American Capitol Assumption Agreement
Exhibit IV.B. - Enhancement
Methodology for Sharing Statutory Gains and Losses Between
American Capitol and Guaranty Associations
Objective
The Parties' objective is to have a formula-driven methodology for
adjusting the financial deficiency funding provided by the guaranty
associations. The adjustment should take place in a reasonable
time, such as 3 years, after closing such that the uncertainty as to
the potential profitability of the business is significantly
reduced. The adjustment will take the form of a sharing of
statutory gains and losses (actual gains/losses plus updated
projected gains/losses) to the extent they exceed the gains/losses
that were "expected" as of the closing date upon which the financial
deficiency funding was based. The methodology for determining the
adjustment should have an appropriate balance between equity to the
Parties and simplicity to administer. To the extent possible, the
calculation formulas should use factors agreed upon at closing and
not be subject to renewed negotiation at the time of settlement.
Initial Data
Initial Funding by GAs: $5.1 million, by agreement, representing
the sum of the $1.8 million AC investment in
Statesman and $3.3 million present value of
expected future losses on the three blocks of
business.
Effective Date: 6/1/99 for Attained Age and Issue Age blocks.
11/1/98 for the Pre-Standard block, which was the
effective date of AC's coinsurance of that block.
Projected Policy Count and Statutory Gains and Losses:
Attained Age: Use ▇. ▇▇▇▇▇▇'▇ latest projection (4/30/99),
which was basis for agreed funding. It has a
valuation date of 1/1/99.
Pre-Standard: Use ▇.▇. ▇▇▇▇▇▇'▇ Test Code 502 since it is the
medium shock lapse/anti-selection scenario and,
when combined with the Attained Age projection,
results in a 20% rate of return on the $1 million
allowance from American Capitol for these two
blocks in the development of the $5.1 million
funding. It has a valuation date of 4/1/99. Use
AC's reported gain of $122,900 on this block for
the period 11/1/98 to 3/31/99.
Issue Age: Use ▇. ▇▇▇▇▇▇'▇ latest projection (4/30/99, with
reduced commissions) adjusted by reducing each year's
projected gains or losses, consistent with American Capitol's
method of arriving at a $4.3 million present value. It has
a valuation date of 1/1/99.
Projected Pre-Tax Statutory Gains/Losses
Year 502 Issue Attained
Ending Pre-Standard Age Age Total
12/31/1998 49,160 49,160
12/31/1999 360,491 -1,809,351 -98,912 -1,547,772
12/31/2000 289,554 -1,437,091 -114,696 -1,262,233
12/31/2001 245,205 -960,868 -115,623 -831,286
12/31/2002 206,563 -566,222 -94,944 -454,603
12/31/2003 169,814 -222,650 -69,372 -122,208
12/31/2004 143,879 17,593 129,010 290,482
12/31/2005 121,014 67,844 278,021 466,879
12/31/2006 101,940 77,284 286,960 466,184
12/31/2007 84,716 68,365 296,086 449,167
12/31/2008 70,219 50,311 300,489 421,019
Projected Policy Count
Year 502 Issue Attained
Ending Pre-Standard Age Age Total
12/31/1998
12/31/1999 1,092 6,193 5,787 13,072
12/31/2000 780 4,954 4,538 10,272
12/31/2001 557 3,964 3,765 8,286
12/31/2002 434 3,171 3,170 6,775
12/31/2003 341 2,537 2,693 5,571
12/31/2004 270 2,029 2,289 4,588
12/31/2005 215 1,623 1,946 3,784
12/31/2006 171 1,299 1,654 3,124
12/31/2007 136 1,039 1,406 2,581
12/31/2008 108 831 1,195 2,134
Investment Earnings Rate: 5.3%, as used in projections
Discount Rate:
Pre-Standard: 20%
Issue Age: 5.3%
Attained Age: 20%
Assumed Present Value, as of 12/31/01 of Future Statutory Gains and
Losses Per Policy In Force at 12/31/01:
Pre-Standard: $935
Issue Age: -132
Attained Age: 101
e.g., Attained Age = [(-$94,944 ) 1.20) + (-$69,372 ) 1.202) + ... +
($300,489 ) 1.20 )]) 3,765 pols.
Annuity Factor at 12/31/01:
Pre-Standard: 1.80
Issue Age: 2.70
Attained Age: 2.19
e.g., Attained Age = [(3,170 ) 1.20) + (2,693 ) 1,20 ) + ... +
(1,195 ) 1.207)] ) 3,765
Statutory Gains and Losses Share Percentage to GAs:
Excess of Expected Over Actual 0%
First $500,000 of Excess of Actual over Expected 50%
Next $500,000 of Excess of Actual over Expected 75%
Over $1,000,000 of Excess of Actual over Expected 90%
Additional Active Life, Unearned Premium, and Claim Reserves at
Effective Date:
For Attained Age and Issue Age, reserves as booked by Statesman
at 12/31/98 and funded by GAs.
For Pre-Standard, reserves as transferred by Statesman to AC at
11/1/98.
