-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, TzMI+Dabp9WIN6FQvsZy6EiVSZ2g/eid5T4BB+OpgZH72lKhcXeiojlLb+1/LNhO Ci0yJTC3rHLGTU2ygu8EPw== 0000950152-02-008442.txt : 20021114 0000950152-02-008442.hdr.sgml : 20021114 20021113212246 ACCESSION NUMBER: 0000950152-02-008442 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20020930 FILED AS OF DATE: 20021114 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CERES GROUP INC CENTRAL INDEX KEY: 0000215403 STANDARD INDUSTRIAL CLASSIFICATION: LIFE INSURANCE [6311] IRS NUMBER: 341017531 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-08483 FILM NUMBER: 02821741 BUSINESS ADDRESS: STREET 1: 17800 ROYALTON RD CITY: STRONGSVILLE STATE: OH ZIP: 44136 BUSINESS PHONE: 2165722400 MAIL ADDRESS: STREET 1: 17800 ROYALTON RD CITY: STRONGSVILLE STATE: OH ZIP: 44136 FORMER COMPANY: FORMER CONFORMED NAME: CENTRAL RESERVE LIFE CORP DATE OF NAME CHANGE: 19920703 10-Q 1 l96793ae10vq.txt CERES GROUP FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 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 0-8483 CERES GROUP, INC. (Exact name of registrant as specified in its charter) Delaware 34-1017531 -------- ---------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 17800 Royalton Road Cleveland, Ohio 44136-5197 (Address of principal executive offices) ---------------------------------------- (Zip Code) (440) 572-2400 (Registrant's telephone number, including area code) 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 periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes (X) No ( ) Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ( ) No (X) Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Common Stock, $.001 par value - 34,057,951 shares as of November 1, 2002. CERES GROUP, INC. AND SUBSIDIARIES INDEX PART I. FINANCIAL INFORMATION PAGE Item 1. Financial Statements - Unaudited Condensed Consolidated Balance Sheets - September 30, 2002 and 3 December 31, 2001 Condensed Consolidated Statements of Operations - Three and nine months ended September 30, 2002 and 2001 4 Condensed Consolidated Statements of Stockholders' Equity - Nine months ended September 30, 2002 5 Condensed Consolidated Statements of Cash Flows - Nine months ended September 30, 2002 and 2001 6 Notes to Condensed Consolidated Financial Statements - September 30, 2002 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 17 Item 3. Quantitative and Qualitative Disclosure about Market Risk 31 Item 4. Controls and Procedures 31 PART II. OTHER INFORMATION Item 1. Legal Proceedings 32 Item 2. Changes in Securities and Use of Proceeds 32 Item 3. Defaults Upon Senior Securities 32 Item 4. Submission of Matters to a Vote of Security Holders 32 Item 5. Other Information 32 Item 6. Exhibits and Reports on Form 8-K 32 SIGNATURES 33
2 PART I. FINANCIAL INFORMATION ----------------------------- ITEM 1. FINANCIAL STATEMENTS - UNAUDITED - ---------------------------------------- CERES GROUP, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (DOLLARS IN THOUSANDS)
SEPTEMBER 30, DECEMBER 31, 2002 2001 -------- -------- (UNAUDITED) (NOTE A) ASSETS Investments Fixed maturities available-for-sale, at fair value $481,407 $471,485 Surplus notes 5,203 5,211 Policy and mortgage loans 6,031 5,926 -------- -------- Total investments 492,641 482,622 Cash and cash equivalents (of which $6,115 and $9,881 is restricted, respectively) 34,018 74,573 Accrued investment income 5,927 7,200 Premiums receivable 5,116 5,230 Reinsurance receivable 193,422 223,330 Property and equipment, net 7,671 8,100 Deferred federal income taxes -- 1,112 Deferred acquisition costs 88,891 77,377 Value of business acquired 32,603 33,470 Goodwill 19,314 24,443 Licenses 5,129 -- Other assets 10,947 8,559 -------- -------- TOTAL ASSETS $895,679 $946,016 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Policy liabilities and benefits accrued Future policy benefits, losses and claims $398,221 $408,918 Unearned premiums 49,639 47,339 Other policy claims and benefits payable 165,949 198,296 -------- -------- 613,809 654,553 Deferred reinsurance gain 11,527 13,881 Other policyholders' funds 21,643 28,659 Federal income taxes payable -- 1,259 Debt 26,085 31,000 Deferred federal income taxes payable 8,140 -- Other liabilities 40,360 60,089 -------- -------- TOTAL LIABILITIES 721,564 789,441 -------- -------- Stockholders' equity Non-voting preferred stock, $0.001 par value, 1,900,000 shares authorized, none issued -- -- Common stock, $0.001 par value, 50,000,000 shares authorized, 34,038,006 and 33,857,895 shares issued and outstanding, respectively 34 34 Additional paid-in capital 132,800 132,061 Retained earnings 28,865 23,831 Accumulated other comprehensive income 12,416 649 -------- -------- TOTAL STOCKHOLDERS' EQUITY 174,115 156,575 -------- -------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $895,679 $946,016 ======== ========
The accompanying notes are an integral part of these condensed consolidated financial statements. 3 CERES GROUP, INC AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS UNAUDITED (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------------- ------------------------- 2002 2001 2002 2001 --------- --------- --------- --------- REVENUES Premiums, net Medical $ 91,851 $ 103,987 $ 281,508 $ 305,278 Senior and other 66,097 58,568 195,599 166,042 --------- --------- --------- --------- Total premiums, net 157,948 162,555 477,107 471,320 Net investment income 7,474 8,124 23,624 24,274 Net realized gains (losses) 3,078 3,616 1,788 5,215 Fee and other income 7,311 9,885 23,474 27,568 Amortization of deferred reinsurance gain 478 646 2,354 3,301 --------- --------- --------- --------- 176,289 184,826 528,347 531,678 --------- --------- --------- --------- BENEFITS, LOSSES AND EXPENSES Benefits, claims, losses and settlement expenses Medical 67,102 79,385 226,370 248,638 Senior and other 48,016 42,946 145,253 125,951 --------- --------- --------- --------- Total benefits, claims, losses and settlement expenses 115,118 122,331 371,623 374,589 Selling, general and administrative expenses 49,618 54,167 155,093 165,265 Net (deferral) amortization and change in acquisition costs and value of business acquired (151) (1,839) (10,539) (20,288) Amortization of goodwill -- 274 -- 824 Interest expense and financing costs 490 1,170 1,536 3,934 Special charges - Note D -- -- 2,668 7,097 --------- --------- --------- --------- 165,075 176,103 520,381 531,421 --------- --------- --------- --------- Income before federal income taxes, minority interest, and preferred stock dividends 11,214 8,723 7,966 257 Federal income tax expense 3,927 3,179 2,969 1,122 --------- --------- --------- --------- Income (loss) after tax, before minority interest and preferred stock dividends 7,287 5,544 4,997 (865) Minority interest (10) (14) (37) (37) --------- --------- --------- --------- NET INCOME (LOSS) 7,297 5,558 5,034 (828) Convertible voting preferred stock dividends -- (207) -- (579) --------- --------- --------- --------- NET INCOME (LOSS) ATTRIBUTABLE TO COMMON STOCKHOLDERS $ 7,297 $ 5,351 $ 5,034 $ (1,407) ========= ========= ========= ========= NET INCOME (LOSS) PER SHARE ATTRIBUTABLE TO COMMON STOCKHOLDERS Basic $ 0.21 $ 0.30 $ 0.15 $ (0.08) Diluted 0.21 0.29 0.15 (0.08)
The accompanying notes are an integral part of these condensed consolidated financial statements. 4 CERES GROUP, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2002 UNAUDITED (DOLLARS IN THOUSANDS, EXCEPT SHARE AMOUNTS) COMMON STOCK Balance at September 30, 2002 $ 34 =========== ADDITIONAL PAID-IN CAPITAL Balance at beginning of year $ 132,061 Issuance of stock: Employee benefit plans 739 ----------- Balance at September 30, 2002 $ 132,800 =========== RETAINED EARNINGS Balance at beginning of year $ 23,831 Net income 5,034 ----------- Balance at September 30, 2002 $ 28,865 =========== ACCUMULATED OTHER COMPREHENSIVE INCOME Balance at beginning of year $ 649 Unrealized gain on securities, net of tax expense of $5,629 11,697 Other 70 ----------- Balance at September 30, 2002 $ 12,416 =========== TOTAL STOCKHOLDERS' EQUITY $ 174,115 =========== NUMBER OF SHARES OF COMMON STOCK Balance at beginning of year 33,857,895 Issuance of stock: Employee benefit plans 180,111 ----------- Balance at September 30, 2002 34,038,006 =========== The accompanying notes are an integral part of these condensed consolidated financial statements. 5 CERES GROUP, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS UNAUDITED (DOLLARS IN THOUSANDS)
NINE MONTHS ENDED SEPTEMBER 30, ------------------------- 2002 2001 --------- --------- OPERATING ACTIVITIES Net income (loss) $ 5,034 $ (828) Adjustments to reconcile net income (loss) to cash provided by (used in) operating activities: Depreciation and amortization 2,584 2,495 Net realized gains (losses) (1,788) (5,215) Deferred federal income taxes 3,586 1,630 Changes in assets and liabilities: Accrued investment income 1,273 1,109 Reinsurance and premiums receivable 30,022 22,274 Deferred acquisition costs (11,406) (13,171) Value of business acquired 867 (1,251) Goodwill and licenses -- 702 Other assets (1,697) (2,250) Future policy benefits, claims and funds payable (40,239) 21,752 Unearned premium 2,300 4,187 Deferred reinsurance gain (2,354) (3,301) Federal income taxes payable/recoverable (1,950) (541) Other liabilities (19,403) (2,530) --------- --------- Net cash provided by (used in) operating activities (33,171) 25,062 --------- --------- INVESTING ACTIVITIES Net purchases of furniture and equipment (710) (597) Purchase of fixed maturities available-for-sale (181,475) (193,986) Increase in policy and mortgage loans, net (105) (91) Proceeds from sales of fixed maturities available-for-sale 140,646 104,822 Proceeds from calls and maturities of fixed maturities available-for sale 48,258 57,309 Proceeds from sale of Cleveland headquarters -- 15,586 --------- --------- Net cash provided by (used in) investing activities 6,614 (16,957) --------- --------- FINANCING ACTIVITIES Increase in annuity account balances 5,823 20,297 Decrease in annuity account balances (15,645) (18,783) Principal payments on mortgage note payable -- (8,018) Increase in debt borrowings -- 10,000 Principal payments on debt (4,915) (16,500) Proceeds from issuance of common stock related to employee benefit plans 739 2,234 --------- --------- Net cash used in financing activities (13,998) (10,770) --------- --------- NET DECREASE IN CASH (40,555) (2,665) Cash and cash equivalents at beginning of year 74,573 59,512 --------- --------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 34,018 $ 56,847 ========= ========= SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Cash paid during the period for interest $ 1,698 $ 3,659 Cash paid during the period for federal income taxes 1,275 500
