10-K/A 1 x75099a1e10-ka.txt GLOBAL PREFERRED HOLDINGS, INC. -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 --------------------- FORM 10-K/A (AMENDMENT NO. 1) [X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001 [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 0-23637 --------------------- GLOBAL PREFERRED HOLDINGS, INC. (Exact Name of Registrant as Specified in its Charter) DELAWARE 58-2179041 (State or other Jurisdiction of (I.R.S. Employer Identification Number) Incorporation or Organization)
11315 JOHNS CREEK PARKWAY DULUTH, GEORGIA 30097 (770) 248-3311 (Address, Including Zip Code and Telephone Number, Including Area Code, of Registrant's Principal Executive Offices) SECURITIES REGISTERED UNDER SECTION 12(b) OF THE EXCHANGE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED ------------------- ----------------------------------------- None None
SECURITIES REGISTERED UNDER SECTION 12(g) OF THE EXCHANGE ACT: COMMON STOCK, PAR VALUE $.001 (Title of class) EXPLANATORY NOTE This Amendment No. 1 to Annual Report on Form 10-K/A is being filed to revise the following items in this Report: (1) Discussion of "Future Policy Benefits" in Note 2 to the Global Preferred Holdings, Inc. Consolidated Financial Statements; (2) Discussion of "Statutory Restrictions" in Note 10 to the Global Preferred Holdings, Inc. Consolidated Financial Statements; and (3) Part III: Items 10, 11, 12 and 13. -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The following financial statements are attached hereto commencing on page F-1. - Independent Auditors' Report (December 31, 2000 and 2001) - Consolidated Balance Sheets at December 31, 2000 and 2001 - Consolidated Statements of Income for the years ended December 31, 1999, 2000 and 2001 - Consolidated Statements of Stockholders' Equity and Comprehensive Income for the years ended December 31, 1999, 2000 and 2001 - Consolidated Statements of Cash Flows for the years ended December 31, 1999, 2000 and 2001 - Notes to Consolidated Financial Statements for the years ended December 31, 1999, 2000 and 2001 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The directors and executive officers and their ages as of the date of this report are as follows:
NAME AGE POSITION ---- --- -------- Edward F. McKernan(3)..................... 46 Director, Chief Executive Officer and President; President of Global Preferred Re Bradley E. Barks.......................... 42 Chief Financial Officer and Senior Vice President -- Finance Caryl P. Shepherd......................... 32 Chief Accounting Officer, Treasurer, Controller, Secretary and Vice President; Vice President and Treasurer of Global Preferred Re Thomas Bobowski........................... 43 Vice President of Marketing Joseph F. Barone(1)(2)(3)................. 64 Chairman of the Board of Directors Thomas W. Montgomery(3)................... 53 Director; Director of Global Preferred Re C. Simon Scupham(1)(2).................... 47 Director; Director of Global Preferred Re Eugene M. Howerdd, Jr.(2)(3).............. 66 Director Milan M. Radonich(1)...................... 51 Director
--------------- (1) Member of the Audit Committee (2) Member of the Compensation Committee (3) Member of the Investment Committee The following is additional information concerning each of our executive officers and directors. Edward F. McKernan has served as a Director since August 1997 and as Chief Financial Officer since December 1997. Mr. McKernan was elected as Chief Executive Officer in January 2002, as President in December 2000 and as President of our subsidiary, Global Preferred Re Limited ("Global Preferred Re") in December 2000. McKernan has served as the Actuary for Global Preferred Re since April 1996. From August 1995 until December 2000, Mr. McKernan served as Senior Vice President and as Senior Vice President of Global Preferred Re. From April 1996 until June 2001, Mr. McKernan was also Senior Vice President and Actuary of World Marketing Alliance, Inc. ("WMA Agency"). Prior to joining our company, he was a Senior Manager in the Life Actuarial Consulting Practice of KPMG LLP from 1993 through 1996. From August 1990 through September 1993, Mr. McKernan was the Marketing Actuary of U.S. Operations for Seaboard Life Insurance Company. Prior to his tenure with Seaboard Life, Mr. McKernan was employed as a consultant associated with Tillinghast, a Towers Perrin company, an 2 international actuarial consulting firm. He is a Fellow of the Society of Actuaries and a Member of the American Academy of Actuaries. Bradley E. Barks has served as our Chief Financial Officer and Senior Vice President -- Finance since March 2002. Prior to joining our company, Mr. Barks was self-employed as an independent financial and management consultant. From 1990 to 2000, Mr. Barks served as Senior Vice President -- Finance of LifeUSA Holding, Inc. and its successor company Allianz Life Insurance Company of North America. Prior to his tenure with LifeUSA, Mr. Barks was employed as a Senior Consultant for Touche Ross & Co. from 1981 to 1990. Mr. Banks is a certified public accountant, a Fellow of the Society of Actuaries and a member of the American Academy of Actuaries. Caryl P. Shepherd has served as Chief Accounting Officer since February 2002, as Secretary since December 2001, as Vice President since December 2000, and as Vice President and Treasurer of Global Preferred Re since December 2000. Ms. Shepherd joined our company in November 1997 as Controller and was named Treasurer in December 1997, positions she continues to hold. Ms. Shepherd held the position of Assistant Secretary from December 2000 until her election as Secretary. From April 1995 through October 1997, Ms. Shepherd was a Senior Accountant with Western Reserve. Prior to her tenure with Western Reserve, Ms. Shepherd was a Senior Auditor for the public accounting firm of Ernst & Young LLP specializing in life insurance. Ms. Shepherd is a certified public accountant, a Fellow of the Life Management Institute and a member of the American Institute of Certified Public Accountants. Thomas Bobowski has served as our Vice President of Marketing since March 2002. Prior to joining our company, Mr. Bobowski served as the Vice President of Business Development for DotPlanet.com, Inc. From 1998 until 1999, Mr. Bobowski acted as Director of Global Operations for WMA Agency. Prior to his tenure at WMA Agency, Mr. Bobowski was Vice President of Business Development for The Midland Life Insurance Company from 1996 to 1998. Mr. Bobowski is a Chartered Life Underwriter and Certificate Fund Specialist. Joseph F. Barone has served as a Director since June 1998 and as Chairman since January 2002. Since July 1997, Mr. Barone has been Managing Director of Research for Firemark Investments, a private investment firm. From January 1992 through June 1997, he was a Senior Vice President with Swiss Re Insurance. Prior to his tenure with Swiss Re, Mr. Barone was a Managing Director of Investment Banking for the insurance industry at Bear, Stearns & Co., Inc. Mr. Barone is a Chartered Financial Analyst and a member of the New York Society of Security Analysts and the Association of Insurance and Financial Analysts. Thomas W. Montgomery has served as a Director since March 1995 and a Director of Global Preferred Re since August 1995. From March 1995 until December 2001, Mr. Montgomery served as Executive Vice President and Secretary. Mr. Montgomery served as Executive Vice President of Global Preferred Re from August 1995 until December 2001. Mr. Montgomery is president of WMA Agency. Mr. Montgomery serves as a director of World Money Group, Inc., a financial services holding company. Mr. Montgomery is a certified public accountant, member of the American Institute of Certified Public Accountants and a member of the Georgia Society of Certified Public Accountants. C. Simon Scupham has served as a Director since April 1996 and as a Director of Global Preferred Re since August 1995. Since 1991, Mr. Scupham has been Chairman of CFM Insurance Managers Ltd., a member of the Mutual Risk Management Ltd. group of companies, which provides professional management services to international companies operating in Bermuda. Prior to joining CFM, Mr. Scupham served as the General Manager of Bermuda operations of the Kemper Group. He is a qualified Chartered Accountant and Associate Fellow of the Institute of Mathematics and its Applications. Mr. Scupham is also a director of MRM Global Captive Group and Chairman of Shoreline Mutual Management (Bermuda) Ltd. Eugene M. Howerdd, Jr. has served as a Director since May 2001. Mr. Howerdd is Chairman and Chief Executive Officer of Howerdd Financial Corporation, a diversified financial company that he founded in 1989. Prior to 1989, he served as Chairman of William W. Lowry & Associates, which was acquired by 3 USF&G Insurance Company. From 1996 through January 2001, Mr. Howerdd also served as president of WMA Investment Advisors, Inc., a firm offering asset allocation modeling, portfolio rebalancing and separate account money management. Milan M. Radonich has served as a Director since July 2001. Mr. Radonich is self-employed as an independent consultant. From September 2000 to September 2001, he was Chief Financial Officer of Allied North American Insurance Brokerage Corp. of New York, an independently owned, multi-line insurance brokerage firm. Prior to his affiliation with Allied, Mr. Radonich was with Ernst & Young LLP for 27 years in the insurance industry practice. Mr. Radonich is a certified public accountant, a Fellow of the Life Management Institute and serves as Co-Chairman of the Society of Insurance Financial Management's Accounting Committee. He also holds memberships in the American Institute of Certified Public Accountants, the FLMI Society of Greater New York, the New York Area IASA, and the Illinois and New York State Certified Public Accountant Societies. ITEM 11. EXECUTIVE COMPENSATION The following table shows compensation we paid to our Chief Executive Officer and next most highly compensated executive officers for the last three fiscal years (collectively, the "Named Executive Officers"). SUMMARY COMPENSATION TABLE
LONG-TERM ANNUAL COMPENSATION COMPENSATION --------------------------------- ------------ SECURITIES ALL OTHER UNDERLYING NAME AND PRINCIPAL YEAR SALARY BONUS COMPENSATION OPTIONS ------------------ ---- -------- ------- ------------ ------------ S. Hubert Humphrey, Jr.(1)............. 2001 -- -- $23,616(2) -- Former Chief Executive Officer 2000 -- -- 48,992(2) 450,000(4) 1999 -- -- 48,851(2) -- Edward F. McKernan..................... 2001 $258,333 $40,000 $33,462(3) -- President and Chief Financial Officer 2000 203,347 -- 84,948(3) 52,500(4) 1999 181,867 -- -- -- Caryl P. Shepherd...................... 2001 $ 85,731 $20,000 $ -- -- Vice President, Treasurer, Controller 2000 80,300 -- -- 3,750(4) and Secretary 1999 77,975 -- -- --
--------------- (1) Mr. Humphrey retired effective December 28, 2001. (2) Amounts shown represent payments made to entities controlled by Mr. Humphrey pursuant to written agreements between these entities and us. These payments, while not paid directly to Mr. Humphrey, may be deemed indirect compensation to Mr. Humphrey. (3) Amounts shown represent payments made to Mr. McKernan by WMA Agency, which may be deemed to be indirect compensation from us to Mr. McKernan based on the common control of Global Preferred and WMA Agency by Mr. Humphrey until June 2001. (4) All of these options were granted under our 1999 Stock Option Plan and by their terms expired on January 1, 2002. Accordingly, these options had no value as of December 31, 2001. 4 AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND YEAR-END OPTION VALUES The following table summarizes the value of the outstanding options held by the Named Executive Officers at December 31, 2001:
NUMBER OF SECURITIES UNDERLYING UNEXERCISED OPTIONS VALUE OF UNEXERCISED IN-THE-MONEY AT FISCAL YEAR-END OPTIONS AT FISCAL YEAR-END -------------------------------- ---------------------------------- NAME EXERCISABLE UNEXERCISABLE(1) EXERCISABLE UNEXERCISABLE(1) ---- ------------ ----------------- ----------- ---------------- S. Hubert Humphrey, Jr............... -- 450,000 $ -- $ -- Edward F. McKernan................... -- 52,500 $ -- $ -- Caryl P. Shepherd.................... -- 3,750 $ -- $ --
--------------- (1) All of these options were granted under our 1999 Stock Option Plan and by their terms expired on January 1, 2002. Accordingly, these options had no value as of December 31, 2001. TERMS OF DIRECTORS The board of directors currently consists of six members, each of which are elected for a one-year term that will expire upon the election and qualification of successor directors at the next Annual Meeting of stockholders. There are no family relationships between any of the directors or executive officers. COMMITTEES OF THE BOARD OF DIRECTORS Compensation Committee. The board of directors has established a Compensation Committee, composed of independent directors, on which Messrs. Barone, Howerdd and Scupham serve. The Compensation Committee, reviews and evaluates the compensation and benefits of all the officers, reviews general policy matters relating to compensation and benefits of employees, including the administration of the Stock Incentive Plan and Directors Stock Option Plan, and makes recommendations concerning these matters to the board of directors. Audit Committee. The board of directors has also established an Audit Committee, comprised of independent directors, on which Messrs. Barone, Radonich and Scupham serve. The Audit Committee is responsible for: - Engaging independent accountants; - Approving independent audit fees; - Reviewing quarterly and annual financial statements, audit results and reports, including management comments and recommendations thereto; - Reviewing our system of controls and policies, including those covering conflicts of interest and business ethics; - Evaluating reports of actual or threatened litigation; and - Considering significant changes in accounting practices; examining improprieties or suspected improprieties, with the authority to retain outside counsel or experts. Investment Committee. The board of directors has established an investment committee, comprised of Messrs. Barone, McKernan, Montgomery and Howerdd, to periodically review the guidelines and investment portfolio and to make recommendations to the board of directors regarding any changes. Our Treasurer and Controller, Ms. Shepherd, also participates in an advisory role in meetings of the Investment Committee. The board of directors reviews our investment guidelines annually. 