-----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, NEy0s5snjLktWp9B6YnXL8BZ17wtsae3B5SJWrhsGF3ZpO1RO0TdBLf+DlQe2Ztt Jje5RscL9ZOCpEyRzbSGcw== 0000878897-04-000051.txt : 20041104 0000878897-04-000051.hdr.sgml : 20041104 20041104145549 ACCESSION NUMBER: 0000878897-04-000051 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 20040930 FILED AS OF DATE: 20041104 DATE AS OF CHANGE: 20041104 FILER: COMPANY DATA: COMPANY CONFORMED NAME: AMERICAN MEDICAL SECURITY GROUP INC CENTRAL INDEX KEY: 0000878897 STANDARD INDUSTRIAL CLASSIFICATION: HOSPITAL & MEDICAL SERVICE PLANS [6324] IRS NUMBER: 391431799 STATE OF INCORPORATION: WI FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-13154 FILM NUMBER: 041119382 BUSINESS ADDRESS: STREET 1: 3100 AMS BLVD CITY: GREEN BAY STATE: WI ZIP: 54313 BUSINESS PHONE: 9206611111 MAIL ADDRESS: STREET 1: 3100 AMS BLVD CITY: GREEN BAY STATE: WI ZIP: 54313 FORMER COMPANY: FORMER CONFORMED NAME: UNITED WISCONSIN SERVICES INC /WI DATE OF NAME CHANGE: 19930328 10-Q 1 form10q3qtr2004.txt AMERICAN MEDICAL SECURITY GROUP, INC. 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, 2004 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 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes __X__ No ____ Indicate by check mark, whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes __X__ No ____ Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Common stock, no par value, outstanding as of October 31, 2004: 13,683,383 shares AMERICAN MEDICAL SECURITY GROUP, INC. INDEX PART I FINANCIAL INFORMATION Item 1. Financial Statements (Unaudited) Condensed Consolidated Balance Sheets September 30, 2004 and December 31, 2003.....................3 Condensed Consolidated Statements of Operations Three months ended September 30, 2004 and 2003; Nine months ended September 30, 2004 and 2003................4 Condensed Consolidated Statements of Cash Flows Nine months ended September 30, 2004 and 2003................5 Notes to Condensed Consolidated Financial Statements September 30, 2004...........................................6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations...................................12 Item 3. Quantitative and Qualitative Disclosures About Market Risk..........20 Item 4. Controls and Procedures.............................................20 PART II OTHER INFORMATION Item 1. Legal Proceedings...................................................21 Item 6. Exhibits............................................................22 Signatures....................................................................23 Exhibit Index...............................................................EX-1 2 PART I FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS AMERICAN MEDICAL SECURITY GROUP, INC. CONDENSED CONSOLIDATED BALANCE SHEETS
September 30, December 31, (THOUSANDS, EXCEPT SHARE DATA) 2004 2003 - -------------------------------------------------------------------------------------------------------------------- (Unaudited) ASSETS Investments: Fixed maturity securities available for sale, at fair value $ 302,119 $ 302,277 Fixed maturity securities held to maturity, at amortized cost 3,164 3,377 Trading securities, at fair value 1,797 1,424 - -------------------------------------------------------------------------------------------------------------------- Total investments 307,080 307,078 Cash and cash equivalents 20,756 17,289 Property and equipment, net 39,922 37,446 Goodwill 32,138 32,138 Other intangibles, net 1,468 1,957 Other assets 39,323 48,179 - -------------------------------------------------------------------------------------------------------------------- Total assets $ 440,687 $ 444,087 ==================================================================================================================== LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Medical and other benefits payable $ 106,274 $ 129,809 Advance premiums 15,350 15,865 Payables and accrued expenses 23,846 24,099 Notes payable 30,158 30,158 Other liabilities 21,838 26,332 - -------------------------------------------------------------------------------------------------------------------- Total liabilities 197,466 226,263 Shareholders' equity: Common stock (no par value, $1 stated value, 50,000,000 shares authorized, 16,654,315 issued and 13,683,383 outstanding at September 30, 2004, 16,654,315 issued and 13,511,183 outstanding at December 31, 2003) 16,654 16,654 Paid-in capital 195,610 194,431 Retained earnings 56,164 32,168 Accumulated other comprehensive income (net of taxes of $2,795 at September 30, 2004 and $3,302 at December 31, 2003) 5,190 6,133 Treasury stock (2,970,932 shares at September 30, 2004 and 3,143,132 shares at December 31, 2003, at cost) (30,397) (31,562) - -------------------------------------------------------------------------------------------------------------------- Total shareholders' equity 243,221 217,824 - -------------------------------------------------------------------------------------------------------------------- Total liabilities and shareholders' equity $ 440,687 $ 444,087 ==================================================================================================================== SEE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
3 AMERICAN MEDICAL SECURITY GROUP, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
Three Months Ended Nine Months Ended September 30, September 30, ------------------------------------------------------------ (THOUSANDS, EXCEPT PER COMMON SHARE DATA) 2004 2003 2004 2003 - -------------------------------------------------------------------------------------------------------------------- REVENUES Insurance premiums $ 175,789 $ 176,735 $ 530,039 $ 534,566 Net investment income 3,506 3,211 10,498 9,958 Net realized investment gains (losses) 28 1,416 (24) 1,882 Other revenue 4,076 3,899 12,480 11,784 - -------------------------------------------------------------------------------------------------------------------- Total revenues 183,399 185,261 552,993 558,190 EXPENSES Medical and other benefits 117,598 119,218 348,156 359,131 Selling, general and administrative 55,539 52,873 164,058 163,178 Interest 255 309 697 972 Amortization of intangibles 163 238 489 715 - -------------------------------------------------------------------------------------------------------------------- Total expenses 173,555 172,638 513,400 523,996 - -------------------------------------------------------------------------------------------------------------------- Income from continuing operations, before income tax expense 9,844 12,623 39,593 34,194 Income tax expense 4,593 4,735 15,597 12,883 - -------------------------------------------------------------------------------------------------------------------- Income from continuing operations 5,251 7,888 23,996 21,311 Income from discontinued operations - 923 - 732 - -------------------------------------------------------------------------------------------------------------------- Net income $ 5,251 $ 8,811 $ 23,996 $ 22,043 ==================================================================================================================== Earnings per common share - basic: Income from continuing operations $ 0.38 $ 0.59 $ 1.75 $ 1.62 Income from discontinued operations - 0.07 - 0.06 - -------------------------------------------------------------------------------------------------------------------- Net income $ 0.38 $ 0.66 $ 1.75 $ 1.67 ==================================================================================================================== Earnings per common share - diluted: Income from continuing operations $ 0.36 $ 0.55 $ 1.64 $ 1.52 Income from discontinued operations - 0.06 - 0.05 - -------------------------------------------------------------------------------------------------------------------- Net income $ 0.36 $ 0.61 $ 1.64 $ 1.58 ==================================================================================================================== SEE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
4 AMERICAN MEDICAL SECURITY GROUP, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Nine Months Ended September 30, --------------------------------- (THOUSANDS) 2004 2003 - -------------------------------------------------------------------------------------------------------------------- OPERATING ACTIVITIES Net income $ 23,996 $ 22,043 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 6,372 8,219 Net gain from sale of subsidiary - (950) Net realized investment losses (gains) 24 (1,882) Change in trading securities (373) (328) Deferred income tax expense 6,455 1,165 Changes in operating accounts: Other assets 3,010 (4,414) Medical and other benefits payable (23,535) (7,456) Advance premiums (515) 950 Payables and accrued expenses (253) (5,599) Other liabilities (3,663) (4,253) - -------------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 11,518 7,495 INVESTING ACTIVITIES Proceeds from sale of subsidiary - 3,500 Purchases of available for sale securities (75,593) (105,380) Proceeds from sale of available for sale securities 63,162 95,233 Proceeds from maturity of available for sale securities 9,705 2,375 Proceeds from maturity of held to maturity securities 200 500 Purchases of property and equipment (6,937) (7,325) Proceeds from sale of property and equipment 3 6 - -------------------------------------------------------------------------------------------------------------------- Net cash used in investing activities (9,460) (11,091) FINANCING ACTIVITIES Issuance of common stock 1,409 4,719 Purchase of treasury stock - (660) Repayment of notes payable - (900) - -------------------------------------------------------------------------------------------------------------------- Net cash provided by financing activities 1,409 3,159 - -------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents: Net change 3,467 (437) Balance at beginning of year 17,289 30,620 - -------------------------------------------------------------------------------------------------------------------- Balance at end of period $ 20,756 $ 30,183 ==================================================================================================================== SEE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
5 AMERICAN MEDICAL SECURITY GROUP, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) SEPTEMBER 30, 2004 1. BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements 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 accounting principles generally accepted in the United States ("GAAP") for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the three and nine months ended September 30, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and footnotes thereto included in the American Medical Security Group, Inc. (the "Company") Annual Report on Form 10-K for the year ended December 31, 2003. 2. STOCK-BASED COMPENSATION The Company has stock-based compensation plans for the benefit of eligible employees and directors of the Company, which are described more fully in Note 11 in the Company's 2003 Annual Report on Form 10-K. During the first quarter of 2004, the Company granted 20,700 shares of restricted stock to outside members of the Company's Board of Directors. As a result, the Company's statements of operations for the three and nine months ended September 30, 2004 include compensation expense of $24,000 and $72,000 respectively, net of tax. The Company follows Accounting Principles Board Opinion No. 25, the intrinsic value method of accounting for stock-based compensation, under which no compensation expense is recorded when the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant. The following table illustrates the pro forma net income and pro forma net income per share as if the Company had followed the fair value method of accounting for stock-based compensation under Statement of Financial Accounting Standards No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION ("Statement 123").
