| CERES GROUP INC ITEM 1A RISK FACTORS The following factors could impact our business, financial condition and results of operations: Failure to accurately predict health care costs when pricing our products and establishing our liabilities for future policy benefits and claim liabilities could have a significant impact on our business and results of operations |
| If actual claims experience is less favorable than our underlying assumptions used in setting the prices for our products and establishing our liabilities, the required change in our claims reserves could have a material adverse effect on our business, financial condition and results of operations |
| Reserves represent our estimates, require a 15 _________________________________________________________________ [69]Table of Contents degree of judgment, and are sensitive to changes in medical claims payment patterns and changes in medical cost trends |
| To mitigate this risk, we employ actuaries and consultants who have developed, refined and used the same set of reserve models over the past several years |
| In addition, the premium charged for our products may be insufficient to cover the costs associated with the distribution of such products, including benefits, claims and losses, settlement expenses, acquisition expenses, and other corporate expenses |
| We utilize a variety of actuarial and qualitative methods to set our pricing levels |
| Any negative fluctuation in our estimates of the effect of continued medical inflation and high benefit utilization could have a material adverse impact on our results of operations |
| In connection with the sale of our insurance policies, we defer and amortize a portion of the policy acquisition costs over the related premium paying periods of the life of the policy |
| Deferred acquisition costs are affected by unanticipated termination of policies because, upon termination, we expense fully the unamortized deferred acquisition costs associated with the terminated policies |
| Therefore, the unanticipated termination of a significant number of policies or the determination that deferred acquisition costs are unrecoverable could have a material adverse effect on our financial condition and results of operations |
| Increased policy termination by our policyholders, or lapsation, will also result in reduced premium collection and a greater percentage of higher-risk insureds |
| Increased claims in future periods and unfavorable loss ratios are usually associated with blocks of business that have greater percentages of higher-risk insureds and, therefore, lapsation could adversely impact our future earnings |
| We may lose business to competitors offering products similar to ours at lower prices |
| We operate in highly competitive markets (senior and major medical) where we compete with large national, regional and specialty health and life insurers, many of whom have substantially greater financial resources, broader product lines and greater experience than we do |
| We compete, and will continue to compete with these companies, for customers and agents |
| We compete not only for individual and group customers, but also for agents and marketing relationships |
| Increased competition may exert strong pressures upon our profitability and impair our ability to successfully grow |
| Our profitability depends in large part on our ability to accurately predict and effectively manage rising health care costs, and accurately predict loss ratios, persistency, and the performance of and improvements in our business, as well as implement necessary increases in premium rates |
| Health care costs, increased use of medical services, the aging population, advances in medical technology, increased use of pharmaceutical products and services, and government imposed limitations on Medicare reimbursements are some of the factors which could adversely affect our ability to accurately predict and manage rising health care costs and accurately predict the performance of our business, which could result in a material adverse effect on our business, financial condition and results of operations |
| In addition, we face pressure to contain premium prices |
| Our insureds may select our more restricted benefit packages to lower their premium costs |
| Alternatively, our customers may move to a competitor to obtain more favorable premiums |
| Our ability to raise premiums is subject to regulatory constraints |
| Limitations on our ability to increase or maintain our premium rates could adversely affect our business, financial condition and results of operations |
| Changes in government regulation may affect our profitability, increase our costs of compliance or cause us to discontinue marketing certain products or marketing in certain states |
| We conduct business in a highly regulated industry |
| Changes in government regulation may affect our profitability by increasing our costs of compliance or by causing us to discontinue marketing certain products or marketing our products in certain states |
| We are subject to extensive federal and state regulation and compliance with these regulations could increase our insurance companies’ operating costs |
| Most insurance regulations are designed to protect the interests of policyholders rather than stockholders and other investors |
| In some circumstances, failure to comply with certain insurance regulations could subject an insurance company to regulatory 16 _________________________________________________________________ [70]Table of Contents actions by such insurance company’s state of domicile, including revocation of our license |
| Our failure to comply with new or existing regulations could subject us to significant fines and penalties |
| As government regulation changes, the costs of compliance may cause us to change our operations significantly, which may adversely affect our business and results of operations |
| Also, changes in the level of regulation of the insurance industry (whether federal or state) or changes in laws or regulations (or interpretations of these laws) could have a material adverse effect on our business |
| We are subject to a variety of legal actions relating to our business operations, including claims related to the denial of benefits, which may result in financial losses or harm our reputation |