Tabular factors for future Additional Active Life Reserves will
be same as used in projections.
Experience Period for Determining Final Settlement: Effective Date
through 12/31/01.
Final Settlement Date: September 1, 2002, which will allow the use
of June, 2002 paid claims on 2001 and prior
incurrals to estimate the 12/31/01 claim reserves.
Data Needed at Final Settlement
Number of policies in force at 12/31/01 for each product.
"Actual" Statutory Gains and Losses on each of 3 blocks for each calendar
year from effective date to 12/31/01, with corresponding policy years of
exposure. Exposure will be tabulated using monthly policy counts.
Any policies that are converted/re-written to American Capitol/Texas
Imperial Medicare Supplement policy forms will be tracked for purposes of
this enhancement calculation and the appropriate gain/loss data included
in the calculation as if the conversion did not take place.
Actual Statutory Gains and Losses during first 3 years:
An accounting will be done for the three blocks after each
calendar yearend. A final accounting will be done after
paid claims through 6/30/02 are reported. The formula will
be:
Actual Statutory Gain/Loss = Earned Premium
+ Interest on Reserves(5.3% H Avg. policy
+ claim reserve balance)
- Paid Claims*
- Increase in Claim Reserve @
- Increase in Additional Active Life Reserve @
- Earned Commissions
- Accrued Premium Tax
- Maintenance Expense Allowance (8% of
Earned Premium)
@ For the period 1/1/99 through the Closing Date, Earned
Commissions on the Issue Age business will be calculated as
20.8% of collected premium.
*Paid claims includes amounts paid in settlement of claims,
including judgments, but does not include any portion of a
settlement or judgment attributable to American Capitol's or
Texas Imperial's policy administration services.
3 Beginning reserve will be 12/31/98 reserves for Issue Age
and Attained Age.
The only item that should require estimation is the 12/31/01
claim liability still remaining unpaid as of 6/30/02.
Example for policy years of exposure:
Attained Age
Policies In Force
1/99 5,600
2/99 5,550
3/99 5,500
4/99 5,450
5/99 5,400
6/99 5,350
7/99 5,300
8/99 5,250
9/99 5,200
10/99 5,150
11/99 5,100
12/99 5,050
Total Exposure Months 63,900
divided by 12
Total Policy Years of Exposure 5,325
Calculation Process
Actual Statutory Gains and Losses will be determined, according
to the formula, for each of the three blocks separately for
each calendar year from the Effective Date through 12/31/01.
Within each block, the sum of the actual Statutory Gains and
Losses will be compared to the sum of the expected Statutory
Gains and Losses over the same period and the excess of actual
over expected will be divided by the number of policy years of
exposure during the experience period to get the Excess
Statutory Gains and Losses Per Policy Per Year for each block.
The Excess Statutory Gains and Losses Per Policy Per Year is
multiplied by the number of policies in force for each block
at 12/31/01 and then multiplied by an annuity factor (unique
to each block) to get the Present Value, as of 12/31/01, of
Excess Statutory Gains and Losses over the remaining 7 years
of the projection period through 12/31/08.
The number of policies in force at 12/31/01 for each block are
multiplied by an annuity factor, unique to each block, to get
the Present Value, as of 12/31/01, of Expected Statutory Gains
and Losses over the remaining 7 years of the projection
period.
The actual Statutory Gains and Losses in each calendar year
through 12/31/01, the Present Value of Excess Statutory Gains
and Losses as of 12/31/01, and the Present Value of Expected
Statutory Gains and Losses as of 12/31/01 are discounted to
12/31/98 at each block's discount rate and added to the
accumulated gain from the Pre-Standard block prior to
12/31/98. This amount is the total "actual" Statutory Gains
and Losses for American Capitol.
The total "actual" Gains and Losses is compared to the total
"expected" Gains and Losses of -$3,300,000. To the extent
the actual gains and losses exceeds the expected gains and
losses, the excess is refunded to the guaranty associations
according to the following schedule:
First $500,000 of Excess 50%
Next $500,000 of Excess 75%
Over $1,000,000 of Excess 90%
The refund to the guaranty associations will not exceed the
$5,100,000 of initial funding provided by the guaranty
associations, accumulated at the rate of 5.3% from closing until
the date of the refund payment.