The accompanying notes are an integral part of these condensed consolidated financial statements. 6 CERES GROUP, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2002 UNAUDITED - -------------------------------------------------------------------------------- A. BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements of Ceres Group, Inc. and subsidiaries, included herein, have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the nine month period ended September 30, 2002 are not necessarily indicative of the results that may be expected for the year ended December 31, 2002. The condensed consolidated financial statements for September 30, 2002 include the accounts of Central Reserve Life Insurance Company, Provident American Life and Health Insurance Company, Continental General Corporation and its wholly-owned subsidiary, Continental General Insurance Company, United Benefit Life Insurance Company, and Pyramid Life Insurance Company. The balance sheet presented at December 31, 2001 has been derived from the audited financial statements at that date, but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. For further information, refer to the consolidated financial statements and footnotes thereto included in Ceres' Annual Report on Form 10-K for the year ended December 31, 2001. Unless the context indicates otherwise, "we," "our" and "us" refers to Ceres Group, Inc. and its subsidiaries on a consolidated basis. RECLASSIFICATIONS Certain prior period amounts have been reclassified to conform to the current period presentation. CASH AND CASH EQUIVALENTS Cash and cash equivalents include cash and all liquid securities with maturities of 90 days or less when purchased. At September 30, 2002 and December 31, 2001, $6.1 million and $9.9 million, respectively, of cash was held related to fully-insured employer shared risk plans, which is restricted from any other use. We are entitled to the investment income from these funds. A corresponding liability is included in the accompanying condensed consolidated financial statements. INVESTMENTS Our insurance subsidiaries had certificates of deposit and fixed maturity securities on deposit 7 CERES GROUP, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED SEPTEMBER 30, 2002 UNAUDITED - -------------------------------------------------------------------------------- with various state insurance departments to satisfy regulatory requirements. NEW ACCOUNTING PRONOUNCEMENTS In June 2002, the Financial Accounting Standards Board, or FASB, issued Statement of Financial Accounting Standards, or SFAS, No. 146, Accounting for Costs Associated with Exit or Disposal Activities, which supercedes Emerging Issues Task Force, or EITF, Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring). The provisions of this Statement are effective for exit or disposal activities initiated after December 31, 2002. SFAS No. 146 requires recognition of a liability for costs associated with an exit or disposal activity when the liability is incurred, rather than when the entity commits to an exit plan under EITF Issue No. 94-3. This Statement applies to costs associated with an exit activity that does not involve an entity newly acquired in a business combination or with a disposal activity covered by SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. Additionally, this Statement does not apply to costs associated with the retirement of a long-lived asset covered by SFAS No. 143, Accounting for Asset Retirement Obligations. We anticipate that the adoption of this standard will not have a material effect on our results of operations, financial position or liquidity. In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections. This Statement rescinds SFAS No. 4, Reporting Gains and Losses from Extinguishment of Debt, SFAS No. 44, Accounting for Intangible Assets of Motor Carriers, and SFAS No. 64, Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements. This Statement amends SFAS No. 13, Accounting for Leases, to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. This Statement also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions. The provisions of SFAS No. 145 related to the rescission of SFAS No. 4 require any gain or loss on extinguishment of debt that was classified as an extraordinary item in prior periods presented that does not meet the criteria in APB Opinion No. 30, Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions, for classification as an extraordinary item to be reclassified. The adoption of SFAS No. 145 on May 15, 2002 did not have a material effect on our results of operations, financial position or liquidity. In August 2001, the FASB issued SFAS, No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. Effective January 1, 2002, this Statement superseded SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of, and the accounting and reporting provisions of Accounting Principles Board Opinion, or APB Opinion No. 30, Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring 8 CERES GROUP, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED SEPTEMBER 30, 2002 UNAUDITED - -------------------------------------------------------------------------------- Events and Transactions, for the disposal of a segment of a business. This Statement also amended Accounting Research Bulletin No. 51, Consolidated Financial Statements. This Statement requires that one accounting model be used for long-lived assets to be disposed of by sale, whether previously held and used or newly acquired, and broadens the presentation of discontinued operations to include more disposal transactions. The provisions of this Statement generally are to be applied prospectively. The adoption of SFAS No. 144 on January 1, 2002 did not have a material effect on our results of operations, financial position or liquidity. In June 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement Obligations, which addressed financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. This Statement is effective for financial statements issued for fiscal years beginning after June 15, 2002. The adoption of this standard on June 15, 2002 did not have a material effect on our results of operations, financial position or liquidity. In June 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible Assets, which replaces APB Opinion No. 17, Intangible Assets. This Statement addresses how intangible assets that are acquired individually or with a group of other assets (but not those acquired in a business combination) should be accounted for in financial statements upon their acquisition. Additionally, this Statement discussed how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements. This Statement: - specifies that goodwill and intangible assets that have indefinite useful lives will not be amortized but rather will be tested at least annually for impairment; - provides specific guidance for testing goodwill for impairment; and - requires additional disclosures not previously required. Effective January 1, 2002, we adopted the provisions of SFAS No. 142 as required. Application of the nonamortization provisions of this Statement are expected to reduce annual expense by approximately $1.1 million, which is projected to result in an increase in net income of approximately $0.7 million, or $0.02 per diluted share, in 2002 and subsequent years, subject to the impairment test described herein. SFAS No. 142, as part of its adoption provisions, requires a transitional impairment test to be applied to all goodwill and other indefinite-lived intangible assets within the first half of 2002 and any resulting impairment loss be reported as a change in accounting principle. Our internal analysis, together with analysis prepared by independent consultants, indicated that an impairment loss against our goodwill and intangible assets was not required as of the transitional date. In general, application of the new provisions for goodwill and other indefinite-lived intangible assets may result in more income statement volatility due to the potential for periodic 9 CERES GROUP, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED SEPTEMBER 30, 2002 UNAUDITED - -------------------------------------------------------------------------------- recognition of impairment losses, which could vary in amount and regularity versus reducing those assets through systematic amortization over a finite period of time. In June 2001, the FASB issued SFAS No. 141, Business Combinations, which addressed the accounting and reporting for business combinations and expanded the criteria for recording intangible assets separate from goodwill. On July 1, 2001, we adopted this Statement which requires us to use the purchase method of accounting for all business combinations initiated after June 30, 2001. Additionally, in conjunction with our goodwill testing above and following the guidance of SFAS No. 141, we have reclassed licenses of $5.1 million as a separate indefinite-lived intangible asset from goodwill. B. DEBT SEPTEMBER 30, DECEMBER 31, 2002 2001 ------- ------- (dollars in thousands) Bank credit facility $26,085 $28,500 Revolver -- 2,500 ------- ------- $26,085 $31,000 ======= ======= To provide funds for the acquisition of Continental General, on February 17, 1999, we entered into a credit agreement among Ceres, various lending institutions, and JPMorgan Chase Bank (formerly the Chase Manhattan Bank) as Administrative Agent. Under the agreement, Ceres borrowed $40.0 million under a tranche A