<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1997
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________ to _________
Commission file number 0-21223
PROFESSIONALS INSURANCE COMPANY MANAGEMENT GROUP
(Exact name of registrant as specified in its charter)
Michigan 38-3273911
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
2600 Professionals Drive 48864
Okemos, Michigan (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code: (517) 349-6500
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, no
par value per share
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K. / /
The number of the registrant's shares of common stock, no par value per share,
outstanding as of March 16, 1998 was 3,505,750.
Based on the closing price of shares of the registrant's common stock as
reported on the Nasdaq National Market on March 16, 1998 ($41.50) the
aggregate market value of the shares of the registrant's common stock held by
non-affiliates of the registrant as of March 16, 1998 was $137,003,162.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's Notice of Annual Meeting of Stockholders and Proxy
Statement for its 1998 Annual Meeting of Stockholders are incorporated by
reference in Part III hereof.
<PAGE> 2
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page No.
PART I
<S> <C> <C>
Item 1. Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
General . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Products and Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Marketing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Underwriting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Claims Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Reserves and Losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Reinsurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
Competition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
Subsidiaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
Employees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
Forward-Looking Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
Glossary of Selected Insurance Terms . . . . . . . . . . . . . . . . . . . . . . . . . 25
Item 2. Properties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27
Item 3. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27
Item 4. Submission of Matters to a Vote of
Security Holders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27
Executive Officers of Registrant . . . . . . . . . . . . . . . . . . . . . . . . . . . 27
PART II
Item 5. Market for Registrant's Common Equity and
Related Stockholder Matters . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29
Item 6. Selected Financial Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations . . . . . . . . . . . . . . . . . . . 32
Financial Condition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32
Results of Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34
Liquidity and Capital Resources . . . . . . . . . . . . . . . . . . . . . . . . . . . 38
Impact of Inflation and Changing Prices . . . . . . . . . . . . . . . . . . . . . . . 42
Reinsurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42
Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44
Effects of New Accounting Pronouncements . . . . . . . . . . . . . . . . . . . . . . . 44
Year 2000 Compliance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45
Item 7A. Quantitative and Qualitative Disclosures
about Market Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45
Item 8. Financial Statements and Supplementary Data . . . . . . . . . . . . . . . . . . . . . 46
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure . . . . . . . . . . . . . . . . . . . . . . 79
PART III
Item 10. Directors and Executive Officers of
the Registrant . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79
Item 11. Executive Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79
Item 12. Security Ownership of Certain Beneficial
Owners and Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80
Item 13. Certain Relationships and Related Transactions . . . . . . . . . . . . . . . . . . . . 80
PART IV
Item 14. Exhibits, Financial Statement Schedules,
and Reports on Form 8-K . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81
Signatures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 86
</TABLE>
2
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PART I
Item 1. Business
General:
Professionals Insurance Company Management Group ("Professionals
Group," and together with its direct and indirect subsidiaries, the "Company")
is a Michigan business corporation that functions as an insurance holding
company. The Company had consolidated assets of $413.2 million and $357.4
million at December 31, 1997 and 1996, respectively. Professionals Group was
incorporated on January 31, 1996 under the laws of the State of Michigan, its
principal executive offices are located at 2600 Professionals Drive, Okemos,
Michigan 48864, and its telephone number is (517) 349-6500.
Products and Services:
The principal product currently offered by the Company is medical
professional liability insurance for physicians, surgeons, dentists, hospitals
and other health care providers. Such insurance is primarily offered through
PICOM Insurance Company, a stock insurance company incorporated under Michigan
law in 1980 and a wholly owned subsidiary of Professionals Group ("PICOM").
Medical professional liability insurance provides insurance against the legal
liability of an insured (and against loss, damage or expense incident to a claim
of such liability) arising out of bodily injury, sickness, disease or death
sustained by a patient arising from an act or omission occuring in the
furnishing of health care services to a patient. PICOM is licensed to provide
such insurance in Florida, Kentucky, Indiana, Illinois, Iowa, Michigan,
Missouri, Ohio, Pennsylvania and Wisconsin and operates primarily in Michigan,
Illinois, Indiana and Ohio. ProNational Casualty Company, a stock insurance
company incorporated under the laws of Illinois in 1994 and a wholly owned
subsidiary of PICOM ("ProNational Casualty"), is licensed to provide such
insurance in Illinois.