Three Months Ended Nine Months Ended September 30, September 30, ------------------------------------------------------------ (THOUSANDS, EXCEPT PER COMMON SHARE DATA) 2004 2003 2004 2003 - -------------------------------------------------------------------------------------------------------------------- Net income, as reported $ 5,251 $ 8,811 $ 23,996 $ 22,043 Add: Stock-based compensation expense included in reported net income, net of tax 24 - 72 - Deduct: Stock-based compensation expense in accordance with the fair value method of Statement 123, net of tax (313) (391) (843) (1,202) - -------------------------------------------------------------------------------------------------------------------- Pro forma net income $ 4,962 $ 8,420 $ 23,225 $ 20,841 ==================================================================================================================== Net income per common share, as reported: Basic $ 0.38 $ 0.66 $ 1.75 $ 1.67 Diluted $ 0.36 $ 0.61 $ 1.64 $ 1.58 Pro forma net income per common share: Basic $ 0.36 $ 0.63 $ 1.70 $ 1.58 Diluted $ 0.34 $ 0.59 $ 1.58 $ 1.49
6 In determining compensation expense in accordance with Statement 123, the fair value of options was estimated at the date of grant using the Black-Scholes option valuation model, which is commonly used in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. Option valuation models require the input of highly subjective assumptions including the expected stock price volatility and the expected life of the options. Because 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. 3. PENDING MERGER WITH PACIFICARE On September 15, 2004, the Company entered into a definitive agreement and plan of merger with PacifiCare Health Systems, Inc. ("PacifiCare") whereby PacifiCare will acquire all of the outstanding shares of common stock of the Company through a cash merger in which the Company will become a wholly-owned subsidiary of PacifiCare. Under the terms of the merger agreement, PacifiCare will pay $32.75 in cash for each share of the Company's common stock outstanding for a total equity purchase price of approximately $500 million on a fully diluted basis. It is anticipated that the acquisition will be completed following approvals by the Company's shareholders, the Wisconsin Office of the Commissioner of Insurance and the Georgia Department of Insurance, and compliance with the Hart-Scott-Rodino Antitrust Improvement Act of 1976, as amended ("Hart-Scott-Rodino Act"), as well as other customary approvals. The Company's statements of operations for the three and nine months ended September 30, 2004 include merger-related transaction costs of approximately $2.6 million. 4. DISCONTINUED OPERATIONS During the third quarter of 2003, the Company sold all of the outstanding common shares of its preferred provider organization network subsidiary, Accountable Health Plans of America, Inc. ("AHP"). The network contracted with more than 900 hospitals and 100,000 physicians in eight primary states: Arizona, Florida, Iowa, Nebraska, North Dakota, South Dakota, Texas and Wisconsin. Subject to the terms of the agreement, AHP will continue to provide network services to the Company at least until September 2008. At the time of the sale, AHP served approximately 13% of the Company's members. The three and nine-month periods ended September 30, 2003 as presented in the Company's statements of operations have been reclassified to exclude the results of the discontinued networking business from reported income from continuing operations. 5. PHARMACY BENEFITS MANAGER SETTLEMENT During the first quarter of 2004, the Company reached an agreement with its former pharmacy benefits manager settling a dispute related to pricing and prescription drug fees charged from 1995 through 2002. As a result of the settlement, the Company received a cash payment of $5.9 million, and the results for the nine months ended September 30, 2004 include a one-time gain of approximately $3.4 million or $0.23 per diluted share, net of taxes and other related expenses. The settlement provided a refund of medical and other benefit expenses, which resulted in an improvement in the Company's health segment loss ratio of 1.0% for the nine months ended September 30, 2004. 7 6. EARNINGS 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 from continuing operations and provides a reconciliation of the number of weighted average basic and diluted shares outstanding:
Three Months Ended Nine Months Ended September 30, September 30, ----------------------------------------------------------- (THOUSANDS, EXCEPT PER COMMON SHARE DATA) 2004 2003 2004 2003 - ------------------------------------------------------------------------------------------------------------------- Numerator: Income from continuing operations $ 5,251 $ 7,888 $ 23,996 $ 21,311 =================================================================================================================== Denominator: Denominator for basic EPS 13,763 13,392 13,694 13,179 Effect of dilutive employee stock options 929 948 954 799 - ------------------------------------------------------------------------------------------------------------------- Denominator for diluted EPS 14,692 14,340 14,648 13,978 =================================================================================================================== Earnings per common share - income from continuing operations: Basic $ 0.38 $ 0.59 $ 1.75 $ 1.62 Diluted $ 0.36 $ 0.55 $ 1.64 $ 1.52 ===================================================================================================================
Certain options to purchase shares of common stock were not included in the computation of diluted earnings per common share for the three and nine months ended September 30, 2003 because the options' exercise prices were greater than the average market price of the outstanding common shares for the period and, therefore, the effect would be antidilutive. 7. COMPREHENSIVE INCOME Under existing accounting standards, comprehensive income for the Company includes net income and unrealized gains and losses on certain investments in debt and equity securities, net of tax effects. Comprehensive income for the Company is calculated as follows:
Three Months Ended Nine Months Ended September 30, September 30, ------------------------------------------------------------ (THOUSANDS) 2004 2003 2004 2003 - -------------------------------------------------------------------------------------------------------------------- Net income $ 5,251 $ 8,811 $ 23,996 $ 22,043 Unrealized gain (loss) on available for sale securities 3,096 (2,443) (943) (125) - -------------------------------------------------------------------------------------------------------------------- Comprehensive income $ 8,347 $ 6,368 $ 23,053 $ 21,918 ====================================================================================================================
8 8. 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 in 1998 it discontinued writing certain health insurance policies and offered new policies to insureds. 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. In 2002, a Circuit Court Judge ruled against the Company and ordered the question of damages be tried before a jury, at a later date. In September 2004, the Company entered into an agreement to settle with the plaintiffs. The settlement has received preliminary approval by the Circuit Court. If the settlement receives final approval, all claims of participating class members will be dismissed and the litigation terminated in exchange for settlement consideration. The Company believes it is adequately reserved for the anticipated cost of the settlement and related expenses. As a result, the agreement is not expected to have a material effect on the Company's earnings or results of operations. The Company expects final approval of the settlement by the Circuit Court in December 2004. The Company is a defendant in a number of other lawsuits in various states, primarily Alabama, alleging misrepresentation of the rating methodology used by the Company with respect to certain MedOne(R) 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. 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 has reached an agreement of settlement regarding a class action lawsuit involving these issues in Alabama and Georgia. Final approval of the settlement has been received from the Alabama Circuit Court, although a motion for reconsideration has been filed and the time for filing an appeal has not yet expired. A Georgia Superior Court, in a separate matter, enjoined the Company from settling with Georgia residents who are members of the class. The Company has appealed to the Georgia Supreme Court and expects the injunction to be overturned. The Company believes it is adequately reserved for the cost of the settlement and related expenses. The Company is vigorously defending itself in the other pending 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 in excess of amounts reserved that may arise from the above-mentioned and all other legal and regulatory actions would not have a material adverse effect on 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 9. SEGMENT INFORMATION 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 preferred provider organization products: MedOne(R) (for individuals and families) 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 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 realized gains and losses on the Company's investment portfolio. The accounting policies of the reportable segments are the same as those used to report the Company's consolidated financial statements. Significant intercompany transactions have been eliminated prior to reporting reportable segment information. A reconciliation of segment income (loss) before income taxes to consolidated income from continuing operations before income taxes is as follows:
Three Months Ended Nine Months Ended SEGMENT SUMMARY September 30, September 30, ------------------------------------------------------------ (THOUSANDS) 2004 2003 2004 2003 - -------------------------------------------------------------------------------------------------------------------- Health segment $ 10,242 $ 9,833 $ 36,123 $ 28,438 Life segment 1,636 1,518 4,706 4,445 All other (2,034) 1,272 (1,236) 1,311 - -------------------------------------------------------------------------------------------------------------------- Income from continuing operations, before tax $ 9,844 $ 12,623 $ 39,593 $ 34,194 ====================================================================================================================
Operating results and statistics for each of the Company's segments are as follows:
Three Months Ended Nine Months Ended HEALTH SEGMENT September 30, September 30, ------------------------------------------------------------ (THOUSANDS, EXCEPT MEMBERSHIP DATA) 2004 2003 2004 2003 - -------------------------------------------------------------------------------------------------------------------- REVENUES Insurance premiums $ 173,003 $ 173,744 $ 521,486 $ 525,371 Net investment income 1,417 1,596 4,481 4,994 Other revenue 4,030 3,828 12,327 11,565 - -------------------------------------------------------------------------------------------------------------------- Total revenues 178,450 179,168 538,294 541,930 EXPENSES Medical and other benefits 117,178 118,518 346,576 356,938 Selling, general and administrative 51,030 50,817 155,595 156,554 - -------------------------------------------------------------------------------------------------------------------- Total expenses 168,208 169,335 502,171 513,492 - -------------------------------------------------------------------------------------------------------------------- Income from continuing operations, before tax $ 10,242 $ 9,833 $ 36,123 $ 28,438 ==================================================================================================================== Loss ratio 67.7% 68.2% 66.5% 67.9% Expense ratio 27.2% 27.0% 27.5% 27.6% - -------------------------------------------------------------------------------------------------------------------- Combined ratio 94.9% 95.3% 93.9% 95.5% ==================================================================================================================== Health membership at end of period: Fully-insured medical 272,140 270,401 Self-funded medical 43,218 43,858 Dental 214,664 226,734 - ------------------------------------------------------------------------------------ Total health membership 530,022 540,993 ====================================================================================
10
Three Months Ended Nine Months Ended LIFE SEGMENT September 30, September 30, ------------------------------------------------------------ (THOUSANDS, EXCEPT MEMBERSHIP DATA) 2004 2003 2004 2003 - -------------------------------------------------------------------------------------------------------------------- REVENUES Insurance premiums $ 2,786 $ 2,991 $ 8,553 $ 9,195 Net investment income 116 121 351 383 Other revenue 46 71 153 219 - -------------------------------------------------------------------------------------------------------------------- Total revenues 2,948 3,183 9,057 9,797 EXPENSES Medical and other benefits 420 700 1,580 2,216 Selling, general and administrative 892 965 2,771 3,136 - -------------------------------------------------------------------------------------------------------------------- Total expenses 1,312 1,665 4,351 5,352 - -------------------------------------------------------------------------------------------------------------------- Income from continuing operations, before tax $ 1,636 $ 1,518 $ 4,706 $ 4,445 ==================================================================================================================== Loss ratio 15.1% 23.4% 18.5% 24.1% Expense ratio 30.4% 29.9% 30.6% 31.7% - -------------------------------------------------------------------------------------------------------------------- Combined ratio 45.4% 53.3% 49.1% 55.8% ==================================================================================================================== Life membership at end of period 127,075 137,395 ====================================================================================
11 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS BUSINESS 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 medical insurance for small employer groups and medical insurance marketed to individuals and their families ("MedOne(R)"). The Company also offers dental, life, prescription drug, disability and accidental death insurance, and provides self-funded benefit administration. The Company has two reportable segments: health insurance products (which accounted for approximately 98% of the Company's total premium revenues for the nine months ended September 30, 2004 and 2003) and life insurance products. The Company markets its products in 33 states and the District of Columbia through independent agents. The Company has approximately 75 sales managers and representatives located in sales offices throughout the United States to support the independent agents. The Company's products generally provide discounts to members that utilize preferred provider organizations with which the Company contracts. PENDING MERGER WITH PACIFICARE On September 15, 2004, the Company entered into a definitive agreement with PacifiCare Health Systems, Inc. ("PacifiCare") whereby PacifiCare will acquire all of the outstanding shares of common stock of the Company through a cash merger in which the Company will become a wholly-owned subsidiary of PacifiCare. Under the terms of the merger agreement, PacifiCare will pay $32.75 in cash for each share of the Company's common stock outstanding for a total equity purchase price of approximately $500 million on a fully diluted basis. It is anticipated that the acquisition will be completed following approvals by the Company's shareholders, the Wisconsin Office of the Commissioner of Insurance and the Georgia Department of Insurance, and compliance with the Hart-Scott-Rodino Act, as well as other customary approvals. The Company's statements of operations for the three and nine months ended September 30, 2004 include merger-related transaction costs of approximately $2.6 million. A special meeting of shareholders will be held December 2, 2004, at which shareholders will be asked to consider and vote upon the proposal to approve the agreement and plan of merger with PacifiCare and the transactions contemplated by the merger agreement. A proxy statement for the special meeting was mailed to shareholders on or about November 1, 2004. FINANCIAL RESULTS SUMMARY The Company reported net income of $5.3 million or $0.36 per diluted share for the three months ended September 30, 2004, compared to net income of $8.8 million or $0.61 per diluted share for the corresponding quarter in the prior year. The decrease in quarterly net income resulted primarily from the following: (1) net income for the third quarter of the prior year included a net gain of $0.9 million from discontinued operations related to the sale of the Company's network subsidiary; (2) realized investment gains were higher net of tax in the third quarter of the prior year by $0.9 million, net of tax resulting from a realignment of the Company's investment portfolio; and (3) net income for the third quarter of 2004 includes a charge for merger-related transaction costs of $2.6 million. For the nine months ended September 30, 2004, the Company reported net income of $24.0 million or $1.64 per diluted share compared to net income for the first nine months of the prior year of $22.0 million or $1.58 per diluted share. Net income for the year was impacted by the items identified in the preceding paragraph, in addition to a settlement of a dispute with the Company's former pharmacy benefits manager related to pricing and prescription drug fees charged to the Company from 1995 through 2002 (the "PBM settlement") in the first quarter of 2004. As a result of the PBM settlement, the Company received a cash payment of $5.9 million and the Company's financial results for the nine months ended September 30, 2004 include a one-time gain of $3.4 million or $0.23 per diluted share, net of taxes and other related expenses. 12 INSURANCE PREMIUM REVENUE AND MEMBERSHIP Insurance premium revenue for the three months ended September 30, 2004 decreased to $175.8 million from $176.7 million for the corresponding period in 2003. For the nine months ended September 30, 2004, insurance premium revenue declined to $530.0 million from $534.6 million for the same period of the prior year. The decrease in premium revenue was caused by a decline in membership, coupled with a trend of members choosing lower priced products with higher deductibles and copayments, resulting in lower premiums per member per month. Total health membership, which includes medical and dental members, declined 10,971 members from 540,993 members at September 30, 2003 to 530,022 members at September 30, 2004. The Company's dental membership declined by 12,070 members from September 30, 2003. Medical membership increased slightly in the third quarter of 2004 due to an increase in MedOne membership, partially offset by a decline in the Company's small group line of business. The impact of rapidly rising health care costs and the cost of health insurance coverage continues to be a major challenge faced by individuals and small business owners, the Company's primary markets. To help alleviate the impact of rising health care costs, the Company has designed product offerings that provide insurance consumers with a greater financial stake in their health care decisions. In exchange for higher deductibles and copayments, the Company's products attempt to offer more affordable premiums. To mitigate the increasing cost of healthcare, small employers are offering health insurance plans with more limited benefits. Management believes this trend is contributing to the decline in dental membership as fewer small businesses are offering dental benefits to employees. Also, employee attrition among existing small employer groups continues to negatively impact the Company's ability to increase membership in the small employer group market. INVESTMENT INCOME Net investment income was $3.5 million for the three months ended September 30, 2004, compared to $3.2 million for the same period in 2003. Net