term loan and secured a $10.0 million revolver. Interest on the outstanding balance of the term loan is determined based on our selection each quarter of either a Base Rate Loan or a Eurodollar Loan. Under the Base Rate Loan, the interest rate will be 2.5% per annum plus the higher of (a) the rate which is 0.50% of 1.0% in excess of a federal funds rate or (b) Chase's prime rate as in effect from time to time. Under the Eurodollar Loan, the interest rate will be 3.5% per annum plus a Eurodollar rate, which is the arithmetic average of the offered quotation to first-class banks in the interbank Eurodollar market by Chase, adjusted for certain reserve requirements. The credit agreement was amended on July 25, 2000 to increase the revolver from $10.0 million to $15.0 million in connection with the acquisition of Pyramid Life. Any amount outstanding on the revolver had to be repaid on February 17, 2002. The revolver bore interest at the same rate choices as the $40.0 million tranche A term loan. On February 17, 2002, the balance of the revolver was permanently repaid from proceeds of our December 2001 public offering. On March 30, 2001, our credit agreement was again amended to enter into a new $10.0 million term loan with CIT Equipment Financing, Inc. The proceeds of this term loan, the tranche B term loan, were used to permanently pay down $10.0 million of our then fully-drawn $15.0 million revolver under the credit agreement. The terms of the amendment provide for CIT Group to participate equally with the syndicate of banks and Chase under the credit agreement. 10 CERES GROUP, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED SEPTEMBER 30, 2002 UNAUDITED - -------------------------------------------------------------------------------- At September 30, 2002, the interest rate on our tranche A term loan balance of $16.8 million was 5.3% per annum and on our $9.3 million CIT tranche B term loan was 5.8% per annum. The first principal payment on the CIT tranche B term loan of $0.3 million was made on June 17, 2002. Quarterly principal payments are due thereafter as follows: $0.3 million through March 17, 2004; $0.6 million thereafter through March 17, 2005; and $1.2 million thereafter through March 17, 2006. On December 27, 2001, our credit agreement was again amended in connection with our December 2001 stock offering. The credit agreement, as amended, contains financial and other covenants that among other things: - prohibit the payment of cash dividends on our shares of common stock; - restrict the creation of liens and sales of assets; and - require that we, at a minimum, maintain: - a leverage ratio (consolidated debt to consolidated total capital) of 0.30 to 1.00; - an interest coverage ratio (consolidated earnings before interest, income taxes, depreciation, and amortization to consolidated interest expense) of 3.00 to 1.00; - a risk-based capital (RBC) ratio at year-end for any of our regulated insurance company subsidiaries of not less than 125.0% of the RBC Company Action Level; - consolidated net worth, excluding goodwill, of no less than the sum of (i) $85.0 million plus (ii) 80% of the net proceeds from the equity offering excluding the $5.0 million repurchase of our convertible voting preferred stock plus (iii) 50% of our aggregate consolidated net income calculated quarterly; and - a fixed charge coverage ratio of not less than 1.05 to 1.00 through June 30, 2003, and 1.10 to 1.00 thereafter. In addition, the amended agreement required us to: - repay a portion of our tranche A term loan with $10.0 million of the proceeds from the December 2001 equity offering; - repay the term loans with 25% of the net cash proceeds from any future sale or issuance of our equity, excluding warrants and compensation awards or plans; 11 CERES GROUP, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED SEPTEMBER 30, 2002 UNAUDITED - -------------------------------------------------------------------------------- - set aside $2.5 million of the proceeds from the equity offering for the permanent repayment of the balance of our revolver due February 17, 2002; and - increase the interest rate of the tranche B term loan by 0.5% per annum. Finally, the credit agreement, as amended: - restructured our scheduled tranche A term loan debt payments as follows: quarterly principal payments of $0.8 million through November 17, 2002, $0.9 million through November 17, 2004, and a payment of $8.5 million on February 17, 2005; - allowed repurchase of all of our convertible voting preferred stock with $5.0 million of the proceeds from the equity offering; and - allowed capital contributions to our insurance subsidiaries with proceeds from the equity offering after the repayments to the banks and repurchase of our convertible voting preferred stock. In addition, the common stock of Central Reserve, Continental General, and most of our non-regulated subsidiaries are pledged as security for the credit agreement. At September 30, 2002, we were in compliance with the covenants in our credit agreement, as amended. C. REINSURANCE We have entered into several quota-share reinsurance treaties, including treaties with Hannover Life Reassurance Company of America, on various blocks of business of our subsidiaries. Under the provisions of the treaties, we cede between 50% and 100% of the premiums for these policies and in return receive reimbursement, for the same percentage, of the claims. In addition, we receive a commission and expense allowance. In another reinsurance arrangement, we also assume certain policies, in which we paid certain commission and expense allowances, which are classified as reinsurance expenses below. 12 CERES GROUP, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED SEPTEMBER 30, 2002 UNAUDITED - -------------------------------------------------------------------------------- The following table summarizes the net impact of our reinsurance arrangements on premiums and benefits, claims, losses and settlement expenses, commissions, and other operating expenses:
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------------- ------------------------- 2002 2001 2002 2001 --------- --------- --------- --------- (dollars in thousands) Premiums, net Direct $ 187,323 $ 207,742 $ 571,097 $ 619,146 Assumed 28 2,045 73 6,114 Ceded (29,403) (47,232) (94,063) (153,940) --------- --------- --------- --------- Total premiums, net $ 157,948 $ 162,555 $ 477,107 $ 471,320 ========= ========= ========= ========= Benefits, claims, losses and settlement expenses $ 131,672 $ 157,255 $ 436,151 $ 504,972 Reinsurance recoveries (16,554) (34,924) (64,528) (130,383) --------- --------- --------- --------- Total benefits, claims, losses and settlement expenses $ 115,118 $ 122,331 $ 371,623 $ 374,589 ========= ========= ========= ========= Selling, general and administrative expenses Commissions $ 27,738 $ 32,119 $ 87,247 $ 98,036 Other operating expenses 27,854 31,610 86,947 100,023 Reinsurance expenses -- 395 440 1,349 Reinsurance allowances (5,974) (9,957) (19,541) (34,143) --------- --------- --------- --------- Total selling, general and administrative expenses $ 49,618 $ 54,167 $ 155,093 $ 165,265 ========= ========= ========= =========
The insurance companies remain obligated for amounts ceded in the event that the reinsurers do not meet their obligations. Initial ceding allowances received from reinsurers are accounted for as deferred reinsurance gain and are amortized into income over the estimated remaining life of the underlying policies reinsured, except for interest sensitive products, which are amortized over the expected profit stream of the in force business. We have reclassified certain prior period amounts in accordance with current year treatment. D. SPECIAL CHARGES 2002 On April 15, 2002, Peter W. Nauert announced his retirement from his position as our Chief Executive Officer effective June 1, 2002. He will remain as Chairman of the Board of Directors through June 2003. In the first quarter of 2002, we reported a pre-tax non-recurring special charge to operations of approximately $2.7 million related to the early termination of his employment agreement and the payment of certain benefits through June 2003. 13 CERES GROUP, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED SEPTEMBER 30, 2002 UNAUDITED - -------------------------------------------------------------------------------- 2001 We reported special charges of $7.1 million in the first quarter of 2001 related to: - the elimination of $5.9 million deferred acquisition cost (DAC) asset on all products of United Benefit Life and Provident American Life; and - $1.2 million loss on United Benefit Life. Over the past four years, we experienced excessive losses at United Benefit Life and Provident American Life due to high benefit utilization and higher-than-anticipated claims costs. In July 2001, we implemented a program to mitigate future losses of United Benefit Life and Provident American Life by notifying policyholders that their policies would be terminated or replaced with a different Provident American Life product. The business was substantially wound down by the early part of 2002. Therefore, due to the termination of the business in these subsidiaries, these blocks had a $0.2 million pre-tax loss for the quarter ended September 30, 2002 compared to $0.3 million pre-tax income in the third quarter of 2001 including special charges and legal expenses. For the first nine months of 2002, these blocks had a $2.1 million pre-tax loss compared to a $8.4 million pre-tax loss for these blocks for the same period of 2001 including special charges and legal expenses. E. COMPREHENSIVE INCOME Comprehensive income is as follows:
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ---------------------- ---------------------- 2002 2001 2002 2001 -------- -------- -------- -------- (dollars in thousands) Net income (loss) $ 7,297 $ 5,558 $ 5,034 $ (828) Other comprehensive income, net of tax: Unrealized gain on securities, net of tax expense of $3,825, $1,466, $5,629, and $1,466, respectively 7,100 6,418 11,697 11,173 Other 28 33 70 (567) -------- -------- -------- -------- Comprehensive income $ 14,425 $ 12,009 $ 16,801 $ 9,778 ======== ======== ======== ========