In 1994, the Company expanded into other professional liability lines
by providing professional liability coverage to lawyers and law firms through
PICOM. The Company currently provides reinsurance to an unaffiliated lawyers
professional liability insurance company. See "Reinsurance."
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Effective July 1, 1997, PICOM began reinsuring, on a quota-share
basis, 40% of the net personal lines insurance business of Michigan
Educational Employees Mutual Insurance Company, a Michigan domiciled specialty
writer of personal automobile and homeowners coverages for teachers and other
members of the educational community in Michigan ("MEEMIC"). See "Reinsurance"
and "Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Liquidity and Capital Resources."
PICOM and ProNational Casualty Company are rated A- by A.M. Best
Company, Inc. ("A.M. Best") and A- by Standard & Poor's Corporation ("Standard
& Poor's"). See "Glossary of Selected Insurance Terms" for descriptions of the
rating continuums utilized by A.M. Best and Standard & Poor's. In developing
their respective ratings, A.M. Best and Standard & Poor's each evaluate an
insurer's financial and operating performance including a quantitative
evaluation of profitability, leverage and liquidity and a qualitative evaluation
of spread of risk, appropriateness of reinsurance, quality and diversification
of assets, adequacy of reserves and surplus, and management experience. These
ratings are based on factors of concern to policyholders, agents and
intermediaries and are not directed towards the protection of investors.
Marketing:
The Company is licensed to write its insurance products in ten states.
The Company currently markets its insurance products in Michigan, Illinois,
Indiana, Iowa and Ohio and intends to begin
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marketing its insurance products in Florida and Pennsylvania in 1998. The
Company has applied for licenses in Alabama, Delaware, Georgia, Kansas,
Maryland, Minnesota, New Jersey, North Carolina, South Carolina, Tennessee,
Virginia and West Virginia. There can be no assurances as to whether or when
such licenses will be granted.
The marketing and sales of the Company's insurance products is carried
out by the Company through its offices in Okemos, Michigan, Lisle, Illinois,
Indianapolis, Indiana and Columbus, Ohio, and in cooperation with local
independent insurance agencies. The Company is primarily responsible for
general marketing activities such as advertising, product information,
convention participation and relationships with various professional
associations of which the Company's insureds are members. Such independent
insurance agencies are primarily responsible for the sale of the Company's
insurance products by pursuing leads generated by the Company's marketing
activities and through agency-generated leads in their local communities. For
the years ended December 31, 1997, 1996 and 1995, the Company wrote
approximately 85% of its premiums through independent agencies and approximately
15% of its premiums directly. For the years ended December 31, 1997, 1996 and
1995, the Company's top ten independent insurance agencies accounted for
approximately 55%, 58% and 55%, respectively, of the Company's direct written
premiums. In 1997, 1996 and 1995, one independent insurance agency
individually produced approximately 10% of the Company's direct written
premiums.
The Company typically enters into written agreements with those
independent insurance agencies offering the Company's insurance products.
These agreements typically authorize the insurance agency to act as the
Company's agent for the sale and service of specified insurance products in a
specific state. Such agreements are for a stated duration (typically from one
year to five years) and are terminable only upon prior written notice. Each
insurance agency executing such an agreement acts as an independent contractor
and is responsible for all expenses incurred by it. These agreements also (i)
provide for direct billing and collection of all premiums by the Company, (ii)
provide for specific commissions payable to the insurance agency, (iii) provide
for arbitration in the event of disputes, and (iv) prohibit assignment by the
insurance agency without the prior written consent of the Company.
Underwriting:
All underwriting decisions are made by the Company through its
underwriting staff. Each prospective insured is required to submit an
application for coverage that, among other things, reviews the professional
training, area and scope of practice and claims history of the prospective
insured. Through its underwriting process, which involves an evaluation of the
application and, in
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certain situations, may include supplemental on-site risk management
evaluations, the Company will assess the quality and pricing of the risk. In
making such assessment, the Company's underwriting process typically emphasizes
loss history, practice specialty and location.