investment income increased for the nine-month period ended September 30, 2004 to $10.5 million from $10.0 million for the same period of the prior year. The increase in net investment income is due primarily to an increase in average invested assets during the period. Realized investment gains from the sale of securities for the three and nine months ended September 30, 2004 decreased by $1.4 and $1.9 million, respectively, compared to the prior year. Realized investment gains and losses fluctuate as the Company takes advantage of market opportunities and realigns its investment portfolio from time to time. OTHER REVENUE Other revenue, which primarily consists of administrative fee income from claims processing on self-funded business and other administrative services, increased to $4.1 million for the three months ended September 30, 2004 from $3.9 million for the three months ended September 30, 2003. For the first nine months of 2004, other revenue increased to $12.5 million from $11.8 million for the same period of the prior year. The increase in other revenue is due to an increase in self-funded membership. LOSS RATIO The health segment loss ratio improved slightly in the third quarter of 2004 to 67.7%, compared to 68.2% for the third quarter of 2003. For the first nine months, the health segment loss ratio was 66.5% in 2004, compared to 67.9% in 2003. The improvement from the first nine months of the prior year is due primarily to the 1.0% impact of the PBM settlement. The health segment loss ratio is also impacted by a variety of other factors including claims cost trends, product pricing and the cost of litigation. Management closely monitors developments in litigation and emerging trends in claims costs to determine the adequacy and reasonableness of the Company's related reserves, and adjusts such reserves when necessary. The loss ratio for the life segment was favorable at 15.1% for the three months ended September 30, 2004, compared with 23.4% for the corresponding period of the prior year. For the nine months ended September 30, 2004 the life segment improved to 18.5% from 24.1% for the same period of the prior year. 13 SELLING, GENERAL AND ADMINISTRATIVE EXPENSE RATIO The selling, general and administrative ("SG&A") expense ratio includes commissions and selling expenses, administrative expenses net of other revenues, and premium taxes and assessments. The SG&A expense ratio for the health segment for the three months ended September 30, 2004 was 27.2%. This compares to the third quarter of 2003 health segment SG&A expense ratio of 27.0%. EFFECTIVE TAX RATE The effective tax rate for three and nine months ended September 30, 2004 was 46.7% and 39.4%, respectively compared to 37.5% and 37.7% for the same respective periods of the prior year. The increase in the effective rate resulted from non-deductible merger-related transaction costs incurred during the third quarter of 2004. 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 and SG&A expenses. Positive cash flows are invested pending future payments of operating expenses; primarily medical and other benefits. The Company's investment policies are structured to provide sufficient liquidity to meet anticipated payment obligations. The Company's investment portfolio consists almost exclusively of investment grade bonds and has limited exposure to equity securities. At September 30, 2004 and December 31, 2003, greater than 99% of the Company's investment portfolio was invested in debt securities. The bond portfolio had an average quality rating of AA at September 30, 2004 and December 31, 2003, as measured by Standard & Poor's Corporation, and the Company held no below investment grade securities. The majority of the bond portfolio was classified as available for sale. The Company had no investment in mortgage loans, non-publicly traded securities, real estate held for investment or financial derivatives. The Company's operating cash flow fluctuates from quarter to quarter due to variations in the timing of claims, litigation and other operating payments or recoveries. Cash provided by operations for the third quarter of 2004 was $4.7 million compared to cash provided by operations of $9.1 million in the third quarter of the prior year. Cash provided by operations in the third quarter of 2004 was reduced by payments of litigation settlements in excess of $10.0 million, as well as payments of merger-related transaction costs. For the nine months ended September 30, 2004, cash provided by operations was $11.5 million, compared to cash provided by operations of $7.5 million for the corresponding period in the prior year. The majority of the improvement in cash flow for the nine-month period was due to the receipt of a cash payment of $5.9 million in the first quarter of 2004 resulting from the PBM settlement described above. The Company maintains a revolving bank line of credit agreement with a maximum available facility of $50.0 million. At September 30, 2004, the outstanding balance of advances under the credit agreement was $30.2 million. The credit agreement requires a lump-sum payment of the outstanding balance at the end of 2005. 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 September 30, 2004. 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 ("UWLIC"), the Company's principal insurance subsidiary which is domiciled in Wisconsin. During the first nine months of 2004, the Company continued its investment 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 resources to support most of the Company's major business processes. Management believes this software investment will help support business growth, operational efficiency, service improvements and future administrative cost savings. The design and development of certain administrative software applications began during the first quarter of 2003 and modules were implemented during 2003 and the first 14 nine months of 2004, and the remaining implementation is scheduled to be phased in over the next few years. Capital expenditures during the first nine months of 2004 were $6.9 million. In June 2004, the Company amended an agreement with a software vendor resulting in a commitment to purchase software applications and other services to support the Company's core insurance systems. Management believes that the Company's existing working capital and operating cash flow will be sufficient to fund the Company's anticipated future capital expenditures related to the modernization project. 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. During 2003, the Company purchased 87,900 shares of its common stock at an average market price of $15.44 per share, and at an aggregate cost of $1.4 million. No share repurchases were made by the Company during the first nine months of 2004. Dividends paid by UWLIC to the corporate parent may be limited by Wisconsin insurance regulations. The insurance regulator may disapprove any dividend which, together with other dividends paid by UWLIC in the prior 12 months, exceeds the regulatory maximum, computed as the lesser of 10% of statutory capital and surplus or total statutory net gain from operations as of the end of the preceding calendar year. In June 2004, a $6.0 million dividend was paid by UWLIC to the corporate parent. Based upon the financial statements of the Company's insurance subsidiaries as of December 31, 2003, as filed with the insurance regulators, the remaining amount available for dividend without regulatory approval is $0.3 million until December 2004, when a dividend of $11.3 million can be paid without regulatory approval. 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, 2003, 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. Upon the successful completion of the pending merger with PacifiCare, the Company will be obligated to pay a transaction fee for financial advisory services of approximately $4.0 million. In addition, the Company will incur additional merger-related administrative expenses in the process of completing the transaction. 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 the Company's 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: 15 CAUTIONARY FACTORS RELATED TO THE PROPOSED MERGER WITH PACIFICARE APPROVAL OF THE MERGER. Obtaining regulatory and other approvals may delay or prevent completion of the merger with PacifiCare. Any significant delay in completing the merger could adversely affect the Company. In addition to obtaining shareholder approval of the merger and the transactions contemplated by the agreement and plan of merger, completion of the merger is conditioned upon, among other things, the termination or expiration of the applicable waiting periods under the Hart-Scott-Rodino Act and the receipt of approval of PacifiCare's acquisition of control of the Company's insurance subsidiaries from each of the Wisconsin Office of the Commissioner of Insurance and the Georgia Department of Insurance. It is possible that one or more of the governmental entities may seek various regulatory concessions or impose conditions for granting approval of the merger. There can be no assurance that the Company or PacifiCare will agree to any such concessions or will be able to satisfy or comply with any such conditions or be able to cause their respective subsidiaries to agree to any such concessions or satisfy or comply with any such conditions. FAILURE TO COMPLETE MERGER. Failure to complete the merger is likely to negatively impact the Company's stock price and the future business and financial results of the Company. If the merger is not completed, the ongoing business of the Company may be adversely affected and the Company will be subject to several risks, including (1) being required, under certain circumstances, to pay PacifiCare a termination fee of $17.5 million, (2) having to pay certain costs relating to the merger, such as legal, accounting, financial advisor and printing fees, and (3) the focus of management on the merger instead of on pursuing other opportunities that could be beneficial to the Company, in each case without realizing any of the benefits of having the transaction completed. If the merger is not completed, the Company cannot ensure that these risks will not materialize and will not materially affect the business, financial results and Company's stock price. CAUTIONARY FACTORS RELATED TO THE COMPANY'S BUSINESS 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 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, but not be limited to: (1) an increase in the rates charged by providers of health care services and supplies, including pharmaceuticals; (2) higher than expected use of health care services by members; (3) the occurrence of bioterrorism, catastrophes or epidemics; (4) changes in the demographics of members and medical trends affecting them; and (5) 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. 