F. EARNINGS PER SHARE Basic and diluted earnings per common share are calculated in accordance with SFAS No. 128, Earnings per Share. Basic earnings per common share is computed by dividing net income (loss) attributable to common stockholders by the weighted average number of shares outstanding during the period. Diluted earnings per common share is computed by dividing net 14 CERES GROUP, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED SEPTEMBER 30, 2002 UNAUDITED - -------------------------------------------------------------------------------- income (loss) by the weighted average number of shares outstanding during the period including the effect of the assumed exercise of dilutive stock options under the treasury stock method. Basic and diluted weighted average shares of common stock are as follows:
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, -------------------------- -------------------------- 2002 2001 2002 2001 ---------- ---------- ---------- ---------- Weighted average shares: BASIC 34,034,196 17,623,758 33,967,712 17,474,004 Convertible voting preferred stock -- 1,334,195 -- -- Stock awards and incremental shares from assumed exercise of stock options -- 28,403 -- -- ---------- ---------- ---------- ---------- DILUTED 34,034,196 18,986,356 33,967,712 17,474,004 ========== ========== ========== ==========
G. CONTINGENT MATTERS We are involved in litigation arising in the ordinary course of business. In the opinion of management, the effects, if any, of such litigation are not expected to be material to our consolidated financial condition. H. SEGMENT INFORMATION We have three distinct operating segments based upon product types: medical, senior and other, and corporate and other. Products in the medical segment include catastrophic and comprehensive medical plans. Significant products in the senior and other segment include Medicare supplement, long-term care, dental, life insurance, and annuities. The corporate and other segment encompasses all other activities, including investment income, interest expense, and corporate expenses of the parent company. 15 CERES GROUP, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED SEPTEMBER 30, 2002 UNAUDITED - -------------------------------------------------------------------------------- Revenues from each segment are primarily generated from premiums charged to policyholders and interest earned on cash and investments, and are summarized in the following table:
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------------- ------------------------- 2002 2001 2002 2001 --------- --------- --------- --------- (dollars in thousands) MEDICAL Revenues Net premiums $ 91,851 $ 103,987 $ 281,508 $ 305,278 Investment income, realized gains (losses) 2,542 3,688 6,434 9,435 Other income 7,446 10,133 23,974 28,603 --------- --------- --------- --------- 101,839 117,808 311,916 343,316 --------- --------- --------- --------- Expenses Benefits and claims 67,102 79,385 226,370 248,638 Other operating expenses 32,025 36,996 94,001 98,366 Special charges -- -- -- 7,097 --------- --------- --------- --------- 99,127 116,381 320,371 354,101 --------- --------- --------- --------- Segment profit, (loss) before federal income taxes, minority interest and preferred stock dividends $ 2,712 $ 1,427 $ (8,455) $ (10,785) ========= ========= ========= ========= SENIOR AND OTHER Revenues Net premiums $ 66,097 $ 58,568 $ 195,599 $ 166,042 Investment income, realized gains (losses) 7,900 7,878 18,646 19,580 Other income 343 398 1,854 2,266 --------- --------- --------- --------- 74,340 66,844 216,099 187,888 --------- --------- --------- --------- Expenses Benefits and claims 48,016 42,946 145,253 125,951 Other operating expenses 16,980 14,850 49,374 44,603 --------- --------- --------- --------- 64,996 57,796 194,627 170,554 --------- --------- --------- --------- Segment profit before federal income taxes, minority interest and preferred stock dividends $ 9,344 $ 9,048 $ 21,472 $ 17,334 ========= ========= ========= ========= CORPORATE AND OTHER Revenues Investment income, realized gains (losses) $ 110 $ 174 $ 332 $ 474 --------- --------- --------- --------- Expenses Interest and financing costs 490 1,170 1,536 3,934 Other operating expenses 462 756 1,179 2,832 Special charges -- -- 2,668 -- --------- --------- --------- --------- 952 1,926 5,383 6,766 --------- --------- --------- --------- Segment loss before income taxes, minority interest and preferred stock dividends $ (842) $ (1,752) $ (5,051) $ (6,292) ========= ========= ========= ========= INCOME BEFORE FEDERAL INCOME TAXES, MINORITY INTEREST AND PREFERRED STOCK DIVIDENDS $ 11,214 $ 8,723 $ 7,966 $ 257 ========= ========= ========= =========
We do not separately allocate investments or other identifiable assets by industry segment, nor are income tax expenses (benefits) allocated by industry segment. 16 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS - ------------------------------------------------------------------------------- OF OPERATIONS - ------------- This discussion should be read in conjunction with our condensed consolidated financial statements, notes and tables included elsewhere in this report. Management's discussion and analysis may contain forward-looking statements that are provided to assist in the understanding of anticipated future financial performance. However, future performance involves risks and uncertainties which may cause actual results to differ materially from those expressed in the forward-looking statements. See "Forward-Looking Statements" for further information. OVERVIEW We provide a wide array of health and life insurance products to approximately 465,000 insureds through two primary business segments. Our medical segment includes catastrophic and major medical health insurance for individuals, associations and small businesses. The senior segment includes senior health, life and annuity products for Americans age 55 and over. To help control medical costs, we also provide medical cost management services to our insureds. Our nationwide distribution channels include approximately 40,000 independent and exclusive agents and QQLink.com, Inc., our proprietary, patent pending electronic distribution system. 17 RESULTS OF OPERATIONS QUARTER ENDED SEPTEMBER 30, 2002 COMPARED TO QUARTER ENDED SEPTEMBER 30, 2001
INCREASE THREE MONTHS THREE MONTHS (DECREASE) FROM ENDED % OF ENDED % OF PREVIOUS YEAR SEPTEMBER 30, CONSOLIDATED SEPTEMBER 30, CONSOLIDATED --------------------------- 2002 REVENUES 2001 REVENUES DOLLARS % ------------- ------------ ------------- ------------ --------- ------------ (dollars in thousands) Premiums, net Medical $ 91,851 52.1% $ 103,987 56.3% $ (12,136) (11.7)% Senior and other 66,097 37.5 58,568 31.7 7,529 12.9 --------- ------ --------- ------- --------- Total 157,948 89.6 162,555 88.0 (4,607) (2.8) Net investment income 7,474 4.2 8,124 4.4 (650) (8.0) Net realized gains (losses) 3,078 1.7 3,616 2.0 (538) (14.9) Fee and other income 7,311 4.2 9,885 5.3 (2,574) (26.0) Amortization of deferred reinsurance gain 478 0.3 646 0.3 (168) (26.0) --------- ------ --------- ------- --------- Consolidated revenues 176,289 100.0 184,826 100.0 (8,537) (4.6) --------- ------ --------- ------- --------- Benefits, claims, losses and settlement expenses Medical 67,102 38.1 79,385 43.0 (12,283) (15.5) Senior and other 48,016 27.2 42,946 23.2 5,070 11.8 --------- ------ --------- ------- --------- Total 115,118 65.3 122,331 66.2 (7,213) (5.9) Selling, general and administrative expenses 49,618 28.1 54,167 29.3 (4,549) (8.4) Net (deferral) amortization and change in acquisition costs and value of business acquired (151) (0.1) (1,839) (1.0) 1,688 91.8 Amortization of goodwill -- -- 274 0.2 (274) (100.0) Interest expense and financing costs 490 0.3 1,170 0.6 (680) (58.1) --------- ------ --------- ------- --------- Income before federal income taxes, minority interest and preferred stock dividends 11,214 6.4 8,723 4.7 2,491 28.6 Federal income tax expense 3,927 2.2 3,179 1.7 748 23.5 Minority interest (10) -- (14) -- 4 28.6 --------- ------ --------- ------- --------- Net income 7,297 4.2 5,558 3.0 1,739 31.3 Convertible voting preferred stock dividends -- -- (207) (0.1) 207 100.0 --------- ------ --------- ------- --------- Net income attributable to $ 7,297 4.2% $ 5,351 2.9% $ 1,946 36.4% common stockholders ========= ====== ========= ======= ========= Net income per share attributable to common stockholders Basic $ 0.21 $ 0.30 $ (0.09) (30.0)% Diluted 0.21 0.29 (0.08) (27.6)