| Current and future litigation may result in financial losses, harm our reputation and require the dedication of significant resources |
| We are regularly involved in litigation |
| This litigation typically involves our activities as an insurer and often includes claims for punitive damages |
| In recent years, many insurance companies, including us, have been named as defendants in class action lawsuits relating to market conduct or sales activities |
| Based on current information, including consultation with outside counsel, we believe that any ultimate liability that may arise from our current litigation would not materially affect our results of operations |
| However, we cannot predict with certainty, given the inherent unpredictability of litigation, the outcome of any actions against us or the potential costs involved |
| Our evaluation of the likely impact of any of these actions could change in the future and an unfavorable outcome in any case could have a material adverse effect on our financial condition and results of operations |
| Changes in the relationship with the associations that make available our health insurance products to their members and/or changes in laws and regulations governing “association group” insurance could have a material adverse effect on our business, financial condition and results of operations |
| A substantial portion of our major medical insurance products is issued to members of various independent membership associations that act as the master policyholder for these products |
| The associations provide their members access to a number of benefits and products, including health insurance underwritten by us |
| Subject to applicable state law, individuals generally may not obtain insurance under an association’s master policy unless they are also members of the association |
| The agreements with these associations are terminable by us or the association upon not less than 90 days’ advance notice to the other party |
| Our agents act as representatives for these associations by enrolling new association members |
| For such services, some agents may receive compensation from the association |
| In addition to the health insurance premium derived from the sale of health insurance, we receive fee income from the associations, including fees associated with enrollment services, fees for association marketing and administrative services |
| While we believe that we are providing association group coverage in full compliance with applicable law, changes in our relationship with the associations and/or changes in laws and regulations governing “association group” insurance, particularly changes that would subject the issuance of policies to prior premium rate approval and/or require the issuance of policies on a “guaranteed issue” basis, could have a material adverse effect on our business, financial condition and results of operations |
| Our profitability may be adversely affected if we are unable to maintain our current preferred provider organization (PPO) arrangements and to enter into other appropriate arrangements |
| Our profitability is dependent upon our ability to reach favorable arrangements with PPO networks that contract with hospitals, physicians and other health benefits providers |
| The failure to maintain network arrangements or to secure new cost-effective PPO network contracts may result in a loss of policyholders or higher medical costs that could adversely affect our business |
| Our success depends on our ability to develop, market, distribute and administer profitable and competitive products and services in a timely, cost-effective manner |
| Our success depends, in part, on our ability to develop, market, distribute and administer profitable and competitive products and services that meet consumers’ changing health insurance needs and changes in 17 _________________________________________________________________ [71]Table of Contents government requirements |
| In recent years, the health insurance industry has experienced substantial changes, primarily caused by healthcare legislation |
| Our future success will depend, in part, on our ability to effectively enhance our current products, claims processing capabilities, and develop new products on a timely and cost-effective basis |
| A failure of our information systems to provide timely and accurate information could adversely affect our business and results of operations |
| Information processing is critical to our business, and a failure of our information systems to provide timely and accurate information could adversely affect our business and results of operations |
| The failure to maintain effective and efficient information systems or disruptions to our information systems could cause disruptions in our business operations, including the failure to comply with prompt pay laws, loss of existing insureds, difficulty in attracting new customers, disputes with insureds, providers and agents, regulatory issues, increases in administrative expense and other adverse consequences |
| Failure by our reinsurers to timely and fully meet their obligations under our reinsurance agreements could have an adverse effect on our profitability and financial conditions |
| We reinsure a portion of the health and life insurance policies we write |
| However, reinsurance does not discharge us from our primary liability to our insureds |
| Failure by reinsurers to pay in full and in a timely manner the claims made against them in accordance with the terms of our reinsurance agreements could expose our insurance subsidiaries to liabilities in excess of their reserves and surplus and could subject them to insolvency proceedings |
| In 2005, Hannover accounted for approximately 94prca of total premiums ceded by our insurance subsidiaries |
| The inability of Hannover and other reinsurers to satisfy their obligations could have a material adverse effect on our business, financial condition and results of operations |
| Our insurance subsidiaries are subject to risk-based or statutory capital requirements |
| Our failure to meet these standards could subject us to regulatory actions |
| Our insurance subsidiaries are subject to risk-based capital (RBC) standards imposed by their states of domicile |
