does not contract directly with providers.
Accountable Health Plans of America, Inc., operates a commercial PPO network
that contracts with providers primarily in Texas, Florida, Iowa, Nebraska,
Wisconsin, Arizona, North Dakota and South Dakota. Approximately 17% of the
Company's medical members utilized this network in 2002. The Company leases this
PPO network to other insurers, third party administrators and employers that
self insure their benefit plans for a monthly per member fee. Approximately 73%
of Accountable Health Plan's membership is derived from these other sources.
The Company contracts with an outside pharmacy benefit manager to provide
prescription drug benefits to its members. The Company entered into a five-year
pharmacy benefit management agreement that became effective January 1, 2003.
This arrangement allows members to access their prescription benefits at
thousands of retail outlets nationwide or through a mail-order service. The new
pharmacy benefit manager focuses on disease management efforts for certain
conditions through patient education.
MEDICAL MANAGEMENT SERVICES
The Company's care management model is a single streamlined process merging
utilization review, pre-certification, concurrent review and retrospective
review with discharge planning and case management. Under this model certain
patients are assigned a care manager to assist the insured during the entire
episode of care. This integrated model is designed to support physician-directed
treatment plans, improve cost savings, promote quality of care for the Company's
members and enhance member and provider satisfaction. The Company continues to
apply the more traditional approach to reviewing certain select hospital
admission and medical services; however, for other complex and costly
conditions, it applies this proactive care management approach. The Company's
care management team provides coordination of care to patients with chronic,
complex medical conditions. Designated clinical staff manage transplant-related
care situations. Licensed physicians and nurse professionals provide clinical
direction for the Company's medical management services. The Company's
utilization review activities meet national standards and are accredited by
URAC, also know as American Accreditation HealthCare Commission, an organization
that establishes standards for the health care industry.
The Company also offers a demand management telephone service through its wholly
owned subsidiary, Nurse Healthline, Inc. Members can access Nurse Healthline
registered nurses 24 hours a day, 365 days a year. By using a computerized
algorithm-based system, Nurse Healthline is able to provide information to
members to assist them in gauging the relative severity of a problem and
accessing appropriate health care. Nurse Healthline also offers a maternal
wellness program designed to encourage expectant mothers to receive appropriate
prenatal care, to provide them with educational materials and, if appropriate,
to refer them to the Company's care management staff. In 2002, Nurse Healthline
implemented a Heart Healthy Program that targets members with heart conditions
or who have had cardiac procedures.
The Company's subrogation department is responsible for investigating potential
liability for injury claims to determine if other insurance coverage is
available or considered primary. Claims are identified primarily through the use
of a diagnosis code table built into the adjudication system, and are
investigated via the telephone to expedite the process. The majority of savings
achieved are due to the identification of motor vehicle accidents, as well as
work-related injuries and illnesses.
The Company's special investigation team proactively searches for fraud and
abuse on questionable claims submitted by providers and insureds. The Company is
a corporate member of the National Healthcare Anti-Fraud Association. When
appropriate, information is shared with the federal and state regulatory and law
enforcement agencies. In addition, the Company pursues recoveries
post-adjudication when fraud or misrepresentation has been established.
6
OPERATIONS AND INFORMATION TECHNOLOGY
The Company's core operational and administrative functions are currently
supported by a single, custom-built, fully integrated management information
system. The Company's current information system supports all operational
functions including: underwriting, billing, enrollment, claims processing,
customer service, agent licensing and compensation, utilization management,
network analysis and sales reporting. The Company uses extensive personal
computer-based network and software applications that are integrated with the
Company's platform system. The Company has integrated software into its system
with specific functionality for case management and for the repricing of claims
in accordance with PPO contracts providing for further cost savings.
The Company continuously explores ways to upgrade and enhance its technology and
software applications to meet business needs. In an effort to continue
supporting business growth, operational efficiencies, service improvements and
future administrative cost savings, beginning in 2003 the Company will invest in
an enterprise-wide information technology modernization project. The project
involves the purchase of software applications and the utilization of internal
and external technology and consulting resources to support most of the
Company's major business processes. The design, development and implementation
is scheduled to occur over the next few years.
The Company's customer service center is open 24 hours a day. The Company also
offers a customer self-service center where members can use the Internet to
check the status of claims, order identification cards, update addresses and
locate medical providers. The Company also provides an Internet website for its
independent sales agents. The website allows agents to check enrollment, view
new business status, review all active and pending business, and access product
materials, provider information and administrative forms.
REINSURANCE
The Company has entered into a variety of reinsurance arrangements under which
it cedes business to other insurance companies to mitigate large claim risk and
assumes risk from other insurance carriers in connection with certain
acquisitions and other business. The Company transfers, through excess loss
arrangements, certain of the Company's risks on its small employer group and
MedOne(SM) health and life insurance business. This reinsurance allows for
greater diversification of risk to control exposure to potential losses arising
from large claims. In addition, it permits the Company to enhance its premium
and asset growth while maintaining favorable risk-based capital ratios. All
excess loss reinsurers with which the Company contracts are currently rated A-
(Excellent) or better by A.M. Best Company. See the Company's Notes to
Consolidated Financial Statements, Note 1, "Organization and Significant
Accounting Policies-Reinsurance" for a summary of reinsurance assumed and
ceded.
INVESTMENTS
The Company attempts to minimize its business risk through conservative
investment policies. Investment guidelines set quality, concentration and return
parameters. Individual fixed income issues must carry an investment grade rating
at the time of purchase, with an ongoing average portfolio rating of "A-" or
better, based on ratings of Standard & Poor's Corporation or another nationally
recognized securities rating organization. Investment grade debt securities made
up over 97% of the Company's total investment portfolio at December 31, 2002.
Below investment grade debt securities in the Company's investment portfolio
were investment grade when purchased and subsequently downgraded. The Company
invests in securities authorized by applicable state laws and regulations and
follows investment policies designed to maximize yield, preserve principal,
provide liquidity and add value relative to a market index. The Company's
portfolio contains no investments in mortgage loans, nonpublicly traded
securities, real estate held for investment or financial derivatives.
With the exception of short-term investments and securities on deposit with
various state regulators, investment responsibilities have been delegated to
external investment managers. Such investment responsibilities, however, must be
carried out within the investment parameters established by the Company, which
are amended from time to time. See Item 7, "Management's Discussion and Analysis
of Financial Condition and Results of Operations - Market Risk Exposure" and the
Company's Notes to Consolidated Financial Statements, Note 4, "Investments," for
additional information on the Company's investments.
7
REGULATION
Government regulation of employee benefit plans, including health care coverage
and health plans, is a changing area of law that varies from jurisdiction to
jurisdiction and generally gives responsible state and federal administrative
agencies broad discretion with respect to the regulation of health plans, health
insurers and related entities. The Company strives to maintain compliance in all
material respects with all federal and state regulations applicable to its
current operations. To maintain such compliance, it may be necessary for the
Company to make changes from time to time in the Company's services, products,
structure or operations. Additional governmental regulation or future
interpretation of existing regulations could increase the cost of the Company's
compliance or otherwise affect the Company's operations, products, profitability
or business prospects.
The Company is unable to predict what additional government regulations
affecting its business may be enacted in the future or how existing or future
regulations might be interpreted. Most jurisdictions have enacted small employer
group insurance and rating reforms that generally limit the ability of insurers
and health plans to use risk selection as a method of controlling costs for the
small employer group business. These laws sometimes limit or eliminate use of
pre-existing condition exclusions, use of health status and rating and use of
industry codes and rating, and limit the amount of rate increases from year to
year. Under these laws, cost control through provider contracting and managing
care may become more important, and the Company believes its experience in these
areas will allow it to compete effectively. The Company regularly monitors state
and federal legislative and regulatory activity as it affects the Company's
business.
FEDERAL INSURANCE REGULATION
In recent years, federal legislation significantly expanded federal regulation
of small group health plans and health care coverage. The Health Insurance
Portability and Accountability Act of 1996 ("HIPAA"), places restrictions on the
use of pre-existing conditions and eligibility restrictions based upon health
status, and prohibits cancellation of coverage due to claims experience or
health status. HIPAA also prohibits insurance companies from declining coverage
to small employers. Additional federal laws that took effect in 1998 include
prohibitions against separate, lower dollar maximums for mental health benefits
and requirements relating to minimum coverage for maternity inpatient
hospitalization. Many requirements of the federal legislation are similar to
small group reforms that have been in place for many years.
HIPAA also established new requirements regarding the confidentiality and
security of patient health information and standard formats for the electronic
transmission of health care data, including code sets. Final privacy rules
adopted in 2001 require changes in the way health information is handled. The
privacy regulations require most covered entities to be in compliance by April
2003. Final regulations regarding the standard formats for the transmission of
health care information have also been released and require compliance by
October 2003. The Company has implemented new procedures to comply with the
privacy regulations and continues to take action to comply with the
standardization regulations. The regulations will have the effect of increasing
the Company's expenses. In recent years, the Company also has implemented
procedures to comply with the privacy standards for personal information
required by the Gramm-Leach-Bliley Act.
In 2002, the Company implemented procedures to comply with U. S. Department of
Labor regulations that revise claims procedures for employee benefit plans
governed by ERISA. The regulations became effective for claims filed on or after
July 1, 2002 and govern the time frame for making benefit decisions for claims
and appeals and for notification of claimants' rights under the regulations.
Congress has proposed numerous other health care reform measures in recent
years. Congress continues to consider legislation such as a "Patients' Bill of
Rights," which may mandate coverage of additional benefits, give patients the
right to sue their health care company, require payment of claims within a
certain number of days (regardless of whether it is a valid claim) and call for
additional privacy requirements. Additionally, Congress proposed legislation in
2002 that would allow small employers to form association health plans that
would be exempt from state insurance regulations. These legislative initiatives
could affect various aspects of the Company's business. The Company is unable to
predict when or whether such legislation or any additional federal proposals
will be enacted or the effect of such developments on the Company's operations
and financial condition.
8
STATE INSURANCE REGULATION
The Company's insurance subsidiaries are subject to extensive regulation by
various insurance regulatory bodies in each state in which the respective
entities are licensed. This extensive supervisory power over insurance companies
is designed to protect policyholders, rather than investors, and relates to:
o the licensing of insurance companies;
o the approval of forms and insurance policies used, and, in some cases, the
rates charged in connection with those forms;
o the nature of, and limitation on, an insurance company's investments;
o policy administration and claim paying procedures;
o periodic examination of the operations of insurance companies;
o the form and content of annual financial statements and other reports
required to be filed on the financial condition of insurance companies;
o capital adequacy; and
o transactions with affiliates and changes in control.
The Company's insurance subsidiaries are required to file periodic statutory
financial statements in each jurisdiction in which they are licensed. On an
ongoing basis, states consider various health care reform measures relating to
network management, mandated benefits, underwriting, appeals and administrative
procedures and other matters.
The National Association of Insurance Commissioners has adopted risk-based
capital requirements for life and health insurers to evaluate the adequacy of
statutory capital and surplus in relation to investment and insurance risks
associated with asset quality, mortality and morbidity, asset and liability
matching and other business factors. The risk-based capital formula is used by
state insurance regulators as an early warning tool to identify insurance
companies that potentially are inadequately capitalized. At December 31, 2002,
the Company's insurance subsidiaries had risk-based capital ratios substantially
above the levels that would require action by the Company or a regulator.
Dividends paid by the Company's insurance subsidiaries to the Company are
limited by state insurance regulations. For additional information on dividend
restrictions, see the Company's Notes to Consolidated Financial Statements, Note
9, "Shareholders' Equity--Restrictions on Dividends From Subsidiaries."
INSURANCE HOLDING COMPANY SYSTEMS
The Company is an insurance holding company system under applicable state laws.
As such, the Company and its insurance subsidiaries are subject to regulation
under state insurance holding company laws and regulations in the states in
which the insurance subsidiaries are domiciled. The insurance holding company
laws and regulations generally require annual registration with the state
departments of insurance and the filing of reports describing capital structure,
ownership, financial condition, certain intercompany transactions and general
business operations. Various notice and reporting requirements often apply to
transactions between an insurer and its affiliated companies, depending on the
size and nature of the transactions. Certain state insurance holding company
laws and regulations also require prior regulatory approval or notice of certain
material intercompany transactions. Direct or indirect acquisition of control of
an insurance company requires the prior approval of state regulators in the
insurer's state of domicile and sometimes other jurisdictions as well.
Acquisition of a controlling interest of the Company's common stock would
constitute an acquisition of a controlling interest in each of the Company's
insurance subsidiaries. Under applicable state law, control is generally
presumed to exist in any person who beneficially owns or controls greater than
10% of a company's shares.
OTHER STATE REGULATIONS
Certain of the Company's subsidiaries are licensed as third party
administrators. Regulations governing third party administrators, although
differing greatly from state to state, generally contain requirements for
administrative procedures, periodic reporting obligations and minimum financial
requirements. Certain of the operations of the
9
Company's subsidiaries are also subject to laws and/or regulations governing
PPO, managed care and utilization review activities. PPO and managed care
regulations generally contain requirements pertaining to grievance procedures,
provider networks, provider contracting and reporting requirements that vary
from state to state. Utilization review regulations generally require compliance
with specific standards for the performance of utilization review services
including confidentiality, staffing, appeals and reporting requirements. In some
cases, the regulated PPO, managed care and utilization review activities are
delegated by subsidiaries to a third party.
ERISA
The provision of goods and services to or through certain types of employee
health benefit plans is subject to the Employee Retirement Income Security Act
of 1974, as amended, which is commonly referred to as ERISA. ERISA is a complex
set of laws and regulations that is subject to periodic interpretation by the
United States Department of Labor and the Internal Revenue Service. ERISA
governs how the Company's business units may do business with employers whose
employee benefit plans are covered by ERISA, particularly employers who self
fund benefit plans. There have been legislative attempts to limit ERISA's
preemptive effect on state laws. If such limitations were to be enacted, they
might increase the Company's liability exposure under state law-based suits
relating to employee health benefits offered by the Company's health insurance
plans and could permit greater state regulation of other aspects of those
businesses' operations.
EMPLOYEES
As of December 31, 2002, the Company had 1,601 employees, 1,396 of which are
located at its home office facility in Green Bay, Wisconsin. None of its
employees is represented by a union.
TRADEMARKS
The Company has filed for and maintains various service marks, trademarks and
trade names at the federal level and in various states. Although the Company
considers its registered service marks, trademarks and trade names important,
the business of the Company is not dependent on any individual service mark,
trademark or trade name.
ITEM 2. PROPERTIES
The Company's headquarters are located in Green Bay, Wisconsin, in a 400,000
square foot office building owned by the Company and used by both of its
business segments. The property is pledged as collateral to the Company's
commercial lender pursuant to a mortgage that continues until January 1, 2004.
The Company also leases property at approximately 30 locations throughout the
United States primarily for its field sales and provider network offices.
ITEM 3. LEGAL PROCEEDINGS
In February 2000, a class action lawsuit was filed against two of the Company's
wholly owned subsidiaries, American Medical Security, Inc. ("AMS") and United
Wisconsin Life Insurance Company ("UWLIC"), in the Circuit Court for Palm Beach
County, Florida, by Evelyn Addison and others alleging that the Company failed
to follow Florida law when it discontinued writing certain health insurance
policies and offering new policies in 1998. Plaintiffs claim that the Company
wrongfully terminated coverage, improperly notified insureds of conversion
rights and charged improper premiums for new coverage. Plaintiffs also allege
that UWLIC's renewal rating methodology violated Florida law. In a final
judgment entered April 24, 2002, the Circuit Court Judge in the class action
lawsuit found, among other things, that the policy issued by the Company outside
Florida was not exempt from any Florida rating laws and ordered that the
question of damages be tried before a jury. On September 9, 2002, the Circuit
Court Judge declared a mistrial in the damages portion of the lawsuit on the
grounds that the trial could not be completed within the time constraints of the
Court. On September 27, 2002, the Circuit Court Judge recused himself from the
case. A new judge has been assigned to the case but a trial date for the damages
portion of the lawsuit has not been rescheduled.
10
In a separate administrative proceeding involving substantially similar issues,
the Florida Department of Insurance issued an administrative complaint against
UWLIC in May 2001 challenging UWLIC's rating and other practices in Florida
relating to UWLIC's MedOne(SM) products for individuals and their families.
MedOne(SM) products sold by UWLIC in Florida are written pursuant to a group
master policy issued to an association domiciled in another state. In a
recommended order entered April 25, 2002, the Administrative Law Judge held that
the evidence presented by the Florida Department of Insurance did not support a
conclusion that UWLIC had violated any provisions of Florida law. The
Administrative Law Judge recommended that all counts of the Department's
administrative complaint be dismissed. On July 24, 2002, the Florida Department
of Insurance issued a final order affirming the recommendations from the
Administrative Law Judge with respect to six of eight counts. Among other
things, the final order affirmed that the policy issued to the association was
exempt from most Florida rating requirements. However, the Department reversed
the Administrative Law Judge's finding that the Company did not violate state
law applicable to policies issued out of state, and ordered the suspension of
UWLIC's license to sell new business in Florida for one year. The Department's
order specifically permits UWLIC to continue to renew its existing business in
Florida. On July 29, 2002, the First District Court of Appeals for the State of
Florida stayed the order of the Florida Department of Insurance. The stay is
effective until the Court of Appeals rules on the Company's request to overturn
the order. Oral arguments were held before the appellate court on February 12,
2003. The Company is awaiting a ruling. The Company anticipates a reversal of
the final order on appeal. The Company has voluntarily implemented a block
rating system for all of its MedOne(SM) products due to adverse publicity and
misperceptions about the Company's rating practices.