18 1. NET PREMIUMS (NET OF REINSURANCE CEDED) For the quarter ended September 30, 2002, total net premiums were $157.9 million, a decrease of 2.8%, from $162.6 million for the same quarter in 2001. MEDICAL ------- Medical premiums for the quarter ended September 30, 2002 were $91.9 million compared to $104.0 million for the quarter ended September 30, 2001, a decrease of 11.7%. The decrease in medical premiums was primarily the result of a smaller volume of business in force due to our decision in July 2001 to terminate or replace the policies at United Benefit Life and Provident American Life, to cancel other medical business in certain states and to target market in more profitable states. The decrease was partially offset by premium rate increases. SENIOR AND OTHER ---------------- Senior and other premiums were $66.1 million for the quarter ended September 30, 2002 compared to $58.6 million for the quarter ended September 30, 2001, an increase of 12.9%. The increase in senior and other premiums was primarily the result of premium rate increases and an increase in the volume of business in force from new sales. 2. OTHER REVENUES Net investment income was $7.5 million for the third quarter of 2002 compared to $8.1 million for the third quarter of 2001, a decrease of 8.0%, due primarily to lower interest rates. Net realized gains (losses) decreased to $3.1 million for the third quarter of 2002 compared to $3.6 million for the third quarter of 2001. Fee and other income decreased to $7.3 million for the quarter ended September 30, 2002 compared to $9.9 million for the same quarter of 2001, a decrease of 26.0%. This decrease was primarily attributable to a smaller volume of business in force in the medical segment due to the United Benefit Life and Provident American Life termination or replacement program and the cancellation of other medical business in certain states. The amortization of deferred reinsurance gain of $0.5 million for the quarter ended September 30, 2002 represented the recognition of the ceding commission allowances received under our reinsurance agreements. The unamortized amount of $11.5 million at September 30, 2002 was accounted for as a deferred reinsurance gain on the condensed consolidated balance sheet. 3. BENEFITS, CLAIMS, LOSSES AND SETTLEMENT EXPENSES Total benefits, claims, losses and settlement expenses decreased to $115.1 million for the quarter ended September 30, 2002 compared to $122.3 million for the same quarter in 2001, a decrease of 5.9%. 19 MEDICAL ------- Medical benefits, claims, losses and settlement expenses were $67.1 million for the quarter ended September 30, 2002 compared to $79.4 million for the same quarter in 2001, a decrease of 15.5%. The medical loss ratio was 73.1% for the quarter ended September 30, 2002 compared to 76.3% for the same quarter of 2001. The decrease in medical benefits, claims, losses and settlement expenses was primarily the result of a smaller volume of business in force due to our decision in July 2001 to terminate or replace the policies at United Benefit Life and Provident American Life, to cancel other medical business in certain states and to target market in more profitable states. The decrease in medical loss ratio was primarily due to increased premium rates and lower benefit utilization. SENIOR AND OTHER ---------------- Senior and other benefits, claims, losses and settlement expenses were $48.0 million for the quarter ended September 30, 2002 compared to $42.9 million for the same quarter of 2001, an increase of 11.8%. The increase was a result of additional claims and benefits paid on a larger volume of business in force. The senior and other loss ratio was 72.6% for the third quarter of 2002 compared to 73.3% for the third quarter of 2001. 4. OTHER EXPENSES AND NET INCOME Selling, general and administrative expenses decreased to $49.6 million in the third quarter of 2002 compared to $54.2 million in the third quarter of 2001, a decrease of 8.4%. Commissions decreased $4.4 million and other operating expenses decreased $4.2 million as a direct result of our cancelled or replaced business offset by reduced reinsurance allowances of $4.0 million resulting from a lower volume of ceded premiums. As a percentage of revenues, selling, general and administrative expenses decreased to 28.1% in the third quarter of 2002 compared to 29.3% in the third quarter of 2001 due to a reduced workforce at our Cleveland facility, economies of scale achieved from the conversion of the senior business to our Kansas City facility, and a decrease in the overall commission rate due to a reduction in new business. The net (deferral) amortization and change in acquisition costs (DAC) and value of business acquired resulted in a net deferral of $0.2 million for the third quarter of 2002 compared to a net deferral of $1.8 million for the third quarter of 2001. The decrease in the net deferral was primarily attributable to the lower capitalization of DAC due to decreases in new business sales. The Company also wrote-off approximately $3.5 million in Continental General's DAC due to the unprofitability of the business in certain states. This compares to a $4.9 million write-off in Central Reserve's DAC in the third quarter of 2001 due to unprofitability in those states. Interest expense and financing costs decreased to $0.5 million in the third quarter of 2002 compared to $1.2 million in the third quarter of 2001 as a result of a decrease in outstanding debt and declining interest rates. A federal income tax expense of $3.9 million, or 35.0% of the income before federal taxes, was established for the third quarter of 2002. In the third quarter of 2001, federal income tax expense was $3.2 million, or 36.4% of the income before federal taxes. The lower effective tax rate in the third quarter of 2002 was primarily due to fewer permanent tax differences in 2002. As a result of the foregoing, for the third quarter of 2002, net income attributable to common stockholders was $7.3 million, or $0.21 basic and diluted earnings per share of common stock, compared to net income attributable to common stockholders of $5.4 million, or $0.30 basic and $0.29 diluted earnings per share of common stock for the third quarter of 2001. 20 NINE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED TO SEPTEMBER 30, 2001
INCREASE NINE MONTHS NINE MONTHS (DECREASE) FROM ENDED % OF ENDED % OF PREVIOUS YEAR SEPTEMBER 30, CONSOLIDATED SEPTEMBER 30, CONSOLIDATED ------------------------- 2002 REVENUES 2001 REVENUES DOLLARS % ------------- ------------ ------------ ------------ --------- ----------- (dollars in thousands) Premiums, net Medical $ 281,508 53.3% $ 305,278 57.4% $ (23,770) (7.8)% Senior and other 195,599 37.0 166,042 31.2 29,557 17.8 --------- --------- --------- --------- --------- Total 477,107 90.3 471,320 88.6 5,787 1.2 Net investment income 23,624 4.5 24,274 4.6 (650) (2.7) Net realized gains (losses) 1,788 0.3 5,215 1.0 (3,427) (65.7) Fee and other income 23,474 4.4 27,568 5.2 (4,094) (14.9) Amortization of deferred reinsurance gain 2,354 0.5 3,301 0.6 (947) (28.7) --------- --------- --------- --------- --------- Consolidated revenues 528,347 100.0 531,678 100.0 (3,331) (0.6) --------- --------- --------- --------- --------- Benefits, claims, losses and settlement expenses Medical 226,370 42.8 248,638 46.8 (22,268) (9.0) Senior and other 145,253 27.5 125,951 23.7 19,302 15.3 --------- --------- --------- --------- --------- Total 371,623 70.3 374,589 70.5 (2,966) (0.8) Selling, general and administrative expenses 155,093 29.4 165,265 31.1 (10,172) (6.2) Net (deferral) amortization and change in acquisition costs and value of business acquired (10,539) (2.0) (20,288) (3.8) 9,749 48.1 Amortization of goodwill -- -- 824 0.2 (824) (100.0) Interest expense and financing costs 1,536 0.3 3,934 0.7 (2,398) (61.0) Special charges 2,668 0.5 7,097 1.3 (4,429) (62.4) --------- --------- --------- --------- --------- Income before federal income taxes, minority interest and preferred stock dividends 7,966 1.5 257 -- 7,709 N/M Federal income tax expense 2,969 0.5 1,122 0.2 1,847 164.6 Minority interest (37) -- (37) -- -- -- --------- --------- --------- --------- --------- Net income (loss) 5,034 1.0 (828) (0.2) 5,862 N/M Convertible voting preferred stock dividends -- -- (579) (0.1) 579 100.0 --------- --------- --------- --------- --------- Net income (loss) attributable to common stockholders $ 5,034 1.0% $ (1,407) (0.3)% $ 6,441 N/M ========= ========= ========= ========= ========= Net income (loss) per share attributable to common stockholders Basic $ 0.15 $ (0.08) $ 0.23 N/M Diluted 0.15 (0.08) 0.23 N/M
- -------------------------------------------------- N/M = not meaningful 21 1. PREMIUMS (NET OF REINSURANCE CEDED) For the nine months ended September 30, 2002, total net premiums were $477.1 million, an increase of 1.2%, from $471.3 million for the same period in 2001. MEDICAL ------- Medical premiums for the nine months ended September 30, 2002 were $281.5 million compared to $305.3 million for the nine months ended September 30, 2001, a decrease of 7.8%. The decrease in medical premiums was primarily the result of a smaller volume of business in force due to our decision in July 2001 to terminate or replace the policies at United Benefit Life and Provident American Life, to cancel other medical business in certain states and to target market in more profitable states. SENIOR AND OTHER ---------------- Senior and other premiums were $195.6 million for the nine months ended September 30, 2002 compared to $166.0 million for the nine months ended September 30, 2001, an increase of 17.8%. The increase in senior and other premiums was primarily the result of premium rate increases and an increase in the volume of business in force from new sales. 2. OTHER REVENUES Net investment income was $23.6 million for the first nine months of 2002 compared to $24.3 million for the first nine months of 2001, a decrease of 2.7%, due primarily to lower interest rates. Net realized gains (losses) decreased to $1.8 million for the first nine months of 2002 compared to $5.2 million for the same period in 2001. This decrease was primarily due to realized losses on our investment in WorldCom bonds of $2.0 million. Fee and other income decreased to $23.5 million for the nine months ended September 30, 2002 compared to $27.6 million for the same nine months of 2001, a decrease of 14.9%. This decrease was primarily attributable to a smaller volume of business in force in the medical segment due to the United Benefit Life and Provident American Life termination or replacement program and the cancellation of other medical business in certain states. The amortization of deferred reinsurance gain of $2.4 million for the nine months ended September 30, 2002 represented the recognition of the ceding commission allowances received under our reinsurance agreements. The unamortized amount of $11.5 million at September 30, 2002 was accounted for as a deferred reinsurance gain on the condensed consolidated balance sheet. 3. BENEFITS, CLAIMS, LOSSES AND SETTLEMENT EXPENSES Total benefits, claims, losses and settlement expenses decreased to $371.6 million for the nine months ended September 30, 2002 compared to $374.6 million for the nine months ended September 30, 2001, a decrease of 0.8%. 