5 COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION C. Simon Scupham is the Chairman of CFM Insurance Managers Ltd., which acts as the principal representative for Global Preferred Re in Bermuda. COMPENSATION OF DIRECTORS The non-employee members of the board of directors, Messrs. Barone, Howerdd, Montgomery, Scupham and Radonich, receive compensation of $1,500 per quarter for their service on the board of directors. In addition, we pay non-employee directors $500 for each board meeting or committee meeting attended. Directors who are employees do not receive any compensation for services performed in their capacity as directors. We reimburse each director for reasonable out-of-pocket expenses incurred in attending meetings of the board of directors and any of its committees. LIMITATION OF LIABILITY AND INDEMNIFICATION OF OFFICERS AND DIRECTORS Our certificate of incorporation and bylaws provide that we will indemnify our directors and officers to the fullest extent permitted by Delaware law. We believe that the provisions in our certificate of incorporation and bylaws are necessary to attract and retain qualified persons as directors and officers. We have also entered into agreements to indemnify our directors and certain of our officers to the fullest extent permitted under Delaware law. In these agreements, we have agreed to defend, hold harmless and indemnify our directors and certain of our officers against any obligation to pay a judgment, penalty, fine, expenses and settlement amounts in connection with any action, suit or proceeding brought by reason of the fact that he or she is a director or officer, as the case may be, or is serving, at our request, as a director, officer, employee, agent or consultant of another entity. No indemnification will be provided for any misappropriation of any business opportunity, any act or omission involving intentional misconduct or a knowing violation of law, any transaction from which an improper personal benefit was received and other types of liability under Delaware law. Further, we will pay expenses incurred by directors and officers in defending any covered action, suit or proceeding in advance of the final disposition of such action, suit or proceeding. Effective as of April 22, 2002, we have purchased directors' and officers' liability insurance in the aggregate primary limit of $10.0 million, and a $15.0 million excess policy. STOCK OPTIONS 1999 Stock Option Plan. Our 1999 Stock Option Plan became effective on June 15, 1999. The aggregate number of shares of common stock reserved for issuance under the 1999 Stock Option Plan was 700,000 shares. The 1999 Stock Option Plan required that we raise additional capital on or before December 31, 1999 in order for any options granted under the plan to be exercisable, however, we raised no new capital prior to that date and the outstanding options could not, by their terms, be exercised. On May 12, 2000, we approved an amendment to the 1999 Stock Option Plan extending the deadline for receipt of additional capital to January 1, 2002. The exercise price of each option granted under the 1999 Stock Option Plan was $10 per share, as adjusted for our three-for-two stock split in 2001. We did not raise the required minimum amount of additional capital by January 1, 2002 and as of that date the outstanding options granted under the 1999 Stock Option Plan could no longer be exercised. The board of directors terminated the 1999 Stock Option Plan in February 2002. Global Preferred Holdings, Inc. Stock Incentive Plan. Our Stock Incentive Plan became effective on January 9, 2002. The aggregate number of shares of common stock reserved for issuance under the Stock Incentive Plan is 1.5 million shares. The purpose of the Stock Incentive Plan is to provide incentives for employees of Global Preferred and Global Preferred Re to promote our success, thereby benefiting stockholders and aligning the economic interests of the participants with those of the stockholders. Awards granted under the Stock Incentive Plan may be stock appreciation rights, restricted stock, options intended to qualify as "incentive stock options" or nonqualified stock options. 6 No shares of common stock have been issued upon exercise of options granted under the Stock Incentive Plan. The Compensation Committee of the board of directors has approved the grant of options for an aggregate of 215,000 shares of common stock to be granted to certain employees upon the completion of an underwritten registered offering of our common stock, at an exercise price equal to the initial public offering price. Global Preferred Holdings, Inc. Directors Stock Option Plan. Our Directors Stock Option Plan became effective January 9, 2002. The aggregate number of shares of common stock reserved for issuance under the Directors Stock Option Plan is 280,000 shares. After the effective date of an underwritten registered offering of our common stock, we intend to grant options to purchase shares of common stock at a price equal to the initial public offering price to each of our five non-employee directors pursuant to the Directors Stock Option Plan. Upon completion of such underwritten offering, the following options will be granted to our non-employee directors at an exercise price equal to the initial public offering price: Thomas W. Montgomery 35,000 shares Joseph F. Barone 30,000 shares C. Simon Scupham 20,000 shares Eugene M. Howerdd, Jr. 10,000 shares Milan M. Radonich 10,000 shares
Other Options. Effective December 28, 2001, S. Hubert Humphrey, Jr. retired from his positions as a Director and Chairman of our Board of Directors and as our Chief Executive Officer. He also retired from his positions with Global Preferred Re as a Director, Chairman of the Board of Directors and Chief Executive Officer. In recognition of Mr. Humphrey's years of service, we agreed to grant to Mr. Humphrey options to purchase 100,000 shares of common stock upon successful completion of a firm commitment, underwritten registered public offering of the common stock by December 31, 2003. The options are exercisable for a period of five years from the date of grant at an exercise price equal to the initial offering price of shares sold in the underwritten offering. EMPLOYMENT AGREEMENTS Edward F. McKernan is employed by us pursuant to a written employment agreement. Mr. McKernan's employment agreement has an initial term of three years beginning January 1, 2002 and is automatically renewed for additional one-year periods unless either party provides written notice of termination at least 60 days in advance of the expiration date of the current term. Mr. McKernan will receive a base salary of $325,000 for the year ended December 31, 2002, plus options to purchase 75,000 shares of common stock, to be granted upon completion of an underwritten registered public offering of our common stock. Mr. McKernan is eligible for an annual bonus in an amount to be determined by the board of directors. If, within 90 days of a change of control of Global Preferred, Mr. McKernan resigns for good reason, as defined in the agreement, or is terminated without cause, we will pay him an amount equal to 35 months of his then-current base salary over a twelve month period or in one lump sum payment. Upon Mr. McKernan's resignation for good reason or termination not for cause unrelated to a change of control, we will pay his base salary for the greater of twelve months or the number of months remaining on his employment agreement, not to exceed 24 months. Mr. McKernan's employment agreement includes post-employment restrictive covenants not to solicit our customers or recruit our employees. Bradley E. Barks is employed by us pursuant to a written employment agreement. Mr. Barks' employment agreement has an initial term from March 4, 2002 through February 28, 2003 and is renewable by agreement of the parties for additional one-year periods. Mr. Barks will receive a base salary of $250,000 for the initial term, plus options to purchase 20,000 shares of common stock, to be granted upon completion of an underwritten registered public offering of our common stock. Global Preferred paid Mr. Barks a signing bonus of $9,200 and has agreed to pay $59,450 towards Mr. Barks' relocation expenses and up to six months of actual rental costs for temporary housing prior to his relocation. Mr. Barks is eligible for an annual bonus in an amount to be determined by the board of directors. If Mr. Barks resigns 7 for good reason, as defined in the agreement, or is terminated without cause, we will pay him an amount equal to three months of his base salary if he is terminated prior to completion of an underwritten offering or twelve months of his then-current base salary if he is terminated after completion of an underwritten offering. Mr. Barks' employment agreement includes post-employment restrictive covenants not to solicit our customers or recruit our employees. Caryl P. Shepherd is employed by us pursuant to a written employment agreement. Ms. Shepherd's employment agreement has an initial term from February 1, 2002 through January 31, 2003 and is renewable by agreement of the parties for additional one-year periods. Ms. Shepherd will receive a base salary of $100,000 for the initial term, plus options to purchase 30,000 shares of common stock to be granted upon completion of an underwritten registered public offering of our common stock. Ms. Shepherd is eligible for an annual bonus in an amount to be determined by the board of directors. Upon Ms. Shepherd's resignation for good reason, as defined in the agreement, or termination not for cause, we will pay her base salary for twelve months. Ms. Shepherd's employment agreement includes post-employment restrictive covenants not to solicit our customers or recruit our employees. Thomas Bobowski is employed by us pursuant to a written employment agreement. Mr. Bobowski's employment agreement has an initial term from March 4, 2002 through February 28, 2003 and is renewable by agreement of the parties for additional one-year periods. Mr. Bobowski will receive a base salary of $122,000 for the initial term, plus options to purchase 12,500 shares of common stock to be granted upon completion of an underwritten registered public offering of our common stock. Mr. Bobowski is eligible for an annual bonus in an amount to be determined by the board of directors. Upon Mr. Bobowski's resignation for good reason, as defined in the agreement, or termination not for cause, we will pay his base salary for three months. For each month of Mr. Bobowski's employment over three months, his separation payment upon resignation for good reason or termination without cause will be increased by one month, with a maximum payment equal to twelve months his base salary. Mr. Bobowski employment agreement includes post-employment restrictive covenants not to solicit our customers or recruit our employees. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth certain information regarding the ownership of our common stock, as of March 31, 2002, by each of our directors, each of our executive officers named in the summary compensation table, each person known to us to own beneficially more than 5% of our outstanding common stock and all of our directors and executive officers as a group.
NUMBER OF SHARES BENEFICIALLY PERCENTAGE OF SHARES NAME OWNED(1) OUTSTANDING ---- ------------------- -------------------- S. Hubert Humphrey, Jr.(2)................................. 1,028,091 24.2% Monte Holm(3).............................................. 327,969 7.9% Money Services, Inc.(4).................................... 312,750 7.0% Richard L. Thawley(5)...................................... 305,632 7.4% Thomas W. Montgomery(6).................................... 54,862 1.3% Joseph F. Barone(7)........................................ 30,000 * C. Simon Scupham(8)........................................ 20,000 * Eugene M. Howerdd, Jr.(9).................................. 10,000 * Milan M. Radonich(10)...................................... 10,000 * Edward F. McKernan......................................... 7,500 * Caryl P. Shepherd.......................................... -- * All directors and executive officers as a group (9 persons)(11)............................................. 132,362 3.1%
8 --------------- * Less than one percent (1) For purposes of calculating the percentage beneficially owned, the number of shares deemed outstanding as of March 31, 2002 includes: (a) 4,141,684 shares of common stock outstanding as of March 31, 2002; and (b) shares issuable pursuant to options held by the respective person or group which may be exercised within 60 days following March 31, 2002 ("Presently Exercisable Options"). Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission that deem shares to be beneficially owned by any person or group who has or shares voting and investment power with respect to such shares. Presently Exercisable Options are deemed to be outstanding and beneficially owned by the person or group holding such options for the purpose of computing the percentage ownership of such person or group but are not treated as outstanding for the purpose of computing the percentage ownership of any other person or group. (2) This number includes: (a) 78,092 shares of common stock for which WMA Agency (of which Mr. Humphrey is the principal stockholder) holds voting proxies; and (b) options to purchase 100,000 shares of common stock exercisable within 60 days subject to the successful completion of an underwritten registered public offering of our common stock by December 31, 2003. Mr. Humphrey's business address is 3975 Johns Creek Ct., Suite 100, Suwanee, Georgia 30024. (3) This number includes (a) 60,000 shares held jointly with Mr. Holm's wife; (b) 2,250 shares held jointly with Mr. Steve Marx; and (c) 165,000 shares held in seven trusts created by Mr. Holm and his wife. Mr. Holm's business address is 312 W. Mesquite Blvd., Suite 11, Las Vegas, Nevada 89102. (4) This number includes 312,750 shares of common stock issuable on conversion of a $5.0 million convertible promissory note held by Money Services, Inc. that is immediately convertible. Money Services, Inc. is a wholly owned subsidiary of AEGON USA, Inc., with an address of 4333 Edgewood Road, N.E., Cedar Rapids, Iowa 52499. AEGON USA, Inc. is a subsidiary of AEGON N.V., an international insurance holding company that is publicly traded on the New York Stock Exchange. (5) This number includes (a) 137,700 shares owned by two trusts for the benefit of Mr. Thawley and his wife and (b) 30,000 shares owned by Mr. Thawley's children. Mr. Thawley's business address is 1110 W. Kettleman Lane, Suite 24, Lodi, California 95240. (6) This number includes options to purchase 35,000 shares of common stock exercisable within 60 days, subject to the successful completion of an underwritten registered public offering of our common stock by December 31, 2003. (7) This number includes options to purchase 30,000 shares of common stock exercisable within 60 days, subject to the successful completion of an underwritten registered public offering of our common stock by December 31, 2003. (8) This number includes options to purchase 20,000 shares of common stock exercisable within 60 days, subject to the successful completion of an underwritten registered public offering of our common stock by December 31, 2003. (9) This number includes options to purchase 10,000 shares of common stock exercisable within 60 days, subject to the successful completion of an underwritten registered public offering of our common stock by December 31, 2003. (10) This number includes options to purchase 10,000 shares of common stock exercisable within 60 days, subject to the successful completion of an underwritten registered public offering of our common stock by December 31, 2003. (11) This number includes options to purchase 105,000 shares of common stock exercisable within 60 days, subject to the successful completion of an underwritten registered public offering of our common stock by December 31, 2003. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The following sections discuss various transactions and relationships between us and parties affiliated or related to us. We believe that each of our transactions with related parties are on terms as favorable to us as could have been obtained from unrelated third parties. 