The Company's subsidiaries, AMS and UWLIC, are defendants in a number of
lawsuits in various states, primarily Alabama, alleging misrepresentation of the
rating methodology used by the Company with respect to certain MedOne(SM)
products purchased by the plaintiffs. These lawsuits commonly seek unspecified
damages for misrepresentation and emotional distress in addition to punitive
damages. Some of these cases involve multiple plaintiffs. The cases are in
various stages of litigation. One or more of the cases could come to trial as
early as the second quarter of 2003. The Company believes that these lawsuits
are unfounded because the Company properly disclosed the nature of the products
sold. The Company also believes the subject matter of the lawsuits falls under
the primary jurisdiction of state insurance departments. The Company is
vigorously defending itself in these actions.
The Company is involved in various other legal and regulatory actions occurring
in the normal course of business. Based on current information, including
consultation with outside counsel, management believes any ultimate liability
that may arise from the above-mentioned and all other legal and regulatory
actions would not materially affect the Company's consolidated financial
position or results of operations. However, management's evaluation of the
likely impact of these actions could change in the future and an unfavorable
outcome could have a material adverse effect on the Company's consolidated
financial position, results of operations or cash flow of a future period.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of 2002.
11
EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers of the Company, who are elected for one year terms, are
as follows:
NAME AGE TITLE
---------------------- --- -----------------------------------------------------------------------
Samuel V. Miller 57 Chairman of the Board, President and Chief Executive Officer
James C. Modaff 45 Executive Vice President and Chief Actuary
Thomas G. Zielinski 55 Executive Vice President, Operations
Timothy J. Moore 51 Senior Vice President of Corporate Affairs, General Counsel and
Secretary
Timothy F. O'Keefe 48 Senior Vice President and Chief Marketing Officer
Clifford A. Bowers 51 Vice President, Corporate Communications
James E. Prochnow 38 Vice President, Corporate Controller and Interim Treasurer
John R. Wirch 49 Vice President, Human Resources
Samuel V. Miller has been Chairman of the Board, President and Chief Executive
Officer of the Company since September 1998. Prior to that time, he was an
Executive Vice President of the Company since December 1995. During 1994 and
1995, Mr. Miller was a member of the executive staff planning group with the
Travelers Group, serving as Chairman and Group Chief Executive of National
Benefit Insurance Company and Primerica Financial Services Ltd. of Canada. Prior
to 1994, Mr. Miller spent 10 years as President and Chief Executive Officer of
American Express Life Assurance Company.
James C. Modaff has been Executive Vice President and Chief Actuary of the
Company since August 1999. Prior to joining the Company, he was a principal of
Milliman & Robertson, Inc. (a national actuarial and consulting firm) for the
majority of his 14-year career with the firm.
Thomas G. Zielinski has been Executive Vice President of Operations of the
Company since August 1999. Prior to joining the Company, he was a Vice President
of Humana, Inc. (a health services company) where he served as Executive
Director of the Wisconsin Service Center of Humana, Inc. and in various other
capacities, including Vice President, with a predecessor company of Humana, Inc.
since 1981.
Timothy J. Moore has been Senior Vice President of Corporate Affairs, General
Counsel and Secretary of the Company since September 1998. He also served in
that capacity with American Medical Security Holdings, Inc. since March 1997.
Prior to that time, Mr. Moore was a partner with the national law firm of Katten
Muchin & Zavis, practicing at the firm from 1987 to 1997.
Timothy F. O'Keefe has been Senior Vice President and Chief Marketing Officer of
the Company since January 2002. Prior to joining the Company, he was President
of the Major Medical Division of Conseco, Inc.'s insurance operations, having
served in other senior management positions from 1997 until he became President
in 1998. From 1991 to 1997 he held various positions, including Chief Marketing
Officer, with various subsidiaries of Pioneer Financial Services.
Clifford A. Bowers has been Vice President of Corporate Communications of the
Company since September 1998. He also served in that capacity with American
Medical Security Holdings, Inc. since October 1997. From 1988 to 1997, Mr.
Bowers was Director of Communications with Fort Howard Corporation (a paper
manufacturer). Prior to that time, Mr. Bowers held management positions with
Tenneco, Manville and Brunswick corporations.
James E. Prochnow has been a Vice President of the Company since August 1999 and
Corporate Controller since June 1997. In December 2002, he began serving as the
Company's principal financial officer and became Interim Treasurer. From 1988 to
1997, Mr. Prochnow was an auditor with the firm of Ernst & Young LLP.
John R. Wirch has been Vice President of Human Resources of the Company since
September 1998. He also served in that capacity with American Medical Security
Holdings, Inc. since February 1996. Prior to that time, Mr. Wirch was Vice
President of Human Resources for Little Rapids Corporation (a manufacturer of
specialty papers) from 1993 to 1996, having served as Director of Human
Resources of Little Rapids Corporation from 1980 to 1993.
12
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The common stock of the Company is traded on the New York Stock Exchange
("NYSE") under the symbol "AMZ". The following table sets forth the per share
high and low sales prices for the common stock as reported on the NYSE.
2002 2001
----------------------------------------------------
Share Price Share Price
High Low High Low
--------------------------------------------------------------------------------------------------------------------
Quarter Ended:
March 31 $ 18.15 $ 11.00 $ 7.00 $ 4.75
June 30 24.09 15.45 6.96 5.00
September 30 23.98 11.41 6.85 4.80
December 31 14.85 10.80 12.45 5.60
The Company did not pay any cash dividends during the periods indicated above
and is prohibited from declaring or paying any future cash dividends by debt
covenant restrictions on the Company's line of credit agreement. In addition,
dividends paid by the Company's insurance subsidiaries to the parent Company are
limited by state insurance regulations. See Item 7, "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Liquidity and
Capital Resources" for a detailed discussion of insurance subsidiary dividend
limitations.
As of February 28, 2003, there were 201 shareholders of record of common stock.
Based on information obtained from the Company's transfer agent and from
participants in security position listings and otherwise, the Company has reason
to believe there are approximately 2,600 beneficial owners of shares of common
stock.
13
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data as of and for the years ended December 31,
1998 through 2002 has been derived from the Company's consolidated financial
statements. The following data should be read in conjunction with the Company's
consolidated financial statements, the related notes thereto, and "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
As of and for the years ended December 31,
---------------------------------------------------------------
(THOUSANDS, EXCEPT PER SHARE DATA) 2002(a) 2001 2000 1999 1998(b)
--------------------------------------------------------------------------------------------------------------------
STATEMENT OF OPERATIONS DATA:
REVENUES
Insurance premiums $ 754,460 $ 838,672 $ 951,071 $ 1,056,107 $ 914,017
Total revenues 789,529 876,621 989,865 1,097,380 960,869
EXPENSES
Medical and other benefits 507,205 601,942 724,613 860,473 691,767
Total expenses 752,367 866,189 983,749 1,136,369 965,765
Income (loss) from continuing operations,
before income taxes 37,162 10,432 6,116 (38,989) (4,896)
Income tax expense (benefit) 14,676 6,257 3,447 (13,043) (1,868)
--------------------------------------------------------------------------------------------------------------------
Income (loss) from continuing operations 22,486 4,175 2,669 (25,946) (3,028)
Income from discontinued operations,
less applicable income taxes - - - - 10,003
Cumulative effect of a change in accounting
principle (60,098) - - - -
--------------------------------------------------------------------------------------------------------------------
Net income (loss) $ (37,612) $ 4,175 $ 2,669 $ (25,946) $ 6,975
====================================================================================================================
PER SHARE DATA:
Income (loss) from continuing operations per share:
Basic $ 1.72 $ 0.30 $ 0.18 $ (1.58) $ (0.18)
Diluted $ 1.63 $ 0.29 $ 0.18 $ (1.58) $ (0.18)
Weighted average common shares outstanding:
Basic 13,047 14,049 14,899 16,470 16,559
Diluted 13,835 14,228 15,049 16,470 16,559
Cash dividends per common share $ - $ - $ - $ - $ 0.36
OTHER DATA:
Cash and investments $ 314,056 $ 300,253 $ 284,982 $ 293,539 $ 309,562
Total assets 428,940 473,015 471,923 503,094 498,722
Notes payable 33,858 40,058 41,258 42,523 55,064
Total shareholders' equity 182,750 229,400 221,177 220,280 266,451
Cash flow from operating activities 35,175 17,590 (3,159) 26,428 (3,709)
(a) During 2002, the Company changed its method of accounting for goodwill and
other intangible assets. See the Company's Notes to Consolidated Financial
Statements, Note 2, "New Accounting Standard" for a comprehensive
discussion of the impact of the new accounting standard.
(b) Discontinued operations include the operations of Newco/UWS through
September 25, 1998, the spin-off distribution date. Continuing operations
includes interest on debt assumed by Newco/UWS through September 11, 1998,
the spin-off effective date.
14
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
American Medical Security Group, Inc., together with its subsidiary companies
(the "Company"), is a provider of individual and small employer group insurance
products. The Company's principal product offerings are health insurance for
small employer groups and health insurance marketed to individuals and their
families ("MedOne(SM)"). The Company also offers dental, life, prescription
drug, disability and accidental death insurance, and provides self-funded
benefit administration. The Company's products are marketed in 32 states and the
District of Columbia through independent agents. The Company has approximately
75 sales managers located in sales offices throughout the United States to
support the independent agents. The Company's products generally provide
discounts to insureds that utilize preferred provider organizations. The Company
owns a preferred provider network and also contracts with other networks to
ensure cost-effective health care choices to its customers.
SUMMARY OF 2002 RESULTS
The Company reported significant earnings improvement during 2002. Income for
2002, before the cumulative effect of a change in accounting principle, was
$22.5 million or $1.63 per diluted share. That compares to 2001 net income of
$4.2 million or $0.29 per diluted share. The results for 2001 include an
after-tax charge of $5.8 million or $0.41 per share resulting from an adverse
ruling in a lawsuit brought against the Company by Skilstaf, Inc. Effective
January 1, 2002, the Company changed its method of accounting for goodwill and
other intangibles. This change in accounting principle resulted in the
elimination of goodwill amortization, which increased 2002 earnings per diluted
share by $0.19, as compared to 2001. In addition, effective January 1, 2002, the
Company recognized a non-cash goodwill impairment charge of $60.1 million, which
was reported as the cumulative effect of a change in accounting principle. See
the Company's Notes to Consolidated Financial Statements, Note 2, "New
Accounting Standard" for a comprehensive discussion of the impact of the new
accounting standard.
The improvement in profitability from the prior year, excluding the items noted
above, resulted principally from a lower health loss ratio as premiums per
member continued to rise faster than claims per member. The improvement in the
loss ratio is primarily attributed to management's strategic actions including
increased premium rates on new and renewal business, focused marketing efforts
for small employer group products in markets with the best prospects for
profitability and future growth, and redesigned products to meet the changing
needs of today's insurance consumers. The Company's health loss ratio and its
resulting quarterly earnings have improved sequentially for the past two years.
The Company continues to operate in an environment of rapidly rising health care
costs. Significant advances in medical technology and drug treatments over the
last few years have led to higher quality of care resulting in increased
utilization of care at higher prices. The Company's claims cost trend, a measure
of health care inflation, increased approximately 16% during 2002, well in
excess of the consumer price index. In an effort to address high claims cost
trends, the Company implemented significant premium rate increases and
redesigned its product offerings to provide for more patient responsibility for
routine health care.
The Company experienced declining revenues and membership over the past several
years. This is due to several factors, including the Company's exit from
unprofitable markets and discontinuance of unprofitable products, the difficulty
individuals and small employer groups face in affording increasing health
insurance premiums and the effect of a declining economy with many employer
groups being forced to layoff or downsize their workforce. Also, during 2002,
the Company experienced negative national publicity surrounding the Company's
MedOne(SM) rating practices and related legal matters. Management believes the
publicity negatively affected the Company's MedOne(SM) new member enrollment
during the last half of 2002. To address the negative publicity, the Company
voluntarily implemented a block rating system for its MedOne(SM) products in all
markets, effective January 1, 2003. Management believes the transition to block
rating will have no material adverse effect on future earnings, and that the
transition to block rating will not disrupt the Company's operations.
15
Building profitable membership and revenue is management's top priority for
2003. Beginning in 2002 and continuing into 2003, management has implemented a
comprehensive plan to improve new member enrollment and persistency of
membership inforce. The Company has restructured its distribution system by
expanding and realigning its sales organization to maximize existing management
and organizational strengths. Management continues to introduce new products,
establish new distribution channels for the Company's MedOne(SM) products, and
implement aggressive agent recruitment and incentive programs to improve
productivity. Management is also continuing its focus on the Company's small
group business, which is experiencing increased new member enrollment as well as
improved profitability. As a result of these initiatives, management is
expecting to see improved membership and revenue in 2003.
COMPARISON OF RESULTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2002 AND 2001
Insurance premium revenues decreased 10.0% to $754.5 million in 2002 from $838.7
million in 2001. Premium revenues have decreased as a result of the Company's
membership decline. Total medical and dental membership declined to 571,000 at
the end of 2002 compared with 637,000 at the end of 2001. In addition, premium
revenue was also impacted by the Company's change in its product mix. The
MedOne(SM) business, which has become a larger percentage of the Company's total
business, has a smaller premium per member compared with the small group
business, which was declining in the period. Partially offsetting the membership
decline was the effect of rising premium rates on the continuing block of
business. After the effect of buydowns in coverage and terminations, average
fully insured medical premium per month for 2002 increased 11% compared with
2001.
The health segment loss ratio improved 470 basis points to 67.9% for 2002
compared to 72.6% for 2001. The improvement in the health loss ratio is due in
part to improved performance on the Company's small group business resulting
from repricing efforts. In 2002, average premiums per member per month increased
at a higher rate than average claims costs per member resulting in a lower loss
ratio. The health loss ratio also benefited, to a lesser degree, from the change
in product mix to a larger percentage of MedOne(SM) business, which has a lower
loss ratio. During 2002, the Company increased its reserves for litigation,
which are included in medical and other benefits payable. This increase was
offset by favorable claims experience on 2001 reserves during 2002. The life
segment, which represents less than 2% of the Company's total revenues,
experienced a favorable loss ratio at 29.1% for 2002 compared with 36.4% for
2001.
Net investment income decreased to $15.0 million in 2002 from $17.4 million in
2001. The decrease resulted mainly from a decrease in the annual investment
yield. The annual investment yield was 5.5% for 2002 compared to 6.4% for the
prior year.
Other revenue, which primarily consists of administrative fee income from claim
processing on self funded business and other administrative services, decreased
to $20.0 million in 2002 from $21.3 million in 2001. The decrease resulted from
the decrease in membership during 2002.
The expense ratio includes commissions, general and administrative expenses,
premium taxes and assessments less other revenues. The health segment expense
ratio increased to 28.4% in 2002 from 26.6% in 2001, excluding the Skilstaf
litigation charge discussed in the comparison of 2001 and 2000 results of
operations. Including the litigation charge, the health segment expense ratio
for 2001 was 29.8%. The increase from the prior year largely reflected the
decrease in premium volume in 2002 compared to 2001. The change in the Company's
product mix also contributed to the increase in the health segment expense
ratio. MedOne(SM) business has higher agent commissions and issue costs than
small group products, but lower claim costs.
Interest expense on the outstanding balance of the Company's line of credit
decreased to $1.8 million in 2002 from $2.9 million in 2001. The decrease in
interest expense is largely due to a reduction in the amount of debt outstanding
from $40.1 million at the end of 2001 to $33.9 million at the end of 2002. In
addition, the interest rate charged on the outstanding balance on the Company's
line of credit agreement is tied to the short-term borrowing rate, which
declined throughout most of 2002.
16
Amortization of goodwill and other intangible assets was $0.7 million for 2002
compared to $3.6 million for the prior year. Effective January 1, 2002, the
Company applied new accounting rules for goodwill and other intangible assets.
See the Company's Notes to Consolidated Financial Statements, Note 2, "New
Accounting Standard" for a comprehensive discussion of the impact of this new
accounting standard.
The effective tax rate for 2002 was 39.5% compared to 60.0% for 2001. The change
in the effective tax rate relates to the elimination of amortization of goodwill
in 2002 and the effect of other permanent items. The Company had deferred tax
assets recorded, net of valuation allowances, of $3.3 million related to state
net operating loss carryforwards at December 31, 2002. State net operating loss
carryforwards begin to expire in 2008. Management believes that the deferred tax
assets will be realized primarily through future taxable income.
YEARS ENDED DECEMBER 31, 2001 AND 2000
During the first quarter of 2001, the Company received an adverse decision by
the Eleventh Circuit Federal Court of Appeals affirming a 1999 jury verdict in a
lawsuit brought against the Company by Skilstaf, Inc., an Alabama employee
leasing company. The Company recognized an after-tax charge of $5.8 million or
$0.41 per share during the first quarter of 2001 representing the full loss
including punitive damages and other expenses. In July 2001, at the direction of
the district court, the Company paid the full amount of the verdict plus
interest and the case was closed.
Insurance premiums decreased 11.8% to $838.7 million in 2001 from $951.1 million
in 2000. Premium revenues decreased as a result of the Company's membership
decline. Membership reductions resulted from product repricing, market exits and
focusing marketing efforts in profitable markets. Total medical and dental
membership declined to 637,000 at the end of 2001 compared with 814,000 at the
end of 2000. The Company's change in its product mix also impacted premium
revenue. The MedOne(SM) business, which became a larger percentage of the
Company's total business in 2001 compared to 2000, has a smaller premium per
member compared with the declining small group business. Partially offsetting
the membership decline and the change in the product mix was the effect of
increasing premium rates on the continuing block of business.
The health segment loss ratio improved 460 basis points to 72.6% for 2001
compared to 77.2% for 2000. The improvement in the health loss ratio was due in
part to improved performance on the Company's small group business resulting
from repricing efforts. In 2001, average premiums per member per month increased
at a higher rate than average claims costs per member resulting in a lower loss
ratio. The health loss ratio also benefited, to a lesser degree, from the change
in product mix to a larger percentage of MedOne(SM) business, which has a lower
loss ratio. The life segment loss ratio remained relatively stable with the
prior year at 36.4% for 2001 compared with 34.5% for 2000.
Net investment income decreased to $17.4 million in 2001 from $19.0 million in
2000. The decrease resulted mainly from a decrease in the annual investment
yield. The annual investment yield was 6.4% for 2001 compared to 6.7% for the
prior year.