22 MEDICAL ------- Medical benefits, claims, losses and settlement expenses were $226.4 million for the nine months ended September 30, 2002 compared to $248.6 million for the same period in 2001, a decrease of 9.0%. The decrease was primarily the result of a smaller volume of business in force due to the termination or replacement program and cancellation of other medical business as mentioned previously. The medical loss ratio was 80.4% for the nine months ended September 30, 2002 compared to 81.4% for the same period of 2001. The ratio decreased due to the termination or replacement program and the cancellation of business in poor performing markets, as well as pricing increases and benefit changes to keep pace with medical inflation. However, the decrease was substantially offset by higher-than-anticipated claims costs associated with a reduction in pending claims inventory at Continental General. SENIOR AND OTHER ---------------- Senior and other benefits, claims, losses and settlement expenses were $145.3 million for the nine months ended September 30, 2002 compared to $126.0 million for the same period of 2001, an increase of 15.3%. The increase was a result of additional claims and benefits paid on a larger volume of business in force. The senior and other loss ratio decreased to 74.3% for the first nine months of 2002 compared to 75.9% for the first nine months of 2001, primarily attributable to premium rate adjustments in several major states and a larger volume of business in force from new sales. 4. OTHER EXPENSES AND NET INCOME Selling, general and administrative expenses decreased to $155.1 million for the first nine months of 2002 compared to $165.3 million in the first nine months of 2001, a decrease of 6.2%. Commissions decreased $10.8 million and other operating expenses decreased $14.6 million as a direct result of our cancelled or replaced business offset by reduced reinsurance allowances of $14.6 million resulting from a lower volume of ceded premiums and $0.6 million in severance charges related to the May 2002 reduction in workforce at our Cleveland facility. As a percentage of revenues, selling, general and administrative expenses decreased to 29.4% in the first nine months of 2002 compared to 31.1% in the same period in 2001 due to a reduced workforce at our Cleveland facility, economies of scale achieved from the conversion of the senior business to our Kansas City facility, and a decrease in the overall commission rate. The net (deferral) amortization and change in acquisition costs (DAC) and value of business acquired resulted in a net deferral of $10.5 million for the first nine months of 2002 compared to a net deferral of $20.3 million for the first nine months of 2001. The decrease in the net deferral was primarily attributable to lower capitalization of DAC due to decreases in new business sales and a $2.1 million increase in the amortization of value of business acquired (VOBA). The Company also wrote-off $3.5 million in Continental General's DAC due to the unprofitability of the business in certain states. This compared to a $5.9 million write-off of Central Reserve's DAC in the first nine months of 2001 in certain states due to unprofitability in those states. Interest expense and financing costs decreased to $1.5 million in the first nine months of 2002 compared to $3.9 million in the first nine months of 2001 as a result of a decrease in outstanding debt and declining interest rates. The special charge for the first half of 2002 represented a pre-tax non-recurring charge of $2.7 million related to the retirement of Peter W. Nauert, our former CEO (see Note D, Special 23 Charges for further information). Special charges of $7.1 million in the first quarter of 2001 represented a $5.9 million write-off of the DAC asset for United Benefit Life and Provident American Life and a $1.2 million write-off of costs associated with United Benefit Life. The DAC asset was written off due to the planned termination of this business. Federal income tax expense was $3.0 million, or 37.3% of the income before federal taxes, for the first nine months of 2002. In the first nine months of 2001, a federal income tax expense was established of $1.1 million, or 35.0% of the income before federal taxes (excluding losses at United Benefit Life where no federal income tax benefit was recorded). The higher effective tax rate in 2002 was primarily due to more permanent tax differences in the first nine months. As a result of the foregoing, for the first nine months of 2002, net income attributable to common stockholders was $5.0 million, or $0.15 basic and diluted earnings per share of common stock, compared to a net loss attributable to common stockholders of $1.4 million, or $0.08 basic and diluted loss per share of common stock for the first nine months of 2001. LIQUIDITY AND CAPITAL RESOURCES Liquidity is our ability to generate adequate amounts of cash to meet our financial commitments. Our major needs for cash are to enable our insurance subsidiaries to pay claims and expenses as they come due and for Ceres to pay interest on, and to repay principal of, its indebtedness. The primary sources of cash are premiums, investment income, fee income, equity and debt financings, and reimbursements from reinsurers. Payments consist of current claim payments to insureds, medical cost management expenses, operating expenses such as salaries, employee benefits, commissions, taxes and interest on debts. Assets decreased 5.3% to $895.7 million at September 30, 2002 from $946.0 million at December 31, 2001. Assets of $492.6 million, or 55.0% of the total assets, were in investments at September 30, 2002. Fixed maturities, our primary investment, were $481.4 million, or 97.7% of total investments, at September 30, 2002. Other investments consist of surplus notes, policy loans and mortgage loans. We have classified all of our fixed maturities as "available-for-sale" and accordingly have reported them at estimated fair value at September 30, 2002. Approximately 94.8% of our bonds were of investment grade quality at September 30, 2002. In addition to the fixed maturities, we also had $34.0 million in cash and cash equivalents of which, $6.1 million was restricted. The total reinsurance receivable was $193.4 million at September 30, 2002. Of this amount, $188.3 million represents reserves held by our reinsurers under our various reinsurance treaties. Hannover holds most of these reserves. The total policy liabilities and benefits accrued (reserves) were 85.1% of the total liabilities at September 30, 2002 compared to 82.9% at December 31, 2001. To provide funds for the acquisition of Continental General, on February 17, 1999, we entered into a credit agreement among Ceres, various lending institutions, and JPMorgan Chase Bank (formerly the Chase Manhattan Bank) as Administrative Agent. Under the agreement, Ceres borrowed $40.0 million under a tranche A term loan and secured a $10.0 million revolver. Interest on the outstanding balance of the term loan is determined based on our selection each quarter of either a Base Rate Loan or a Eurodollar Loan. Under the Base Rate Loan, the 24 interest rate will be 2.5% per annum plus the higher of (a) the rate which is 0.50% of 1.0% in excess of a federal funds rate or (b) Chase's prime rate as in effect from time to time. Under the Eurodollar Loan, the interest rate will be 3.5% per annum plus a Eurodollar rate, which is the arithmetic average of the offered quotation to first-class banks in the interbank Eurodollar market by Chase, adjusted for certain reserve requirements. The credit agreement was amended on July 25, 2000 to increase the revolver from $10.0 million to $15.0 million in connection with the acquisition of Pyramid Life. Any amount outstanding on the revolver had to be repaid on February 17, 2002. The revolver bore interest at the same rate choices as the $40.0 million tranche A term loan. On February 17, 2002, the balance of the revolver was permanently repaid from proceeds of our December 2001 public offering. On March 30, 2001, our credit agreement was again amended to enter into a new $10.0 million term loan with CIT Equipment Financing, Inc. The proceeds of this term loan, the tranche B term loan, were used to permanently pay down $10.0 million of our then fully-drawn $15.0 million revolver under the credit agreement. The terms of the amendment provided for CIT Group to participate equally with the syndicate of banks and Chase under the credit agreement. At September 30, 2002, the interest rate on our tranche A term loan balance of $16.8 million was 5.3% per annum and on our $9.3 million CIT tranche B term loan was 5.8% per annum. The first principal payment on the CIT tranche B term loan of $0.3 million was made on June 17, 2002. Quarterly principal payments are due thereafter as follows: $0.3 million through March 17, 2004; $0.6 million thereafter through March 17, 2005; and $1.2 million thereafter through March 17, 2006. On December 27, 2001, our credit agreement again was amended in connection with our December 2001 stock offering. The credit agreement, as amended, contains financial and other covenants that among other things: - prohibit the payment of cash dividends on our shares of common stock; - restrict the creation of liens and sales of assets; and - require that we, at a minimum, maintain: - a leverage ratio (consolidated debt to consolidated total capital) of 0.30 to 1.00; - an interest coverage ratio (consolidated earnings before interest, income taxes, depreciation, and amortization to consolidated interest expense) of 3.00 to 1.00; - a risk-based capital (RBC) ratio at year-end for any of our regulated insurance company subsidiaries of not less than 125.0% of the RBC Company Action Level; - consolidated net worth, excluding goodwill, of no less than the sum of (i) $85.0 million plus (ii) 80% of the net proceeds from the equity offering excluding the $5.0 million repurchase of our convertible voting preferred 25 stock plus (iii) 50% of our aggregate consolidated net income calculated quarterly; and - a fixed charge coverage ratio of not less than 1.05 to 1.00 through June 30, 2003, and 1.10 to 1.00 thereafter. In addition, the amended agreement required us to: - repay a portion of our tranche A term loan with $10.0 million of the proceeds from the December 2001 equity offering; - repay the term loans with 25% of the net cash proceeds from any future sale or issuance of our equity, excluding warrants and compensation awards or plans; - set aside $2.5 million of the proceeds from the equity offering for the permanent repayment of the balance of our revolver due February 17, 2002; and - increase the interest rate of the tranche B term loan by 0.5% per annum. Finally, the credit agreement, as amended: - restructured our scheduled tranche A term loan debt payments as follows: quarterly principal payments of $0.8 million through November 17, 2002, $0.9 million through November 17, 2004, and a payment of $8.5 million on February 17, 2005; - allowed repurchase of all of our convertible voting preferred stock with $5.0 million of the proceeds from the equity offering; and - allowed capital contributions to our insurance subsidiaries with proceeds from the equity offering after the repayments to the banks and repurchase of our convertible voting preferred stock. In addition, the common stock of Central Reserve, Continental General, and most of our non-regulated subsidiaries are pledged as security for the credit agreement. At September 30, 2002, we were in compliance with the covenants in our credit agreement, as amended. We lease our corporate headquarters in Cleveland for a term of 15 years beginning August 1, 2001 with four optional five-year extensions. Rent payments annually total $1.7 million through July 2003, $1.8 million through July 2006, $2.0 million through July 2011, and $2.1 million through July 2016. 