Liquidity and Capital Resources

The Company's need for capital is primarily to maintain or increase the surplus of its Insurance Subsidiaries and to support the Company as an insurance holding company, including the maintenance of its status as a public company. In addition, the Company requires capital to fund its anticipated growth through acquisitions of other companies and blocks of insurance business.

The Company

The Company requires cash to pay the operating expenses necessary to function as an insurance holding company (which under applicable Insurance Department regulations must bear its own expenses), and to meet the cost involved in being a publicly owned company. In addition, it requires cash to meet Universal American's obligations under the loan agreement discussed below and the debentures outstanding with American Progressive.

Loan Agreements

As of December 31, 2000, the Company had outstanding $69.5 million of an $80 million credit facility consisting of a $70 million term loan and a $10 million revolving loan facility. The term loan calls for interest at the London Interbank Offering Rate for one, two, three or six months ("LIBOR") plus 350 basis points (currently 9.38%) with principal repayment over a seven-year period and a final maturity date of July 31, 2006. The term loan is secured by a first priority interest in 100% of the outstanding common stock of American Exchange, American Progressive, PFI, Inc. (an immaterial subsidiary), Quincy Coverage Corp. (an immaterial subsidiary), and WorldNet and 65% of the outstanding common stock of UAFC (Canada) Inc. (the 100% parent of PennCorp Life of Canada). The Company has drawn down $3.0 million of the revolving loan facility in connection with the acquisition of CHCS, Inc. in August 2000 and pays a commitment fee of 50 basis points on the unutilized facility. For the year ended December 31, 2000, the Company paid $7.1 million in interest and $3.4 million in principal.

In connection with an agreement entered into in 1996 whereby American Pioneer became a direct subsidiary of Universal American, rather than an indirect subsidiary owned through American Progressive, Universal American has $7.9 million in debentures outstanding to its subsidiary, American Progressive. The debentures pay interest quarterly at 8.50% and are due between September 2002 and May 2003. During the year ended December 31, 2000, the Company paid $0.7 million in interest on these debentures to American Progressive, which was eliminated in consolidation.

Management believes that the current cash position, the availability of the revolving loan facility, the expected cash flows of the non-insurance companies, the surplus note interest payments from American Exchange and the availability of dividends from its Insurance Subsidiaries can support the obligations of Universal American noted above for the foreseeable future. However, there can be no assurance as to the expected future cash flows or to the availability of dividends from the Insurance Subsidiaries.

Insurance Subsidiaries

American Progressive, American Pioneer, American Exchange, Constitution Life, Marquette, Peninsular Life, PennCorp Life of Canada, Pennsylvania Life and Union Bankers (collectively, the "Insurance Subsidiaries") are required to maintain minimum amounts of capital and surplus as determined by statutory accounting. Each of the Insurance Subsidiaries' statutory capital and surplus exceeds its respective minimum requirement. However, substantially more than such minimum amounts are needed to meet statutory and administrative requirements of adequate capital and surplus to support the current level of the Insurance Subsidiaries' operations. At December 31, 2000 the statutory capital and surplus, including asset valuation reserves, of the U.S. Insurance Subsidiaries totaled $86.5 million.

The National Association of Insurance Commissioners ("NAIC") imposes regulatory risk-based capital ("RBC") requirements on life insurance enterprises and at December 31, 2000 all of the Insurance Subsidiaries maintained ratios of total adjusted capital to RBC in excess of the Authorized Control Level.

PennCorp Life of Canada and Pennsylvania Life's Canadian branch report to Canadian regulatory authorities based upon Canadian statutory accounting principles that vary in some respects from U.S. statutory accounting principles. Canadian net assets based upon Canadian statutory accounting principles were $56.5 million as of December 31, 2000. PennCorp Life of Canada maintained a Minimum Continuing Capital and Surplus Requirement Ratio ("MCCSR") in excess of the minimum requirement and Pennsylvania Life's Canadian branch maintained a Test of Adequacy of Assets in Canada and Margin Ratio ("TAAM") in excess of the minimum requirement at December 31, 2000.