Other revenue, which primarily consists of administrative fee income from claim
processing on self funded business and other administrative services, increased
slightly to $21.3 million in 2001 from $20.1 million in 2000. The increase
resulted from a general increase in fees charged during 2001.
The expense ratio includes commissions, general and administrative expenses,
premium taxes and assessments less other revenues. The health segment expense
ratio, excluding the Skilstaf litigation charge, increased to 26.6% in 2001 from
24.2% in 2000. Including the litigation charge, the health segment expense ratio
for 2001 was 29.8%. The increase largely reflected the change in the Company's
product mix. MedOne(SM) business has higher agent commissions and issue costs
than small group products, but lower claim costs. The decrease in premium volume
also contributed to the increase in the health expense ratio.
Interest expense on the outstanding balance of the Company's line of credit
decreased to $2.9 million in 2001 from $3.6 million in 2000. The interest rate
charged on the outstanding balance on the Company's line of credit agreement is
tied to the short-term borrowing rate, which declined throughout most of 2001
resulting in decreased interest expense for the Company.
17
Amortization of goodwill and other intangible assets remained relatively stable
at $3.6 million for 2001 compared to $3.8 million for the prior year.
The effective tax rate for 2001 was 60.0%. Excluding the effect of the Skilstaf
litigation charge, the effective tax rate was 48.4% for 2001 compared to 56.4%
for 2000. The change in the effective tax rate related to the amortization of
non-deductible goodwill and other permanent items in relation to pre-tax income.
CRITICAL ACCOUNTING POLICIES
Management has identified the following items that represent the Company's most
sensitive and subjective accounting estimates that have or could have a material
impact on the Company's financial statements. These estimates required
management to make assumptions about matters that are highly uncertain at the
time the estimates are made. Changes to these estimates occur from period to
period and may have a material impact on the Company's financial statements.
Management has discussed the development, selection and disclosure of these
estimates with the Company's audit committee.
LIABILITIES FOR UNPAID CLAIMS
The Company recognizes claim costs in the period the service was provided to its
members. However, claim costs incurred in a particular period are not known with
certainty until after the Company receives, processes and pays the claim. The
receipt and payment date of claims may lag significantly from the date the
service was provided. Consequently, the Company must estimate its liabilities
for claims that are incurred but not yet paid.
Liabilities for unpaid claims are based on an estimation process that is complex
and uses information obtained from both company specific and industry data, as
well as general economic information. These estimates are developed using
actuarial methods based upon historical data for payment patterns, medical
inflation, product mix, seasonality, utilization of health care services and
other relevant factors. The amount recorded for unpaid claims liabilities is
sensitive to judgments and assumptions made in the estimation process. The most
significant assumptions used in the estimation process include determining
utilization and inflation trends, the expected consistency in the frequency and
severity of claims incurred but not yet reported, changes in the timing of
claims submission patterns from providers, changes in the Company's speed of
processing claims and expected costs to settle unpaid claims.
Actual conditions could differ from those assumed in the estimation process. Due
to the uncertainties associated with the factors used in these assumptions,
materially different amounts could be reported in the Company's statement of
operations for a particular period under different conditions or using different
assumptions. As is common in the health insurance industry, the Company believes
that actual results may vary within a reasonable range of possible outcomes.
Management believes that the Company's reasonable range of actual outcomes may
vary up to 10% to 15% of the total liabilities for unpaid claims recorded at the
end of a period.
In determining the liability for unpaid claims at December 31, 2001, management
anticipated increased utilization by the general population of mental health and
other health care services in the fourth quarter of 2001 due to various factors
including, as previously disclosed, the indirect impact of the September 11,
2001 events and subsequent bio-terrorism threats and attacks. The Company did
not experience a discernable adverse impact from these factors and events during
2002, and as a result, these reserves are no longer held as of December 31,
2002.
Management considered the favorable claims experience in 2002 when it
established its liabilities for unpaid claims at December 31, 2002. Management
believes that the recorded liabilities for unpaid claims at December 31, 2002 is
in the higher end of a reasonable range of outcomes. Management closely monitors
and evaluates developments and emerging trends in claims costs to determine the
reasonableness of judgments made. A retrospective test is performed on prior
period claims liabilities and, as adjustments to the liabilities become
necessary, the adjustments are reflected in current operations. Management
believes that the amount of medical and other benefits payable is adequate to
cover the Company's liabilities for unpaid claims as of December 31, 2002.
18
LIABILITIES FOR LITIGATION
The Company is involved in various legal and regulatory actions. Such actions
typically involve disputes over policy coverage and benefits, but also may
relate to premium rating methodology or misrepresentations, agent and employment
related issues, regulatory compliance and market conduct, contractual
relationships and other matters. These disputes are resolved by settlement,
dismissal or upon a decision rendered by a judge, jury or regulatory official.
In determining the amount to be recorded as a litigation reserve, judgments are
generally made by management on a case-by-case basis based on the facts and the
merits of the case, advice from outside legal counsel, the general litigation
and regulatory environment of the originating state, the Company's past
experience with outcomes of cases in a particular jurisdiction, historical
results of similar cases and other relevant factors. Management closely monitors
and evaluates developments and emerging facts of each case to determine the
reasonableness of the judgments and assumptions on which litigation reserves are
based. Such assumptions relate to matters that are highly uncertain. Estimates
could be made based on other reasonable assumptions or judgments that would
differ materially from those estimates recorded. Management's evaluation of the
likely outcome of these actions and the resulting estimate of the potential
liability are subject to periodic adjustments, which may have a material impact
on the Company's financial condition and results of operations of a future
period.
During 2002, management significantly increased its liabilities for litigation
primarily due to an adverse ruling rendered against the Company in a Florida
class action lawsuit in early 2002, and due to other rate related cases filed
against the Company in certain states. Management believes that legal matters
relating to the Company's rating practices involve significantly more
variability than the Company's other legal matters. Inherent uncertainties
surround legal proceedings and actual results could differ materially from those
assumed in estimating the liabilities. The possibility exists that a decision
could be rendered against the Company, and in some circumstances, include
punitive or other damage awards in excess of amounts reserved, which may have a
material impact on the Company's financial condition, results of operations or
cash flow of a future period. See Item 3, "Legal Proceedings" for a detailed
discussion of the Company's material pending litigation.
NEW ACCOUNTING STANDARD
On January 1, 2002, the Company adopted Statement of Financial Accounting
Standards No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS ("Statement 142").
Statement 142 impacts the Company in two ways. First, goodwill is no longer
amortized. Second, goodwill was subject to an initial impairment test in
accordance with Statement 142, and the remaining balance of goodwill is subject
to continuing impairment testing on an annual basis and between annual tests if
an event occurs or circumstances change indicating a possible goodwill
impairment.
The Company completed the initial goodwill impairment test during the second
quarter of 2002. The Company's measurement of fair value was based on an
evaluation of ranges of future discounted cash flows, public company trading
multiples and market comparisons of similar assets and liabilities. This
evaluation utilized assumptions and projections based on the best information
available to management. Certain key assumptions considered included forecasted
trends in membership, revenue, medical costs, operating expenses and effective
tax rates. As a result of this initial impairment test, the Company recognized a
non-cash goodwill impairment charge of $60.1 million. The impairment charge was
recorded as a cumulative effect of a change in accounting principle as of
January 1, 2002. The impairment charge had no impact on cash flows or the
statutory-basis capital and surplus of the Company's insurance subsidiaries. See
the Company's Notes to Consolidated Financial Statements, Note 2, "New
Accounting Standard" for a comprehensive discussion of the impact of this new
accounting standard.
19
LIQUIDITY AND CAPITAL RESOURCES
The Company's sources of cash flow consist primarily of insurance premiums,
administrative fee revenue and investment income. The primary uses of cash
include payment of medical and other benefits, selling, general and
administrative expenses and debt service costs. Positive cash flows are invested
pending future payments of medical and other benefits and other operating
expenses. The Company's investment policies are structured to provide sufficient
liquidity to meet anticipated payment obligations.
The Company's cash provided by operations was $35.2 million for 2002 and $17.6
million for 2001. The 2001 cash provided by operations included a $7.6 million
payment made by the Company resulting from an adverse ruling in a lawsuit
brought against the Company by Skilstaf, Inc. The increase in cash provided by
operations from 2001 to 2002 is primarily attributable to improved underwriting
margins and the receipt of funds resulting from a new pharmacy benefit
management agreement. During 2002, the Company entered into a five-year pharmacy
benefit management agreement, effective January 1, 2003. In conjunction with
this agreement, the Company received a $7.5 million payment during the fourth
quarter of 2002. Substantially all of the payment was deferred and reflected in
other liabilities as of December 31, 2002, and will be amortized on a
straight-line basis to income over the contract term beginning January 1, 2003.
At the end of 2002, the Company refinanced its revolving bank line of credit
agreement. As a result, the maximum available facility increased from $30.2
million to $50.0 million. In addition, the new three-year agreement provides for
a lump-sum repayment of outstanding advances at the end of 2005. At December 31,
2002, the outstanding balance of advances under the credit agreement was $30.2
million. The credit agreement contains customary covenants which, among other
matters, require the Company to achieve certain minimum financial results,
prohibit the Company from paying future cash dividends and restrict or limit the
Company's ability to incur additional debt and dispose of assets outside the
ordinary course of business. The Company was in compliance with all such
covenants at December 31, 2002. The Company's obligations under the credit
agreement are guaranteed by its subsidiary, American Medical Security Holdings,
Inc. ("AMS Holdings"), and secured by pledges of stock of AMS Holdings and
United Wisconsin Life Insurance Company, the Company's principal insurance
subsidiary.
In an effort to continue supporting business growth, operational efficiency,
service improvements and future administrative cost savings, the Company's
management approved a plan to invest in an enterprise-wide information
technology modernization project. The project involves the purchase of software
applications and the utilization of internal and external technology and
consulting resources to support most of the Company's major business processes.
The design and development of the software applications is expected to begin in
2003, with a phased implementation scheduled over the next few years. For the
past three years, the Company's total capital expenditures have averaged
approximately $6.0 million per year. As a result of the information technology
modernization project, management anticipates total capital expenditures in 2003
to increase to approximately $16.0 million. Management believes that the
Company's existing working capital, operating cash flow and, if necessary,
available facility under its current credit agreement, will be sufficient to
fund the Company's anticipated future capital expenditures.
On March 19, 2002, the Company entered into a stock purchase agreement with
Cobalt Corporation and its wholly owned subsidiary, Blue Cross & Blue Shield
United of Wisconsin ("BCBSUW"), the Company's then largest shareholder, to
repurchase 1.4 million shares of the Company's common stock owned by BCBSUW at a
total cost of $19.5 million, including related transaction costs. In conjunction
with the stock repurchase, BCBSUW completed the sale of 3,001,500 shares of the
Company's common stock in an underwritten secondary offering during the second
quarter of 2002. As a result of these transactions, BCBSUW's ownership of the
Company was reduced from approximately 45% at December 31, 2001 to approximately
11% at December 31, 2002. In January 2003, BCBSUW sold all of its remaining
shares of the Company's stock.
In January 2003, the Company's Board of Directors approved a share repurchase
program, which provides the Company with the authority to repurchase up to $10.0
million of its outstanding common shares. The plan allows the Company to buy
back its shares, from time to time, in open market or privately negotiated
transactions, subject to price and market conditions. The share repurchase
program will be funded through operating cash flow.
20
The Company's insurance subsidiaries operate in states that require certain
levels of regulatory capital and surplus and may restrict the amount of
dividends that may be paid to their parent companies. The insurance regulator in
the insurer's state of domicile may disapprove any dividend which, together with
other dividends paid by an insurance company in the prior 12 months, exceeds the
regulatory maximum, computed as the lesser of 10% of statutory surplus or total
statutory net gain from operations as of the end of the preceding calendar year.
In January 2003, regulatory approval was obtained, and a $2,000,000 dividend was
paid to the parent company by an insurance subsidiary. Based upon the financial
statements of the Company's insurance subsidiaries as of December 31, 2002, as
filed with the insurance regulators, the additional aggregate amount available
for dividend without regulatory approval is $11,300,000.
The National Association of Insurance Commissioners has adopted risk-based
capital ("RBC") standards for life and health insurers designed to evaluate the
adequacy of statutory capital and surplus in relation to various business risks
faced by such insurers. The RBC formula is used by state insurance regulators as
an early warning tool to identify insurance companies that potentially are
inadequately capitalized. At December 31, 2002, each of the Company's insurance
subsidiaries had RBC ratios substantially above the levels that would require
Company or regulatory action.
The Company does not expect to pay any cash dividends in the foreseeable future
and intends to employ its earnings in the continued development of its business.
The Company's future dividend policy will depend on its earnings, capital
requirements, debt covenant restrictions, financial condition and other factors
considered relevant by the Company's Board of Directors.
MARKET RISK EXPOSURE
The primary investment objective of the Company is to maximize investment income
while controlling risks and preserving principal. The Company uses outside
investment managers to manage its investment portfolio within the Company's
investment guidelines. The Company seeks to meet its investment objectives
through diversity of coupon rates, liquidity, investment type, industry, issuer,
duration and geographic location. The Company manages credit risk by seeking to
maintain high average quality ratings and by limiting investments in equity
securities. At December 31, 2002, approximately 99% of the Company's total
investment portfolio was invested in debt securities. The bond portfolio had an
average quality rating of "AA" at December 31, 2002 and 2001, as measured by
Standard & Poor's Corporation, and less than 3% of the Company's total
investment portfolio was below investment grade at December 31, 2002. The below
investment grade debt securities were investment grade when purchased and
subsequently downgraded. None of the below investment grade securities were in
default at December 31, 2002.
Almost the entire portfolio was classified as available for sale. The market
value of available for sale securities exceeded amortized cost by $11.8 million
and $2.9 million at December 31, 2002 and 2001, respectively. The Company had no
investment mortgage loans, nonpublicly traded securities, real estate held for
investment or financial derivatives.
The primary market risk affecting the Company is interest rate risk. Assuming an
immediate increase of 100 basis points in interest rates, the net hypothetical
decline in fair value of shareholders' equity is estimated to be $5.4 million
after-tax at December 31, 2002. This amount represents approximately 3% of the
Company's shareholders' equity.
At December 31, 2002, the fair value of the Company's outstanding balance of
advances under the credit agreement approximated the carrying value. Market risk
was estimated as the potential increase in the fair value resulting from a
hypothetical 1% decrease in the Company's weighted average short-term borrowing
rate at December 31, 2002, and was not materially different from the year-end
carrying value.
21
INFLATION
Health care costs have been rising and are expected to continue to rise at a
rate that exceeds the consumer price index. The Company's cost control measures
and premium rate increases are designed to reduce the adverse effect of medical
cost inflation on its operations. In addition, the Company uses its underwriting
and medical management capabilities to help control inflation in health care
costs. However, there can be no assurance that the Company's efforts will fully
offset the impact of inflation or that premium revenue increases will equal or
exceed increasing health care costs.
CAUTIONARY FACTORS
This report and other documents or oral presentations prepared or delivered by
and on behalf of the Company contain or may contain "forward-looking statements"
within the meaning of the safe harbor provisions of the United States Private
Securities Litigation Reform Act of 1995. Forward-looking statements are
statements based upon management's expectations at the time such statements are
made. The Company undertakes no obligation to publicly update or revise any
forward-looking statements, whether as a result of new information, future
events or otherwise. Forward-looking statements are subject to risks and
uncertainties that could cause the Company's actual results to differ materially
from those contemplated in the statements. Readers are cautioned not to place
undue reliance on the forward-looking statements. When used in written documents
or oral presentations, the terms "anticipate," "believe," "estimate," "expect,"
"may," "objective," "plan," "possible," "potential," "project," "will" and
similar expressions are intended to identify forward-looking statements. In
addition to the assumptions and other factors referred to specifically in
connection with such statements, factors that could impact our business and
financial prospects include, but are not limited to, those discussed below and
those discussed from time to time in the Company's various filings with the
Securities and Exchange Commission or in other publicly disseminated written
documents:
MEDICAL CLAIMS AND HEALTH CARE COSTS. If the Company is unable to accurately
estimate medical claims and control health care costs, its results of operations
may be materially adversely affected.
The Company estimates the costs of its future medical claims and other expenses
using actuarial methods based upon historical data, medical inflation, product
mix, seasonality, utilization of health care services and other relevant
factors. The Company establishes premiums based on these methods. The premiums
the Company charges its customers generally are fixed for one-year periods, and
therefore, costs the Company incurs in excess of its medical claim projections
generally are not recovered in the contract year through higher premiums.
Certain factors may and often do cause actual health care costs to vary from
what the Company estimated and reflected in premiums. These factors may include:
o An increase in the rates charged by providers of health care services and
supplies, including pharmaceuticals;
o higher than expected use of health care services by members;
o the occurrence of bioterrorism, catastrophes or epidemics;
o changes in the demographics of members and medical trends affecting them;
and
o new mandated benefits or other regulatory changes that increase the
Company's costs.
The occurrence of any of these factors, which are beyond the Company's control,
could result in a material adverse effect on its business, financial condition
and results of operations.
GOVERNMENT REGULATIONS. The Company conducts business in a heavily regulated
industry, and changes in government regulation could increase the costs of
compliance or cause the Company to discontinue marketing its products in certain
states.
22
The Company's business is extensively regulated by federal and state
authorities. Some of the new federal and state regulations promulgated under the
Health Insurance Portability and Accountability Act of 1996, or HIPAA, relating
to health care reform will require the Company to implement additional changes
in its current programs and systems in order to maintain compliance, which will
increase the Company's expenses.
Federal and state legislatures are considering health care reform measures
including a "Patients' Bill of Rights," which may result in higher medical
costs. Congress is also considering legislation allowing small employers to form
association health plans exempt from state insurance regulations, which may
impact the risk profile of employers willing to purchase insurance from the
Company. In addition, the implementation of "prompt pay" laws, whereby a claim
must be paid in a certain number of days regardless of whether it is a valid
claim or not, subject to a right of recovery, may have a negative effect on the
Company's results of operations.