26 The following schedule summarizes our current and future contractual obligations as of September 30, 2002:
PAYMENTS DUE BY YEAR --------------------------------------------------------------- LESS THAN 1 CONTRACTUAL OBLIGATIONS TOTAL YEAR 1-3 YEARS 4-5 YEARS AFTER 5 YEARS - ------------------------ ------- ----------- --------- --------- ------------- (in thousands) Long-term debt $26,085 $4,892 $19,993 $ 1,200 $ -- Operating leases 30,166 2,967 5,129 4,190 17,880 ------- ------- ------- ------- ------- Total $56,251 $7,859 $25,122 $ 5,390 $17,880 ======= ======= ======= ======= =======
We believe that cash flow from operating activities will be sufficient to meet our currently anticipated operating and capital expenditure requirements over the next 12 months. We also believe that funds should be sufficient to meet all our debt obligations over the next 12 months. Funds to meet our debt obligations are generated from fee income from our non-regulated subsidiaries and from dividends of our insurance subsidiaries, if available. Our ability to make scheduled payments of the principal and interest on our indebtedness depends on our future performance and the future performance of our non-regulated subsidiaries, which are subject to economic, financial, competitive and other factors beyond our control. Dividends from our regulated insurance subsidiaries are subject to, and limited by, state insurance regulations. As of September 30, 2002, none of our insurance subsidiaries (Central Reserve and Continental General) could pay a dividend to Ceres Group, the parent company, without prior approval of their respective state regulators as a result of their respective statutory levels of unassigned surplus. If our non-regulated subsidiaries do not generate sufficient fee income to service all of our debt obligations, there may be a material adverse effect on our business, financial condition and results of operations, and a significant adverse effect on the market value of our common stock. In addition, if necessary, additional financing may not be available on terms favorable to us or at all. See also "Market Risk and Management Policies - Legal/Regulatory Risks." FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS We have three segments: medical, which includes catastrophic and comprehensive medical plans; senior and other, which includes Medicare supplement, long-term care, dental, life insurance and annuities; and corporate and other, which includes interest income, interest expense, and corporate expenses of the parent company. See Note H, Segment Information, to the Notes to our Condensed Consolidated Financial Statements for further information. MARKET RISK AND MANAGEMENT POLICIES The following is a description of certain risks facing health and life insurers and how we mitigate those risks: Inadequate Pricing Risk is the risk that the premium charged for insurance and insurance related products is insufficient to cover the costs associated with the distribution of such products, including benefits, claims and losses, settlement expenses, acquisition expenses and other corporate expenses. We utilize a variety of actuarial and qualitative methods to set such pricing levels. Any negative fluctuation in our estimates of the effect of continued medical inflation and high benefit utilization could have a material adverse impact on our results of operations. 27 Legal/Regulatory Risk is the risk that changes in the legal or regulatory environment in which an insurer operates will create additional expenses not anticipated by the insurer in pricing its products. For example, regulatory initiatives designed to reduce insurer profits or otherwise affecting the industry in which the insurer operates, new legal theories or insurance company insolvencies through guaranty fund assessments, may create costs for the insurer beyond those recorded in the financial statements. We attempt to mitigate this risk by offering a wide range of products and by operating in many states, thus reducing our exposure to any single product and by employing underwriting practices that identify and minimize the adverse impact of this risk. In addition, insurance companies are subject to extensive federal and state regulation and compliance with these regulations could increase the insurance companies' operating costs. In some circumstances, failure to comply with certain insurance regulations could subject an insurance company to regulatory actions, including state supervision or liquidation, by such insurance company's state of domicile or in other states in which the insurance company does business. For example, states have statutory risk-based capital, or RBC, requirements for health and other insurance companies based on the RBC Model Act. These RBC requirements are intended to assess the capital adequacy of life and health insurers, taking into account the risk characteristics of an issuer's investments and products. In general, under these laws, an insurance company must submit a report of its RBC level to the insurance department of its state of domicile as of the end of the previous calendar year. These laws provide for four different levels of regulatory attention depending on the ratio of an insurance company's total adjusted capital (defined as the total of its statutory capital, surplus and asset valuation reserve) to its risk-based capital. As of December 31, 2001, our risk-based capital levels for each of our insurance subsidiaries exceeded the levels required by regulatory authorities. However, without additional capital or reinsurance, the statutory capital level at Continental General may be below "Company Action Level" at December 31, 2002, requiring it to submit a comprehensive plan to the Nebraska Department of Insurance that discusses proposed correctional actions to improve Continental General's capital position. We intend to resolve Continental General's capital needs through reinsurance transactions, sale of assets or other initiatives to raise additional capital. However, additional capital may not be available on terms favorable to us or at all. Credit Risk is the risk that issuers of securities owned by us will default or that other parties, including reinsurers that have obligations to us, will not pay or perform. We attempt to minimize this risk by adhering to a conservative investment strategy and by maintaining sound reinsurance and credit and collection policies. Interest Rate Risk is the risk that interest rates will change and cause a decrease in the value of an insurer's investments. This change in rates may cause certain interest-sensitive products to become uncompetitive or may cause disintermediation if we attempt to mitigate this risk by charging fees for non-conformance with certain policy provisions and/or by attempting to match the maturity schedule of our assets with the expected payouts of its liabilities. To the extent that liabilities come due more quickly than assets mature, we would have to sell assets prior to maturity and recognize a gain or loss. Assuming an immediate increase of 100 basis points in interest rates, the net hypothetical decline in fair value of stockholders' equity is estimated to be $19.8 million at September 30, 2002. This amount represents approximately 11.4% of our stockholders' equity at such date. We also have long-term debt that bears interest at variable rates. Therefore, our results of operations would be affected by interest rate changes. We do not expect a significant rate change in the near future that would have a material effect on our near-term results of operations. 