9 AGREEMENTS WITH MONEY SERVICES, INC. AND ITS AFFILIATES We issued a $5.0 million convertible note, due July 29, 2004, to Money Services, Inc., a subsidiary of AEGON USA, Inc. The note bears simple interest at a rate of 7.5% per year and is currently convertible into 312,750 shares of our common stock. If Money Services were to convert the note, it would own approximately 7% of our outstanding common stock. We have the option to redeem the note, in whole or in part, between July 29, 2002 and July 29, 2004. To redeem the note before maturity, we must pay all principal, plus interest accrued from the date of the note through the redemption date at a higher effective interest rate of 9% per annum. We have four separate reinsurance agreements with Western Reserve Assurance Co. of Ohio ("Western Reserve") that cover policies on Western Reserve variable universal life and variable annuity policies issued on or after various dates after January 1, 1992 which were sold by the agents of World Financial Group, Inc. and its predecessor, WMA Agency. Also in June 2001, we entered into the First Right Agreement with Western Reserve. The First Right Agreement provides us the right to reinsure certain policies issued by Western Reserve or its U.S. affiliates which are sold by agents associated with World Financial Group. We entered into a agreement with World Financial Group which requires that World Financial Group will use its commercially reasonable efforts to assist us in attaining the opportunity to reinsure all insurance products sold by its agents for insurance companies with which it has selling agreements, other than Western Reserve and Western Reserve's affiliates. The life insurance companies with which we have reinsurance agreements pay commissions to the agents of World Financial Group for sales of life insurance and annuity contracts reinsured by us. As a result of such relationships, the interests of World Financial Group may conflict with our interests in negotiating reinsurance agreements. We are currently tenants-at-will in approximately 2,100 square feet of office space in Duluth, Georgia. Western Reserve is the landlord on the space that we occupy. As tenants-at-will our landlord is required by law to provide us 60-days notice to vacate. Our monthly rent is $3,482, plus our proportionate share of the taxes. After its acquisition of certain of the assets of WMA Agency, World Financial Group continued to provide the services which WMA Agency provided to us under the Corporate Services Agreement described under "Relationship with our Former Chairman" below. We incurred $22,882 of costs for these services from World Financial Group for the year ended December 31, 2001. Effective January 1, 2002, World Financial Group provides these services to us as invoiced on a monthly basis. Each of World Financial Group, Inc. and Western Reserve are subsidiaries of AEGON USA, Inc. and therefore are entities related to Money Services due to the common ownership. Due to the relationships among us, World Financial Group, Western Reserve, Money Services and AEGON USA, conflicts of interest may arise with respect to existing and future business dealings, including: - The terms of World Financial Group's selling agreements (including commission arrangements) and our reinsurance relationships with life insurance companies; - Agreements among us, World Financial Group, Western Reserve, Money Services, AEGON USA and their affiliates; - Potential acquisitions of properties or businesses; - Potential divestitures of properties or businesses; and - The issuance of additional securities by us. 10 MANAGEMENT AGREEMENT Global Preferred has an insurance management agreement with CFM Insurance Managers Ltd., a member of the Mutual Risk Management Ltd. group of companies, which provides professional insurance management services to companies operating in Bermuda. C. Simon Scupham, a director of our company and of Global Preferred Re, is the Chairman of CFM. Pursuant to this agreement, CFM acts as the managing agent and principal representative under the Bermuda Insurance Act 1978 for Global Preferred Re. This agreement is for an unlimited duration, but may be terminated by either party upon three months prior written notice or upon 30 days prior written notice under specified circumstances. We paid annual fees of $60,000 during 1999, 2000 and 2001 to CFM pursuant to the management agreement. RELATIONSHIP WITH OUR FORMER CHAIRMAN S. Hubert Humphrey, Jr. owns more than 20% of our outstanding capital stock and, until December 28, 2001, served as a director, Chairman of our board of directors and Chief Executive Officer and as a director, Chairman of the board of directors and Chief Executive Officer of Global Preferred Re. Effective December 28, 2001, Mr. Humphrey retired from our board of directors and all of the positions he held with us and with Global Preferred Re. In recognition of Mr. Humphrey's years of service, we agreed to grant to Mr. Humphrey, upon successful completion of an underwritten registered public offering of our common stock, options to purchase 100,000 shares of common stock. The options are exercisable for a period of five years from the date of grant, at an exercise price equal to the initial offering price of shares sold in an underwritten offering. Mr. Humphrey controls WMA Agency and WMA Securities. Effective April 1, 1998, we entered into a Corporate Services Agreement with WMA Agency to provide to us corporate services and supplies for a fixed monthly fee of $2,250, adjustable annually. These services included our computer network system, facilities maintenance, security, mail services, utilities, postage, telephone and copier service. We incurred $48,851, $48,922 and $23,616 of costs for these services from WMA Agency for the years ended December 31, 1999, 2000 and 2001, respectively. In June 1998, we entered into a Directed Reinsurance Agreement with WMA Agency, under which WMA Agency agreed to use its best efforts to cause any life insurance company with which it had selling agreements to enter reinsurance agreements with us. In 1999, we amended the agreement to provide, among other things, that we would issue, for no monetary consideration, warrants to individuals designated by WMA Agency to purchase 300,000 shares of the common stock. These warrants were ultimately issued to key management personnel of WMA Agency. As subsequently amended, the warrants were contingent upon our raising additional capital by January 1, 2002. We raised no new capital by January 1, 2002 and the warrants expired. No shares of our common stock were issued under these warrants. In January 1998, we entered into a Sublease Agreement with WMA Agency for our office space in Duluth, Georgia. The sublease was on a triple-net basis for an initial term through January 2008. The annual base rent until January 2003 was $18,675. The sublease was terminated in June 2001 in conjunction with the purchase by World Financial Group of assets of WMA Agency. 11 SIGNATURES Pursuant to the requirements of Section 13 of 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Duluth, State of Georgia, on April 30, 2002. GLOBAL PREFERRED HOLDINGS, INC. By: /s/ EDWARD F. MCKERNAN ------------------------------------ Edward F. McKernan President and Chief Executive Officer Dated: April 30, 2002 12 GLOBAL PREFERRED HOLDINGS, INC. INDEX TO FINANCIAL STATEMENTS
PAGE ---- FINANCIAL STATEMENTS: Independent Auditors' Report................................ F-2 Consolidated Balance Sheets as of December 31, 2000 and 2001...................................................... F-3 Consolidated Statements of Income for the Years Ended December 31, 1999, 2000 and 2001.......................... F-4 Consolidated Statements of Stockholders' Equity and Comprehensive Income for the Years Ended December 31, 1999, 2000 and 2001....................................... F-5 Consolidated Statements of Cash Flows for the Years Ended December 31, 1999, 2000 and 2001.......................... F-6 Notes to Consolidated Financial Statements.................. F-7
F-1 INDEPENDENT AUDITORS' REPORT The Board of Directors Global Preferred Holdings, Inc.: We have audited the accompanying consolidated balance sheets of Global Preferred Holdings, Inc. and subsidiaries (formerly known as The WMA Corporation) as of December 31, 2000 and 2001, and the related consolidated statements of income, stockholders' equity and comprehensive income and cash flows for each of the years in the three-year period ended December 31, 2001. These consolidated financial statements are the responsibility of Global Preferred's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Global Preferred Holdings, Inc. and subsidiaries as of December 31, 2000 and 2001, and the results of their operations and their cash flows, for each of the years in the three-year period ended December 31, 2001 in conformity with accounting principles generally accepted in the United States of America. KPMG LLP Atlanta, Georgia March 8, 2002 F-2 GLOBAL PREFERRED HOLDINGS, INC. Consolidated Balance Sheets
YEARS ENDED DECEMBER 31, ------------------------- 2000 2001 ----------- ----------- Assets Fixed maturity securities -- available for sale (amortized cost of $5,817,900 and $11,480,749 for 2000 and 2001, respectively)............................................. $ 5,912,379 $12,214,279 Cash and cash equivalents................................... 4,259,153 8,062,110 Investment income due and accrued........................... 113,558 172,055 Reinsurance balances receivable............................. 2,632,949 2,842,908 Reinsured policy loans...................................... 867,023 1,013,629 Deferred acquisition costs.................................. 42,752,339 42,800,269 Prepaid expenses............................................ 31,210 659,538 Fixed assets (net of accumulated depreciation of $102,992 and $147,750 for 2000 and 2001, respectively)............. 48,806 88,114 ----------- ----------- Total assets...................................... $56,617,417 $67,852,902 =========== =========== Liabilities and Stockholders' Equity Liabilities: Future policy benefits.................................... $ 8,025,748 $11,911,532 Reinsurance balances payable.............................. 388,016 188,818 Accrued expenses and accounts payable..................... 140,118 544,683 Accrued interest payable.................................. 161,356 158,219 Dividend payable.......................................... 12,245 -- Current income tax payable................................ 405,431 413,299 Short term debt........................................... 277,285 -- Long term debt............................................ 5,000,000 5,000,000 Deferred tax liability.................................... 5,618,285 7,667,767 ----------- ----------- Total liabilities................................. 20,028,484 25,884,318 ----------- ----------- Stockholders' equity: Preferred stock, par value $2.00, 10,000,000 shares authorized; Series A Preferred Stock, 1,000,000 shares authorized; 266,047 shares issued for 2000 and 2001.... 532,094 532,094 Common stock, par value $.001, 50,000,000 shares authorized; 2,500,000 shares and 3,750,000 shares issued for 2000 and 2001, respectively................. 2,500 3,750 Additional paid-in capital................................ 22,795,581 22,794,331 Accumulated other comprehensive income.................... 62,357 246,531 Retained earnings......................................... 13,246,301 18,441,145 Treasury stock, at cost (7,485 shares and 7,390 shares for 2000 and 2001, respectively)........................... (49,900) (49,267) ----------- ----------- Total stockholders' equity........................ 36,588,933 41,968,584 ----------- ----------- Total liabilities and stockholders' equity.................. $56,617,417 $67,852,902 =========== ===========
See accompanying notes to consolidated financial statements. F-3 GLOBAL PREFERRED HOLDINGS, INC. Consolidated Statements of Income
YEARS ENDED DECEMBER 31, --------------------------------------- 1999 2000 2001 ----------- ----------- ----------- Revenues: Premiums............................................ $ 9,692,649 $16,618,927 $19,240,551 Reinsured policy revenues........................... 13,505,823 12,893,664 11,237,610 Net investment income............................... 349,683 527,613 810,544 Net realized gain (loss) on investments............. (66,000) 2,606 44,807 Loss on recapture of business....................... (822,814) -- -- ----------- ----------- ----------- Total revenue.................................... 22,659,341 30,042,810 31,333,512 ----------- ----------- ----------- Benefits and expenses: Benefits, claims and settlement expenses............ 4,511,469 7,559,164 6,292,392 Change in future policy benefits.................... 313,679 2,052,733 2,411,335 Reinsurance expense allowances, net................. 5,362,263 7,539,492 8,501,197 Amortization of deferred acquisition costs.......... 3,789,318 4,016,629 3,944,660 Operating expenses.................................. 983,148 1,256,080 1,951,634 Interest expense.................................... 1,153,958 665,119 378,145 ----------- ----------- ----------- Total benefits and expenses...................... 16,113,835 23,089,217 23,479,363 ----------- ----------- ----------- Income before income tax......................... 6,545,506 6,953,593 7,854,149 Income tax expense.................................. (2,225,472) (1,820,717) (2,391,568) ----------- ----------- ----------- Net income....................................... $ 4,320,034 $ 5,132,876 $ 5,462,581 ----------- ----------- ----------- Preferred dividends................................. -- 155,198 267,104 ----------- ----------- ----------- Net income available to common stockholders...... $ 4,320,034 $ 4,977,678 $ 5,195,477 =========== =========== =========== Basic earnings per share.............................. $ 1.15 $ 1.33 $ 1.39 =========== =========== =========== Diluted earnings per share............................ $ 1.15 $ 1.30 $ 1.32 =========== =========== =========== Weighted average common shares outstanding............ 3,742,610 3,742,610 3,742,610 =========== =========== =========== Total weighted average common and common equivalent shares outstanding.................................. 3,742,610 3,943,897 4,141,684 =========== =========== ===========
See accompanying notes to consolidated financial statements. F-4 GLOBAL PREFERRED HOLDINGS, INC. Consolidated Statements of Stockholders' Equity and Comprehensive Income Years ended December 31, 1999, 2000, and 2001
ACCUMULATED NUMBER OF NUMBER OF ADDITIONAL OTHER PREFERRED PREFERRED COMMON COMMON PAID-IN COMPREHENSIVE RETAINED SHARES STOCK SHARES STOCK CAPITAL INCOME (LOSS) EARNINGS --------- --------- --------- ------- ----------- ------------- ----------- Balance, January 1, 1999........... -- $ -- 2,500,000 $2,500 $20,228,973 $ 242,977 $ 3,948,589 Comprehensive income............. Net income....................... 4,320,034 Other comprehensive loss, net of tax.............................. -- -- -- -- -- (285,529) -- ------- -------- --------- ------ ----------- --------- ----------- Total comprehensive income....... Balance, December 31, 1999......... -- -- 2,500,000 2,500 20,228,973 (42,552) 8,268,623 Comprehensive income Net income....................... 5,132,876 Other comprehensive income, net of tax.............................. 104,909 Total comprehensive income....... Preferred stock issued............. 266,047 532,094 2,566,608 Preferred dividends................ -- -- -- -- -- -- (155,198) ------- -------- --------- ------ ----------- --------- ----------- Balance, December 31, 2000......... 266,047 532,094 2,500,000 2,500 22,795,581 62,357 $13,246,301 Comprehensive income Net income....................... 5,462,581 Other comprehensive income, net of tax....................... 184,174 Total comprehensive income....... Three-for-two stock split.......... 1,250,000 1,250 (1,250) Preferred dividends................ (267,104) Treasury stock reissued (95 shares).......................... -- -- -- -- -- -- (633) ------- -------- --------- ------ ----------- --------- ----------- Balance, December 31, 2001......... 266,047 $532,094 3,750,000 $3,750 $22,794,331 $ 246,531 $18,441,145 ======= ======== ========= ====== =========== ========= =========== TOTAL TREASURY STOCKHOLDERS COMPREHENSIVE STOCK EQUITY INCOME -------- ------------ ------------- Balance, January 1, 1999........... $(49,900) $24,373,139 Comprehensive income............. Net income....................... 4,320,034 $4,320,034 Other comprehensive loss, net of tax.............................. -- (285,529) (285,529) -------- ----------- ---------- Total comprehensive income....... $4,034,505 ========== Balance, December 31, 1999......... (49,900) 28,407,644 Comprehensive income Net income....................... 5,132,876 $5,132,876 Other comprehensive income, net of tax.............................. 104,909 104,909 ---------- Total comprehensive income....... $5,237,785 ========== Preferred stock issued............. 3,098,702 Preferred dividends................ -- (155,198) -------- ----------- Balance, December 31, 2000......... (49,900) $36,588,933 Comprehensive income Net income....................... 5,462,581 $5,462,581 Other comprehensive income, net of tax....................... 184,174 184,174 ---------- Total comprehensive income....... $5,646,755 ========== Three-for-two stock split.......... Preferred dividends................ (267,104) Treasury stock reissued (95 shares).......................... 633 -- -------- ----------- Balance, December 31, 2001......... $(49,267) $41,968,584 ======== ===========
See accompanying notes to consolidated financial statements. F-5 GLOBAL PREFERRED HOLDINGS, INC. Consolidated Statements of Cash Flows