The Company is also subject to periodic changes in state laws and regulations
regarding the selection and pricing of risks. New regulations regarding these
issues could increase the Company's costs and decrease its premiums. The Company
has in the past, and may in the future, decide to discontinue marketing its
products in states which have enacted, or are considering, various health care
reform regulations.
REGULATORY COMPLIANCE. The Company's failure to comply with new or existing
government regulation could subject it to significant fines and penalties.
The Company's efforts to measure, monitor and adjust its business practices to
comply with the law are ongoing. Failure to comply with enacted regulations,
including the laws mentioned above, could require the Company to pay refunds or
result in significant fines, penalties, or the loss of one or more of its
licenses. The Company has been subject to regulatory penalties, assessments and
restitution orders in a number of states in which it operates. The Company is
currently subject to a regulatory proceeding in Florida in which the Company has
appealed an order, which has been stayed, by the Florida Department of Insurance
to suspend the license of the Company's primary insurance subsidiary to sell new
business (but not renewal business) in Florida for one year. For additional
information concerning the regulatory proceeding in Florida, see Item 3, "Legal
Proceedings." From time to time the Company is also subject to inquiries in
other states related to its rating activities and other practices. The result of
these regulatory actions is unknown and may have a material adverse effect on
the Company. Furthermore, federal and state laws and regulations continue to
evolve. The costs of compliance may cause the Company to change its operations
significantly, or adversely impact the health care provider networks with which
the Company does business, which may adversely affect its business and results
of operations.
LITIGATION. The Company is subject to class actions and other forms of
litigation in the ordinary course of its business, including litigation based on
new or evolving legal theories, which could result in significant liabilities
and costs.
The nature of the Company's business subjects it to a variety of legal actions
and claims relating but not limited to the following:
o denial of health care benefits;
o disputes over rating methodology and practices or termination of coverage;
o disputes with agents over compensation or other matters;
o disputes related to claim administration errors and failure to disclose
network rate discounts and other fee and rebate arrangements;
o disputes over co-payment calculations; and
o customer audits of compliance with the Company's plan obligations.
In addition, a Florida Circuit Court has found the Company liable for damages in
a class action lawsuit in Florida. The trial date for the damages portion of the
lawsuit has not yet been scheduled. Further, the Company is involved in a number
of lawsuits in various states alleging misrepresentation by the Company of its
renewal rating methodology. For additional information, see Item 3, "Legal
Proceedings." The Company cannot predict with certainty the outcome of lawsuits
against the Company or the potential costs involved.
23
COMPETITION. Competition in the Company's industry may limit its ability to
attract new members or to maintain its existing membership in force.
The Company operates in a highly competitive environment. The Company competes
primarily on the basis of price, benefit plan design, strength of provider
networks, quality of customer service, reputation and quality of agent
relations. The Company competes for members with other health insurance
providers and managed care companies, many of whom have larger membership in
regional markets and greater financial resources. The Company cannot provide
assurance that it will be able to compete effectively in this industry. As a
result, the Company may be unable to attract new members or maintain its
existing membership and its revenues may be adversely affected.
BUSINESS GROWTH STRATEGY. The Company's future operating performance is largely
dependent on its ability to execute its growth strategy.
The Company has experienced a decline in membership over the last several years
as part of its strategy to improve profitability and exit certain markets. The
Company's challenge is to increase the number of individuals and small employer
groups purchasing its products and services while encouraging its current
preferred membership to retain their business relationship with the Company. The
Company has expanded and realigned its sales organization, introduced new
products, established new distribution channels for its MedOne(SM) products,
expanded its agent recruitment efforts and developed incentive programs to
improve productivity. If the Company initiatives are not successful and the
Company does not meet its growth goals, the Company's future operating
performance may be adversely affected.
INFORMATION SYSTEMS. A failure of the Company's information system could
adversely affect its business.
Information processing is critical to the Company's business. The Company
depends on its information system for timely and accurate information. The
Company's failure to maintain an effective and efficient information system or
disruptions in its information system could cause disruptions in its business
operations, including any of the following:
o failure to comply with prompt pay laws;
o loss of existing members;
o difficulty in attracting new members;
o disputes with members, providers and agents;
o regulatory problems;
o increases in administrative expenses; and
o other adverse consequences.
Beginning in 2003, the Company is investing in an enterprise-wide information
technology modernization project involving the purchase of software applications
to support most of the Company's major processes. The design and development of
the software applications is expected to begin in 2003, with a phased
implementation scheduled over the next few years. Although the Company is taking
measures to safeguard against disruptions to its information systems during this
process, it cannot provide assurance that disruptions will not occur or that the
project will be successfully implemented or implemented on schedule.
INDEPENDENT AGENT RELATIONSHIPS. The Company depends on the services of
non-exclusive independent agents and brokers to market its products to potential
customers. The Company cannot provide assurance that they will continue to
market the Company's products in the future or that they will not refer the
Company's members to competitors.
The Company markets its products solely through non-exclusive, independent
agents and brokers. They frequently market the health insurance products of
competitors as well as the Company's products. Most of the Company's contracts
with agents and brokers are terminable without cause upon 30-days notice by
either party. The Company faces intense competition for the services and
allegiance of independent agents and brokers, and the Company cannot provide
assurance that agents and brokers will continue to market the Company's products
and services.
24
NEGATIVE PUBLICITY. Negative publicity regarding the Company's business
practices and about the health insurance industry may harm the Company's
business and operating results.
In 2002, the Company was subject to negative national publicity surrounding its
MedOne(SM) rating practices and related legal matters, which management believes
harmed the Company's MedOne(SM) new member enrollment during the last half of
2002. The Company changed its rating practices in all MedOne(SM) markets
effective January 1, 2003. Adverse publicity about the Company's rating
practices or other matters in the future may affect sales of the Company's
products, which could impede the Company's growth plans.
In addition, the health insurance industry, in general, has received negative
publicity and does not have a positive public perception. This publicity and
perception may lead to increased legislation, regulation, review of industry
practices and private litigation. These factors may adversely affect the
Company's ability to market its products, increase the regulatory burdens under
which the Company operates, further increasing the costs of doing business and
adversely affecting operating results.
INSURANCE RISK MANAGEMENT. If the Company's insurers or reinsurers do not
perform their obligations or offer affordable coverage with reasonable
deductibles or limits, the Company could experience significant losses.
The Company's risk management program includes several insurance policies it has
purchased to cover various property, business and other risks of loss. In
addition, the Company carries policies to cover its directors and officers. Many
of the carriers marketing these lines of coverage are experiencing unfavorable
claims experience and loss of their own reinsurance coverage. Several carriers
have exited markets and no longer offer certain lines of coverage. Accordingly,
there is no assurance that the Company will be able to purchase insurance
coverages for its own risk management at affordable premiums or with reasonable
deductibles and policy limits.
The Company has entered into and may continue to enter into a variety of
reinsurance arrangements under which it cedes business to other insurance
companies to mitigate large claims risk. Although reinsurance allows for greater
diversification of risk relating to potential losses arising from large claims,
the Company remains liable if these other insurance companies fail to perform
their obligations. As a result, any failure of an insurance company to perform
its obligations under an agreement could expose the Company to significant
losses. Also, there is no assurance that the Company will be able to purchase
reinsurance at affordable premiums.
PERSONNEL. Loss of key personnel and the inability to attract and retain
qualified employees could have a material adverse impact on the Company's
operations.
The Company is dependent on the continued services of its management team,
including its key executives. Loss of such personnel without adequate
replacement could have a material adverse effect on the Company. Members of the
Company's senior management have developed relationships with some of its
independent agents and brokers. If the Company is unable to retain these
employees, the loss of their services could adversely impact the Company's
ability to maintain relations with certain independent agents and brokers who
market the Company's products. Additionally, the Company needs qualified
managers and skilled employees with insurance industry experience to operate its
businesses successfully. From time to time there may be shortages of skilled
labor that may make it more difficult and expensive for the Company to attract
and retain qualified employees. If the Company is unable to attract and retain
qualified individuals or its costs to do so increase significantly, its
operations could be materially adversely affected.
PROVIDER NETWORK RELATIONSHIPS. The Company's inability to enter into or
maintain satisfactory relationships with provider networks could harm
profitability.
The Company's profitability could be adversely impacted by its inability to
contract on favorable terms with networks of hospitals, physicians, dentists,
pharmacies and other health care providers. The failure to secure cost-effective
health care provider network contracts may result in a loss of membership or
higher medical costs. In addition, the inability to contract with provider
networks, the inability to terminate contracts with existing provider networks
and enter into arrangements with new provider networks to serve the same market
or the inability of
25
providers to provide adequate care, could adversely affect the Company's results
of operations.
A.M. BEST INSURANCE RATING. If the Company's insurance subsidiaries are not able
to maintain their current rating by A.M. Best Company, the Company's results of
operations could be materially adversely affected.
The Company's insurance subsidiaries are assigned a rating by A.M. Best Company,
a nationally recognized rating agency. The rating reflects A.M. Best Company's
opinion of the insurance subsidiaries' financial strength, operating results and
ability to meet their ongoing obligations. Decreases in operating performance
and other financial measures may result in a downward adjustment of A.M. Best
Company's rating of the insurance subsidiaries. In addition, other factors
beyond the Company's control such as general downward economic cycles and
changes implemented by the rating agencies, including changes in the criteria
for the underwriting or the capital adequacy model, may result in a decrease in
the rating. A downward adjustment in A.M. Best's rating of the Company's
insurance subsidiaries could cause the Company's agents or potential customers
to look at the Company with less favor, which could have a material adverse
effect on the Company's results of operations.
REGULATION LIMITING TRANSFER OF FUNDS. Regulations governing the Company's
insurance subsidiaries could affect its ability to satisfy its obligations to
creditors as they become due, including obligations under the credit facility.
The Company's insurance subsidiaries are subject to regulations that limit their
ability to transfer funds to it. If the Company is unable to obtain funds from
its insurance subsidiaries, it will experience reduced cash flow, which could
affect the Company's ability to pay its obligations to creditors as they become
due. The Company will be required to make a lump-sum payment of the total
principal amount of outstanding balances under its credit facility at the end of
2005. The Company's outstanding balance at December 31, 2002 was $30.2 million.
If the Company's insurance subsidiaries are unable to provide these funds, the
Company could default on the its obligations under the credit facility.
CAPITAL AND SURPLUS REQUIREMENTS. If the Company's regulated insurance
subsidiaries are not able to comply with state capital standards, state
regulators may require the Company to take certain actions that could have a
material adverse effect on its results of operations and financial condition.
State regulations govern the amount of capital required to be retained in the
Company's regulated insurance subsidiaries and the ability of those regulated
subsidiaries to pay dividends. Those state regulations include the requirement
to maintain minimum levels of statutory capital and surplus, including meeting
the requirements of the risk-based capital standards promulgated by the National
Association of Insurance Commissioners. State regulators have broad authority to
take certain actions in the event those capital requirements are not met. Those
actions could significantly impact the way the Company conducts its business,
reduce its ability to access capital from the operations of its regulated
insurance subsidiaries and have a material adverse effect on its results of
operations and financial condition. Any new minimum capital requirements adopted
in the future through state regulation may increase the Company's capital
requirements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See Item 7, "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Market Risk Exposure" for information concerning
potential market risks related to the Company's investment portfolio.
26
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
Board of Directors and Shareholders
American Medical Security Group, Inc.
We have audited the accompanying consolidated balance sheets of American Medical
Security Group, Inc. and its subsidiaries (the "Company") as of December 31,
2002 and 2001, and the related consolidated statements of operations, changes in
shareholders' equity and comprehensive income (loss) and cash flows for each of
the three years in the period ended December 31, 2002. Our audits also included
the financial statement schedules listed in the Index at Item 15. These
financial statements and schedules are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and schedules based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of the
Company as of December 31, 2002 and 2001, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 2002, in conformity with accounting principles generally accepted
in the United States. Also, in our opinion, the related financial statement
schedules, when considered in relation to the basic financial statements taken
as a whole, present fairly in all material respects the information set forth
therein.
As discussed in Note 2, in 2002 the Company changed its method of accounting for
goodwill and other intangible assets.
/s/ Ernst & Young LLP
Milwaukee, Wisconsin
January 29, 2003
27
AMERICAN MEDICAL SECURITY GROUP, INC.
CONSOLIDATED BALANCE SHEETS
December 31,
---------------------------------
(THOUSANDS, EXCEPT SHARE DATA) 2002 2001
--------------------------------------------------------------------------------------------------------------------
ASSETS
Investments:
Securities available for sale, at fair value:
Fixed maturities $ 278,222 $ 269,753
Equity securities - preferred - 722
Fixed maturity securities held to maturity, at amortized cost 4,288 4,286
Trading securities, at fair value 926 517
--------------------------------------------------------------------------------------------------------------------
Total investments 283,436 275,278
Cash and cash equivalents 30,620 24,975
Property and equipment, net 33,061 33,381
Goodwill, net 32,846 100,343
Other intangibles, net 2,860 3,591
Other assets 46,117 35,447
--------------------------------------------------------------------------------------------------------------------
Total assets $ 428,940 $ 473,015
====================================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Medical and other benefits payable $ 134,479 $ 135,504
Advance premiums 15,200 16,737
Payables and accrued expenses 29,141 28,032
Notes payable 33,858 40,058
Other liabilities 33,512 23,284
--------------------------------------------------------------------------------------------------------------------
Total liabilities 246,190 243,615
Redeemable preferred stock - Series A adjustable rate
Nonconvertible, $1,000 stated value, 22,879 shares authorized - -
Shareholders' equity:
Preferred stock (no par value, 477,121 shares authorized) - -
Common stock (no par value, $1 stated value, 50,000,000 shares authorized,
16,654,315 issued and 12,905,898 outstanding at December 31, 2002,
16,654,315 issued and 13,955,439 outstanding at December 31, 2001) 16,654 16,654
Paid-in capital 189,813 187,927
Retained earnings 2,858 40,470
Accumulated other comprehensive income (net of taxes
of $4,117 in 2002 and $1,024 in 2001) 7,646 1,903
Treasury stock (3,748,417 shares at December 31, 2002
and 2,698,876 shares at December 31, 2001, at cost) (34,221) (17,554)
--------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 182,750 229,400
--------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 428,940 $ 473,015
====================================================================================================================
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
28
AMERICAN MEDICAL SECURITY GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Year ended December 31,
------------------------------------------------
(THOUSANDS, EXCEPT PER SHARE DATA) 2002 2001 2000
--------------------------------------------------------------------------------------------------------------------
REVENUES
Insurance premiums $ 754,460 $ 838,672 $ 951,071
Net investment income 15,005 17,443 19,007
Net realized investment gains (losses) 39 (779) (325)
Other revenue 20,025 21,285 20,112
--------------------------------------------------------------------------------------------------------------------
Total revenues 789,529 876,621 989,865
EXPENSES
Medical and other benefits 507,205 601,942 724,613
Selling, general and administrative 242,584 257,742 251,767
Interest 1,848 2,877 3,584
Amortization of goodwill and other intangibles 730 3,628 3,785
--------------------------------------------------------------------------------------------------------------------
Total expenses 752,367 866,189 983,749
Income before income tax expense and cumulative
effect of a change in accounting principle 37,162 10,432 6,116
Income tax expense 14,676 6,257 3,447
--------------------------------------------------------------------------------------------------------------------
Income before cumulative effect of a
change in accounting principle 22,486 4,175 2,669
Cumulative effect of a change in accounting principle (60,098) - -
--------------------------------------------------------------------------------------------------------------------
Net income (loss) $ (37,612) $ 4,175 $ 2,669
====================================================================================================================
Earnings per common share - basic:
Income before cumulative effect of a
change in accounting principle $ 1.72 $ 0.30 $ 0.18
Cumulative effect of a change in accounting principle (4.61) - -
--------------------------------------------------------------------------------------------------------------------
Net income (loss) $ (2.88) $ 0.30 $ 0.18
====================================================================================================================
Earnings per common share - diluted:
Income before cumulative effect of a
change in accounting principle $ 1.63 $ 0.29 $ 0.18
Cumulative effect of a change in accounting principle (4.34) - -
--------------------------------------------------------------------------------------------------------------------
Net income (loss) $ (2.72) $ 0.29 $ 0.18
====================================================================================================================
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
29
AMERICAN MEDICAL SECURITY GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended December 31,
------------------------------------------------
(THOUSANDS) 2002 2001 2000
--------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income (loss) $ (37,612) $ 4,175 $ 2,669
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Cumulative effect of a change in accounting principle 60,098 - -
Depreciation and amortization 8,957 10,493 9,762
Net realized investment (gains) losses (39) 779 325
Net change in trading securities (409) (257) (260)
Deferred income tax expense (benefit) (13,374) 609 6,029
Changes in operating accounts:
Other assets 7,206 7,722 9,119
Medical and other benefits payable (1,025) (9,806) (23,807)
Advance premiums (1,537) (831) 291
Payables and accrued expenses 1,109 2,130 858
Other liabilities 11,801 2,576 (8,145)
--------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) operating activities 35,175 17,590 (3,159)
INVESTING ACTIVITIES
Purchases of available for sale securities (174,920) (143,148) (14,512)
Proceeds from sale of available for sale securities 168,338 129,038 25,460
Proceeds from maturity of available for sale securities 6,550 15,417 4,045
Proceeds from maturity of held to maturity securities 1,925 - 630
Purchases of held to maturity securities (1,925) - -
Purchases of property and equipment (6,756) (6,546) (4,584)
Proceeds from sale of property and equipment 8 21 13
--------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) investing activities (6,780) (5,218) 11,052
FINANCING ACTIVITIES
Issuance of common stock 2,990 413 4
Purchase of treasury stock (19,540) (2,216) (8,292)
Proceeds from notes payable borrowings 30,158 - 39,158
Repayment of notes payable (36,358) (1,200) (40,423)
--------------------------------------------------------------------------------------------------------------------
Net cash used in financing activities (22,750) (3,003) (9,553)
--------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents:
Net increase (decrease) during year 5,645 9,369 (1,660)
Balance at beginning of year 24,975 15,606 17,266
--------------------------------------------------------------------------------------------------------------------
Balance at end of year $ 30,620 $ 24,975 $ 15,606
====================================================================================================================
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
30
AMERICAN MEDICAL SECURITY GROUP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
AND COMPREHENSIVE INCOME (LOSS)
Accumulated
Other
Common Stock Paid-In Retained Comprehensive Treasury
(THOUSANDS, EXCEPT SHARE DATA) Shares Amount Capital Earnings Income (Loss) Stock Total
--------------------------------------------------------------------------------------------------------------------------------
Balance at January 1, 2000 16,653,646 $ 16,654 $ 187,952 $ 33,626 $ (10,464) $ (7,488) $ 220,280
Comprehensive income:
Net income 2,669 2,669
Change in net unrealized gain (loss) on
securities, net of taxes of $3,508 6,516 6,516
------------
Comprehensive income 9,185
------------
Issuance of common stock 669 4 4
Purchase of treasury stock
(1,261,870 shares, at cost) (8,292) (8,292)
--------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2000 16,654,315 16,654 187,956 36,295 (3,948) (15,780) 221,177
Comprehensive income:
Net income 4,175 4,175
Change in net unrealized gain (loss) on
securities, net of taxes of $3,150 5,851 5,851
------------
Comprehensive income 10,026
------------
Issuance of common stock (29) 442 413
Purchase of treasury stock
(367,262 shares, at cost) (2,216) (2,216)
--------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2001 16,654,315 16,654 187,927 40,470 1,903 (17,554) 229,400
Comprehensive loss:
Net loss (37,612) (37,612)
Change in net unrealized gain (loss) on
securities, net of taxes of $3,093 5,743 5,743
------------
Comprehensive loss (31,869)
------------
Issuance of common stock 1,886 2,873 4,759
Purchase of treasury stock
(1,400,000 shares, at cost) (19,540) (19,540)
--------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2002 16,654,315 $ 16,654 $ 189,813 $ 2,858 $ 7,646 $(34,221) $ 182,750
================================================================================================================================
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
31
AMERICAN MEDICAL SECURITY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION
American Medical Security Group, Inc., together with its subsidiary companies
(the "Company"), is a provider of individual and small employer group insurance
products. The Company's principal product offering is health insurance for small
employer groups and individuals and their families. The Company also offers
life, dental, prescription drug, disability and accidental death insurance, and
provides self-funded benefit administration. The Company's products are marketed
in 32 states and the District of Columbia through independent agents. At
December 31, 2002, the Company's leading states with respect to medical
membership were Florida, Illinois, Texas and Michigan, each individually
representing approximately 10% of the Company's total medical membership.