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 insurance regulations require the Company to implement changes in its programs and systems in order to maintain compliance. The Company has incurred significant expenditures as a result of HIPAA regulations and expects to continue to incur expenditures as various regulations become effective. The Company is subject to periodic changes in state laws and regulations regarding the selection and pricing of risks and other matters. New regulations regarding these issues could increase the Company's costs and decrease its premiums. The Company has in the past decided, and may in the future decide, to discontinue marketing its products 16 in states that have enacted, or are considering, various health insurance regulations that would impair the Company's ability to market its products profitably. Federal and state legislatures also are considering regulatory measures that may result in higher health insurance costs. Congress is 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. Various states occasionally consider community rating legislation that would restrict risk factors that the Company could take into consideration when rating its products, which could impact the profitability of our products and the availability of insurance coverage. 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. 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. From time to time the Company is subject to inquiries related to its activities and practices in states in which it operates. The Company has been subject to regulatory penalties, assessments and restitution orders in a number of states. 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. For example, the Company recently entered into an agreement to settle a class action lawsuit in which the Florida Circuit Court previously had found the Company liable for damages. The settlement agreement is subject to final approval by the Circuit Court. The Company also recently received final approval from a Alabama Circuit Court of the certification and settlement of a class action lawsuit involving the rating methodology formerly used by the Company for group health benefit plans marketed to individuals in Alabama and Georgia. The Company is involved in a number of other lawsuits in various states that allege misrepresentation by the Company of its renewal rating methodology. For additional information, see Part II, Item 1, "Legal Proceedings." The nature of the Company's business subjects it to a variety of legal actions and claims relating but not limited to the following: (1) denial of health care benefits; (2) disputes over rating methodology and practices or termination of coverage; (3) disputes with agents over compensation or other matters; (4) disputes related to claim administration errors and failure to disclose network rate discounts and other fee and rebate arrangements; (5) disputes related to managed care or cost containment activities, (6) disputes over co-payment calculations; and (7) customer audits of compliance with the Company's plan obligations. The Company cannot predict with certainty the outcome of lawsuits against the Company or the potential costs involved. COMPETITION. Competition in the Company's industry may limit its ability to attract new members or to maintain its existing membership in force. As competitors seek to increase market share, they may lower prices and/or enter the markets in which the Company competes. 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. Consolidations within the industry may also contribute to the competitive environment. 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. 17 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. The Company's challenge is to increase the number of individuals and small employer groups purchasing its products and services and to retain existing members. Also impacting the Company's growth prospects is the affordability of health insurance premiums as health care costs continue to rise, as well as the downsizing or restrained hiring among small employers as a result of economic uncertainty. If the Company's 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: (1) failure to comply with prompt pay laws; (2) loss of existing members; (3) difficulty in attracting new members; (4) disputes with members, providers and agents; (5) regulatory problems; (6) increases in administrative expenses; and (7) other adverse consequences. 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 began in early 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. These agents and brokers 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. 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. In addition, the Company has a relationship with a general agent who, along with affiliated subagents, generated approximately 10% of the Company's premium revenue for the nine months ended September 30, 2004. The loss of this relationship could hamper the Company's growth plans and, as a result, adversely affect the Company's future operating performance. 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(R) rating practices and related legal matters, which management believes harmed the Company's MedOne(R) new member enrollment during the last half of 2002. The Company changed its rating practices in all MedOne(R) 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 and 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. 18 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, or increased costs for, 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. 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 could have a material adverse effect on the Company. Some of the members of the Company's senior management have developed relationships with some of the Company's 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, and/or the inability of 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 Company's credit facility. 19 The Company's insurance subsidiaries are subject to regulations that limit their ability to transfer funds to the Company. 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 outstanding balance under its credit facility at the end of 2005. The Company's outstanding balance at September 30, 2004 was $30.2 million. If the Company's insurance subsidiaries are unable to provide these funds, the Company could default on 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 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company's market risk has not substantially changed from the year ended December 31, 2003. ITEM 4. CONTROLS AND PROCEDURES The Company's management, with the participation of the Company's Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company's disclosure controls and procedures as of September 30, 2004. Based on that evaluation, the Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective as of September 30, 2004. There were no changes in the Company's internal control over financial reporting during the third quarter of 2004 that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. 20 PART II OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The following report of recent developments in previously reported legal proceedings should be read in conjunction with Item 3, Legal Proceedings, in the Company's annual report on Form 10-K for the year ended December 31, 2003, and quarterly reports on Form 10-Q for the quarters ended March 31, 2004 and June 30, 2004. On September 23, 2004, two of the Company's wholly owned subsidiaries, American Medical Security, Inc. ("AMS") and United Wisconsin Life Insurance Company ("UWLIC") entered into an agreement to settle a class action lawsuit brought by Evelyn Addison and others, pending in the Circuit Court of Palm Beach County, Florida. The lawsuit was filed in February 2000 and alleges that the Company failed to follow Florida law when in 1998 it discontinued writing certain health insurance policies and offered new policies to insureds. 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. In April 2002, the Circuit Court Judge had ruled against the Company and ordered that the question of damages be tried before a jury. The settlement has received preliminary approval by the Circuit Court. If the settlement receives final approval, all claims of participating class members will be dismissed and the litigation terminated in exchange for settlement consideration. The Company believes it is adequately reserved for the anticipated cost of the settlement and related expenses. As a result, the agreement is expected to have no material effect on the Company's earnings or results of operations. The Company expects final approval of the settlement by the Circuit Court in December 2004. On September 29, 2004, the Circuit Court of Montgomery County, Alabama, granted final approval of the certification and settlement of a class action lawsuit, GADSON V. UNITED WISCONSIN LIFE INSURANCE COMPANY, although a motion for reconsideration has been filed and the time for filing an appeal has not yet expired. The Circuit Court had granted preliminary approval of the certification and settlement in March 2004. The lawsuit was filed in 2001 and involves issues relating to the rating methodology formerly used by the Company for group health benefit plans marketed to individuals in Alabama and Georgia. All claims of participating class members have been dismissed in exchange for the settlement consideration. On June 14, 2004, the Superior Court of Cobb County, Georgia, in PARKER V. AMERICAN MEDICAL SECURITY GROUP, INC., issued an order enjoining the Company from settling with Georgia residents who are members of the Gadson class. On September 2, 2004 the Superior Court certified a class of Georgia residents. The Company believes this injunction and class certification violates general principles of comity and the Full Faith and Credit clause of the United States Constitution and expects the injunction and certification to be overturned by the Georgia Supreme Court, where the Company's appeal of the order is currently pending. The Company believes it is adequately reserved for the cost of the settlement, including related attorneys' fees. The Company believes a portion of the cost of settlement of the Florida and Alabama class actions should be covered by insurance. Any potential insurance recovery is not reflected as an asset on the Company's balance sheet. The Company's subsidiaries, AMS and UWLIC, are defendants in a number of other lawsuits in various states, primarily Alabama, alleging misrepresentation of the rating methodology used by the Company with respect to certain MedOne(R) 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. 