YEARS ENDED DECEMBER 31, ---------------------------------------- 1999 2000 2001 ------------ ----------- ----------- Cash flows from operating activities: Net income................................................ $ 4,320,034 $ 5,132,876 $ 5,462,581 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Amortization and depreciation........................... 3,924,990 4,064,604 3,989,418 Deferred tax expense.................................... 2,225,472 1,304,642 1,954,605 Net realized (gain) loss on investments................. 66,000 (2,606) (44,807) Loss on recapture of business........................... 822,814 -- -- Change in: Investment income due and accrued....................... 116,753 (94,115) (58,497) Reinsurance balances receivable......................... (1,944,005) 352,989 (209,959) Reinsured policy loans.................................. (283,265) (580,060) (146,606) Deferred acquisition costs.............................. (36,612,052) (7,018,868) (3,992,590) Prepaid expenses........................................ (130,148) 315,684 (628,328) Other assets............................................ 183,317 -- -- Future policy benefits.................................. 2,651,956 3,530,962 3,885,784 Reinsurance balances payable............................ 13,398,265 (328,314) (199,198) Accrued expenses and accounts payable................... (16,090) (20,022) 404,565 Accrued interest payable................................ 564,690 (504,433) (3,137) Current income tax payable.............................. -- 405,431 7,868 ------------ ----------- ----------- Net cash provided by (used in) operating activities... (10,711,269) 6,558,770 10,421,699 ------------ ----------- ----------- Cash flows from investing activities: Proceeds from sale of available for sale securities....... 6,924,903 194,856 1,674,272 Proceeds from maturities and principal payments on mortgage-backed securities of available for sale securities.............................................. 391,924 127,730 474,925 Purchase of available-for-sale securities................. -- (4,019,176) (8,127,239) Purchase of fixed assets.................................. (50,880) (8,449) (84,066) ------------ ----------- ----------- Net cash provided by (used in) investing activities... 7,265,947 (3,705,039) (6,062,108) ------------ ----------- ----------- Cash flows from financing activities: Issuance of preferred stock............................... -- 3,098,702 -- Preferred dividends....................................... -- (142,953) (279,349) Purchase of treasury stock and warrants................... -- -- -- Proceeds from short term debt............................. -- -- (277,285) Proceeds from (repayment of) long term debt............... 5,000,000 (5,026,277) -- Decrease in principal due on short term debt.............. (4,696,438) -- -- ------------ ----------- ----------- Net cash provided by (used in) financing activities... 303,562 (2,070,528) (556,634) ------------ ----------- ----------- Net increase (decrease) in cash and cash equivalents......................................... (3,141,760) 783,203 3,802,957 Cash and cash equivalents at beginning of period............ 6,617,710 3,475,950 4,259,153 ------------ ----------- ----------- Cash and cash equivalents at end of period.................. $ 3,475,950 $ 4,259,153 $ 8,062,110 ============ =========== =========== Supplemental disclosure of cash flow information: Interest paid............................................. $ -- $ 1,169,552 $ 381,282 ============ =========== =========== Income taxes paid......................................... $ -- $ 110,644 $ 429,095 ============ =========== =========== Change in preferred dividend accrual...................... $ -- $ 12,245 $ (12,245) ============ =========== =========== Recapture of reinsurance business: Reduction of deferred acquisition costs................. $ 20,610,500 -- -- Reduction of reinsured policy loans..................... 41,804 -- -- Increase in reinsurance balances receivable............. (940,898) -- -- Reduction of future policy benefits..................... (781,190) -- -- Reduction of reinsurance balances payable............... (18,107,402) -- -- ------------ ----------- ----------- Loss on recapture of business........................... $ 822,814 -- -- ============ =========== =========== Non-cash financing activities: Treasury shares issued for stock split fractional shares................................................ -- -- 95 ============ =========== ===========
See accompanying notes to consolidated financial statements. F-6 GLOBAL PREFERRED HOLDINGS, INC. Notes to Consolidated Financial Statements December 31, 1999, 2000 and 2001 1. ORGANIZATION Global Preferred Holdings, Inc. (formerly known as The WMA Corporation) was formed March 9, 1995 as an insurance holding company. The consolidated financial statements include the assets, liabilities, and results of operations of Global Preferred Holdings, Inc. ("Global Preferred") and its wholly-owned subsidiary, Global Preferred Re Limited (formerly known as WMA Life Insurance Company Limited), a Bermuda company registered as a long-term insurer under the Bermuda Insurance Act 1978 ("Global Preferred Re" together with Global Preferred shall be referred to collectively as "Global Preferred" unless the context otherwise requires or otherwise as expressly stated). Global Preferred, through its subsidiary, Global Preferred Re, provides reinsurance for variable universal life insurance and variable annuity products. Historically, Global Preferred's reinsurance business has been based on its relationship with the independent agents of World Financial Group, Inc., which is an independent marketing organization ("IMO") that markets the products Global Preferred Re currently reinsures. World Financial Group is an indirect subsidiary of AEGON USA, Inc. An independent marketing organization is an organization of independent agents that contracts with one or more insurance companies to distribute and market securities and insurance products. The foundation for Global Preferred's relationship with the agents associated with World Financial Group is the equity participation that many of them have in Global Preferred. Reinsurance is an arrangement under which an insurance company (the "reinsurer") agrees to indemnify another insurance company (the "ceding life company") for all or a portion of the insurance risks underwritten by the ceding life company. The reinsurer, in turn, assumes a portion of the underwritten risk in exchange for a portion of the premium collected. Global Preferred currently assumes portions of mortality and other risks relating to variable universal life insurance and variable annuity policies in order to share in the net profits generated through the sale of such policies by the independent registered agents associated with World Financial Group. To date, all life insurance and annuity policies reinsured by Global Preferred have been sold by the agents associated with World Financial Group who, until June 2001, were associated with World Marketing Alliance, Inc. ("WMA Agency"). In June 2001, World Financial Group acquired certain assets of WMA Agency. As a result of the acquisition, substantially all of the agents became associated with World Financial Group. Global Preferred has been informed that World Group Securities, Inc., the broker-dealer affiliated with World Financial Group, is in the process of obtaining approval for the transfer of the securities licenses of agents from WMA Securities, Inc., the broker-dealer affiliated with WMA Agency. Global Preferred understands that the formation of World Group Securities and its business plan have been approved by the National Association of Securities Dealers and World Group Securities is awaiting state regulatory approvals. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Consolidation and Basis of Presentation. The consolidated financial statements of Global Preferred have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the reported amounts of revenues and expenses during the reporting period. Accounts that Global Preferred deems to be sensitive to changes in estimates include deferred acquisition costs and future policy benefits. In all instances, actual results could differ from estimates. F-7 The accompanying financial statements consolidate the accounts of Global Preferred and its subsidiary. All significant inter-company balances and transactions have been eliminated. Investments. Global Preferred classifies all fixed maturity securities and equity securities as "available for sale" and accordingly, such securities are reported at fair value. Fixed maturity securities available for sale are so classified based upon the possibility that such securities could be sold prior to maturity if that action enables Global Preferred to execute its investment philosophy and appropriately match investment results to operating and liquidity needs. Unrealized gains and losses on marketable equity securities and fixed maturity securities available for sale, less applicable deferred income taxes, are reported as a separate component of accumulated other comprehensive income within stockholders' equity. Global Preferred's policy is to reflect an other-than-temporary impairment in securities when the fair value of these securities is lower than the cost basis for an extended period of time. Any such impairment identified would result in a write-down of the cost basis of the individual security to its fair value to establish a new cost basis and to reflect a realized capital loss in the consolidated statements of income. No impairments in value have occurred which would require Global Preferred to make such an adjustment. Investment income is recognized as it accrues or is legally due. Income on mortgage-backed securities includes amortization and accretion of purchase premiums and discounts using a method that approximates a level yield, taking into consideration assumed prepayment patterns. The retrospective adjustment method is used to adjust for prepayment activity. Realized gains and losses on investments using the specific identification method are included in income. Fair Value Disclosure. The carrying values of cash and cash equivalents, reinsurance receivables and payables, short-term debt, accrued expenses and accounts payable approximate their fair values due to the short-term nature of these accounts. Taking into consideration the basis of reinsurance under the reinsurance agreements, the carrying value of future policy benefits approximates its fair value. See Note 3 for fair value information covering Global Preferred's investment portfolio. Cash and Cash Equivalents. Cash and cash equivalents include cash on hand and on deposit purchased with an original maturity of three months or less. Deferred Acquisition Costs. Costs of acquiring new business, which vary with and are primarily related to the production of new business, have been deferred to the extent that such costs are deemed recoverable from future revenues. Such costs include reinsurance commission and expense allowances paid to ceding life companies, and certain other underwriting costs, including actuarial, legal and accounting fees. Deferred acquisition costs are amortized over the lives of the underlying policies with regard to the terms of the reinsurance agreement. On those policies reinsured under a monthly renewable term agreement, deferred acquisition costs are amortized in proportion to the premium revenue related to the mortality risk reinsured. Such premium revenue is estimated using the same assumptions used for computing liabilities for future policy benefits. Such assumptions include estimates of expected investment yields, mortality, persistency and expenses applicable at the time the policies are reinsured. Original assumptions on monthly renewable term business continue to be used in subsequent accounting periods to determine changes in the deferred acquisition costs unless a premium deficiency exists. Under the renewable term agreements, the rate of amortization depends on the approach utilized, static or dynamic. Under the static approach, the amortization is in proportion to the ratio of premiums collected during the then current period to total anticipated premiums. Often the static approach is used in the first policy year or until the business is sufficiently large to warrant the complexity of the dynamic approach. Under the dynamic approach, the amortization under the static approach is adjusted to reflect actual persistency of the insurance in effect. Currently, we use the dynamic amortization approach for all our policies reinsured under our renewable term agreements. For policies reinsured under a coinsurance or modified coinsurance agreement, deferred acquisition costs are amortized in proportion to the expected gross profits associated with mortality charges, investment margins, surrender charges and expense loads reinsured. Management periodically reviews F-8 Global Preferred's assumptions concerning future experience with regard to mortality, persistency, investment yields and expenses in determining its estimates of future gross profits. Upon adoption of any change in assumptions used with regard to future experience, the amortization of Global Preferred's deferred acquisition costs will be recalculated and will be reflected during the then current accounting period. Reinsurance Expense Allowances. Allowances generally represent a percentage of each reinsurance premium that is paid or allowed by Global Preferred to the ceding life company for each policy reinsured in recognition of commissions and other expenses associated with the reinsured policies. These other expenses relate to costs associated with underwriting, marketing, policy issue and maintenance. The reinsurance expense allowances represent Global Preferred's share of acquisition and maintenance expenses incurred by the ceding life company that are attributable to the risks reinsured. Allowances are shown net of amounts deferred as policy acquisition costs. Fixed Assets. Fixed assets are stated at cost less accumulated depreciation. Depreciation is calculated on the straight-line basis over the estimated useful lives of the related assets, which range from three to seven years. Future Policy Benefits. Liabilities for future benefits on life policies are established in an amount believed to be adequate to meet the estimated future obligations on policies in force. Liabilities for future policy benefits under long-term life insurance policies have been computed based on estimates of investment yields, mortality and withdrawal rates expected at the time the policies are reinsured, and other assumptions including estimates for incurred but not reported claims. These assumptions include a margin for adverse deviation and vary with the characteristics of the plan of insurance, year of issue, age of insured and other appropriate factors. The assumptions for estimated investment yields are based upon various factors including then current yields on Global Preferred's investment portfolio and market rates for new investments. Interest rates used in estimating future policy benefits range from 5.5% to 7.0%. The mortality and withdrawal assumptions are based on Global Preferred's experience, industry experience and industry standards. Policy and contract reserves are included in future policy benefits on the consolidated balance sheets. Liabilities for future policy benefits under the coinsurance and modified coinsurance agreements equal reinsured policy account balances on the underlying variable universal life policies and variable annuity contracts. With regard to the separate account benefits reinsured on a modified coinsurance basis, Global Preferred records such liabilities as an offset to related assets as its intentions and rights under the agreements with the ceding life companies meet the appropriate conditions governing rights of setoff. The nature of separate account benefits do not permit Global Preferred to reinsure those benefits on a coinsurance basis. Global Preferred currently reinsures the fixed account portion of variable annuity contracts and variable universal life policies only on a coinsurance basis and, accordingly, the liabilities for that portion of the reinsurance are recorded as future policy benefits. Income Taxes. Global Preferred uses the asset and liability method to record deferred income taxes. Accordingly, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, using an effective federal tax rate of 34%. Statement of Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes specifically excludes recognition of the "small life insurance company deduction" available under Section 806 of the Internal Revenue Code for qualifying life insurance companies. This special deduction can reduce the effective federal income tax rate from 34% to less than 20% depending upon the amount of taxable income. Consequently, the effective tax rate on Global Preferred's earnings may ultimately prove to be less than the deferred income tax liabilities and related expenses determined under SFAS No. 109, at December 31, 2001. Recognition of Revenues and Related Expenses. Reinsurance premiums received under the monthly renewable term agreements are recognized as revenue over the premium paying periods of the reinsured policies. Benefits and expenses are associated with earned premiums so that profits are recognized over the life of the related contract. This association is accomplished through the provision for future policy benefits F-9 and the amortization of deferred acquisition costs. Other revenue consists of non-recurring items other than reinsurance premiums or investment earnings and is recognized upon completion of the related earnings process. Reinsured Policy Revenues. Reinsured policy revenues are recognized as earned and represent the policy mortality and expense charges, cost of insurance charges net of retrocession reinsurance premiums, policy administration charges, asset-based allowances and deferred sales charges that have been assessed against the reinsured policy account balances under the coinsurance and modified coinsurance agreements, as they relate to variable universal life and variable annuity contracts. Earnings Per Share. Basic earnings per share is computed based on the weighted-average number of common shares outstanding during the period, in accordance with SFAS No. 128, Earnings Per Share. Shares of convertible preferred stock issued in June and July 2000 are included in the calculations of total weighted-average common and common equivalent shares outstanding. The dilution effect on earnings per share from the issuance of convertible preferred stock is shown on the consolidated statements of income. Common Stock. On July 12, 2001, the board of directors declared a three-for-two stock split in the form of a stock dividend, consisting of 1.25 million shares, payable to stockholders of record at the close of business on August 24, 2001. The stock split was distributed on September 7, 2001. Fractional shares were adjusted up to the next share using shares of treasury stock. 