Approximately 75 Company sales managers located in sales offices throughout the
United States support the independent agents. The Company's products generally
provide discounts to insureds that utilize preferred provider organizations. The
Company owns a preferred provider network and also contracts with other networks
to ensure cost-effective health care choices to its members.
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of the Company and
all of its majority-owned subsidiaries. Significant intercompany accounts and
transactions have been eliminated. The accompanying consolidated financial
statements have been prepared in accordance with accounting principles generally
accepted in the United States ("GAAP"). The preparation of financial statements
in conformity with GAAP requires management to make estimates and assumptions
that affect the amounts reported in the consolidated financial statements and
accompanying notes. These estimates are based on knowledge of current events and
anticipated future events, and accordingly, actual results may differ from those
estimates.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include operating cash and short-term investments with
original maturities of three months or less. These amounts are recorded at cost,
which approximates market value.
INVESTMENTS
The Company's investments are classified in three categories. Investments that
the Company has the positive intent and ability to hold to maturity are
classified as held-to-maturity securities and are reported at amortized cost.
Assets which are invested for the purpose of supporting the Company's
nonqualified executive retirement plan are classified as trading securities and
reported at fair value, with unrealized gains and losses included in earnings as
net investment income. All other investments are classified as
available-for-sale securities and are reported at fair value based on quoted
market prices. Unrealized gains and losses on available-for-sale securities are
excluded from earnings and reported as a separate component of shareholders'
equity as accumulated other comprehensive income or loss, net of income tax
effects. The Company evaluates securities for other-than-temporary impairment on
a periodic basis and principally considers the type of security, the severity of
the decline in fair value and the duration of the decline in fair value in
determining whether a security's decline in fair value is other-than-temporary.
Realized gains and losses from the sale or write-down for other-than-temporary
impairments of available-for-sale debt and equity securities are calculated
using the specific identification method.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair values of investments are reported in Note 4, "Investments". The fair
values of all other financial instruments approximate their December 31, 2002
and 2001 carrying values.
32
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost less accumulated depreciation.
Depreciation is calculated using the straight-line method over the estimated
useful lives of assets. Estimated useful lives are 20 to 30 years for land
improvements, 10 to 40 years for buildings and building improvements, three to
five years for computer equipment and software and three to 10 years for
furniture and other equipment.
GOODWILL AND OTHER INTANGIBLES
Goodwill represents the excess of cost over the fair market value of net assets
acquired. Effective January 1, 2002, goodwill is no longer amortized and is
subject to impairment testing as a result of the adoption of a new accounting
standard. Prior to the adoption of this new accounting standard, the Company
measured impairment of goodwill and other intangibles using undiscounted cash
flows. See Note 2, "New Accounting Standard" for a detailed discussion of the
impact of this new accounting standard.
Other intangibles are net of accumulated amortization of $4,443,000 at December
31, 2002 and $3,713,000 at December 31, 2001. Amortization expense for the year
ended December 31, 2002 was $730,000 and is expected to continue at this amount
for each of the next four years.
POLICY ACQUISITION COSTS
Policy acquisition costs consist of commissions and other administrative costs
that the Company incurs to acquire new business. The Company currently does not
defer policy acquisition costs. Premium is collected and billed and commissions
and other administrative costs are incurred on a month-to-month basis. Policy
acquisition costs are expensed in the period incurred.
REINSURANCE
Reinsurance premiums, commissions and expense reimbursements on reinsured
business are accounted for on a basis consistent with those used in accounting
for the original policies issued and the terms of the reinsurance contracts.
Premiums and benefits ceded to other companies have been reported as a reduction
of premium revenue and benefits. Reinsurance receivables and prepaid reinsurance
premium amounts are reported as other assets.
The Company limits the maximum net loss that can arise from certain lines of
business by reinsuring (ceding) a portion of these risks with other insurance
organizations (reinsurers) on an excess of loss or quota share basis. The
Company's retention limit per covered life is $500,000 per policy year for
medical claims and $50,000 for life claims. The Company is liable on reinsurance
ceded in the event that the reinsurers do not meet their contractual
obligations.
A summary of reinsurance assumed and ceded is as follows:
Year ended December 31,
------------------------------------------------
(THOUSANDS) 2002 2001 2000
--------------------------------------------------------------------------------------------------------------------
Reinsurance assumed:
Insurance premiums $ 1,043 $ 1,515 $ 8,725
Medical and other benefits 767 1,395 9,921
Reinsurance ceded:
Insurance premiums $ 2,206 $ 2,532 $ 2,523
Medical and other benefits 1,749 1,910 3,250
33
MEDICAL AND OTHER BENEFITS PAYABLE
The liabilities for medical and other benefits represent estimates of the
ultimate net cost of all reported and unreported claims that are unpaid at year
end. These estimates are developed using actuarial methods based upon historical
data for payment patterns, cost trends, product mix, seasonality, utilization of
health care services and other relevant factors. Estimated liabilities for
claims-related litigation, which are included in medical and other benefits
payable, reflect judgments made by management based on the facts and merits of
the case, advice from legal counsel, the general litigation and regulatory
environment of the originating state, the Company's past experience with
outcomes of cases in a particular jurisdiction, historical results of similar
cases and other relevant factors. The estimates are reviewed periodically and,
as adjustments to the liabilities become necessary, the adjustments are
reflected in current operations. Although considerable variability is inherent
in these estimates, management believes that the amount of medical and other
benefits payable is adequate to cover the Company's liability for unpaid amounts
as of December 31, 2002.
PREMIUM DEFICIENCY RESERVES
The Company recognizes premium deficiency reserves on an existing group of
insurance contracts when the sum of expected future claim costs, claim
adjustment expenses and related maintenance expenses exceeds the expected future
premium revenue and investment income. Insurance contracts are grouped as
relating to highly regulated markets or all other markets consistent with the
Company's manner of acquiring, servicing and measuring the profitability of its
business. The Company continues to evaluate assumptions used in the premium
deficiency reserve analysis and records or adjusts premium deficiency reserves
as necessary.
During 1999, the Company established a premium deficiency reserve of $19,200,000
for its highly regulated markets. Premium deficiency reserves are included in
medical and other benefits payable in the Company's consolidated balance sheets.
At December 31, 2000 and 1999, the Company's recorded premium deficiency
reserves were $1,142,000 and $16,700,000, respectively. No premium deficiency
reserves were recorded at December 31, 2002 and 2001.
INCOME TAXES
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial statement
purposes and the amounts used for income tax purposes. A valuation allowance is
recognized when, based on available evidence, it is more likely than not that
the deferred tax asset may not be realized.
REVENUE RECOGNITION
Premiums for health and life policies are recognized ratably over the period
that insurance coverage is provided. Other revenue, including administrative fee
income from claim processing and other administrative services, is recognized in
the period the service is provided.
STOCK-BASED COMPENSATION
The Company follows Accounting Principles Board Opinion No. 25 and no
compensation expense is recorded because the exercise price of the Company's
employee stock options equaled the market price of the underlying stock on the
date of grant. The Company's pro forma information regarding net income and net
income per share has been determined as if these options had been accounted for
since January 1, 1995, in accordance with the fair value method of Statement of
Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based
Compensation".
34
The Black-Scholes option valuation model is commonly used in estimating the fair
value of traded options which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Since the
Company's employee stock options have characteristics significantly different
from those of traded options, and because changes in the subjective input
assumptions can materially affect the fair value estimates, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
In determining compensation expense in accordance with SFAS No. 123, the fair
value for these options was estimated at the date of grant using the
Black-Scholes option pricing model with the following weighted average
assumptions:
Year ended December 31,
------------------------------------------------
2002 2001 2000
--------------------------------------------------------------------------------------------------------------------
Expected life of options 6 years 6 years 6 years
Risk-free interest rate 4.89% 4.67% 5.73%
Expected dividend yield 0.00% 0.00% 0.00%
Expected volatility factor 51% 53% 56%
Grant date fair value of options:
Exercise price equals market price $ 6.64 $ 5.51 $ 3.09
Exercise price is less than market price $ - $ - $ -
Exercise price exceeds market price $ - $ - $ -
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting period. The Company's pro
forma information is as follows:
Year ended December 31,
------------------------------------------------
(THOUSANDS, EXCEPT PER SHARE DATA) 2002 2001 2000
--------------------------------------------------------------------------------------------------------------------
Net income (loss), as reported $ (37,612) $ 4,175 $ 2,669
Pro forma compensation expense
in accordance with SFAS No. 123, net of tax (1,332) (1,119) (933)
--------------------------------------------------------------------------------------------------------------------
Pro forma net income (loss) $ (38,944) $ 3,056 $ 1,736
====================================================================================================================
Net income (loss) per common share, as reported:
Basic $ (2.88) $ 0.30 $ 0.18
Diluted $ (2.72) $ 0.29 $ 0.18
Pro forma net income (loss) per common share:
Basic $ (2.98) $ 0.22 $ 0.12
Diluted $ (2.83) $ 0.21 $ 0.12
The pro forma disclosures only include the effect of options granted subsequent
to January 1, 1995. Accordingly, the effects of applying the SFAS No. 123 pro
forma disclosures to future periods may not be indicative of future effects.
35
RELATED PARTIES
The Company has deferred compensation payable to employees of $4,057,000 and
$3,167,000 at December 31, 2002 and 2001, respectively.
COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) is defined as net income (loss) plus or minus other
comprehensive income (loss). For the Company, under existing accounting
standards, other comprehensive income (loss) includes unrealized gains and
losses, net of income tax effects, on certain investments in debt and equity
securities. Comprehensive income (loss) is reported by the Company in the
consolidated statements of changes in shareholders' equity and comprehensive
income (loss).
EARNINGS (LOSS) PER COMMON SHARE ("EPS")
Basic EPS is computed by dividing earnings by the weighted average number of
common shares outstanding. Diluted EPS is computed by dividing earnings by the
weighted average number of common shares outstanding, adjusted for the effect of
dilutive stock options.
The following table illustrates the computation of EPS for income before
cumulative effect of a change in accounting principle and provides a
reconciliation of the number of weighted average basic and diluted shares
outstanding:
Year ended December 31,
------------------------------------------------
(THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) 2002 2001 2000
--------------------------------------------------------------------------------------------------------------------
Numerator:
Income before cumulative effect
of a change in accounting principle $ 22,486 $ 4,175 $ 2,669
====================================================================================================================
Denominator:
Denominator for basic EPS 13,046,777 14,048,545 14,898,652
Effect of dilutive employee stock options 788,564 179,143 150,651
--------------------------------------------------------------------------------------------------------------------
Denominator for diluted EPS 13,835,341 14,227,688 15,049,303
====================================================================================================================
Earnings per common share before cumulative effect of a change in accounting
principle:
Basic $ 1.72 $ 0.30 $ 0.18
Diluted $ 1.63 $ 0.29 $ 0.18
Options to purchase 2,922,492, 3,243,767 and 3,460,130 shares of common stock
were outstanding at December 31, 2002, 2001 and 2000, respectively. Of those
shares, approximately 162,000, 1,914,000 and 2,030,000 were excluded from the
computation of diluted earnings (loss) per common share for the respective years
because the option's exercise price was greater than the average market price of
common shares and, therefore, the effect would be antidilutive.
RECLASSIFICATIONS
Certain reclassifications have been made to prior year amounts to conform to the
current year presentation.
36
2. NEW ACCOUNTING STANDARD
On January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and Other
Intangible Assets" ("Statement 142"). Statement 142 impacts the Company in two
ways. First, goodwill is no longer amortized. Second, goodwill was subject to an
initial impairment test in accordance with Statement 142, and the remaining
balance of goodwill is subject to continuing impairment testing on an annual
basis and between annual tests if an event occurs or circumstances change
indicating a possible goodwill impairment.
The Company completed the initial goodwill impairment test during the second
quarter of 2002. The Company's measurement of fair value was based on an
evaluation of ranges of future discounted cash flows, public company trading
multiples and market comparisons of similar assets and liabilities. This
evaluation utilized assumptions and projections based on the best information
available to management. Certain key assumptions considered included forecasted
trends in membership, revenue, medical costs, operating expenses and effective
tax rates. As a result of this initial impairment test, the Company recognized a
non-cash goodwill impairment charge of $60,098,000. The impairment charge was
recorded as a cumulative effect of a change in accounting principle as of
January 1, 2002. The impairment charge had no impact on cash flows or the
statutory-basis capital and surplus of the Company's insurance subsidiaries. As
of December 31, 2002, goodwill balances by segment amounted to $12,722,000 for
health insurance, $19,416,000 for life insurance and $708,000 for all other.
Also on January 1, 2002, in accordance with Statement 142, the Company
reclassified an intangible asset into goodwill because it did not meet the new
recognition criteria for an intangible asset to be recognized apart from
goodwill. The reclassification had the effect of reducing goodwill by
$7,399,000, representing the elimination of the deferred tax liability related
to the reclassified intangible asset. The amortization period used prior to 2002
for this intangible asset was the same as the amortization period for goodwill.
The Company completed its annual goodwill impairment test during the fourth
quarter of 2002 and determined that its remaining balance of goodwill was not
impaired as of December 31, 2002. Subsequent impairment tests will be performed
at least annually, and future goodwill impairments, if any, will be classified
as operating expenses in the Company's statement of operations.
The following table illustrates net income (loss) and net income (loss) per
share adjusted to exclude the effects of amortizing goodwill:
Year Ended December 31,
------------------------------------------------
(THOUSANDS, EXCEPT PER COMMON SHARE DATA) 2002 2001 2000
--------------------------------------------------------------------------------------------------------------------
Reported net income (loss) $ (37,612) $ 4,175 $ 2,669
Add back: goodwill amortization - 2,685 2,685
--------------------------------------------------------------------------------------------------------------------
Adjusted net income (loss) $ (37,612) $ 6,860 $ 5,354
====================================================================================================================
Basic earnings (loss) per common share:
Reported net income (loss) $ (2.88) $ 0.30 $ 0.18
Goodwill amortization - 0.19 0.18
--------------------------------------------------------------------------------------------------------------------
Adjusted net income (loss) $ (2.88) $ 0.49 $ 0.36
====================================================================================================================
Diluted earnings (loss) per common share:
Reported net income (loss) $ (2.72) $ 0.29 $ 0.18
Goodwill amortization - 0.19 0.18
--------------------------------------------------------------------------------------------------------------------
Adjusted net income (loss) $ (2.72) $ 0.48 $ 0.36
====================================================================================================================
37
3. MEDICAL AND OTHER BENEFITS PAYABLE
Activity related to liabilities for unpaid claims included in medical and other
benefits payable is summarized as follows:
December 31,
------------------------------------------------
(THOUSANDS) 2002 2001 2000
--------------------------------------------------------------------------------------------------------------------
Balance at January 1 $ 128,330 $ 134,690 $ 141,177
Less reinsurance recoverables 1,351 476 992
--------------------------------------------------------------------------------------------------------------------
Net balance at January 1 126,979 134,214 140,185
Incurred related to:
Current year 514,764 612,491 720,897
Prior years (7,881) (12,026) (3,397)
--------------------------------------------------------------------------------------------------------------------
Total incurred 506,883 600,465 717,500
Paid related to:
Current year 389,949 487,400 587,828
Prior years 117,748 120,300 135,643
--------------------------------------------------------------------------------------------------------------------
Total paid 507,697 607,700 723,471
--------------------------------------------------------------------------------------------------------------------
Net balance at December 31 126,165 126,979 134,214
Plus reinsurance recoverables 312 1,351 476
--------------------------------------------------------------------------------------------------------------------
Balance at December 31 $ 126,477 $ 128,330 $ 134,690
====================================================================================================================
The incurred amounts related to prior years represent the differences between
the Company's estimated medical and other benefits payable for prior years'
claims and the actual or remaining estimated amounts required to satisfy such
claims. Actual amounts differ from previously recorded liabilities due primarily
to inherent variabilities associated with estimating health insurance benefits
payable and litigation liabilities. The liabilities for unpaid claims at
December 31, 2001, 2000 and 1999 developed redundant in the subsequent years by
$7,881,000, $12,026,000 and $3,397,000, respectively.