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 in excess of amounts reserved that may arise from the above-mentioned and all other legal and regulatory actions would not have a material adverse effect on 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. 21 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) EXHIBITS See the Exhibit Index following the signature page of this report, which is incorporated herein by reference. 22 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. DATE: November 4, 2004 AMERICAN MEDICAL SECURITY GROUP, INC. /s/ John R. Lombardi John R. Lombardi Executive Vice President, Chief Financial Officer and Treasurer (Principal Financial Officer and Chief Accounting Officer and duly authorized to sign on behalf of the Registrant) 23
AMERICAN MEDICAL SECURITY GROUP, INC. (the "Registrant") (Commission File No. 1-13154) EXHIBIT INDEX TO FORM 10-Q QUARTERLY REPORT for quarter ended September 30, 2004 EXHIBIT DESCRIPTION INCORPORATED HEREIN FILED NUMBER BY REFERENCE TO HEREWITH 2 Agreement and Plan of Merger, dated as of Exhibit 2.1 to the Registrant's Form 8-K September 15, 2004, by and among the filed with the Securities and Exchange Registrant, PacifiCare Health Systems, Inc. Commission (the "SEC") on September 16, and Ashland Acquisition Corp. 2004 4.1(a) Rights Agreement, dated as of August 9, 2001 Exhibit 1 to the Registrant's Registration Registrant's by and between the Registrant Statement on Form 8-A, filed with the SEC and Firstar Bank, N.A., as rights agent for on August 14, 2001 (the "Rights Agreement") 4.1(b) Appointment and Assumption Agreement dated Exhibit 4.2 to the Registrant's Form 8-K December 17, 2001 by and between the filed with the SEC on February 5, 2002 Registrant and Firstar Bank, N.A., appointing (the "2/5/02 8-K") LaSalle Bank, N.A. as rights agent for the Rights Agreement 4.1(c) Amendment dated as of February 1, 2002 to the Exhibit 4.1 to 2/5/02 8-K Rights Agreement 4.1(d) Amendment dated as of June 4, 2002 to the Exhibit 4.4(d) to the Registrant's Form Rights Agreement 8-K filed with the SEC on June 19, 2002 4.1(e) Amendment dated as of September 15, 2004 to Exhibit 4.5 to the Registrant's the Rights Agreement Registration Statement on Form 8-A (Amendment No. 1) filed with the SEC on September 15, 2004 10.1 Description of the Executive Management 2004 X Interim Performance Award 10.2 Amendment dated September 15, 2004 to X Employment Agreement between the Registrant and its Chief Executive Officer 10.3 Amendment dated as of September 15, 2004 to X Deferred Stock Agreement by and between the Registrant and its Chief Executive Officer 10.4 Amendment dated September 15, 2004 to the X Registrant's Change of Control Severance Benefit Plan EX-1 EXHIBIT INCORPORATED HEREIN FILED NUMBER DESCRIPTION BY REFERENCE TO HEREWITH 31.1 Certification of Chief Executive Officer X pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended 31.2 Certification of Chief Financial Officer X pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended 32 Certification of Chief Executive Officer and X Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
EX-2 EX-10 2 exhibit10_1.txt AMERICAN MEDICAL SECURITY GROUP, INC. EXHIBIT 10.1 EXECUTIVE MANAGEMENT - 2004 INTERIM PERFORMANCE AWARD - DESCRIPTION: o The award is established and governed by the terms of the Executive Annual Incentive Plan of American Medical Security Group, Inc. o Participants are members of the Executive Management Group. o The purpose of the 2004 Interim Performance Award is to encourage superior performance by executives by awarding compensation to executives based on their accomplishment of performance goals. o The award applies to the 2004 Fiscal Year. PERFORMACE GOAL: o Compensation awarded will be based on the Company's earnings before interest, taxes, depreciation and amortization (EBITDA) performance for the 2004 Fiscal Year. INCENTIVE OPPORTUNITY o The award opportunity is based on competitive incentive opportunities expressed as a percent of base salary, as follows: INCENTIVE POSITION LEVEL OPPORTUNITY President and CEO % Executive Vice President % Senior Vice President, Chief Marketing Officer % Senior Vice President, General Counsel % Vice President, Human Resources % Vice President, Corporate Communications % AWARD LEVERAGE o The table below outlines the structure that will be used to determine the percent of the Interim Performance Award incentive opportunity earned: EBITDA TOTAL IPA INCENTIVE (ACTUAL VS. PLAN) OPPORTUNITY (% OF IPA AWARD EARNED) % % % % % % AWARD DETERMINATION o The Compensation Committee shall certify the amount of the award eligible for payment, based on the attainment of the applicable performance award described above, as soon as practicable after the end of the 2004 Fiscal Year. AWARD VESTING o Payment of incentive awards described above will automatically be deferred through the end of calendar year 2006. Payment of such deferred award shall be contingent upon the participant's continued employment with the company through December 31, 2006. AWARD PAYMENT o Incentive awards for Fiscal Year 2004 granted by the Committee shall be paid in cash to each participant remaining employed on December 31, 2006, as soon as possible after December 31, 2006. o The Committee may permit a participant to further defer the receipt of cash awarded according to rules and procedures it establishes for such deferrals. TERMINATION OF EMPLOYMENT o In the event of termination of employment by reason of death or disability (as determined by the Committee) following the determination of the award but prior to payment of the award, the award shall become payable as soon as practicable following such death or disability. In the event of termination of employment by Retirement (as defined in the Executive Annual Incentive Plan) following the determination of the award but prior to payment of the award, the Committee shall retain discretion over the payment of any unpaid award. In the event of termination of employment for any reason other than death, disability or Retirement following the determination of the award but prior to the payment of the award, the award payment shall be forfeited. CHANGE OF CONTROL o In the event of a Change of Control (as defined in the Change of Control Severance Benefit Plan) following the determination of the award but prior to payment of the award, the award shall become payable upon such Change of Control and shall be paid within 30 days of such Change of Control. NOTES: o All references to base salary mean the incumbent's base salary as of March 2, 2004. o The impact of any change in the Company's accounting policies that are required by a change in Generally Accepted Accounting Principles after the goal is established are excluded from EBITDA. EX-10 3 exhibit10_2.txt AMERICAN MEDICAL SECURITY GROUP, INC. EXHIBIT 10.2 AMENDMENT TO EMPLOYMENT AGREEMENT BY AND BETWEEN AMERICAN MEDICAL SECURITY GROUP, INC. AND SAMUEL V. MILLER This Amendment ("Amendment") to the Employment Agreement by and between AMERICAN MEDICAL SECURITY GROUP, INC. ("Company") and SAMUEL V. MILLER ("Employee") is effective this 15th day of September, 2004. WITNESSETH: WHEREAS, on September 28, 2000, Company and Employee entered into an Employment Agreement which was amended September 28, 2000 and further amended January 1, 2004 (as amended, the "Agreement"). WHEREAS, Company and Employee mutually agree to amend the Agreement as set forth below. NOW, THEREFORE, in consideration of the foregoing premises and for other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the parties agree to amend the Agreement as follows: 1. Section 1.1 is amended by the addition of the following sentence to the end of Section 1.1. Notwithstanding the foregoing, no written notice of intention not to renew shall be given prior to December 3, 2004. 2. Section 4.5(f) is amended to provide that the Company shall satisfy obligations under Section 4.5(f) by providing individual insurance policies and is hereby amended and restated in its entirety to read as follows: (f) individual medical, dental, long-term disability, and life insurance policies (one or more of which may be furnished directly by the Company) which shall provide the Employee and his dependents with substantially equivalent insurance coverage to each coverage that was in place at the time of the Qualifying Separation for a period of three (3) years immediately following the Qualifying Separation. 