95 treasury shares were issued for the fractional shares. Share and per-share amounts have been retroactively adjusted to reflect the stock split on the consolidated statements of income. Stock Compensation Plans. Global Preferred applies Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations, in accounting for stock-based compensation plans. Global Preferred has adopted the disclosure-only provisions of SFAS No. 123, Accounting for Stock-Based Compensation. Recent Accounting Pronouncements. SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended and interpreted establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities on the balance sheet and measure those instruments at fair value. The accounting for changes in the fair value of a derivative will be included in either earnings or other comprehensive income depending on the intended use of the derivative instrument. The provisions of SFAS No. 133 did not have any impact on Global Preferred's financial statements. In September 2000, the Financial Accounting Standards Board ("FASB") issued SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities -- a replacement of FASB Statement No. 125. This statement revises the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures, not previously required under SFAS No. 125. The provisions of SFAS No. 140 did not have any impact on Global Preferred's financial statements. FASB issued four new accounting standards in 2001. SFAS No. 141, SFAS No. 142, SFAS No. 143 and SFAS No. 144 primarily address the accounting for goodwill, business combinations, and the impairment and disposition of long-lived assets. The adoption of these standards in 2002 is not expected to have a material impact on Global Preferred's financial statements. Reclassification. Global Preferred has reclassified the presentation of certain 1999 and 2000 information to conform to the 2001 presentation. F-10 3. INVESTMENTS Major categories of net investment income consist of the following:
YEARS ENDED DECEMBER 31, ------------------------------ 1999 2000 2001 -------- -------- -------- Fixed maturity securities................................... $361,830 $365,536 $718,583 Cash and cash equivalents................................... 59,431 230,200 147,447 -------- -------- -------- 421,261 595,736 866,030 Investment expenses......................................... (71,578) (68,123) (55,486) -------- -------- -------- Net investment income....................................... $349,683 $527,613 $810,544 ======== ======== ========
The amortized cost, unrealized gains and losses, and estimated fair values of fixed maturity securities at December 31, 2000 and 2001 are as follows:
AMORTIZED UNREALIZED UNREALIZED COST GAINS LOSSES FAIR VALUE ----------- ---------- ---------- ----------- 2000 Fixed maturity securities, available for sale: U.S. Government and government agencies........................ $ -- $ -- $ -- $ -- Corporate......................... 3,929,520 83,240 8,060 4,004,700 Asset-backed securities........... 874,058 7,799 1,400 880,457 Mortgage-backed securities........ 1,014,322 17,284 4,384 1,027,222 ----------- -------- ------- ----------- Total........................... $ 5,817,900 $108,323 $13,844 $ 5,912,379 =========== ======== ======= =========== 2001 Fixed maturity securities, available for sale: U.S. Government and government agencies........................ $ 209,704 $ 6,604 $ -- $ 216,308 Corporate......................... 7,158,877 279,551 3,930 7,434,498 Asset-backed securities........... 1,611,012 50,444 -- 1,661,456 Mortgage-backed securities........ 2,861,156 41,194 333 2,902,017 ----------- -------- ------- ----------- Total........................... $11,840,749 $377,793 $ 4,263 $12,214,279 =========== ======== ======= ===========
There were no investments in any entity in excess of 10% of stockholders' equity at December 31, 2001. Fixed maturity securities are valued based upon quoted market prices. At December 31, 2001, the contractual maturities of investments in fixed maturity securities were as follows:
AMORTIZED COST FAIR VALUE -------------- ----------- Available for sale: Due in one year or less......................... $ 598,405 $ 615,406 Due after one year through five years........... 6,570,310 6,825,383 Due after five years through ten years.......... 199,866 210,017 Asset-backed securities......................... 1,611,012 1,661,456 Mortgage-backed securities...................... 2,861,156 2,902,017 ----------- ----------- Total......................................... $11,840,749 $12,214,279 =========== ===========
Expected maturities will differ from contractual maturities because some issuers have the right to call or prepay obligations with or without call or prepayment penalties. F-11 Proceeds from sales of fixed maturity securities for the years ended December 31, 1999, 2000 and 2001, were $6,924,903, $194,856 and $1,674,272, respectively. Components of realized gains and losses are summarized in the following table:
1999 2000 2001 -------- ------ ------- Fixed maturity securities: Gross realized gains.................................... $ 27,267 $2,606 $47,180 Gross realized losses................................... (93,267) -- (2,373) -------- ------ ------- Net realized gain (loss) on investments............... $(66,000) $2,606 $44,807 ======== ====== =======
Changes in net unrealized gains (losses) were $(432,622), $158,953 and $279,051 for the years ended December 31, 1999, 2000 and 2001, respectively. 4. RECAPTURE OF BUSINESS In the first quarter of 1999, Global Preferred negotiated amendments to its coinsurance and modified coinsurance agreements with Western Reserve Assurance Co. of Ohio ("Western Reserve") in contemplation of completing a private offering of Global Preferred's stock begun in 1998. The amendments provided that: (1) Global Preferred could defer payment to Western Reserve of reinsurance expense allowances on new policies reinsured in 1999, until the earlier of the completion of its stock offering, or December 31, 1999; (2) a reinsurance fee at an effective rate of 9% per year accrued on the deferred payments; and (3) Western Reserve could recapture the reinsurance on the policies issued during 1999 if the expense allowances were not paid by December 31, 1999. As contemplated by the new amendments, payment by Global Preferred to Western Reserve of a portion of the reinsurance expense allowances on policies issued in 1999 was deferred pending the completion of Global Preferred's capital raising efforts in 1999. When the funding had not been completed by September 30, 1999, the reinsurance of all Financial Freedom Builder variable universal life policies and riders and 75% of the Freedom Wealth Creator variable annuity policies issued from January 1, 1999 through September 30, 1999 that had been entered into on a coinsurance and modified coinsurance basis was recaptured. These recapture rights exercised by Western Reserve in 1999 were created specifically to address the possibility that Global Preferred would not complete its contemplated capital raising in 1999. Concurrent with the recapture, Global Preferred began reinsuring, on a monthly renewable term basis, 20% of the Financial Freedom Builder variable universal life policies and riders issued by Western Reserve on or after January 1, 1999. Additionally, Global Preferred further amended its reinsurance agreements to reduce its quota share percentage on the reinsurance of the Western Reserve variable annuity business for 1999 and thereafter. However, Global Preferred retained the right to convert its monthly renewable term reinsurance of the variable universal life business to a coinsurance and modified coinsurance basis for all policies issued from January 1999 through March 2003 and the right to increase its quota share percentage of the reinsurance of Western Reserve variable annuity business. The general terms of Global Preferred's reinsurance agreements, including its agreements with Western Reserve, include only limited rights to recapture such as: after the passage of stated periods (ten years or more) from the policy issue date, upon determination, relative to some products, that the total volume of policies reinsured for the product is below a minimum threshold, upon default by Global Preferred and upon the insolvency of Global Preferred. Oftentimes, if a reinsurance agreement provides for early recapture based on criteria such as low product sales volume, then there may be a recapture allowance paid to the reinsurer to compensate for lost future revenues and profits associated with the recaptured policies. Receipt of the recapture allowance would result in an increase in revenues for the period. Similarly, any associated unamortized deferred acquisition cost would be written off in the same reporting period. The net effect of these amounts would then result in either a gain or a loss associated with the recaptured policies. The recapture of business during 1999 resulted in a loss of $822,814. Of the $822,814 loss, $556,304 related to the variable universal life coinsurance and modified coinsurance business, and is composed of F-12 $14.3 million in gross revenues due to Global Preferred for recapture allowances, net of $14.9 million in expenses from the amortization of the related deferred acquisition costs, and the release of the related policy reserve and reinsurance expense allowance accruals. The remaining loss of $266,510, related to the variable annuity coinsurance and modified coinsurance business, is composed of $5.7 million in gross revenues from recapture allowances, net of $5.9 million in expenses from the amortization of the related deferred acquisition costs. The loss on recapture of business included a reinsurance fee relating to the deferral of financial settlements due to Western Reserve during the period in which Global Preferred reinsured the underlying business. Such reinsurance fee in the amount of $722,858 was effectively offset by interest in the amount of $390,761 due to Global Preferred for amounts previously remitted to Western Reserve on business subsequently recaptured. 5. POLICY LIABILITIES Changes in the liability for unpaid policy claims are summarized as follows for the years ended December 31:
YEARS ENDED DECEMBER 31, ------------------------------------ 1999 2000 2001 ---------- ---------- ---------- Unpaid life claims -- January 1 ................. $1,109,567 $1,590,232 $2,119,151 ---------- ---------- ---------- Add claims incurred during the year related to: Current year................................... 4,030,903 7,118,899 6,577,441 Prior years.................................... 174,000 290,248 32,000 ---------- ---------- ---------- Total incurred(1)...................... 4,204,903 7,409,147 6,609,441 ---------- ---------- ---------- Less claims paid during the year: On claims incurred during current year......... 3,236,049 6,150,172 6,068,109 On claims incurred during prior years.......... 488,189 730,056 1,122,098 ---------- ---------- ---------- Total paid............................. 3,724,238 6,880,228 7,190,207 ---------- ---------- ---------- Unpaid life claims -- December 31................ $1,590,232 $2,119,151 $1,538,385 ========== ========== ==========
--------------- (1) Total incurred plus the change in the experience refund for the year equals the amount shown on the consolidated statements of income on line titled "Benefits, claims and settlement expenses." 6. REINSURANCE As of December 31, 2001, Global Preferred has seven reinsurance contracts and one retrocession agreement in place. All policies reinsured under the reinsurance agreements are self-administered by the ceding life companies. The ceding life companies provide Global Preferred with all information necessary for processing the reinsurance, including claims. On June 25, 2001, Global Preferred entered into a new reinsurance agreement with Pacific Life Insurance Company. The new agreement provides monthly renewable term reinsurance for certain individual life plans, including Pacific Life's Select Exec II variable universal life insurance policies, issued on or after January 1, 2001, which are sold by the registered agents associated with World Financial Group. Pursuant to agreements with Western Reserve, Global Preferred has the contractual right to prospectively increase the reinsurance percentages, up to a maximum ranging from 40% to 50%, on Western Reserve's Freedom Wealth Creator and Freedom Premier variable annuity policies which were issued from January 1, 1999 through December 31, 2002 and reinsured by Global Preferred. In order to exercise this contractual right, Global Preferred must demonstrate "sufficient capacity," which is defined as having unassigned invested securities and anticipated cash flows in a sufficient amount to meet expected reinsurance settlements for the ensuing two calendar years with regard to the increased reinsurance. The F-13 right to increase the reinsurance percentage for the variable annuity coinsurance and modified coinsurance expires on December 31, 2002. Pursuant to agreements with Western Reserve, Global Preferred also has the contractual right to convert its monthly renewable term reinsurance of the Financial Freedom Builder variable universal life policies and riders issued by Western Reserve from January 1, 1999 through March 31, 2003, to coinsurance and modified coinsurance, provided Global Preferred demonstrates sufficient capacity. The right to convert the monthly renewable term reinsurance to coinsurance and modified coinsurance expires on March 31, 2003. In 1998, Global Preferred entered into an agreement with WMA Agency under which WMA Agency agreed to use its best efforts to encourage life insurance companies to reinsure policies sold by its agents with Global Preferred. In conjunction with the acquisition of WMA Agency's assets, World Financial Group assumed this best efforts agreement between Global Preferred and WMA Agency, with certain amendments. Under the amended agreement, World Financial Group will, for a period extending through June 8, 2008, use commercially reasonable efforts to assist Global Preferred in attaining the opportunity to reinsure all insurance products sold by its agents for insurance companies with which World Financial Group has selling agreements, other than Western Reserve and Western Reserve's affiliates. Additionally, the agreement provides that World Financial Group will use commercially reasonable efforts to cooperate with Global Preferred in its negotiations to establish reinsurance relationships with life insurance companies and provide certain benefits to the companies that reinsure their business through Global Preferred. In June 2001, Global Preferred entered into the First Right Agreement with Western Reserve that provides Global Preferred Re a first right to reinsure certain new products issued by Western Reserve or its U.S. affiliates that are sold by agents associated with World Financial Group. Global Preferred has the right, subject to minimum sales volume thresholds, to reinsure up to 20% of all single life variable universal life products introduced for sale after July 1, 2001 on a coinsurance and modified coinsurance basis for all policies issued through March 31, 2003 and on a monthly renewable term basis for all policies issued through March 31, 2006. Global Preferred also has the right to reinsure between 40% and 50% of all variable annuity products introduced after December 31, 2000 and issued through December 31, 2002, depending upon the volume of direct written variable annuity premiums issued by Western Reserve or its U.S. affiliates in the previous calendar year. These rights automatically extend for one-year renewal periods unless either party gives notice of termination 180 days prior to the expiration of the applicable initial or renewal term. Global Preferred's decisions to reinsure these products will be made from time to time during the term of the First Right Agreement and such decisions will be based on a number of relevant factors, including the attractiveness of the reinsurance rates prescribed by the agreement, the volume of business and Global Preferred's available capital capacity. Global Preferred has a pool retrocession agreement with four reinsurance companies, whereby Global Preferred retrocedes, or reinsures, standard mortality risks in excess of $100,000 per life to the pool. The retrocession agreement serves to reduce the impact of fluctuations in death claims from period to period and limits Global Preferred's exposure on any one policy reinsured. This retrocession reinsurance agreement does not relieve Global Preferred from its obligations to ceding life companies. Failure of retrocessionaires to honor their obligations could result in losses to Global Preferred; consequently, allowances are established for amounts deemed uncollectible. Currently, no amounts are deemed uncollectible. F-14 The net effect of all reinsurance agreements on premiums and policy revenues is as follows:
YEARS ENDED DECEMBER 31, --------------------------------------- 1999 2000 2001 ----------- ----------- ----------- Reinsurance assumed........................... $23,435,657 $29,977,786 $30,993,041 Reinsurance ceded............................. (237,185) (465,195) (514,880) ----------- ----------- ----------- Net premiums and policy revenues.............. $23,198,472 $29,512,591 $30,478,161 =========== =========== ===========
The net effect of all reinsurance agreements on benefits, claims and settlement expenses is as follows:
YEARS ENDED DECEMBER 31, ------------------------------------ 1999 2000 2001 ---------- ---------- ---------- Reinsurance assumed.............................. $4,511,469 $7,705,566 $6,299,510 Reinsurance ceded................................ -- (146,402) (7,118) ---------- ---------- ---------- Net benefits, claims and settlement expenses..... $4,511,469 $7,559,164 $6,292,392 ========== ========== ==========
The impact of reinsurance on life insurance in force is as follows (in millions):
LIFE INSURANCE IN FORCE DIRECT ASSUMED CEDED NET ----------------------- ------ ------- ----- ------ December 31, 1999................................ -- $8,030 $122 $7,908 December 31, 2000................................ -- $9,378 $169 $9,209 December 31, 2001................................ -- $9,082 $156 $8,926
7. DEFERRED ACQUISITION COSTS The amount of policy acquisition costs deferred and amortized is as follows:
YEARS ENDED DECEMBER 31, ------------------------- 2000 2001 ----------- ----------- Beginning of year.................................. $39,750,100 $42,752,339 Capitalized...................................... 7,018,868 3,992,590 Amortized........................................ (4,016,629) (3,944,660) ----------- ----------- End of year........................................ $42,752,339 $42,800,269 =========== ===========
Retrocession premiums are offset against reinsured policy revenues and premiums for the respective issue years. Consequently, retrocession premiums, benefit claims and allowances lose their identity in calculating estimated gross profits as used in amortizing capitalized acquisition costs. As such, there are no separate, reportable deferred acquisition costs or associated amortization. 8. INCOME TAX Under current Bermuda law, Global Preferred Re is not required to pay taxes in Bermuda on either income or capital gains. Global Preferred Re has received an assurance from the Minister of Finance in Bermuda under the Exempted Undertaking Tax Protection Act 1966 of Bermuda that if any legislation is enacted in Bermuda that would impose tax on profits or income, or on any capital asset, gain or appreciation, or any tax in the nature of estate duty or inheritance tax, then the imposition of any such tax will not be applicable to Global Preferred Re or to any of Global Preferred's operations or shares, debentures or other obligations until March 28, 2016. Effective January 1, 1996, Global Preferred Re made an irrevocable election to be treated as a domestic insurance company for United States Federal income tax purposes under section 953(d) of the Internal Revenue Code of 1986, as amended (the "Code"). As a result of this "domestic" election, Global Preferred Re is subject to U.S. taxation on its worldwide income as if it were a U.S. corporation. Global F-15 Preferred determines its income tax expense and liability in accordance with SFAS No. 109, Accounting for Income Taxes. Total income taxes (benefit) for the years ended December 31, 1999, 2000 and 2001 were allocated as follows:
YEARS ENDED DECEMBER 31, ------------------------------------ 1999 2000 2001 ---------- ---------- ---------- Tax attributable to: Income from continuing operations................ $2,225,472 $1,820,717 $2,391,568 ---------- ---------- ---------- Unrealized gains (losses) on securities available for sale....................................... $ (147,093) $ 54,044 $ 94,877 ========== ========== ==========
The federal income tax expense from continuing operations for the years ended December 31, 1999, 2000, and 2001 is as follows:
YEARS ENDED DECEMBER 31, ------------------------------------ 1999 2000 2001 ---------- ---------- ---------- Current.......................................... $ -- $ 516,075 $ 436,963 Deferred......................................... 2,225,472 1,304,642 1,954,605 ---------- ---------- ---------- Total....................................... $2,225,472 $1,820,717 $2,391,568 ========== ========== ==========
The income tax expense from continuing operations for the years ended December 31, 1999, 2000 and 2001 differed from the amounts computed by applying the U.S. federal income tax rate of 34% to income before income taxes as a result of the following:
YEARS ENDED DECEMBER 31, ------------------------------------ 1999 2000 2001 ---------- ---------- ---------- Computed expected tax expense.................... $2,225,472 $2,364,222 $2,670,411 Small life insurance company deduction........... -- (605,880) (269,976) Other, net....................................... -- 62,375 (8,867) ---------- ---------- ---------- Total....................................... $2,225,472 $1,820,717 $2,391,568 ========== ========== ==========
During 2000 and 2001, Global Preferred Re was able to benefit from the "small life insurance company deduction" available under Section 806 of the Code and the "alternative minimum tax" treatment available under Section 55 of the Code at rates less than 34%. Deferred income taxes reflect the net tax effects of temporary differences between the carrying values of assets and liabilities for financial reporting purposes and federal income tax purposes. The net deferred tax liability at December 31, 2000 and 2001 is composed of the following amounts:
2000 2001 ----------- ----------- Deferred tax assets: Alternative minimum tax credit..................... $ 35,646 $ 8,597 Capital losses realized in excess of gains......... 20,535 7,247 Reserve differences................................ 8,262,095 6,139,342 Net operating loss carry-forward................... 779,960 1,030,018 DAC tax capitalized................................ -- 258,252 Other.............................................. 81,506 29,216 ----------- ----------- Gross deferred tax assets..................... 9,179,742 7,472,672 ----------- -----------
F-16
2000 2001 ----------- ----------- Deferred tax liabilities: Policy benefit reserves............................ 230,110 461,348 Deferred acquisition costs......................... 14,535,795 14,552,091 Unrealized gain on securities held for sale........ 32,122 127,000 ----------- ----------- Gross deferred tax liabilities................ 14,798,027 15,140,439 ----------- ----------- Net deferred tax liabilities.................. $ 5,618,285 $ 7,667,767 =========== ===========
There were no valuation allowances for deferred tax assets as of December 31, 2000 and 2001 since it is management's belief that it is more likely than not that the deferred tax assets will be realized. This assessment is made based on the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies. At December 31, 2001, Global Preferred had net operating loss carry-forwards for income tax purposes of $3,029,000, which begin to expire in 2018. Global Preferred Re does not have a policyholder surplus account. Therefore, Global Preferred Re is not subject to the potential addition to federal income tax imposed by Section 815 of the Code. 9. RELATED PARTY TRANSACTIONS Global Preferred issued a $5.0 million convertible note, due July 29, 2004, to Money Services, Inc., a subsidiary of AEGON USA, Inc. The note bears simple interest at a rate of 7.5% per year and is currently convertible into 312,750 shares of Global Preferred common stock. If Money Services were to convert the note, it would own approximately 8% of Global Preferred's outstanding common stock as of December 31, 2001. Each of World Financial Group and Western Reserve are subsidiaries of AEGON USA, Inc. and therefore are entities related to Money Services due to the common ownership. Global Preferred entered into an agreement with World Financial Group, which requires that World Financial Group will use its commercially reasonable efforts to assist Global Preferred in attaining the opportunity to reinsure all insurance products sold by its agents for insurance companies with which World Financial Group has selling agreements, other than Western Reserve and Western Reserve's affiliates. Global Preferred is a tenant-at-will in approximately 2,100 square feet of office space in Duluth, Georgia. Western Reserve is the landlord on the space that Global Preferred occupies. Global Preferred's monthly rent is $3,482, plus its proportionate share of the taxes. After its acquisition of certain of the assets of WMA Agency, World Financial Group continued to provide the services that WMA Agency provided to Global Preferred under the Corporate Services Agreement described below. Global Preferred incurred $22,882 of costs for these services from World Financial Group for the year ended December 31, 2001. Global Preferred has four separate reinsurance agreements with Western Reserve that cover policies on Western Reserve variable universal life and variable annuity policies issued on or after various dates after January 1, 1992 which were sold by the agents of World Financial Group and its predecessor. Also in June 2001, Global Preferred entered into the First Right Agreement with Western Reserve. The First Right Agreement provides Global Preferred the right to reinsure certain policies issued by Western Reserve or its U.S. affiliates which are sold by agents associated with World Financial Group. In 1995, Global Preferred Re entered into an agreement with CFM Insurance Managers, Ltd. ("CFM"), a member of the Mutual Risk Management Ltd. group of companies, which provides professional insurance management services to international companies operating in Bermuda. C. Simon Scupham, a director of Global Preferred and of Global Preferred Re, is the Chairman of CFM. Pursuant to this agreement, CFM acts as the managing agent and the Principal Representative for Global Preferred Re in Bermuda. This agreement is for an unlimited duration, but may be terminated by either party upon three months prior written notice or upon 30 days prior written notice under specified circumstances. F-17 Global Preferred paid $60,000 in fees during each of the years ended December 31, 1999, 2000 and 2001 pursuant to the agreement with CFM. Prior to December 28, 2001, S. Hubert Humphrey, Jr. served as a director, Chairman of the Board and Chief Executive Officer of Global Preferred and of Global Preferred Re. Effective December 28, 2001, Mr. Humphrey retired from Global Preferred's and Global Preferred Re's boards of directors and all of the positions he held with Global Preferred and with Global Preferred Re. As of December 31, 2001, Mr. Humphrey was the beneficial owner of 22.7% of Global Preferred's outstanding common stock. Mr. Humphrey controls WMA Agency and WMA Securities. Global Preferred agreed to grant to Mr. Humphrey, upon successful completion of a firm commitment, underwritten registered public offering, options to purchase 100,000 shares of Global Preferred common stock. The options are exercisable for a period of five years from the date of grant, at an exercise price equal to the initial offering price of shares sold in the underwritten offering. Effective April 1, 1998, Global Preferred entered into a Corporate Services Agreement with WMA Agency to provide to Global Preferred corporate services and supplies for a fixed monthly fee of $2,250, adjustable annually. These services included computer network system, facilities maintenance, security, mail services, utilities, postage, telephone and copier service. Global Preferred incurred $48,851, $48,922 and $23,616 of costs for these services from WMA Agency for the years ended December 31, 1999, 2000 and 2001, respectively. In June 1998, Global Preferred entered into a Directed Reinsurance Agreement with WMA Agency, under which WMA Agency agreed to use its best efforts to cause any life insurance company with which it had selling agreements to enter reinsurance agreements with Global Preferred. In 1999, the parties amended the agreement to provide, among other things, that Global Preferred would issue, for no monetary consideration, warrants to individuals designated by WMA Agency to purchase 300,000 shares of Global Preferred common stock. These warrants were ultimately issued to key management personnel of WMA Agency. As subsequently amended, the warrants were contingent upon Global Preferred raising additional capital by January 1, 2002. Global Preferred raised no new capital by January 1, 2002 and the warrants expired. No shares of common stock were issued under these warrants. In June 1998, Global Preferred entered into a Sublease Agreement with WMA Agency for office space in Duluth, Georgia. The sublease was on a triple-net basis for an initial term through January 2008. The annual base rent until January 2003 was $18,675. The sublease was terminated in June 2001 in conjunction with the purchase by World Financial Group of assets of WMA Agency. 10. STATUTORY RESTRICTIONS Global Preferred Re is a Bermuda company registered as a long-term insurer under the Bermuda Insurance Act 1978 (the "Insurance Act") and as such is subject to the restrictions of the Insurance Act. The Insurance Act requires that Global Preferred Re maintain a solvency margin, defined as the excess of statutory assets over statutory liabilities, of at least $250,000. Statutory assets and liabilities refer to those assets and liabilities recorded on the statutory balance sheet required by the Insurance Act. As of December 31, 2001, Global Preferred Re had total statutory capital and surplus, the excess of statutory assets over statutory liabilities, as determined under the Insurance Act, of $9.6 million. Global Preferred relies, and will continue to rely, primarily on funds retained at the holding company level, dividends and other permitted payments, such as debt service payments, from Global Preferred Re to meet ongoing cash requirements. The payment of dividends by Global Preferred Re to Global Preferred is subject to Bermuda law and regulations. Under the Insurance Act, Global Preferred Re must maintain long-term assets with a value of at least $250,000 more than its long-term liabilities and is prohibited from declaring or paying dividends that would result in noncompliance if, among other things, it has reasonable grounds for believing that after making such a payment, it would not be able to pay its liabilities as they become due. During 2001, Global Preferred Re paid no dividends to Global Preferred. F-18 11. COMMITMENTS AND CONTINGENT LIABILITIES From time to time Global Preferred may be subject to litigation and arbitration in the normal course of business. Management does not believe that Global Preferred is a party to any such pending litigation or arbitration that would have a material adverse effect on its financial position or future operations. Global Preferred has obtained letters of credit in favor of unaffiliated insurance companies with whom Global Preferred has reinsurance agreements. The posting of a letter of credit allows the ceding life company to take statutory reserve credit for reinsurance ceded, which would otherwise not be available as Global Preferred Re is not a licensed reinsurer by the ceding life company's state of domicile. At December 31, 2001, the outstanding letters of credit totaled $8.85 million. The letters of credit were issued by Global Preferred's custodian and secured by Global Preferred's investments held by the custodian. Prior to June 2001, Global Preferred subleased office space in Duluth, Georgia from WMA Agency. The sublease was terminated in June 2001 in conjunction with World Financial Group's purchase of WMA Agency's assets. Since the termination of the lease, Global Preferred has been a tenant-at-will in approximately 2,100 square feet of the same office space in Duluth, Georgia. Global Preferred does not own or lease any other properties. 12. SHORT-TERM AND LONG-TERM DEBT At December 31, 2000 and 2001, short-term and long-term debt were as follows, in summary:
2000 2001 ---------- ---------- Line of credit - short term................................. $ 277,285 $ -- Line of credit - long term.................................. -- -- Convertible Term Note - 7.5% interest, principal and interest due at July 29, 2004........................... 5,000,000 5,000,000 ---------- ---------- Total short and long-term debt..................... 5,277,285 5,000,000 Less anticipated current maturity of line of credit......... 277,285 -- ---------- ---------- Total long-term debt............................... $5,000,000 $5,000,000 ========== ==========
In July 1999, Global Preferred issued a $5 million, five-year convertible term note to Money Services, Inc. due on July 29, 2004. Money Services is a subsidiary of AEGON USA, Inc. Proceeds of this note were used to reduce a portion of the outstanding principal balance on a line of credit with Money Services from $10 million to $5 million. Interest is payable at 7.5% per annum (except in the event of redemption), on the 29th of each succeeding January and July through and including July 29, 2004. Money Services has the right to convert the outstanding principal balance of this note into shares of Global Preferred's common stock at any time. Upon conversion, Money Services will receive 6.25 shares of common stock for each $100 of the outstanding principal amount of the note, which reflects our three-for-two stock split in 2001. Global Preferred has the option to redeem the note, in whole or in part, between July 29, 2002 and July 29, 2004. To redeem the note before maturity, Global Preferred must pay all principal, plus interest accrued from the date of the note through the redemption date at a higher effective interest rate of 9% per annum. As of December 31, 2001, Global Preferred had an outstanding principal balance on the note of $5 million and accrued interest of $158,000. Global Preferred also had a $5 million line of credit with Money Services which was paid in full on February 15, 2001 together with the related accrued interest. Principal payments totaled $277,285 during 2001. F-19 13. COMPREHENSIVE INCOME The following table sets forth the amounts of other comprehensive income (loss) along with the related tax effects allocated to other comprehensive income (loss) for the years ended December 31, 1999, 2000, and 2001:
TAX BEFORE-TAX (EXPENSE) NET-OF-TAX AMOUNT BENEFIT AMOUNT ---------- --------- ---------- 1999 Net unrealized holding losses arising during period........ $(366,622) $124,653 $(241,969) Plus: reclassification adjustment for losses realized in net income............................................... (66,000) 22,440 (43,560) --------- --------- --------- Other comprehensive loss................................... $(432,622) $147,093 $(285,529) ========= ========= ========= 2000 Net unrealized holding gains arising during period......... $ 161,559 $(54,930) $ 106,629 Less: reclassification adjustment for gains realized in net income................................................... 2,606 (886) 1,720 --------- --------- --------- Other comprehensive income................................. $ 158,953 $(54,044) $ 104,909 ========= ========= ========= 2001 Net unrealized holding gains arising during period......... $ 323,858 $(110,111) $ 213,747 Less: reclassification adjustment for gains realized in net income................................................... 44,807 (15,234) 29,573 --------- --------- --------- Other comprehensive income................................. $ 279,051 $(94,877) $ 184,174 ========= ========= =========
14. SEGMENT REPORTING We have defined our reportable segments based on the nature of the reinsurance agreements and the accounting treatment used for the various reinsurance agreements. Based on this definition, we have identified two reportable segments: non-universal life-type agreements and universal life-type agreements (as each is referenced in SFAS No. 97, Accounting and Reporting by Insurance Enterprises for Certain Long-duration Contracts and for Realized Gains and Losses from the Sale of Investments, paragraphs 44 and 45). Global Preferred reinsures certain variable universal life policies on a renewable term basis, which are reported below as Non-Universal Life-Type Agreements and, as such, revenues therefrom are classified as premiums revenue. Renewable term reinsurance involves the reinsurance of mortality risk whereby premiums are not directly related to the premium rates on the original plan of insurance and the ceding life company is liable for the total net amount of risk of the policies reinsured. Global Preferred's renewable term agreements are accounted for under SFAS No. 60 accounting principles. Global Preferred reinsures variable annuity policies and certain other variable universal life policies on a coinsurance and modified coinsurance basis, which are reported below as Universal Life-Type Agreements and, as such, revenues therefrom are classified as reinsured policy revenues. Coinsurance involves the reinsurance of mortality and investment risks on the same basis as that of the underlying policies. The ceding life companies and Global Preferred share in these risks on a pro rata basis. Global Preferred's existing coinsurance and modified coinsurance agreements are accounted for under SFAS No. 97 accounting principles. Items not directly related to the business segments and unallocated corporate items (i.e., other income, interest expense on corporate debt and unallocated operating expenses) are shown separately, consistent with Global Preferred's internal measurement process. Segment assets reported include those assets directly attributable to the reinsurance agreements such as reinsurance balances receivable, deferred acquisition costs, policy loans, prepaid expenses, invested assets and cash. Cash and invested assets are allocated to the agreements based upon statutory reserves, the letters of credit posted in support of the F-20 statutory reserves held, and allocated surplus which is consistent with Global Preferred's internal measurement process.
SEGMENT REPORTING YEAR ENDED DECEMBER 31 1999 ---------------------- ----------------------------------------- NON- UNIVERSAL UNIVERSAL LIFE-TYPE LIFE-TYPE OTHER TOTAL (Dollars in thousands) --------- --------- ------- ------- Premiums.................................................... $9,693 $ -- $ -- $ 9,693 Reinsured policy revenues................................... -- 13,506 -- 13,506 Benefits, claims and settlement expenses.................... 3,215 1,610 -- 4,825 Reinsurance expense allowances, net......................... 2,775 2,588 -- 5,363 Amortization of deferred acquisition cost................... 171 3,618 -- 3,789 Loss on recapture of business............................... -- 823 -- 823 ------ ------- ------- ------- Underwriting profit......................................... 3,532 4,867 -- 8,399 Net investment income....................................... 118 132 100 350 Net realized loss on investments............................ -- -- (66) (66) Other expenses.............................................. 22 422 1,693 2,137 ------ ------- ------- ------- Segment operating income (loss) before income tax........... 3,628 4,577 (1,659) 6,546 Income tax expense (benefit)................................ 1,234 1,556 (564) 2,226 ------ ------- ------- ------- Segment net income (loss)................................... $2,394 $ 3,021 $(1,095) $ 4,320 ------ ------- ------- ------- Preferred dividends......................................... -- -- -- -- ------ ------- ------- ------- Segment net income (loss) available to common stockholders.............................................. $2,394 $ 3,021 $(1,095) $ 4,320 ====== ======= ======= ======= Segment assets.............................................. $7,762 $40,220 $ 1,026 $49,008 ====== ======= ======= =======
SEGMENT REPORTING YEAR ENDED DECEMBER 31 2000 ---------------------- ----------------------------------------- NON- UNIVERSAL UNIVERSAL LIFE-TYPE LIFE-TYPE OTHER TOTAL (Dollars in thousands) --------- --------- ------- ------- Premiums.................................................... $16,619 $ -- $ -- $16,619 Reinsured policy revenues................................... -- 12,894 -- 12,894 Benefits, claims and settlement expenses.................... 8,658 954 -- 9,612 Reinsurance expense allowances, net......................... 5,711 1,829 -- 7,540 Amortization of deferred acquisition cost................... 116 3,901 -- 4,017 ------- ------- ------- ------- Underwriting profit......................................... 2,134 6,210 -- 8,344 Net investment income....................................... 213 171 144 528 Net realized gain on investments............................ -- -- 3 3 Other expenses.............................................. 150 184 1,588 1,922 ------- ------- ------- ------- Segment operating income (loss) before income tax........... 2,197 6,197 (1,441) 6,953 Income tax expense (benefit)................................ 589 1,659 (428) 1,820 ------- ------- ------- ------- Segment net income (loss)................................... $ 1,608 $ 4,538 $(1,013) $ 5,133 ------- ------- ------- ------- Preferred dividends......................................... -- -- 155 155 ------- ------- ------- ------- Segment net income (loss) available to common stockholders.............................................. $ 1,608 $ 4,538 $(1,168) $ 4,978 ======= ======= ======= ======= Segment assets.............................................. $ 9,279 $44,688 $ 2,650 $56,617 ======= ======= ======= =======
F-21
SEGMENT REPORTING YEAR ENDED DECEMBER 31 2001 ---------------------- ----------------------------------------- NON- UNIVERSAL UNIVERSAL LIFE-TYPE LIFE-TYPE OTHER TOTAL (Dollars in thousands) --------- --------- ------- ------- Premiums.................................................... $19,240 $ -- $ -- $19,240 Reinsured policy revenues................................... -- 11,238 -- 11,238 Benefits, claims and settlement expenses.................... 7,833 871 -- 8,704 Reinsurance expense allowances, net......................... 6,859 1,642 -- 8,501 Amortization of deferred acquisition cost................... 197 3,748 -- 3,945 ------- ------- ------- ------- Underwriting profit......................................... 4,351 4,977 -- 9,328 Net investment income....................................... 215 230 366 811 Net realized gain on investments............................ -- -- 45 45 Other expenses.............................................. 123 216 1,991 2,330 ------- ------- ------- ------- Segment operating income (loss) before income tax........... 4,443 4,991 (1,580) 7,854 Income tax expense (benefit)................................ 1,353 1,520 (481) 2,392 ------- ------- ------- ------- Segment net income (loss)................................... $ 3,090 $ 3,471 $(1,099) $ 5,462 ------- ------- ------- ------- Preferred dividends......................................... -- -- 267 267 ------- ------- ------- ------- Segment net income (loss) available to common stockholders.............................................. $ 3,090 $ 3,471 $(1,366) $ 5,195 ======= ======= ======= ======= Segment assets.............................................. $ 8,615 $46,748 $12,490 $67,853 ======= ======= ======= =======
During 1999, 2000, and 2001, the percentages of total premiums and reinsured policy revenues that relate to Western Reserve were 87%, 88% and 89%, respectively. The percentages of the total underwriting profit that relates to Western Reserve for 1999, 2000 and 2001 were 83%, 83% and 86%, respectively. Global Preferred estimates that approximately 43% of variable universal life premiums and 22% of variable annuity premiums, written through Western Reserve and sold by agents associated with World Financial Group, originated in California. 15. CAPITAL INFUSION During 1999, Global Preferred conducted a private placement offering of up to 1,000,000 shares of Series A Preferred Stock to a limited number of individual investors that qualified as "accredited investors" within the meaning of Rule 501 of Regulation D under the Securities Act of 1933. The Series A Preferred Stock was designated non-voting and unregistered with a par value of $2.00 per share. The Series A Preferred Stock had a liquidation preference equal to $2.00 per share in the event of any liquidation, dissolution, or winding up of the affairs of Global Preferred. The terms of the Series A Preferred Stock provided for automatic conversion into common stock upon the earlier of (i) the closing of any Qualifying Sale of shares of common stock or (ii) January 1, 2002. A Qualifying Sale was defined as net proceeds to Global Preferred of at least $10 million from the sale of its shares of common stock. In August 2000, Global Preferred closed its offering of the Series A Preferred Stock, which resulted in approximately $4 million of gross proceeds to Global Preferred. Global Preferred issued 266,047 shares of Series A Preferred Stock to the investors in this offering. The net proceeds were loaned to Global Preferred Re, which were applied toward repayment of the line of credit with Money Services. On December 15, 2001, Global Preferred paid a 7% annual dividend to the preferred stockholders in the amount of $279,349. 16. STOCK OPTIONS AND WARRANTS Stock Options 1999 Stock Option Plan. The 1999 Stock Option Plan became effective on June 15, 1999. The aggregate number of shares of common stock reserved for issuance under the 1999 Stock Option Plan was 700,000 shares. The exercise price of each option granted under the 1999 Stock Option Plan was $10 per share, as adjusted for Global Preferred's three-for-two stock split in 2001. The 1999 Stock Option Plan F-22 required that Global Preferred raise additional capital on or before December 31, 1999 in order for any options to be exercisable, however, Global Preferred raised no new capital prior to that date and the outstanding options could not, by their terms, be exercised. On May 12, 2000, the board of directors approved an amendment to the 1999 Stock Option Plan extending the deadline for receipt of a minimum of $15 million of additional capital from the sale of stock to January 1, 2002. Other Options. In connection with S. Hubert Humphrey, Jr.'s retirement in December 2001, Global Preferred agreed to grant to Mr. Humphrey options to purchase 100,000 shares of common stock upon successful completion of a firm commitment, underwritten registered public offering of common stock by December 31, 2003. The options are exercisable for a period of five years from the date of grant, at an exercise price equal to the initial offering price of shares sold in the underwritten offering. Warrants In June 1998, Global Preferred entered into a Directed Reinsurance Agreement with WMA Agency, under which WMA Agency agreed to use its best efforts to cause any life insurance company with which it had selling agreements to enter reinsurance agreements with Global Preferred. In 1999, the board of directors approved an amendment to the agreement to provide, among other things, that Global Preferred would issue, for no monetary consideration, warrants to individuals designated by WMA Agency to purchase 300,000 shares of Global Preferred's common stock. These warrants were ultimately issued to key management personnel of WMA Agency. As subsequently amended, the warrants were contingent upon Global Preferred raising a minimum of $15 million of additional capital from the sale of stock prior to January 1, 2002. As amended, these warrants had an exercise price of $10 per share, as adjusted for Global Preferred's three-for-two stock split in 2001. Such options and warrants have been considered for purposes of stock compensation expense under SFAS No. 123, Accounting for Stock-Based Compensation, Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees and FASB Interpretation No. 44, Accounting for Certain Transactions involving Stock Compensation. However, since no shares can be issued upon exercising the options or warrants until the amount of capital raised by Global Preferred from the sale of stock prior to January 1, 2002 is equal to or greater than $15 million, there is no compensation expense reflected in the accompanying financial statements. Additionally, the amount of compensation expense is indeterminable as the amount of options and warrants vary with the amount of capital raised. 