| These laws, based on the RBC Model Act adopted by the NAIC, require our regulated insurance subsidiaries to report their results of risk-based capital calculations to the departments of insurance and the NAIC Failure to meet the minimum RBC requirements or statutory capital requirements could subject our insurance subsidiaries to further examination or corrective action, including state supervision or liquidation, which could have a material adverse effect on our business, financial condition and results of operations |
| A decline in our financial agency ratings could adversely affect our operations |
| Our principal insurance subsidiaries are currently rated by AM Best Company and Fitch |
| Decreases in operating performance and other financial measures may result in a downgrade in the ratings of our insurance subsidiaries |
| A downgrade in these current ratings could have a material adverse effect on our business, financial condition and results of operations |
| Our investment portfolio involves risks, including risks inherent with ownership of bonds and risks associated with rising interest rates |
| Our investment portfolio primarily consists of fixed maturity securities |
| There exists a risk that all amounts due (both principal and interest) on our fixed maturity investments will not be collected according to the security’s contractual terms |
| We attempt to minimize this risk by adhering to a conservative investment strategy |
| With the exception of short-term investments and securities on deposit with various state regulators, investment responsibilities have been delegated to external investment managers within the investment parameters established by us |
| Our external investment managers prepare a monthly investment surveillance list to analyze our fixed maturity portfolio for potential other-than-temporary impairment |
| All of our fixed maturity investments are reported at fair market value at December 31, 2005 |
| The amortized cost and estimated fair value of fixed maturities on our investment surveillance list at December 31, 2005 were dlra2dtta5 million and dlra2dtta4 million, respectively 18 _________________________________________________________________ [72]Table of Contents In addition, interest rates could change and cause a decrease in the value of an insurer’s investments |
| This change in rates may cause certain interest-sensitive products to become uncompetitive or may cause disintermediation if we attempt to mitigate this risk by charging fees for non-conformance with certain policy provisions and/or by attempting to match the maturity schedule of our assets with the expected payouts of its liabilities |
| To the extent that liabilities come due more quickly than assets mature, we would have to sell assets prior to maturity and recognize a gain or loss |
| Assuming an immediate increase of 100 basis points in interest rates, the net hypothetical decline in fair value of stockholders’ equity is estimated to be dlra12dtta6 million after-tax at December 31, 2005 |
| This amount represents approximately 6dtta2prca of our stockholders’ equity at such date |
| Applicable laws restrict the acquisition of more than 10prca of our outstanding voting securities |
| Ceres is a regulated holding company by the jurisdictions in which our insurance company subsidiaries are domiciled |
| These laws require prior approval by the state insurance regulators of changes in control of an insurer |
| Generally these laws require notice to the insurer and prior written approval by the state insurance regulator of the jurisdiction in which the insurance company is domiciled |
| Under these laws, anyone acquiring more than 10prca of our outstanding voting securities would be presumed to have acquired control of Ceres, unless such presumption is rebutted |
| Our Company faces additional risks, such as: • changing regulations of corporate governance and public disclosure that has increased both our costs and the risk of non-compliance, including Section 404 of the Sarbanes-Oxley Act of 2002; • our dependence on senior management and key personnel; • our ability to continue to meet the terms of our debt obligations under our credit agreement, as amended, which contains a number of significant financial and other covenants; • the adequacy of funds, including fee income, received from our non-regulated subsidiaries, and the restrictions on our insurance subsidiaries’ ability to pay dividends to Ceres, to meet our debt obligations; • the performance of others on whom we rely for administrative and operations services; • changes in accounting and reporting practices; • payments to state assessment funds; • changes in tax laws; and • our ability to fully collect all agent advances |
| The risks listed above should not be construed as exhaustive |
| Forward-Looking Statements This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 |
| Forward-looking statements are necessarily based on estimates and assumptions that are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which, with respect to future business decisions, are subject to change |
| These uncertainties and contingencies can affect actual results and could cause actual results to differ materially from those expressed in any forward-looking statements made by, or on behalf of, us |
| In particular, forward-looking statements can be identified by the use of words such as “may,” “will,” “should,” “expect,” “anticipate,” “estimate,” “continue” or similar words |
| In light of the risks and uncertainties inherent in all future projections, the inclusion of forward-looking statements in this report should not be considered as a representation by us or any other person that our objectives or plans will be achieved |
| Numerous factors could cause our actual results to differ materially and adversely from those in the forward-looking statements, including those risks outlined above in “Risk Factors |
| ” We undertake no obligation to publicly release the results of any future 19 _________________________________________________________________ [73]Table of Contents revisions we may make to forward-looking statements to reflect events or circumstances after the date of this report or to reflect the occurrence of unanticipated events |