Exhibit IV B-1
Total Expected Profits and Expected Return
(as agreed upon)
Effective Date - attained Age & Issue Age Blocks 6/1/99
Effective Date - Pre-Standard Block 11/1/98
Investment Earnings Rate 5.3%
Pre-Standard & Attained Age Discount Rate 20.0%
Issue Age Discount Rate 5.3%
Projected Pre-Tax Statutory Gains/Losses
Year 502 Issue Attained
Ending Pre-Standard Age Age Total
K 12/31/1998 49,160 49,160
L 12/31/1999 360,491 -1,809,351 -98,912 -1,547,772
M 12/31/2000 289,554 -1,437,091 -114,696 -1,262,233
N 12/31/2001 245,205 -960,868 -115,623 -831,286
O 12/31/2002 206,563 -566,222 -94,944 -454,603
P 12/31/2003 169,814 -222,650 -69,372 -122,208
Q 12/31/2004 143,879 17,593 129,010 290,482
R 12/31/2005 121,014 67,844 278,021 466,879
S 12/31/2006 101,940 77,284 286,960 466,184
T 12/31/2007 84,716 68,365 296,086 449,167
U 12/31/2008 70,219 50,311 300,489 421,019
V This line intentionally left blank
W This line intentionally left blank
Projected Policy Count
Year 502 Issue Attained
Ending Pre-Standard Age Age Total
K 12/31/1998
L 12/31/1999 1,092 6,193 5,787 13,072
M 12/31/2000 780 4,954 4,538 10,272
N 12/31/2001 557 3,964 3,765 8,286
O 12/31/2002 434 3,171 3,170 6,775
P 12/31/2003 341 2,537 2,693 5,571
Q 12/31/2004 270 2,029 2,289 4,588
R 12/31/2005 215 1,623 1,946 3,784
S 12/31/2006 171 1,299 1,654 3,124
T 12/31/2007 136 1,039 1,406 2,581
U 12/31/2008 108 831 1,195 2,134
V This line intentionally left blank
W This line intentionally left blank
502 Pre- Issue Attained
Standard Age Age Total
X Expected Profits
K+L+M+N 944,410 (3,583,616) (189,909) (2,829,115)
Y Annuity Factor PV
of Profits O through
U)/Policy Count (N) 1.80 2.70 2.19
Note: Pre-Standard and Attained Age use 20% and Issue Age uses 5.3%.
Exhibit IV B-2
Actual Profit (Note: Amount Below are for Illustrative Purposes Only)
(from Exhibit VI A at the end of Year 3)
Year Pre- Issue Attained
Ending Standard Age Age Total
Z 12/31/1998 49,160
AA 12/31/1999 460,491 (12,709,351) 1,088 (1,247,772)*
AB 12/31/2000 389,554 (1,337,091) (14,696) (962,233)*
AC 12/31/2001 345,205 (860,868) (15,623) (531,286)*
-------------------------------------------------
AD 1,244,410 (3,907,310) (29,231) (2,692,131)@
===========
* Amounts are for illustrative purposes only and will change
based upon actual experience
@ = Z+AA+AB+AC
Exhibit IV B-3
Policies (Note: Amounts Below are for Illustrative Purposes Only)
(from Exhibit VI A at the end of Year Three)
Pre- Issue Attained
Standard Age Age Total
AE Policy Years of Exposure 3,300 16,429 15,607 35,336 *
AF Policies in Force at End
of Year Three 557 3,964 3,765 8,236 *
Assumed Present Value of Future Profits Per Policy in Force at
End of Year Three
Pre- Issue Attained
Standard Age Age Total
AG Policies in Force at End
of Year Three 557 3,964 3,765 8,236
AH Present Value PV of
Profits (O though U) 520,620 (523,380) 379,782 377,023
AI PV/Policies AH/AG 935 (132) 101 46
* Amounts are for illustrative purposes only and will change
based upon actual experience.
Exhibit IV B-4
Excess Profits (Note: Amounts Below are for Illustrative Purposes Only)
502 Pre- Issue Attained
Standard Age Age Total
AJ Excess Profits Per
Policy Per Year
(X-AD)/AE 90.91 -19.70 10.30 3.88 *
AK PV of Excess Profits
at End of Year Three
Y*AF*AJ 91,165 (210,853) 84,874 (34,814)*
* Amounts are for illustrative purposes only and will change
based upon actual experience.
Exhibit IV B-5
Total "Actual" Return to American Capitol as of Effective Date
(Note: Amounts Below are for Illustrative Purposes Only)
Source
AL Present Value of Excess Profits AK times Discount Factor
AM Present Value of Expected Profits AH times Discount Factor
AN Actual Profit Pre-Closing Z
AO Actual Profit Year 1 AA
AP Actual Profit Year 2 AB
AQ Actual Profit Year 3 AC
Pre-Standard Issue Age Attained Age
AL 56,922 (184,518) 52,994
AM 325,065 (458,012) 237,128
AN 49,160 0 0
AO 414,030 (1,658,624) 978
AP 291,875 (1,232,110) (11,011)
AQ 215,539 (753,350) (9,755)
Years of Discount Discount Factor
Discount Factor at 5.3% at 20% Total
AL 2.583 0.87510 0.62438 (74,603) *
AM 2.583 0.87510 0.62438 104,180 *
AN 0.000 1.00000 1.00000 49,160
AO 0.583 0.97032 0.89911 (1,243,616) *
AP 1.583 0.92149 0.74926 (941,245) *
AQ 2.583 0.87510 0.62438 (547,566) *
(2,663,689) *
Note: Pre-Standard and Attained Age are discounted at 20%, Issue
Age is discounted at 5.3%.
* Amounts are for illustrative purposes only and will change
based upon actual experience.