3. Section 4.5(g) is hereby amended and restated in its entirety to read as follows: (g) if the excise tax imposed under the Internal Revenue Code of 1986, as amended, (the "Code") Section 4999 on "excess parachute payments", as defined in the Code Section 280G, is incurred on account of (A) any amount paid or payable to or for the benefit of the Employee pursuant to this Article IV, (B) fees and expenses under Section 6.7 of this Agreement or (C) any other amount paid or payable by the Company, any entity whose actions result in a Change of Control or an affiliate of the Company or any such entity (the "Change of Control Benefits"), the Company shall indemnify the Employee and hold him harmless against all claims, losses, damages, penalties, expenses, and excise taxes. To effect this indemnification, the Company shall pay the Employee the Additional Amount on the date the Employee becomes entitled to receive any payment or benefit purusant to clause (i) or (ii) above that is subject to the excise tax imposed under Section 4999 of the Code (or such successor provision thereto) (the "Excise Tax"). For purposes of the Plan, the "Additional Amount" shall mean the amount necessary to indemnify and hold the Employee harmless from (A) the Excise Tax with respect to the Change of Control Benefits and (B) the amount required to satisfy (y) the additional Excise Tax, and (z) the federal, state and local income taxes for which the Employee is liable with respect to the Additional Amount (the sum of items (A) and (B) of this Section 4.5(g) being hereunder referred to as the "Additional Tax Liability"). (1) For purposes of determining the amount and timing of the payments of the Additional Amount, (i) all Change of Control Benefits shall be treated as "parachute payments" (within the meaning of Section 280G(b)(2) of the Code) unless, in the opinion of the Company's independent auditors or other qualified professional engaged by the Company (the "Auditor"), such payments or benefits (in whole or in part) do not constitute parachute payments including by reason of Section 280G(b)(4)(A) of the Code, (ii) all "excess parachute payments" within the meaning of Section 280G(b)(1) of the Code shall be treated as subject to the Excise Tax unless, in the opinion of the Auditor, such excess paracute payments (in whole or in part) represent reasonable compensation for services actually rendered (within the meaning of Section 280G(b)(4)(B) of the Code) in excess of the base amount (within the meaning of Section 280G(b)(3) of the Code) allocable to such reasonable compensation, or are otherwise not subject to the Excise Tax, and (iii) the value of any noncash benefits or any deferred payment or benefit shall be determined by the Auditor in accordance with the principles of Sections 280G(d)(3) and (4) of the Code. For purposes of determining the amount of the Additional Amount, the Employee shall be deemed to pay federal income tax at the highest marginal rate of federal income taxation and state and local income taxes at the highest marginal rate of taxation in the state and locality of the Employee's residence, net of the maximum reduction in federal income taxes which could be obtained from deduction of such state and local taxes. The Auditor shall address any opinion required hereunder to the Employee and such opinion shall state that the Employee is entitled to rely on such opinion without risk of any penalty. (2) If the Employee's Additional Tax Liability is subsequently determined to be less than the amount of the Additional Amount paid to the 2 Employee, the Employee shall repay to the Company that portion of the Additional Amount payment attributable to such reduction (plus interest on the amount of such repayment at the rate provided in Section 1274(b)(2)(B) of the Code). If the Employee's Additional Tax Liability is subsequently determined to be more than the amount of the Additional Amount paid to the Employee, the Company shall make an additional payment in respect of such excess, as well as the amount of any penalty or interest assessed with respect thereto at the time that the amount of such excess, penalty or interest is finally determined. (3) Notwithstanding any other provision of this Section 4.5(g) to the contrary, if the aggregate "After-Tax Amount" (as defined below) of the Change of Control Benefits that would be payable to the Employee does not equal or exceed 110% of the "After-Tax Floor Amount" (as defined below), then no Additional Amount shall be payable to the Employee and the aggregate amount of Change of Control Benefits payable to the Employee shall be reduced (but not below the "Floor Amount" as defined below) to the largest amount that would both (i) not cause any Additional Tax Liability to be payable by the Employee and (ii) not cause any Change of Control Benefits to become nondeductible by the Company by reason of Section 280G of the Code (or any successor provision). For purposes of the preceding sentence, the Employee shall be deemed to be subject to the highest marginal rate of federal, state, and local taxes, excluding Social Security, Medicare, and alternative minimum taxes or similar tax consequences. "After-Tax Amount" means the portion of a specified amount that would remain after payment of all federal, state, and local taxes (excluding Social Security, Medicare, and alternative minimum taxes or similar tax consequences), and Additional Tax Liability paid or payable by the Employee in respect of such specified amount. "After-Tax Floor Amount" means the After-Tax Amount of the Floor Amount. "Floor Amount" means the greatest pre-tax amount of Change of Control Benefits that could be paid to the Employee without causing the Employee to become liable for any Additional Tax Liability in connection therewith. 3 IN WITNESS WHEREOF, the parties have executed this Amendment on this 15th day of September, 2004. AMERICAN MEDICAL SECURITY GROUP By: /s/ Timothy J. Moore Name: Timothy J. Moore Title: Senior Vice President of Corporate Affairs, General Counsel and Secretary EXECUTIVE /s/ Samuel V. Miller 4 EX-10 4 exhibit10_3.txt AMERICAN MEDICAL SECURITY GROUP, INC. EXHIBIT 10.3 AMENDMENT TO THE DEFERRED STOCK AGREEMENT BETWEEN AMERICAN MEDICAL SECURITY GROUP, INC. AND SAMUEL V. MILLER THIS AMENDMENT, dated as of September 15, 2004, is by and between American Medical Security Group, Inc., a Wisconsin corporation ("AMSG") and Samuel V. Miller (the "Executive") and is effective this 15th day of September, 2004. RECITALS AMSG and the Executive entered into a Deferred Stock Agreement, effective November 17, 1998, which provides that the Executive will receive 73,506 shares of AMSG common stock (the "Deferred Stock") on January 2nd of the year following the year in which the Executive's termination of employment occurs, to the extent that the Deferred Stock is vested on such date. The Deferred Stock fully vested on November 17, 2002. The Board of Directors of AMSG has approved the Agreement and Plan of Merger (the "Merger Agreement") to be entered into by and among AMSG, Pacificare Health Systems, Inc., a Delaware corporation, and Ashland Acquisition Corp., a newly formed Wisconsin corporation and a wholly-owned subsidiary of Parent. Section 2.4(b) of the Merger Agreement provides that immediately prior to the Effective Time (as defined in the Merger Agreement), the Deferred Stock shall be cancelled for a payment equal to the product of (i) the number of shares of AMSG common stock subject to such award, and (ii) the Merger Consideration (as defined in the Merger Agreement). AGREEMENT NOW THEREFORE, AMSG and the Executive agree as follows: 1. Notwithstanding anything to the contrary contained in the Deferred Stock Agreement, immediately prior to the consummation of the Merger, the Deferred Stock shall be cancelled for a payment equal to the product of 73,506 and (ii) the Merger Consideration. Upon such event, AMSG shall have no further obligations to the Executive pursuant to the Deferred Stock Agreement. 2. In the event that the Merger is not consummated, this Amendment shall be of no force and effect. IN WITNESS WHEREOF, the parties have executed this Amendment on this 15th day of September, 2004. AMERICAN MEDICAL SECURITY GROUP By: /s/ Timothy J. Moore Name: Timothy J. Moore Title: Senior Vice President of Corporate Affairs, General Counsel and Secretary EXECUTIVE /s/ Samuel V. Miller 2 EX-10 5 exhibit10_4.txt AMERICAN MEDICAL SECURITY GROUP, INC. EXHIBIT 10.4 AMENDMENT TO THE AMERICAN MEDICAL SECURITY GROUP, INC. CHANGE OF CONTROL SEVERANCE BENEFIT PLAN (AS AMENDED AND RESTATED NOVEMBER 29, 2001) This Amendment to the American Medical Security Group, Inc. Change of Control Severance Benefit Plan (As Amended and Restated November 29, 2001) (the "Plan") is made and effective the 15th day of September, 2004, subject to, with respect to each participant, the participant's consent to the amendment. WITNESSETH: WHEREAS, American Medical Security Group, Inc. ("AMSG") desires to amend the Plan as set forth below and the Board of Directors of AMSG has authorized amending the Plan as set forth below. WHEREAS, the Company and the Executives mutually agree to amend the Plan as set forth below. NOW THEREFORE, in consideration for the following promises and for other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the parties agree to amend the Plan as follows: 1. Article VII. "Amendment and Termination," is amended to change the reference to the one year period therein to a two year period and is hereby amended and restated in its entirety to read as follows: VII. AMENDMENT AND TERMINATION The Plan may be modified, amended, changed, or terminated only upon the approval of the Company's Board of Directors during a regular, annual or special meeting; provided, however, that any modification, amendment, change or termination of the Plan that has an adverse effect on any Executive who is a participant in the Plan on the date such modification, amendment, change or termination is adopted shall not be effective until two (2) years after the date of adoption. Any modification, amendment, change, or termination of the Plan shall be in writing and signed by at least two officers of the Company at the level of executive vice president and above. 2. Section 3.4 is amended to provide that the benefits under the Plan will apply only to the first Change of Control following the adoption of this amendment and is hereby amended and restated in its entirety to read as follows: 3.4 CONTROL CHANGE DATE. The "Control Change Date" means the first date on which an event described in Section 3.3 occurs following the effective date of this Plan (as provided in Article II herein). If a Change of Control occurs on account of a series of transactions, the Control Change Date is the date of occurrence of the last of such transactions. 