In determining the liability for unpaid claims at December 31, 2001, management
anticipated increased utilization by the general population of mental health and
other health care services in the fourth quarter of 2001 due to various factors
including, as previously disclosed, the indirect impact of the September 11,
2001 events and subsequent bio-terrorism threats and attacks. The Company did
not experience a discernable adverse impact from these factors and events during
2002, which accounts for the developed redundancy on the liability as of
December 31, 2001. These reserves are no longer held as of December 31, 2002.
The developed redundancy on the liability as of December 31, 2000 was due to an
improvement as compared to previous years in the Company's average medical
claims cost per member in late 2000. No additional premiums are collected or
returned as a result of incurred claims from prior years.
38
4. INVESTMENTS
Net investment income and net realized investment gains (losses) include the
following:
Year ended December 31,
------------------------------------------------
(THOUSANDS) 2002 2001 2000
--------------------------------------------------------------------------------------------------------------------
Net investment income:
Interest on fixed maturities $ 14,290 $ 15,728 $ 17,867
Dividends on equity securities 18 148 148
Unrealized loss on trading securities (66) (34) (21)
Interest on cash equivalents and other investment income 1,384 2,223 1,629
Investment expenses (621) (622) (616)
--------------------------------------------------------------------------------------------------------------------
Net investment income $ 15,005 $ 17,443 $ 19,007
====================================================================================================================
Net realized investment gains (losses):
Realized investment gains $ 2,972 $ 1,544 $ 111
Realized investment losses (2,933) (2,323) (436)
--------------------------------------------------------------------------------------------------------------------
Net realized investment gains (losses) $ 39 $ (779) $ (325)
====================================================================================================================
Unrealized gains (losses) are computed as the difference between estimated fair
value and amortized cost for fixed maturities and equity securities classified
as available for sale. A summary of the net change in unrealized gains (losses),
which is included in accumulated other comprehensive income (loss), is as
follows:
Year ended December 31,
------------------------------------------------
(THOUSANDS) 2002 2001 2000
--------------------------------------------------------------------------------------------------------------------
Fixed maturities $ 8,850 $ 8,847 $ 9,854
Equity securities (14) 154 170
--------------------------------------------------------------------------------------------------------------------
Net change in unrealized gains (losses) $ 8,836 $ 9,001 $ 10,024
====================================================================================================================
Changes in accumulated other comprehensive income (loss) related to changes in
unrealized gains and losses on securities are as follows:
Year ended December 31,
------------------------------------------------
(THOUSANDS) 2002 2001 2000
--------------------------------------------------------------------------------------------------------------------
Change in net unrealized gain (loss) on securities, net of taxes $ 5,768 $ 5,345 $ 6,305
Less: reclassification adjustment for gains (losses) included in
net income (loss), net of tax expense of $14 in 2002 and net of
tax benefit of $273 and $114 in 2001 and 2000, respectively 25 (506) (211)
--------------------------------------------------------------------------------------------------------------------
Change in net unrealized gain (loss) on securities, net of taxes $ 5,743 $ 5,851 $ 6,516
====================================================================================================================
39
The amortized cost and estimated fair values of investments are as follows:
Gross Gross
Amortized Unrealized Unrealized Estimated
(THOUSANDS) Cost Gains Losses Fair Value
--------------------------------------------------------------------------------------------------------------------
AT DECEMBER 31, 2002:
Available for sale:
Fixed maturities:
U.S. Treasury securities $ 56,781 $ 2,519 $ - $ 59,300
Corporate debt securities 100,664 5,272 (335) 105,601
Foreign government securities 11,657 674 - 12,331
Government agency mortgage-backed securities 87,709 3,028 - 90,737
Municipal securities 9,648 605 - 10,253
--------------------------------------------------------------------------------------------------------------------
266,459 12,098 (335) 278,222
Held to maturity:
U.S. Treasury securities 4,288 277 - 4,565
--------------------------------------------------------------------------------------------------------------------
$ 270,747 $ 12,375 $ (335) $ 282,787
====================================================================================================================
Gross Gross
Amortized Unrealized Unrealized Estimated
(THOUSANDS) Cost Gains Losses Fair Value
--------------------------------------------------------------------------------------------------------------------
AT DECEMBER 31, 2001:
Available for sale:
Fixed maturities:
U.S. Treasury securities $ 47,869 $ 283 $ (1) $ 48,151
Corporate debt securities 115,263 2,447 (1,068) 116,642
Foreign government securities 12,391 442 (2) 12,831
Government agency mortgage-backed securities 77,966 691 (101) 78,556
Municipal securities 13,351 223 (1) 13,573
--------------------------------------------------------------------------------------------------------------------
266,840 4,086 (1,173) 269,753
Equity securities - preferred 708 14 - 722
Held to maturity:
U.S. Treasury securities 4,286 73 - 4,359
--------------------------------------------------------------------------------------------------------------------
$ 271,834 $ 4,173 $ (1,173) $ 274,834
====================================================================================================================
40
The amortized cost and estimated fair values of debt securities at December 31,
2002 by contractual maturity are shown below. Expected maturities will differ
from contractual maturities because borrowers may have the right to call or
prepay obligations.
Available-for-Sale Held-to-Maturity
Amortized Estimated Amortized Estimated
(THOUSANDS) Cost Fair Value Cost Fair Value
--------------------------------------------------------------------------------------------------------------------
Due in one year or less $ 11,292 $ 11,568 $ 804 $ 814
Due after one through five years 94,455 98,848 3,484 3,751
Due after five through ten years 56,363 60,018 - -
Due after ten years 16,640 17,051 - -
--------------------------------------------------------------------------------------------------------------------
178,750 187,485 4,288 4,565
Government agency mortgage-backed securities 87,709 90,737 - -
--------------------------------------------------------------------------------------------------------------------
$ 266,459 $ 278,222 $ 4,288 $ 4,565
====================================================================================================================
At December 31, 2002, the insurance subsidiaries had fixed securities and cash
equivalents on deposit with various state insurance departments with carrying
values of approximately $4,488,000.
5. PROPERTY AND EQUIPMENT
Property and equipment are stated at cost and are summarized as follows:
December 31,
--------------------------------
(THOUSANDS) 2002 2001
--------------------------------------------------------------------------------------------------------------------
Land and land improvements $ 3,930 $ 3,893
Building and building improvements 24,489 24,315
Computer equipment and software 22,771 18,121
Furniture and other equipment 14,826 13,559
--------------------------------------------------------------------------------------------------------------------
66,016 59,888
Less accumulated depreciation (32,955) (26,507)
--------------------------------------------------------------------------------------------------------------------
$ 33,061 $ 33,381
====================================================================================================================
The Company recognized depreciation expense on property and equipment of
$7,064,000, $5,555,000 and $4,656,000 in 2002, 2001 and 2000, respectively.
41
6. DEBT
Notes payable consists of the following:
December 31,
--------------------------------
(THOUSANDS) 2002 2001
--------------------------------------------------------------------------------------------------------------------
Line of credit, commercial banks, adjusted periodically,
interest payments due quarterly through December 2005 $ 30,158 $ 35,158
Mortgage payable, commercial bank, 9.05% interest, monthly
principal payments of $100,000 plus interest through January 1, 2004 3,700 4,900
--------------------------------------------------------------------------------------------------------------------
$ 33,858 $ 40,058
====================================================================================================================
On December 30, 2002, the Company refinanced its revolving bank line of credit
agreement. As a result, the maximum available credit increased from $30,158,000
to $50,000,000. In addition, the new three-year agreement provides for a
lump-sum repayment of outstanding advances at the end of 2005. At December 31,
2002, the outstanding balance of advances under the credit agreement was
$30,158,000. Interest is charged on the outstanding balance based upon an
indexed floating rate of interest. The credit agreement contains customary
covenants which, among other matters, require the Company to achieve certain
minimum financial results, prohibit the Company from paying future cash
dividends, and restrict or limit the Company's ability to incur additional debt
and dispose of assets outside the ordinary course of business. The Company was
in compliance with all such covenants at December 31, 2002. The Company's
obligations under the credit agreement are guaranteed by its subsidiary,
American Medical Security Holdings, Inc. ("AMS Holdings"), and secured by
pledges of stock of AMS Holdings and United Wisconsin Life Insurance Company,
the Company's principal insurance subsidiary.
Future annual principal amounts due for all of the Company's debt, including the
credit agreement, as of December 31, 2002 are $1,200,000 for 2003, $2,500,000
for 2004, and $30,158,000 for 2005. During 2002, 2001 and 2000, interest paid
totaled $1,856,000, $2,931,000 and $4,005,000, respectively.
The mortgage payable is collateralized by the Company's home office property
located in Green Bay, Wisconsin. The Company believes the carrying value of all
notes payable approximates fair value.
42
7. INCOME TAXES
The Company and most of its subsidiaries file a consolidated federal income tax
return. The Company and its subsidiaries file separate state franchise, income
and premium tax returns as applicable.
The Company had a net current federal income tax payable of $6,520,000 and
$4,012,000 at December 31, 2002 and 2001, respectively. The Company and its
subsidiaries had state net business loss carryforwards totaling $98,502,000 at
December 31, 2002, which will begin to expire in the year 2008.
The components of income tax expense are as follows:
Year ended December 31,
------------------------------------------------
(THOUSANDS) 2002 2001 2000
--------------------------------------------------------------------------------------------------------------------
Current:
Federal $ 26,391 $ 5,410 $ (3,077)
State 1,659 238 495
--------------------------------------------------------------------------------------------------------------------
28,050 5,648 (2,582)
Deferred:
Federal (12,591) 313 5,673
State (783) 296 356
--------------------------------------------------------------------------------------------------------------------
(13,374) 609 6,029
--------------------------------------------------------------------------------------------------------------------
Income tax expense $ 14,676 $ 6,257 $ 3,447
====================================================================================================================
The differences between income tax expense computed at the federal statutory
rate and recorded income tax expense are as follows:
Year ended December 31,
------------------------------------------------
(THOUSANDS) 2002 2001 2000
--------------------------------------------------------------------------------------------------------------------
Income tax expense at federal statutory rate $ 13,007 $ 3,651 $ 2,141
Goodwill amortization - 829 829
Stock issuance costs 250 - -
State income and franchise taxes, net of federal benefit 579 571 415
Other, net 840 1,206 62
--------------------------------------------------------------------------------------------------------------------
Income tax expense $ 14,676 $ 6,257 $ 3,447
====================================================================================================================
43
Significant components of the Company's federal and state deferred tax
liabilities and assets are as follows:
December 31, 2002 December 31, 2001
----------------------------------------------------------------
(THOUSANDS) Federal State Federal State
--------------------------------------------------------------------------------------------------------------------
Deferred tax assets:
Insurance liabilities $ 13,030 $ 670 $ 2,755 $ 142
Unearned income 3,139 175 782 56
Employee compensation and benefits 3,221 568 2,561 440
Accrued expenses 1,542 297 2,765 532
Acquisition costs 1,790 289 2,010 320
Net business loss carryforwards 1,047 6,789 1,082 6,384
Other deductible temporary differences 1,180 506 2,428 586
--------------------------------------------------------------------------------------------------------------------
24,949 9,294 14,383 8,460
Valuation allowances (1,918) (3,441) (1,963) (3,431)
--------------------------------------------------------------------------------------------------------------------
23,031 5,853 12,420 5,029
Deferred tax liabilities:
Intangibles 1,001 226 7,702 1,740
Prepaid assets 853 88 1,145 115
Depreciation and amortization 998 189 1,889 361
Unrealized gain on investments 4,117 - 1,024 -
Other taxable temporary differences 1,880 8 1,815 11
--------------------------------------------------------------------------------------------------------------------
8,849 511 13,575 2,227
--------------------------------------------------------------------------------------------------------------------
Net deferred tax assets (liabilities) $ 14,182 $ 5,342 $ (1,155) $ 2,802
====================================================================================================================
The federal deferred benefit arising from the deductibility of state deferred
taxes is included as a component of other federal deferred taxes. The net
deferred taxes are included in other assets in the accompanying consolidated
balance sheets. During 2002, the Company recognized, as an adjustment to
additional paid-in capital, an income tax benefit of $1,769,000 resulting from
the deduction received by the Company upon the exercise of employee stock
options. The Company paid net federal and state income taxes of $22,903,000 in
2002 and received net federal and state income tax refunds of $739,000 and
$6,910,000 in 2001 and 2000, respectively.
8. COMMITMENTS AND CONTINGENCIES
In February 2000, a class action lawsuit was filed against the Company in the
state of Florida alleging that the Company failed to follow Florida law when it
discontinued writing certain health insurance policies and offering new policies
in 1998. Plaintiffs claim that the Company wrongfully terminated coverage,
improperly notified insureds of conversion rights and charged improper premiums
for new coverage. Plaintiffs also allege that the Company's renewal rating
methodology violated Florida law. On April 24, 2002, a Circuit Court Judge ruled
against the Company and ordered the question of damages be tried at a later
date. The damages portion of the lawsuit has not yet been scheduled.
44
In a separate administrative proceeding involving substantially similar issues,
the Florida Department of Insurance issued an administrative complaint against
the Company in May 2001 challenging the Company's rating and other practices in
Florida relating to its MedOne(SM) products for individuals and their families.
MedOne(SM) products sold by the Company in Florida are written pursuant to a
group master policy issued to an association domiciled in another state. In a
recommended order entered April 25, 2002, the Administrative Law Judge held that
the evidence presented by the Florida Department of Insurance did not support a
conclusion that the Company had violated any provisions of Florida law. The
Administrative Law Judge recommended that all counts of the Department's
administrative complaint be dismissed. On July 24, 2002, the Florida Department
of Insurance issued a final order affirming the recommendations from the
Administrative Law Judge with respect to six of eight counts. Among other
things, the final order affirmed that the policy issued to the association was
exempt from most Florida rating requirements. However, the Department reversed
the Administrative Law Judge's finding that the Company did not violate state
law applicable to policies issued out of state, and ordered the suspension of
the Company's license to sell new business in Florida for one year. The
Department's order specifically permits the Company to continue to renew its
existing business in Florida. On July 29, 2002, the First District Court of
Appeals for the State of Florida stayed the order of the Florida Department of
Insurance. The stay is effective until the Court of Appeals rules on the
Company's request to overturn the order. Oral arguments were held before the
appellate court on February 12, 2003. The Company is awaiting a ruling. The
Company anticipates a reversal of the final order on appeal. The Company has
voluntarily implemented a block rating system for all of its MedOne(SM) products
due to adverse publicity and misperceptions about the Company's rating
practices.
The Company is a defendant in a number of lawsuits in various states, primarily
Alabama, alleging misrepresentation of the rating methodology used by the
Company with respect to certain MedOne(SM) products purchased by the plaintiffs.
These lawsuits commonly seek unspecified damages for misrepresentation and
emotional distress in addition to punitive damages. Some of these cases involve
multiple plaintiffs. The cases are in various stages of litigation. One or more
of the cases could come to trial as early as the second quarter of 2003. The
Company believes that these lawsuits are unfounded because the Company properly
disclosed the nature of the products sold. The Company also believes the subject
matter of the lawsuits falls under the primary jurisdiction of state insurance
departments. The Company is vigorously defending itself in these actions.
The Company is involved in various other legal and regulatory actions occurring
in the normal course of business. Based on current information, including
consultation with outside counsel, management believes any ultimate liability
that may arise from the above-mentioned and all other legal and regulatory
actions would not materially affect the Company's consolidated financial
position or results of operations. However, management's evaluation of the
likely impact of these actions could change in the future and an unfavorable
outcome could have a material adverse effect on the Company's consolidated
financial position, results of operations or cash flow of a future period.
9. SHAREHOLDERS' EQUITY
STATUTORY FINANCIAL INFORMATION
State insurance laws and regulations prescribe accounting practices for
determining statutory net income and equity for insurance companies. These
regulations require, among other matters, the filing of financial statements
prepared in accordance with statutory accounting practices prescribed or
permitted for insurance companies. The combined statutory capital and surplus of
the Company's insurance subsidiaries, United Wisconsin Life Insurance Company
and American Medical Security Insurance Company of Georgia, at December 31, 2002
and 2001, was $157,487,000 and $155,629,000, respectively. The combined
statutory net income of the Company's insurance subsidiaries was $13,150,000,
$18,052,000 and $7,808,000 for the years ended December 31, 2002, 2001 and 2000,
respectively.
45
State insurance regulations also require the maintenance of a minimum compulsory
surplus based on a percentage of premiums written. At December 31, 2002, the
Company's insurance subsidiaries were in compliance with these compulsory
regulatory requirements.
RESTRICTIONS ON DIVIDENDS FROM SUBSIDIARIES
Dividends paid by the insurance subsidiaries to the parent Company are limited
by state insurance regulations. The insurance regulator in the insurer's state
of domicile may disapprove any dividend which, together with other dividends
paid by an insurance company in the prior 12 months, exceeds the regulatory
maximum, computed as the lesser of 10% of statutory surplus or total statutory
net gain from operations as of the end of the preceding calendar year. In
January 2003, regulatory approval was obtained, and a $2,000,000 dividend was
paid to the parent company by an insurance subsidiary. Based upon the financial
statements of the Company's insurance subsidiaries as of December 31, 2002, as
filed with the insurance regulators, the additional aggregate amount available
for dividend without regulatory approval is $11,300,000.