28 Seasonality is the risk of fluctuations of revenues and operating results. Historically, our revenues and operating results have varied from quarter to quarter and are expected to continue to fluctuate in the future. These fluctuations have been due to a number of factors, including higher benefit utilization by our insureds during the winter months and the use of deductibles. More specifically, our senior segment's seasonality is the opposite of our medical segment's, meaning that earnings in the senior segment are generally lower in the first quarter and higher later in the year. This is mainly a factor of our Medicare Supplement products that pay the Medicare deductible for our insureds generally during the early months of the year. IMPACT OF INFLATION Inflation rates impact our financial condition and operating results in several areas. Changes in inflation rates impact the market value of the investment portfolio and yields on new investments. Inflation has had an impact on claim costs and overall operating costs and although it has been lower in the last few years, hospital and medical costs have still increased at a higher rate than general inflation, especially prescription drug costs. New, more expensive and wider use of pharmaceuticals is inflating health care costs. We will continue to establish premium rates in accordance with trends in hospital and medical costs along with concentrating on various cost containment programs. FORWARD-LOOKING STATEMENTS This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements are necessarily based on estimates and assumptions that are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which, with respect to future business decisions, are subject to change. These uncertainties and contingencies can affect actual results and could cause actual results to differ materially from those expressed in any forward-looking statements made by, or on behalf of, us. In particular, forward-looking statements can be identified by the use of words such as "may," "will," "should," "expect," "anticipate," "estimate," "continue" or similar words. In light of the risks and uncertainties inherent in all future projections, the inclusion of forward-looking statements in this report should not be considered as a representation by us or any other person that our objectives or plans will be achieved. Numerous factors could cause our actual results to differ materially and adversely from those in the forward-looking statements, including those risks outlined above in "Market Risk and Management Policies," and the following: - unforeseen losses with respect to loss and settlement expense reserves for unreported and reported claims or adverse changes in persistency or profitability of insurance contracts that would accelerate the amortization of our deferred acquisition costs; - our ability to implement increases in premium rates and to develop, distribute and administer competitive products and services in a timely, cost-effective manner; 29 - rising healthcare costs, especially the rising costs of prescription drug costs that are rising faster than other medical costs, and rising utilization rates; - developments in healthcare reform and other regulatory issues, including the Health Insurance Portability and Accountability Act of 1996 and increased privacy regulation, and changes in laws and regulations in key states in which we operate; - our ability to meet risk-based or statutory capital requirements and the outcome of our efforts to meet these capital requirements; - our ability to continue to meet the terms of our debt obligations under our credit agreement which contains a number of significant financial and other covenants; - the adequacy of funds, including fee income, received from our non-regulated subsidiaries, and the restrictions on our insurance subsidiaries' ability to pay dividends to Ceres, to meet our debt obligations; - the performance of others on whom we rely for reinsurance, particularly Hannover Life Reassurance Company of America upon whom we have relied for substantially all of our reinsurance; - the risk of material adverse outcomes in litigation; - the risk of selling investments to meet liquidity requirements; - our ability to obtain additional debt or equity financing on terms favorable to us to facilitate our long-term growth; - the risk that issuers of securities owned by Ceres will default or that other parties will not pay or perform; - our financial and claims paying ratings, including any potential downgrades; - our ability to maintain our current PPO network arrangements; - dependence on senior management and key personnel; - the performance of others on whom we rely for administrative and operations services; - changes in accounting and reporting practices; - the failure to successfully manage our expanding operations and integrate future acquisitions, if any, including the failure to achieve cost savings; - payments to state assessment funds; - business conditions and competition in the healthcare industry; - changes in tax laws; and - our ability to fully collect all agent advances. 30 The factors listed above should not be constructed as exhaustive. We undertake no obligation to release publicly the results of any future revisions we may make to forward-looking statements to reflect events or circumstances after the date of this report or to reflect the occurrence of unanticipated events. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK - ----------------------------------------------------------------- The information called for by this item is provided under the caption "Market Risk and Management Policies" under Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations. ITEM 4. CONTROLS AND PROCEDURES - ------------------------------- Within the 90 days prior to the date of this report, we carried out an evaluation, under the supervision and with the participation of management, including our President and Chief Executive Officer along with the Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, our President and Chief Executive Officer along with our Chief Financial Officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information relating to Ceres (including its consolidated subsidiaries) required to be included in our periodic SEC filings. There have been no significant changes in our internal controls or in other factors, which could significantly affect internal controls subsequent to the date we carried out our evaluation. 31 PART II. OTHER INFORMATION - -------------------------- ITEM 1. LEGAL PROCEEDINGS - ------------------------- We have been sued for compensatory damages and, in some cases, unspecified punitive damages in a number of actions pertaining to the insureds of United Benefit Life arising from claims payment issues. While we do not believe that United Benefit Life has harmed any of the plaintiffs in these lawsuits and we believe our reserves are adequate, we cannot predict the outcome of the lawsuits, including the award of punitive damages and, therefore, we cannot predict the financial impact on us of these lawsuits. We intend to vigorously contest these actions. In addition to the above, we are also involved in litigation arising in the ordinary course of business. In the opinion of management, the effects, if any, of such litigation are not expected to be material to our consolidated financial condition. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS - ------------------------------------------------- On July 1, 2002, we issued 18,854 shares of our common stock to Peter W. Nauert, our then President and Chief Executive Officer, pursuant to the stock award provision of his former employment agreement. This issuance was exempt from registration in accordance with Section 4(2) of the Securities Act of 1933, as amended, and exemptions available under applicable state securities laws. ITEM 3. DEFAULTS UPON SENIOR SECURITIES - --------------------------------------- None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - ----------------------------------------------------------- None. ITEM 5. OTHER INFORMATION - ------------------------- None. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K - ---------------------------------------- a) Exhibits: None. b) Reports on Form 8-K: Form 8-K, dated August 14, 2002, related to Section 906 certification for the quarter ended June 30, 2002. 32 SIGNATURES ---------- Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. CERES GROUP, INC. Date: November 13, 2002 By: /s/ Charles E. Miller, Jr. ----------------- -------------------------------- Charles E. Miller, Jr. Executive Vice President and Chief Financial Officer (Principal Financial Officer and Chief Accounting Officer) 33 CERTIFICATIONS PURSUANT TO 17 CFR SECTION 240.13a-14 - ---------------------------------------------------- I, Thomas J. Kilian, President and Chief Executive Officer of Ceres Group, Inc., certify that: 1. I have reviewed this quarterly report on Form 10-Q of Ceres Group, Inc. 2. Based on my knowledge, this quarterly 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 quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly 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 quarterly 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 we 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 quarterly 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 quarterly report (the "Evaluation Date"); and c) presented in this quarterly 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 function): 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 quarterly report whether or not 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: November 13, 2002 /s/ Thomas J. Kilian - -------------------- THOMAS J. KILIAN President and Chief Executive Officer (Principal Executive Officer) I, Charles E. Miller, Jr., Executive Vice President and Chief Financial Officer of Ceres Group, Inc., certify that: 1. I have reviewed this quarterly report on Form 10-Q of Ceres Group, Inc. 2. Based on my knowledge, this quarterly 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 quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly 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 quarterly 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 we 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 quarterly 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 quarterly report (the "Evaluation Date"); and c) presented in this quarterly 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 function): 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 quarterly report whether or not 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: November 13, 2002 /s/ Charles E. Miller, Jr. - -------------------------- CHARLES E. MILLER, JR. Executive Vice President and Chief Financial Officer (Principal Financial Officer) Simultaneously with the filing of this quarterly report on Form 10-Q, the Company submitted to the Securities and Exchange Commission the certification of this report by its chief executive and chief financial officer required by 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. -----END PRIVACY-ENHANCED MESSAGE-----