Cash generated by the Insurance Subsidiaries will be made available to Universal American, the ultimate parent, principally through periodic payments of principal and interest on surplus debentures. Currently, the surplus notes between Universal American and American Exchange total $70 million, which calls for interest at the LIBOR rate plus 375 basis points. The Company anticipates that the surplus note will be primarily serviced by dividends from Pennsylvania Life, a wholly owned subsidiary of American Exchange, and by tax-sharing payments among the insurance companies which are wholly owned by American Exchange filing a consolidated Federal income tax return. During the year-end December 31, 2000, Pennsylvania Life and Union Bankers paid dividends amounting to $2.9 million and $2.0 million, respectively. In addition, the insurance companies included in the tax allocation agreement with American Exchange, paid $4.8 million of taxes to American Exchange. During the year ended December 31, 2000, American Exchange paid $7.0 million in interest to Universal American. No principal payments were made during 2000.

Dividend payments by insurance companies are limited by, or subject to the approval of the insurance regulatory authorities of each insurance company's state of domicile. Such dividend requirements and approval processes vary significantly from state to state. The maximum amount of dividends which can be paid to American Exchange from Pennsylvania Life, without the prior approval of the Pennsylvania Department of Insurance, is restricted to the greater of 10% of the Pennsylvania Life's surplus as regards policyholders as of the preceding December 31, or, the net gain from operations during the preceding year, but such dividends can be paid only out of unassigned surplus. Thus, future earnings of the company would be available for dividends without prior approval, subject to the restrictions noted above. Based upon the current dividend regulations of the respective states, Pennsylvania Life and Union Bankers would be able to pay ordinary dividends of approximately $12.1 million and $1.4 million, respectively, to American Exchange without the prior approval from the respective insurance departments.

Liquidity for the Life Insurance Subsidiaries is measured by their ability to pay scheduled contractual benefits, pay operating expenses, and fund investment commitments. Sources of liquidity include scheduled and unscheduled principal and interest payments on investments, premium payments and deposits and the sale of liquid investments. These sources of liquidity for the Insurance Subsidiaries significantly exceed scheduled uses.

Liquidity is also affected by unscheduled benefit payments including death benefits, benefits under accident & health policies and interest-sensitive policy surrenders and withdrawals. The amount of surrenders and withdrawals is affected by a variety of factors such as credited interest rates for similar products, general economic conditions and events in the industry that affect policyholders' confidence. Although the contractual terms of substantially all of the Company's in-force life insurance policies and annuities give the holders the right to surrender the policies and annuities, the Company imposes penalties for early surrenders. At December 31, 2000 the Company held reserves that exceeded the underlying cash surrender values of its in-force life insurance and annuities by $16.0 million. The insurance companies, in management's view, have not experienced any material changes in surrender and withdrawal activity in recent years.

Changes in interest rates may affect the incidence of policy surrenders and withdrawals. In addition to the potential impact on liquidity, unanticipated surrenders and withdrawals in a changed interest rate environment could adversely affect earnings if the Company were required to sell investments at reduced values in order to meet liquidity demands. The Company manages the asset and liability portfolios in order to minimize the adverse earnings impact of changing market rates. The Company seeks to invest in assets that have duration and interest rate characteristics similar to the liabilities that they support.

The net yields on the Company's cash and invested assets increased slightly from 6.79% in 1999 to 6.88% in 2000. A significant portion of these securities are held to support the liabilities for policyholder account balances, which liabilities are subject to periodic adjustments to their credited interest rates. The credited interest rates of the interest-sensitive policyholder account balances are determined by management based upon factors such as portfolio rates of return and prevailing market rates and typically follow the pattern of yields on the assets supporting these liabilities.

At December 31, 2000, the Insurance Subsidiaries held cash and cash equivalents totaling $33.2 million, as well as fixed maturity and equity securities that could readily be converted to cash with carrying values (and fair values) of $751.7 million. The fair values of these holdings totaled more than $784.9 million.