SHAREHOLDERS' RIGHTS AGREEMENT
In August 2001, the Board of Directors of the Company adopted a shareholders'
rights agreement (the "rights agreement") and declared a dividend of one
preferred share purchase right for each outstanding share of common stock of the
Company. When exercisable, each right entitles the registered holder to purchase
from the Company a unit consisting of one ten-thousandth of a share of Series B
Junior Cumulative Preferred Stock of the Company at a price of $30.00. The
rights agreement, as amended, is designed to deter takeover initiatives not
considered to be in the best interests of the Company's shareholders. In the
event that a person or a group has become the beneficial owner of 16% or more of
the common shares then outstanding, in certain circumstances the rights become
exercisable, and each holder of a right will have the right to receive, upon
exercise, common shares having a value equal to two times the exercise price of
the right. The rights are redeemable by action of the Company's Board of
Directors at any time prior to their becoming exercisable. The rights expire on
August 20, 2011.
10. EMPLOYEE BENEFIT PLANS
RETIREMENT SAVINGS PLAN
The Company's employees are included in a qualified defined contribution plan
(the "Retirement Savings Plan") with profit sharing and discretionary savings
provisions covering all eligible salaried and hourly employees. Participant
contributions up to 6% of the participant's compensation were matched 70% by the
Company in 2002 and 60% in 2001 and 2000. Profit sharing contributions to the
Retirement Savings Plan are determined annually by the Company. Participants
vest in Company contributions in three years. The Company recognized expense
associated with the Retirement Savings Plan of $3,711,000, $1,881,000 and
$1,944,000 in 2002, 2001 and 2000, respectively. For 2002, the expense includes
a profit sharing contribution of approximately $1,300,000, or 2% of eligible
wages. No profit sharing contributions were made in 2001 or 2000.
NONQUALIFIED EXECUTIVE RETIREMENT PLAN
The Company has a nonqualified executive retirement plan (the "Nonqualified
Plan") to provide key management with the opportunity to accumulate deferred
compensation which cannot be accumulated under the Retirement Savings Plan due
to compensation limitations imposed by the Internal Revenue Service. The
Nonqualified Plan is funded through a rabbi trust and has contribution and
investment options similar to those of the Retirement Savings Plan. The Company
recognized expense associated with the Nonqualified Plan of $116,000, $53,000
and $77,000 during 2002, 2001 and 2000, respectively.
46
STOCK BASED COMPENSATION PLANS
The Company has a stock-based compensation plan, the Equity Incentive Plan (the
"Plan"), for the benefit of eligible employees and directors of the Company. The
Plan permits the grant of nonqualified stock options ("NQSO"), incentive stock
options, stock appreciation rights, restricted stock awards and performance
awards. Persons eligible to participate in the Plan include all full-time active
employees and outside directors of the board of directors. The Plan allows for
the granting of up to 4,000,000 shares of which 448,113 shares are available for
grant as of December 31, 2002. The Company's 1995 Director Stock Option Plan
also permits the grant of NQSOs. The plan allows for the granting of up to
75,000 shares of which 9,000 shares are available for grant as of December 31,
2002.
The terms of incentive stock options and nonqualified stock options granted
under the Plan cannot exceed more than 10 and 12 years, respectively, and the
option exercise price generally cannot be less than the fair market value of the
Company's common stock on the date of grant. Incentive stock options and NQSOs
are not exercisable in any event prior to six months following the grant date.
The Company's outstanding NQSOs generally vest 25% per year for employees and
33.3% per year for directors beginning on the first anniversary of the date of
grant and each subsequent anniversary date thereafter provided the employee or
director remains in service.
Stock appreciation rights generally have a grant price at least equal to 100% of
the fair market value of the Company's common stock. The term of the stock
appreciation rights cannot exceed 12 years. Stock appreciation rights are not
exercisable prior to six months following the grant date.
Restricted stock generally may not be sold or otherwise transferred for certain
periods based on the passage of time, the achievement of performance goals or
the occurrence of other events. However, participants may exercise full voting
rights and are entitled to receive all dividends and other distributions with
respect to restricted stock. Restricted stock does not vest prior to six months
following the date of grant.
The Company has a deferred compensation plan for the benefit of certain outside
directors of the Company who wish to defer the receipt of eligible compensation
which they may otherwise be entitled to receive from the Company. Directors who
choose to participate in the plan may elect to have their deferred compensation
credited to, in whole or in part, either an interest account or a Company stock
unit account.
During 1998, the Company and a key executive entered into a deferred stock
agreement. Under the agreement the Company has an obligation to issue 73,506
shares of the Company's common stock in the year after employment terminates.
The Company incurred expense of $197,000 in 2002 and $225,000 in each of the two
years ended 2001 and 2000 related to this agreement.
On July 9, 2001, the Company and a key executive entered into a restricted stock
agreement. Under the agreement, the Company granted the executive 25,000 shares
of common stock, subject to certain rights and restrictions, in exchange for the
surrender for cancellation of 443,857 shares of the executive's nonqualified
stock options. The 25,000 shares of restricted stock vested in December 2001
upon the occurrence of certain triggering events, as specified under the
restricted stock agreement. The Company incurred expense of $139,000 during 2001
related to this agreement.
47
Stock option activity for all plans is as follows:
Year ended December 31,
-----------------------------------------------------
2002 2001 2000
---------------------------------------------------------------------------------------------------------------------------
TOTAL NUMBER OF NQSOS
Outstanding at beginning of year 3,243,767 3,460,130 2,809,143
Granted 245,000 426,000 715,000
Exercised (350,459) (26,756) -
Forfeited (215,816) (615,607) (64,013)
---------------------------------------------------------------------------------------------------------------------------
Outstanding at end of year 2,922,492 3,243,767 3,460,130
===========================================================================================================================
Exercisable at end of year 2,004,846 1,826,017 1,807,963
Available for grant at end of year 457,113 486,297 296,690
WEIGHTED AVERAGE EXERCISE PRICE OF NQSOS
Outstanding at beginning of year $ 9.11 $ 9.86 $11.10
Granted - Exercise price equals market price on grant date 12.24 9.97 5.28
Granted - Exercise price is less than market price on grant date - - -
Granted - Exercise price exceeds market price on grant date - - -
Exercised 8.53 5.15 -
Forfeited 11.27 14.09 13.14
Outstanding at end of year 9.28 9.11 9.86
Exercisable at end of year 9.48 10.33 12.60
NQSOS BY EXERCISE PRICE RANGE
Range of exercise prices $ 3.01 - $8.88 $ 3.01 - $8.88 $ 3.01 - $8.88
Weighted average exercise price $5.85 $5.75 $5.71
Weighted average remaining contractual life (years) 10.33 10.08 11.03
Exercisable at end of year 775,396 605,954 260,877
Outstanding at end of year 1,165,000 1,471,454 1,571,960
Weighted average exercise price of options exercisable at end of year $5.94 $5.77 $5.64
Range of exercise prices $10.20 - $14.38 $10.20 - $14.38 $10.25 - $14.38
Weighted average exercise price $11.18 $11.07 $11.54
Weighted average remaining contractual life (years) 9.16 8.78 8.75
Exercisable at end of year 1,114,602 964,984 848,151
Outstanding at end of year 1,637,644 1,517,234 1,189,234
Weighted average exercise price of options exercisable at end of year $13.45 $11.48 $11.66
Range of exercise prices $15.34 - $22.74 $15.76 - $22.74 $15.76 - $22.74
Weighted average exercise price $16.74 $16.83 $16.33
Weighted average remaining contractual life (years) 7.66 6.45 7.48
Exercisable at end of year 114,848 255,079 698,936
Outstanding at end of year 119,848 255,079 698,936
Weighted average exercise price of options exercisable at end of year $16.80 $16.83 $16.33
48
11. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Selected quarterly financial data for the years ended December 31, 2002 and 2001
are as follows:
Quarter
---------------------------------------------------------
(THOUSANDS, EXCEPT PER SHARE DATA) First Second Third Fourth Total
--------------------------------------------------------------------------------------------------------------------
2002
Total revenues $ 203,744 $ 199,572 $ 195,710 $ 190,503 $ 789,529
Income before cumulative effect of a
change in accounting principle 5,430 5,241 5,738 6,077 22,486
Net income (loss) (54,668) 5,241 5,738 6,077 (37,612)
Earnings per common share - basic:
Income before cumulative effect of a
change in accounting principle $ 0.39 $ 0.42 $ 0.45 $ 0.47 $ 1.72
Net income (loss) $ (3.96) $ 0.42 $ 0.45 $ 0.47 $ (2.88)
Earnings per common share - diluted:
Income before cumulative effect of a
change in accounting principle $ 0.37 $ 0.38 $ 0.42 $ 0.45 $ 1.63
Net income (loss) $ (3.77) $ 0.38 $ 0.42 $ 0.45 $ (2.72)
2001
Total revenues $ 232,258 $ 223,306 $ 213,388 $ 207,669 $ 876,621
Net income (loss) (5,140) 1,466 3,504 4,345 4,175
Net income (loss) per common share:
Basic (0.36) 0.10 0.25 0.31 0.30
Diluted (0.36) 0.10 0.25 0.30 0.29
12. SEGMENTS OF THE BUSINESS
The Company has two reportable segments: 1) health insurance products; and 2)
life insurance products. The Company's health insurance products consist of the
following coverages related to small group PPO products: MedOne(SM) and small
group medical, self-funded medical, dental and short-term disability. Life
products consist primarily of group term life insurance. The "All Other"
category includes operations not directly related to the business segments and
unallocated corporate items (i.e., corporate investment income, interest expense
on corporate debt, amortization of goodwill and intangibles and unallocated
overhead expenses). The reportable segments are managed separately because they
differ in the nature of the products offered and in profit margins.
The Company evaluates segment performance based on income or loss before income
taxes, excluding gains and losses on the Company's investment portfolio. The
accounting policies of the reportable segments are the same as those described
in the summary of significant accounting policies. Significant intercompany
transactions have been eliminated prior to reporting reportable segment
information.
49
Selected financial data for the Company by segment is as follows:
YEAR ENDED DECEMBER 31, 2002:
Health Life Total
(THOUSANDS) Insurance Insurance All Other Consolidated
--------------------------------------------------------------------------------------------------------------------
REVENUES
Insurance premiums $ 740,677 $ 13,780 $ 3 $ 754,460
Net investment income 6,671 559 7,775 15,005
Net realized investment gains - - 39 39
Other revenue 16,609 113 3,303 20,025
--------------------------------------------------------------------------------------------------------------------
Total revenues 763,957 14,452 11,120 789,529
EXPENSES
Medical and other benefits 503,180 4,006 19 507,205
Selling, general and administrative 227,000 4,559 11,025 242,584
Interest - - 1,848 1,848
Amortization of other intangibles - - 730 730
--------------------------------------------------------------------------------------------------------------------
Total expenses 730,180 8,565 13,622 752,367
--------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes and cumulative
effect of a change in accounting principle $ 33,777 $ 5,887 $ (2,502) $ 37,162
====================================================================================================================
As of December 31, 2002:
Segment assets $ 225,502 $ 39,452 $ 163,986 $ 428,940
====================================================================================================================
YEAR ENDED DECEMBER 31, 2001:
Health Life Total
(THOUSANDS) Insurance Insurance All Other Consolidated
--------------------------------------------------------------------------------------------------------------------
REVENUES
Insurance premiums $ 820,658 $ 17,424 $ 590 $ 838,672
Net investment income 9,197 656 7,590 17,443
Net realized investment losses - - (779) (779)
Other revenue 17,272 154 3,859 21,285
--------------------------------------------------------------------------------------------------------------------
Total revenues 847,127 18,234 11,260 876,621
EXPENSES
Medical and other benefits 595,811 6,334 (203) 601,942
Selling, general and administrative 244,453 5,446 7,843 257,742
Interest - - 2,877 2,877
Amortization of goodwill and other intangibles - - 3,628 3,628
--------------------------------------------------------------------------------------------------------------------
Total expenses 840,264 11,780 14,145 866,189
--------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes $ 6,863 $ 6,454 $ (2,885) $ 10,432
====================================================================================================================
As of December 31, 2001:
Segment assets $ 299,149 $ 41,939 $ 131,927 $ 473,015
====================================================================================================================
50
YEAR ENDED DECEMBER 31, 2000:
Health Life Total
(THOUSANDS) Insurance Insurance All Other Consolidated
--------------------------------------------------------------------------------------------------------------------
REVENUES
Insurance premiums $ 907,722 $ 22,578 $ 20,771 $ 951,071
Net investment income 9,513 638 8,856 19,007
Net realized investment losses - - (325) (325)
Other revenue 16,115 217 3,780 20,112
--------------------------------------------------------------------------------------------------------------------
Total revenues 933,350 23,433 33,082 989,865
EXPENSES
Medical and other benefits 700,511 7,781 16,321 724,613
Selling, general and administrative 235,649 6,581 9,537 251,767
Interest - - 3,584 3,584
Amortization of goodwill and other intangibles - - 3,785 3,785
--------------------------------------------------------------------------------------------------------------------
Total expenses 936,160 14,362 33,227 983,749
--------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes $ (2,810) $ 9,071 $ (145) $ 6,116
====================================================================================================================
As of December 31, 2000:
Segment assets $ 292,279 $ 43,880 $ 135,764 $ 471,923
====================================================================================================================
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
51
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information required by this item with respect to directors and executive
officers is incorporated herein by reference to the information included under
the headings " Proposal 1 - Election of Directors" and "Section 16(a) Beneficial
Ownership Reporting Compliance" in the Company's definitive Proxy Statement
relating to the Annual Meeting of Shareholders scheduled for May 21, 2003 (the
"2003 Proxy Statement") and the information under the heading "Executive
Officers of the Registrant" in Part I of this report. The 2003 Proxy Statement
will be filed with the Securities and Exchange Commission not later than 120
days after the end of the Company's fiscal year.
ITEM 11. EXECUTIVE COMPENSATION
Information required by this item is included under the headings "Executive
Compensation" and "Election of Directors -- Compensation of Directors" in the
2003 Proxy Statement, which sections are hereby incorporated by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
Information required by this item is included under the heading "Security
Ownership of Certain Beneficial Owners and Management" and "Equity Compensation
Plan Information" in the 2003 Proxy Statement, which sections are hereby
incorporated by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information required by this item is included under the heading "Certain
Transactions" in the 2003 Proxy Statement, which section is hereby incorporated
by reference.
ITEM 14. CONTROLS AND PROCEDURES
The Company maintains disclosure controls and procedures designed to ensure that
the information the Company must disclose in its filings with the Securities and
Exchange Commission ("SEC") is recorded, processed, summarized and reported on a
timely basis. The Company's principal executive officer and principal financial
officer have reviewed and evaluated the Company's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this report
(the "Evaluation Date"). Based on such evaluation, such officers have concluded
that, as of the Evaluation Date, the Company's disclosure controls and
procedures are effective in bringing to their attention on a timely basis
material information relating to the Company required to be included in the
Company's periodic SEC filings. Since the Evaluation Date, there have not been
any significant changes in the internal controls of the Company, or in other
factors that could significantly affect these controls subsequent to the
Evaluation Date.
52
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1 and 2. FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
PAGE IN
FORM 10-K
REPORT
The following consolidated financial statements of American Medical Security Group, Inc. and
subsidiaries are included in Item 8:
Report of Independent Auditors..........................................................................27
Consolidated Balance Sheets at December 31, 2002 and 2001...............................................28
Consolidated Statements of Operations for the years ended December 31, 2002, 2001 and 2000..............29
Consolidated Statements of Cash Flows for the years ended December 31, 2002, 2001 and 2000..............30
Consolidated Statements of Changes in Shareholders' Equity and Comprehensive Income (Loss)
for the years ended December 31, 2002, 2001 and 2000.................................................31
Notes to Consolidated Financial Statements..............................................................32
PAGE IN
FORM 10-K
REPORT
The following financial statement schedules of American Medical Security Group, Inc. and
subsidiaries are included in Item 15(d):
Schedule II - Condensed Financial Information of Registrant.............................................54
Schedule III - Supplementary Insurance Information......................................................57
Schedule IV - Reinsurance...............................................................................58
Schedule V - Valuation and Qualifying Accounts..........................................................59
All other schedules for which provision is made in applicable accounting
regulations of the Securities and Exchange Commission are not required under the
related instructions or are inapplicable, and therefore have been omitted.
3. EXHIBITS
See the Exhibit Index included as the last page of this report, which is
incorporated herein by reference. Each management contract and compensatory plan
or arrangement required to be filed as an exhibit to this report is identified
in the Exhibit Index by an asterisk following its exhibit number.
(b) REPORTS ON FORM 8-K
No reports on Form 8-K were filed during the fourth quarter of 2002.
(c) EXHIBITS
See the Exhibit Index following the Certification pages of this report.
(d) FINANCIAL STATEMENT SCHEDULES
The financial statement schedules referenced in Item 15(a) are as follows.
53
SCHEDULE II
AMERICAN MEDICAL SECURITY GROUP, INC.
(Parent Company Only)
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED BALANCE SHEETS
December 31,
(THOUSANDS) 2002 2001
--------------------------------------------------------------------------------------------------------------------
ASSETS
Cash and cash equivalents $ 972 $ 3,137
Other assets:
Investment in consolidated subsidiaries 175,835 250,794
Goodwill and other intangibles, net 34,998 19,666
Due from affiliates 4,388 -
Other assets 510 239
--------------------------------------------------------------------------------------------------------------------
Total other assets 215,731 270,699
--------------------------------------------------------------------------------------------------------------------
Total assets $ 216,703 $ 273,836
====================================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Notes payable $ 30,158 $ 35,158
Taxes payable 2,819 7,821
Due to affiliates - 634
Other liabilities 976 823
--------------------------------------------------------------------------------------------------------------------
Total liabilities 33,953 44,436
Shareholders' equity:
Common stock 16,654 16,654
Paid-in capital 189,813 187,927
Retained earnings 2,858 40,470
Accumulated other comprehensive income 7,646 1,903
Treasury stock (34,221) (17,554)
--------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 182,750 229,400
--------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 216,703 $ 273,836
====================================================================================================================
54
SCHEDULE II
AMERICAN MEDICAL SECURITY GROUP, INC.