17. SUBSEQUENT EVENTS 1999 Stock Option Plan and Warrants. Global Preferred did not raise the minimum of $15 million of additional capital from the sale of stock by January 1, 2002 and as of that date the outstanding options granted under the 1999 Stock Option Plan could no longer be exercised, the board of directors terminated the 1999 Stock Option Plan in February 2002. Additionally, since Global Preferred did not raise the minimum amount of additional capital by January 1, 2002, the warrants issued to the management personnel of WMA Agency expired. No shares of common stock were issued under the warrants. Preferred Stock Conversion. On January 1, 2002, 266,047 shares of Series A Preferred Stock issued were automatically converted into 399,074 shares of common stock. The conversion reflected the three-for-two stock split effective in September 2001. Stock Incentive Plan. Global Preferred's Stock Incentive Plan became effective on January 9, 2002. The aggregate number of shares of common stock reserved for issuance under the Stock Incentive Plan is 1.5 million shares. Awards granted under the Stock Incentive Plan may be stock appreciation rights, restricted stock, options intended to qualify as "incentive stock options" or nonqualified stock options. No shares of common stock have been issued upon exercise of options granted under the Stock Incentive Plan. The Compensation Committee of the board of directors has approved the grant of options to purchase an aggregate of 215,000 shares of common stock to certain employees to be granted upon completion of an initial public offering, at an exercise price equal to the initial public offering price. F-23 Directors Stock Option Plan. Global Preferred's Directors Stock Option Plan became effective January 9, 2002. The aggregate number of shares of common stock reserved for issuance under the Directors Stock Option Plan is 280,000 shares. Upon completion of an initial public offering prior to December 31, 2003, options to purchase 105,000 shares will be granted to Global Preferred's five non-employee directors under the Directors Stock Option Plan and options to purchase 100,000 shares will be granted outside of the Directors Stock Option Plan to a retired director. Each of these options will have an exercise price equal to the initial public offering price. Global Preferred has estimated that if the initial public offering is completed prior to December 31, 2003, then the resulting compensation charge from the grants of these options to current and retired directors will be between $335,000 and $980,000, depending upon numerous variables, including the exercise price of the options, the estimated effective life of the options and the volatility of the stock (estimated in part by reference to the stock performance of comparable companies). Employment Agreements. Global Preferred's executive officers, Edward F. McKernan, Bradley E. Barks, Caryl P. Shepherd and Thomas Bobowski, are employed pursuant to written employment agreements. Mr. McKernan, President and Chief Executive Officer, has an initial employment agreement term of three years beginning January 1, 2002 and is automatically renewed for additional one-year periods unless either party provides written notice of termination at least 60 days in advance of the expiration date of the current term. Mr. McKernan will receive a base salary of $325,000 for the year ended December 31, 2002, plus options to purchase 75,000 shares of common stock, to be granted upon completion of an initial public offering. If, within 90 days of a change of control of Global Preferred, Mr. McKernan resigns for good reason, as defined in the agreement, or is terminated without cause, Global Preferred will pay him an amount equal to 35 months of his then-current base salary over a 12 month period or in one lump sum payment. Upon Mr. McKernan's resignation for good reason or termination not for cause unrelated to a change of control, Global Preferred will pay his base salary for the greater of 12 months or the number of months remaining on his employment agreement, not to exceed 24 months. Mr. Barks, Chief Financial Officer and Senior Vice President -- Finance, has an initial employment agreement term from March 4, 2002 through February 28, 2003, which is renewable by agreement of the parties for additional one-year periods. Mr. Barks will receive a base salary of $250,000 for the initial term, plus options to purchase 20,000 shares of common stock, to be granted upon completion of an initial public offering. Global Preferred paid Mr. Barks a signing bonus of $9,200 and has agreed to pay $59,450 towards Mr. Barks' relocation expenses and up to six months of actual rental costs for temporary housing prior to his relocation. If Mr. Barks resigns for good reason, as defined in the agreement, or is terminated without cause, Global Preferred will pay him an amount equal to three months of his base salary if he is terminated prior to completion of an initial public offering, or twelve months of his then-current base salary if he is terminated after completion of an initial public offering. Ms. Shepherd, Chief Accounting Officer, Treasurer, Controller, Secretary and Vice President, has an initial employment agreement term from February 1, 2002 through January 31, 2003, which is renewable by agreement of the parties for additional one-year periods. Ms. Shepherd will receive a base salary of $100,000 for the initial term, plus options to purchase 30,000 shares of common stock, to be granted upon completion of an initial public offering. Upon Ms. Shepherd's resignation for good reason, as defined in the agreement, or termination not for cause, Global Preferred will pay her base salary for twelve months. Mr. Bobowski, Vice President of Marketing, has an initial employment agreement term from March 4, 2002 through February 28, 2003, which is renewable by agreement of the parties for additional one-year periods. Mr. Bobowski will receive a base salary of $122,000 for the initial term, plus options to purchase 12,500 shares of common stock to be granted upon completion of an initial public offering. Upon Mr. Bobowski's resignation for good reason, as defined in the agreement, or termination not for cause, Global Preferred will pay his base salary for three months. For each month of Mr. Bobowski's employment over three months, his separation payment upon resignation for good reason or termination without cause will be increased by one month, with a maximum payment equal to twelve months of his base salary. F-24 Mr. McKernan, Mr. Barks, Ms. Shepherd and Mr. Bobowski are eligible for an annual bonus in an amount to be determined by the board of directors. Mr. McKernan, Mr. Barks, Ms. Shepherd and Mr. Bobowski's employment agreements include post-employment restrictive covenants not to solicit Global Preferred's customers or recruit Global Preferred's employees. Registration Statement. On February 22, 2002, Global Preferred filed a registration statement with the Securities and Exchange Commission for an initial public offering of common stock at a proposed maximum aggregate offering price of $131,100,000. F-25 18. PARENT COMPANY FINANCIAL INFORMATION. BALANCE SHEETS (PARENT COMPANY) DECEMBER 31, 2000 AND 2001
2000 2001 ----------- ----------- Assets Investment in common stock of subsidiary(1)................. $14,260,526 $14,260,526 Fixed maturity securities -- available for sale (amortized cost of $0 and $2,241,534 for 2000 and 2001, respectively)............... -- 2,296,563 Cash and cash equivalents................................... 443,277 1,374,016 Investment income due and accrued........................... 2,876 42,192 Investment income due and accrued -- intercompany(1)........ 305,330 201,219 Intercompany receivables(1)................................. 2,573,807 155,118 Note receivable -- intercompany(1).......................... 8,100,029 6,087,550 Prepaid expenses............................................ 28,472 654,699 Current income tax receivable............................... -- 1,875 Fixed assets (net of accumulated depreciation of $102,992 and $147,750 for 2000 and 2001, respectively).............................. 48,806 88,114 Deferred tax benefit........................................ 792,271 1,047,737 ----------- ----------- Total assets...................................... $26,555,394 $26,209,609 =========== =========== Liabilities and Stockholders' Equity Liabilities: Accrued expenses and accounts payable..................... $ 79,102 $ 530,880 Accrued interest payable.................................. 158,219 158,219 Dividend payable.......................................... 12,245 -- Current income tax payable................................ 7,306 -- Long term debt............................................ 5,000,000 5,000,000 ----------- ----------- Total liabilities................................. 5,256,872 5,689,099 ----------- ----------- Stockholders' equity: Preferred stock, par value $2.00, 10,000,000 shares authorized; Series A Preferred Stock, 1,000,000 shares authorized; 266,047 shares issued for 2000 and 2001.... 532,094 532,094 Common stock, par value $.001, 50,000,000 shares authorized; 2,500,000 shares and 3,750,000 shares issued for 2000 and 2001, respectively........................................... 2,500 3,750 Additional paid-in capital................................ 22,795,581 22,794,331 Accumulated other comprehensive income.................... -- 36,319 Retained earnings......................................... (1,981,753) (2,796,717) Treasury stock, at cost (7,485 shares and 7,390 shares for 2000 and 2001, respectively)........................... (49,900) (49,267) ----------- ----------- Total stockholders' equity........................ 21,298,522 20,520,510 ----------- ----------- Total liabilities and stockholders' equity.................. $26,555,394 $26,209,609 =========== ===========
--------------- (1) Eliminated on consolidation F-26 STATEMENTS OF INCOME (PARENT COMPANY ONLY) YEARS ENDED DECEMBER 31, 1999, 2000 AND 2001
1999 2000 2001 ----------- ---------- ---------- Revenues: Net investment income................................. $ 27,450 $ 85,053 $ 133,575 Net realized gain (loss) on investments............... (2,997) -- 4,904 Intercompany interest income(1)....................... -- 613,298 674,298 Gain (loss) on dissolution of subsidiary.............. (5,266) -- -- ----------- ---------- ---------- Total revenue................................. 19,187 698,351 812,777 ----------- ---------- ---------- Benefits and expenses: Operating expenses.................................... 855,627 99,752 1,259,273 Interest expense...................................... 868,252 375,000 375,000 ----------- ---------- ---------- Total benefits and expenses........................ 1,723,879 474,752 1,634,273 ----------- ---------- ---------- Income before income tax and equity in undistributed net income of subsidiaries......... (1,704,692) 223,599 (821,496) Income tax benefit (expense).......................... 579,595 (120,224) 274,269 ----------- ---------- ---------- Income before equity in undistributed net income of subsidiaries..................................... $(1,125,097) $ 103,375 $ (547,227) Equity in earnings of subsidiaries.................... 5,445,131 5,029,501 6,009,808 ----------- ---------- ---------- Net income............................................ 4,320,034 5,132,876 5,462,581 Preferred dividends................................... -- 155,198 267,104 ----------- ---------- ---------- Net income available to common stockholders........... $ 4,320,034 $4,977,678 $5,195,477 =========== ========== ==========
--------------- (1) Eliminated on consolidation F-27 STATEMENTS OF CASH FLOWS (PARENT COMPANY ONLY) YEARS ENDED DECEMBER 31, 1999, 2000 AND 2001
1999 2000 2001 ----------- ------------ ----------- Cash flows from operating activities: Net income............................................ 4,320,034 5,132,876 5,462,581 Less equity in earnings of subsidiaries............... (5,445,131) (5,029,501) (6,009,808) ----------- ------------ ----------- Income before equity in undistributed net income of subsidiaries........................................ $(1,125,097) $ 103,375 $ (547,227) Adjustments to reconcile net income to net cash provided by (used in) operating activities: Amortization and depreciation....................... 108,597 47,975 44,758 Deferred tax expense (benefit)...................... (579,595) 112,918 (274,176) Net realized (gain) loss on investments............. 2,997 -- (4,905) Change in: Investment income due and accrued................... 13,880 (2,876) (39,316) Investment income due and accrued -- intercompany(1)....................... -- (305,330) 104,111 Intercompany receivables(1)......................... (44,089) (2,563,711) 2,418,689 Prepaid expenses.................................... (139,698) 317,297 (626,227) Current income tax receivable....................... -- -- (1,875) Other receivables................................... 171,375 -- -- Accrued expenses and accounts payable............... (42,196) (22,574) 451,778 Accrued interest payable............................ 564,690 (507,570) -- Current income tax payable.......................... -- 7,306 (7,306) ----------- ------------ ----------- Net cash provided by (used in) operating activities..................................... (1,069,136) (2,813,190) 1,518,304 ----------- ------------ ----------- Cash flows from investing activities: Dividend received from subsidiary(1).................. -- 3,400,000 -- Return of capital from subsidiary(1).................. -- 10,000,000 -- Investment in subsidiary(1)........................... 11,544 -- -- Proceeds from sale of available for sale securities... 618,080 -- 439,955 Purchase of available-for-sale securities............. -- -- (2,676,584) Purchase of fixed assets.............................. (50,880) (8,449) (84,066) ----------- ------------ ----------- Net cash provided by (used in) investing activities..................................... 578,744 13,391,551 (2,320,695) ----------- ------------ ----------- Cash flows from financing activities: Issuance of preferred stock........................... -- 3,098,702 -- Preferred dividends................................... -- (142,953) (279,349) Proceeds from (repayment of) long term debt........... 303,562 (5,303,562) -- Issuance (repayment) of notes receivable -- intercompany(1)....................... -- (8,100,029) 2,012,479 ----------- ------------ ----------- Net cash provided by (used in) financing activities..................................... 303,562 (10,447,842) 1,733,130 ----------- ------------ ----------- Net increase (decrease) in cash and cash equivalents.................................... (186,830) 130,519 930,739 Cash and cash equivalents at beginning of period........ 499,588 312,758 443,277 ----------- ------------ ----------- Cash and cash equivalents at end of period.............. $ 312,758 $ 443,277 $ 1,374,016 =========== ============ ===========
--------------- (1) Eliminated on consolidation F-28