3. Section 4.4 is amended to provide that the Company shall satisfy obligations under Section 4.4 by providing individual insurance policies and is hereby amended and restated in its entirety to read as follows: 4.4 INSURANCE COVERAGE. In addition to the Plan Benefits, the Company shall provide an Executive with individual health, dental, long-term disability, and life insurance policies (one or more of which may be furnished directly by the Company) which shall provide the Executive and his dependents with substantially equivalent insurance coverage to each coverage that was in place at the time of the Qualifying Separation for a period of three (3) years immediately following the Qualifying Separation with respect to a Senior Executive and for a period of one and one-half (1.5) years immediately following the Qualifying Separation with respect to an Other Executive. Thereafter, the Company will provide an Executive with an explanation of any right to continue such coverage under COBRA and any other applicable state or federal law. 4. Section 4.6 is hereby amended and restated in its entirety to read as follows: 4.6 EXCISE TAXES. (a) If the excise tax imposed under the Internal Revenue Code of 1986, as amended, (the "Code") Section 4999 on "excess parachute payments", as defined in the Code Section 280G, is incurred on account of (i) any amount paid or payable to or for the benefit of an Executive under this Section as legal fees and expenses, or (ii) any payments or benefits which an Executive receives or has the right to receive under this Plan or any other plan or compensation arrangement of the Company, any entity whose actions result in a Change of Control or an affiliate of the Company or any such entity (the "Change of Control Benefits"), the Company shall indemnify the Executive and hold him or her harmless against all claims, losses, damages, penalties, expenses, and excise taxes. To effect this indemnification, the Company shall pay the Executive the Additional Amount on the date the Executive becomes entitled to receive any payment or benefit pursuant to clause (i) or (ii) above that is subject to the excise tax imposed under Section 4999 of the Code (or such successor provision thereto) (the "Excise Tax"). For purposes of the Plan, the "Additional Amount" shall mean the amount necessary to indemnify and hold the Executive harmless from (A) the Excise Tax with respect to the Change of Control Benefits and (B) the amount required to satisfy (y) the additional Excise Tax, and (z) the federal, state and local income taxes for which an Executive is liable with respect to the Additional Amount (the sum of items (A) and (B) of this Section 4.6 being hereunder referred to as the "Additional Tax Liability"). (b) For purposes of determining the amount and timing of the payments of the Additional Amount, (i) all Change of Control Benefits shall be treated as "parachute payments" (within the meaning of Section 280G(b)(2) of the Code) unless, in the opinion of the Company's independent auditors or other qualified professional engaged by the Company (the "Auditor"), such payments or benefits (in whole or in part) do not constitute parachute payments including by reason of Section 280G(b)(4)(A) of the Code, 2 (ii) all "excess parachute payments" within the meaning of Section 280G(b)(1) of the Code shall be treated as subject to the Excise Tax unless, in the opinion of the Auditor, such excess parachute payments (in whole or in part) represent reasonable compensation for services actually rendered (within the meaning of Section 280G(b)(4)(B) of the Code) in excess of the base amount (within the meaning of Section 280G(b)(3) of the Code) allocable to such reasonable compensation, or are otherwise not subject to the Excise Tax, and (iii) the value of any noncash benefits or any deferred payment or benefit shall be determined by the Auditor in accordance with the principles of Sections 280G(d)(3) and (4) of the Code. For purposes of determining the amount of the Additional Amount, the Executive shall be deemed to pay federal income tax at the highest marginal rate of federal income taxation and state and local income taxes at the highest marginal rate of taxation in the state and locality of the Executive's residence, net of the maximum reduction in federal income taxes which could be obtained from deduction of such state and local taxes. The Auditor shall address any opinion required hereunder to the Executive and such opinion shall state that the Executive is entitled to rely on such opinion without risk of any penalty. (c) If the Executive's Additional Tax Liability is subsequently determined to be less than the amount of the Additional Amount paid to the Executive, the Executive shall repay to the Company that portion of the Additional Amount payment attributable to such reduction (plus interest on the amount of such repayment at the rate provided in Section 1274(b)(2)(B) of the Code). If the Executive's Additional Tax Liability is subsequently determined to be more than the amount of the Additional Amount paid to the Executive, the Company shall make an additional payment in respect of such excess, as well as the amount of any penalty or interest assessed with respect thereto at the time that the amount of such excess, penalty or interest is finally determined. (d) Notwithstanding any other provision of this Section 4.6 to the contrary, if the aggregate "After-Tax Amount" (as defined below) of the Change of Control Benefits that would be payable to Employee does not equal or exceed 110% of the "After-Tax Floor Amount" (as defined below), then no Additional Amount shall be payable to Employee and the aggregate amount of Change of Control Benefits payable to Employee shall be reduced (but not below the "Floor Amount" as defined below) to the largest amount that would both (i) not cause any Additional Tax Liability to be payable by Employee and (ii) not cause any Change of Control Benefits to become nondeductible by the Company by reason of Section 280G of the Code (or any successor provision). For purposes of the preceding sentence, Employee shall be deemed to be subject to the highest marginal rate of federal, state, and local taxes, excluding Social Security, Medicare, and alternative minimum taxes or similar tax consequences. "After-Tax Amount" means the portion of a specified amount that would remain after payment of all federal, state, and local taxes (excluding Social Security, Medicare, and alternative minimum taxes or similar tax consequences), and Additional Tax Liability paid or payable by Employee in respect of such specified amount. "After-Tax Floor Amount" means the After-Tax Amount of the Floor Amount. 3 "Floor Amount" means the greatest pre-tax amount of Change of Control Benefits that could be paid to Employee without causing Employee to become liable for any Additional Tax Liability in connection therewith. 5. A new Section 4.9 is hereby added to the Plan to provide for non-duplication of benefits under the Plan and shall read as follows: 4.9 NON-DUPLICATION OF BENEFITS. No Executive is eligible to receive benefits under this Plan more than one time. * * * * This Amendment may be executed in one or more counterparts, each of which together shall be deemed an original, but all of which together shall constitute one and the same instrument. Approved by the Board of Directors this 15th day of September, 2004. Required Officer Signatures /s/ Timothy J. Moore /s/ John R. Lombardi Timothy J. Moore /s/ Samuel V. Miller Samuel V. Miller Required Executive Signature /s/ Clifford A. Bowers Executive Clifford A. Bowers /s/ John R. Lombardi Executive John R. Lombardi /s/ James C. Modaff Executive James C. Modaff /s/ Timothy J. Moore Executive Timothy J. Moore /s/ John R. Wirch Executive John R. Wirch /s/ Thomas G. Zielinski Executive Thomas G. Zielinski 4 EX-31 6 exhibit31_1.txt CEO CERTIFICATION EXHIBIT 31.1 CERTIFICATION I, Samuel V. Miller, certify that: 1. I have reviewed this quarterly report on Form 10-Q of American Medical Security Group, Inc.; 2. Based on my knowledge, this 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 report; 3. Based on my knowledge, the financial statements, and other financial information included in this 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 report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting. 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: November 2, 2004 /s/ Samuel V. Miller --------------------------- Chief Executive Officer EX-31 7 exhibit31_2.txt CFO CERTIFICATION EXHIBIT 31.2 CERTIFICATION I, John R. Lombardi, certify that: 1. I have reviewed this quarterly report on Form 10-Q of American Medical Security Group, Inc.; 2. Based on my knowledge, this 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 report; 3. Based on my knowledge, the financial statements, and other financial information included in this 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 report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting. 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: November 4, 2004 /s/ John R. Lombardi ------------------------------- Executive Vice President, Chief Financial Officer and Treasurer EX-32 8 exhibit32.txt CEO & CFO CERTIFICATION EXHIBIT 32 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of American Medical Security Group, Inc. (the "Company") on Form 10-Q for the period ended September 30, 2004 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Samuel V. Miller, Chief Executive Officer of the Company, and I, John R. Lombardi, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Samuel V. Miller /s/ John R. Lombardi - ----------------------- ----------------------- Samuel V. Miller John R. Lombardi Chief Executive Officer Chief Financial Officer November 2, 2004 November 4, 2004 This certification accompanies this Report pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not be deemed filed by the Company for purposes of Section 18 of the Securities Exchange Act of 1934, as amended. A signed original of this written statement required by Section 906, or other document authenticating, acknowledging, or otherwise adopting the signature that appears in typed form within the electronic version of this written statement required by Section 906, has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request. -----END PRIVACY-ENHANCED MESSAGE-----