(Parent Company Only)
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED STATEMENTS OF OPERATIONS
Year ended December 31,
------------------------------------------------
(THOUSANDS) 2002 2001 2000
--------------------------------------------------------------------------------------------------------------------
REVENUES
Fees from consolidated subsidiaries $ 4,752 $ 4,427 $ 4,139
Other revenue 27 103 140
--------------------------------------------------------------------------------------------------------------------
Total revenues 4,779 4,530 4,279
EXPENSES
General and administrative 3,068 563 430
Interest 1,458 2,377 2,972
Amortization of goodwill and other intangibles 365 563 563
--------------------------------------------------------------------------------------------------------------------
Total expenses 4,891 3,503 3,965
--------------------------------------------------------------------------------------------------------------------
Income (loss) before the following items (112) 1,027 314
Income tax expense 1,777 874 154
--------------------------------------------------------------------------------------------------------------------
Income (loss) before the following items (1,889) 153 160
Equity in net income of subsidiaries 24,375 4,022 2,509
--------------------------------------------------------------------------------------------------------------------
Income before cumulative effect of a change
in accounting principle 22,486 4,175 2,669
Cumulative effect of a change in accounting principle (60,098) - -
--------------------------------------------------------------------------------------------------------------------
Net income (loss) $ (37,612) $ 4,175 $ 2,669
====================================================================================================================
55
SCHEDULE II
AMERICAN MEDICAL SECURITY GROUP, INC.
(Parent Company Only)
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED STATEMENTS OF CASH FLOWS
Year ended December 31,
------------------------------------------------
(THOUSANDS) 2002 2001 2000
--------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income (loss) $ (37,612) $ 4,175 $ 2,669
Adjustments to reconcile net income (loss)
to net cash provided by operating activities:
Due from affiliates (5,022) - -
Cumulative effect of change in accounting principle 60,098 - -
Equity in net income of subsidiaries (24,375) (4,022) (2,509)
Dividends received from subsidiaries 25,000 - 16,400
Amortization of intangibles 365 563 563
Deferred income tax expense (benefit) (38) 72 186
Changes in operating accounts:
Net other assets and liabilities 969 2,481 (7,622)
--------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 19,385 3,269 9,687
INVESTING ACTIVITIES
Net cash used in investing activities - - -
FINANCING ACTIVITIES
Issuance of common stock 2,990 413 4
Purchase of treasury stock (19,540) (2,216) (8,292)
Proceeds from notes payable borrowings 30,158 - 39,158
Repayment of notes payable (35,158) - (39,158)
--------------------------------------------------------------------------------------------------------------------
Net cash used in financing activities (21,550) (1,803) (8,288)
Cash and cash equivalents:
Net increase (decrease) during year (2,165) 1,466 1,399
Balance at beginning of year 3,137 1,671 272
--------------------------------------------------------------------------------------------------------------------
Balance at end of year $ 972 $ 3,137 $ 1,671
====================================================================================================================
56
SCHEDULE III
AMERICAN MEDICAL SECURITY GROUP, INC.
SUPPLEMENTARY INSURANCE INFORMATION
Deferred Medical and
Policy Other Other
SEGMENT Acquisition Benefits Advance Policyholder
(THOUSANDS) Costs Payable Premiums Funds
--------------------------------------------------------------------------------------
DECEMBER 31, 2002:
Health $ - $ 123,797 $ 14,412 $ -
Life - 10,570 788 -
All Other - 112 - -
--------------------------------------------------------------------------------------
Total $ - $ 134,479 $ 15,200 $ -
======================================================================================
DECEMBER 31, 2001:
Health $ - $ 125,834 $ 15,912 $ -
Life - 9,480 825 -
All Other - 190 - -
--------------------------------------------------------------------------------------
Total $ - $ 135,504 $ 16,737 $ -
======================================================================================
DECEMBER 31, 2000:
Health $ - $ 133,001 $ 16,814 $ -
Life - 9,924 754 -
All Other - 2,385 - -
--------------------------------------------------------------------------------------
Total $ - $ 145,310 $ 17,568 $ -
======================================================================================
Amortization of
Medical and Deferred
Net Other Policy Other
SEGMENT Premium Investment Benefit Acquisition Operating Premiums
(THOUSANDS) Revenue Income Expenses Costs Expenses Written
-------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 2002:
Health $ 740,677 $ 6,671 $ 503,180 $ - $ 227,000 $ 739,177
Life 13,780 559 4,006 - 4,559
All Other 3 7,775 19 - 11,025 3
----------------------------------------------------------------------------------------------------
Total $ 754,460 $ 15,005 $ 507,205 $ - $ 242,584
====================================================================================================
DECEMBER 31, 2001:
Health $ 820,658 $ 9,197 $ 595,811 $ - $ 244,453 $ 819,756
Life 17,424 656 6,334 - 5,446
All Other 590 7,590 (203) - 7,843 590
----------------------------------------------------------------------------------------------------
Total $ 838,672 $ 17,443 $ 601,942 $ - $ 257,742
====================================================================================================
DECEMBER 31, 2000:
Health $ 907,722 $ 9,513 $ 700,511 $ - $ 235,649 $ 908,365
Life 22,578 638 7,781 - 6,581
All Other 20,771 8,856 16,321 - 9,537 20,771
----------------------------------------------------------------------------------------------------
Total $ 951,071 $ 19,007 $ 724,613 $ - $ 251,767
====================================================================================================
57
SCHEDULE IV
AMERICAN MEDICAL SECURITY GROUP, INC.
REINSURANCE
Percentage
Ceded to Assumed Of Amount
Direct Other from Other Net Assumed
(THOUSANDS) Business Companies Companies Amount to Net
--------------------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31, 2002:
Life insurance in force $ 8,101,953 $ 6,114,861 $ - $ 1,987,092 0.0%
Premiums:
Accident and Health 741,610 1,973 1,043 740,680 0.1%
Life 14,013 233 - 13,780 0.0%
-------------------------------------------------------------------------------------------------------
Total Premiums 755,623 2,206 1,043 754,460 0.1%
=======================================================================================================
YEAR ENDED DECEMBER 31, 2001:
Life insurance in force $ 9,351,321 $ 6,913,662 $ - $ 2,437,659 0.0%
Premiums:
Accident and Health 821,994 2,259 1,513 821,248 0.2%
Life 17,695 273 2 17,424 0.0%
-------------------------------------------------------------------------------------------------------
Total Premiums 839,689 2,532 1,515 838,672 0.2%
=======================================================================================================
YEAR ENDED DECEMBER 31, 2000:
Life insurance in force $ 14,839,256 $ 11,412,772 $ 1,942 $ 3,428,426 0.1%
Premiums:
Accident and Health 922,087 2,236 8,642 928,493 0.9%
Life 22,782 287 83 22,578 0.4%
-------------------------------------------------------------------------------------------------------
Total Premiums 944,869 2,523 8,725 951,071 0.9%
=======================================================================================================
58
SCHEDULE V
AMERICAN MEDICAL SECURITY GROUP, INC.
VALUATION AND QUALIFYING ACCOUNTS
Additions
Balance at Charged to
Beginning Costs and Balance at
(THOUSANDS) of Period Expenses Deductions End of Period
--------------------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31, 2002:
Allowance for bad debts $ 1,292 $ - $ 1,172 $ 120
Valuation allowance for deferred taxes 5,394 13 48 5,359
--------------------------------------------------------------------------------------------------------------------
Total $ 6,686 $ 13 $ 1,220 $ 5,479
====================================================================================================================
YEAR ENDED DECEMBER 31, 2001:
Allowance for bad debts $ 344 $ 1,250 $ 302 $ 1,292
Valuation allowance for deferred taxes 3,861 1,810 277 5,394
--------------------------------------------------------------------------------------------------------------------
Total $ 4,205 $ 3,060 $ 579 $ 6,686
====================================================================================================================
YEAR ENDED DECEMBER 31, 2000:
Allowance for bad debts $ 651 $ 7 $ 314 $ 344
Valuation allowance for deferred taxes 3,549 398 86 3,861
--------------------------------------------------------------------------------------------------------------------
Total $ 4,200 $ 405 $ 400 $ 4,205
====================================================================================================================
59
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
AMERICAN MEDICAL SECURITY GROUP, INC.
Date: March 14, 2003 By: /s/ SAMUEL V. MILLER
Samuel V. Miller, Chairman, President,
and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.*
SIGNATURE TITLE
/s/ SAMUEL V. MILLER Chairman of the Board, President and Chief
Samuel V. Miller Executive Officer; Director
/s/ JAMES E. PROCHNOW Vice President, Corporate Controller and
James E. Prochnow Interim Treasurer (Principal Financial Officer
and Corporate Controller
/s/ ROGER H. BALLOU Director
Roger H. Ballou
/s/ W. FRANCIS BRENNAN Director
W. Francis Brennan
/s/ MARK A. BRODHAGEN Director
Mark A. Brodhagen
/s/ JAMES C. HICKMAN Director
James C. Hickman
/s/ WILLIAM R. JOHNSON Director
William R. Johnson
/s/ EUGENE A. MENDEN Director
Eugene A. Menden
/s/ EDWARD L. MEYER, JR Director
Edward L. Meyer, Jr.
/s/ MICHAEL T. RIORDAN Director
Michael T. Riordan
/s/ H.T. RICHARD SCHREYER Director
H.T. Richard Schreyer
/s/ FRANK L. SKILLERN Director
Frank L. Skillern
/s/ J. GUS SWOBODA Director
J. Gus Swoboda
*Each of the above signatures is affixed as of March 14, 2003.
60
CERTIFICATIONS
I, Samuel V. Miller, certify that:
1. I have reviewed this annual report on Form 10-K of American Medical
Security Group, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this annual report (the "Evaluation Date");
and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent functions):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: March 14, 2003 /s/ Samuel V. Miller
Chief Executive Officer
61
I, James E. Prochnow, certify that:
1. I have reviewed this annual report on Form 10-K of American Medical
Security Group, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this annual report (the "Evaluation Date");
and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent functions):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: March 14, 2003 /s/ James E. Prochnow
Vice President, Corporate Controller
and Interim Treasurer
(Principal Financial Officer)
62
AMERICAN MEDICAL SECURITY GROUP, INC.
(COMMISSION FILE NO. 1-13154)
EXHIBIT INDEX
TO
FORM 10-K ANNUAL REPORT
FOR THE YEAR ENDED DECEMBER 31, 2002
EXHIBIT INCORPORATED HEREIN FILED
NUMBER DOCUMENT DESCRIPTION BY REFERENCE TO HEREWITH
2.1 Distribution and Indemnity Agreement Exhibit 2.1 to Newco/UWS'
between United Wisconsin Services, Registration Statement on Form 10, as
Inc., now known as American Medical amended (File No. 1-14177)
Security Group, Inc. ("AMSG f/k/a
UWS or Registrant") and Newco/UWS,
Inc. ("Newco/UWS") dated as of
September 11, 1998
2.2 Employee Benefits Agreement dated as Exhibit 10.1 to Newco/UWS'
of September 11, 1998, by and Registration Statement on Form 10, as
between AMSG f/k/a UWS and Newco/UWS amended (File No. 1-14177)
2.3 Tax Allocation Agreement, entered Exhibit 10.2 to Newco/UWS'
into as of September 11, 1998, by Registration Statement on Form 10, as
and between AMSG f/k/a UWS and amended (File No. 1-14177)
Newco/UWS
3.1(a) Restated Articles of Incorporation Exhibit 3.1 to the Registrants Form
of Registrant dated as of 10-K for the year ended December 31,
February 17, 1999 1998 (the "1998 10-K")
3.1(b) Articles of Amendment to Restated Exhibit 3 to the Registrant's Form
Articles of Incorporation with 10-Q for the quarter ended June 30,
Respect to Designation, Preferences, 2001.
Limitations and Relative Rights of
Series B Junior Cumulative Preferred
Stock
3.2 Bylaws of Registrant as amended and X
restated November 19, 2002
4.1(a) Credit Agreement dated as of X
December 30, 2002, (the "Credit
Agreement") among the Registrant,
LaSalle Bank National Association
and other Lenders
EX-1
EXHIBIT INCORPORATED HEREIN FILED
NUMBER DOCUMENT DESCRIPTION BY REFERENCE TO HEREWITH
4.2(a) Rights Agreement, dated as of August Exhibit 1 to the Registrant's
9, 2001, between American Medical Registration Statement on Form 8-A
Security Group, Inc. and Firstar filed August 14, 2001 and Exhibit 4
Bank, N.A., as Rights Agents (the to the Registrant's Current Report on
"Rights Agreement') including the Form 8-K dated August 9, 2001, and
form of Rights Certificate as filed on August 14, 2001
Exhibit B thereto
4.2(b) Appointment and Assumption Agreement Exhibit 4.2 to the Registrant's Form
dated December 17, 2001, between the 8-K dated February 1, 2002 (the
Registrant and Firstar Bank, N.A., "2/1/02 8-K")
appointing LaSalle Bank, N.A. as
Rights Agent for the Rights Agreement
4.2(c) Amendment dated as of February 1, Exhibit 4.1 to 2/1/02 8-K
2002, to the Rights Agreement
4.2(d) Amendment dated as of June 4, 2002, Exhibit 4.4(d) to the Registrant's
to the Rights Agreement Form 8-K dated June 4, 2002, and
filed on June 19, 2002 (the "6/4/02
8-K")
10.1* Equity Incentive Plan as amended and Exhibit 10.1 to Registrant's Form
restated November 29, 2001 10-K for the year ended December 31,
2001 (the "2001 10-K")
10.2* Form of Nonqualified Stock Option Exhibit 10.2 to 1998 10-K
Award Agreement for Officers
10.3* Form of Nonqualified Stock Option Exhibit 10.3 to Registrant's Form
Award Agreement for Directors 10-K for the year ended December 31,
1999 (the "1999 10-K")
10.4* Deferred Stock Agreement between the Exhibit 10.3 to 1998 10-K
Registrant and Samuel V. Miller
10.5* 1995 Director Stock Option Plan as Exhibit 10.5 to 2001 10-K
amended November 29, 2001
10.6* Directors Deferred Compensation Plan Exhibit 10.6 to 1999 10-K
adopted November 17, 1999
10.7* Voluntary Deferred Compensation Plan Exhibit 10.7 to 1999 10-K
as Amended and Restated effective
September 25, 1998
10.8(a)* Deferred Compensation Trust Exhibit 10.48 to the Registrant's
Form 10-K for the year ended
December 31, 1997
EX-2
EXHIBIT INCORPORATED HEREIN FILED
NUMBER DOCUMENT DESCRIPTION BY REFERENCE TO HEREWITH
10.8(b)* First Amendment to the Deferred Exhibit 10.9 to 1999 10-K
Compensation Trust
10.9* Restricted Stock Agreement with Exhibit 10 to the Registrant's Form
Chief Executive Officer dated 10-Q for the quarter ended
July 9, 2001 September 30, 2001
10.10* Executive Reimbursement Group Exhibit 10.8 to 1998 10-K
Insurance Policy
10.11* Change of Control Severance Benefit Exhibit 10.11(b) to 2001 10-K
Plan as amended and restated
November 29, 2001
10.12* Severance Benefit for Certain Exhibit 10.10 to 1998 10-K
Executive Officers
10.13* Executive Management Incentive X
Program effective January 1, 2002
10.14* Executive Annual Incentive Plan as X
amended through February 19, 2003
10.15(a)* Employment Agreement of Chief Exhibit 10 to the Registrant's Form
Executive Officer ("CEO") dated 10-Q for the quarter ended
September 28, 2000 September 30, 2000
10.15(b)* Amendment dated as of November 29, Exhibit 10.15(b) to 2001 10-K
2001 to Employment Agreement of CEO
10.16(a)* Nonqualified Executive Retirement Exhibit 10 to the Registrant's Form
Plan effective April 1, 2000 10-Q for the quarter ended March 31,
2000
10.16(b)* Amendment No. 1 dated January 20, X
2003 to Nonqualified Executive
Retirement Plan
10.17 Registration Rights Agreement Exhibit 10.19 to 1998 10-K
between the Registrant and Blue
Cross Blue Shield United of
Wisconsin ("BCBSUW") dated as of
September 1, 1998
10.18 Agreement dated February 1, 2002, Exhibit 10.1 to 2/1/02 8-K
among the Company, Cobalt
Corporation and BCBSUW concerning
the Rights Agreement
EX-3
EXHIBIT INCORPORATED HEREIN FILED
NUMBER DOCUMENT DESCRIPTION BY REFERENCE TO HEREWITH
10.19 Stock Purchase Agreement dated as of Exhibit 10 to the Registrant's Form
March 19, 2002 among the Registrant, 8-K dated March 19, 2002, and filed
Cobalt Corporation and BCBSUW. March 20, 2002
10.20 Underwriting Agreement, dated May Exhibit 10.4 to the 6/4/02 8-K
29, 2002, among the Registrant,
BCBSUW and the Underwriters named on
Schedule I thereto
10.21* Retirement Agreement dated as of Exhibit 10.1 to the Registrant's Form
August 1, 2002 between the 10-Q for the quarter ended
Registrant and Gary D. Guengerich September 30, 2002
21 Subsidiaries of the Registrant X
23 Consent of Ernst & Young LLP X
99.1 Certification pursuant to 18 U.S.C. X
Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley
Act of 2002
99.2 Certification pursuant to 18 U.S.C. X
Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley
Act of 2002
* Indicates compensatory plan or arrangement.