The Company's insurance policy premiums are based upon several
factors, the most important of which are loss history, practice specialty and
location of practice. Generally, physicians practicing in surgical specialties
(such as neurosurgery, obstetrics, general surgery, orthopedic surgery and
plastic surgery) are assessed higher premiums than non-surgeons; and, practices
located in larger metropolitan areas are assessed higher premiums than
practices located in smaller urban areas and rural areas. For the years ended
December 31, 1997, 1996 and 1995, approximately 60%, 63% and 68%, respectively,
of the Company's direct medical malpractice written premiums were generated
from insureds practicing in non-surgical risk groups and 40%, 37% and 32%,
respectively, were generated from insureds practicing in surgical risk groups.
For the years ended December 31, 1997, 1996 and 1995, approximately 50%, 51%
and 52%, respectively, of such written premiums were generated from insureds
practicing in larger metropolitan areas (such as metropolitan Detroit, Michigan
and metropolitan Chicago, Illinois) and 50%, 49% and 48%, respectively, of such
written premiums were generated from insureds practicing in smaller urban areas
and rural areas.
Currently, the majority of medical professional liability policies
issued by the Company are "claims-made" policies, although aproximately 18%, 13%
and 13% of the Company's direct medical professional liability premiums during
1997, 1996 and 1995, respectively, were derived from "occurrence" policies. (A
claims-made policy is an insurance policy covering only those claims which occur
and are reported during the policy period. An occurrence policy is an insurance
policy covering losses occurring during the policy period, without regard to
when the claim is reported to the insurer. See "Glossary of Selected Insurance
Terms.")
Claims Management:
The Company emphasizes early evaluation and aggressive management of
claims. A claim is generally reported directly to the Company by the insured
after the insured has received a court summons or a pre-suit notice of claim.
The reported claim is logged in to a computerized data base by the Company's
claims staff, which then determines whether the potential loss is covered by an
insurance policy issued by the Company. If the claim is covered, it is then
assigned a claims professional for investigation and analysis. If the claim is
in litigation, the claim is also assigned to outside legal counsel selected by
the Company and specializing in professional liability claims. During 1997,
approximately 72% of the Company's claims were litigated and ultimately
resolved through settlement, dismissal or trial, and approximately 28% of the
Company's claims were resolved outside of the litigation process through
settlement or the abandonment of the claim by the plaintiff.
The Company's claims staff evaluates and establishes an initial
reserve for each claim within the first 90 days after notification of a claim.
During the life of a claim, the reserve for such claim is systematically
monitored and revised as new information about the claim develops. For
litigated claims, the Company's claims staff works closely with outside legal
counsel to
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develop case strategies and to foster full communications with the insured.
Medical and/or other professional experts are retained to assist in the
analysis and defense of claims. A claims committee comprised of experienced
Company representatives and outside medical specialists meets regularly to
provide medical insights and input for cases involving complex claims. The
Company's claims staff meets on a weekly basis to review cases scheduled for
trial. The Company's claims staff frequently attends court settlement
conferences along with outside legal counsel and monitors cases during trial.
Reserves and Losses:
The Company establishes balance sheet reserves based on its estimates
of the future amounts necessary to pay claims and expenses associated with
investigation and settlement of claims. These estimates include two
components: case reserves and bulk reserves. Case reserves are estimates of
future losses and loss adjustment expenses ("losses and LAE") for reported
claims and are established by the Company's claims department. Bulk reserves,
which include a provision for losses that have occurred but have not been
reported to the Company as well as development on reported claims, are the
difference between (i) the sum of case reserves and paid losses and (ii) an
actuarially determined estimate of the total losses and LAE necessary for the
ultimate settlement of all reported claims and incurred but not reported
claims, including amounts already paid.
Loss and loss adjustment expense reserves are determined on the basis
of individual claims and actuarially determined estimates of future losses
based on the Company's past loss experience and projections as to future claims
frequency, severity, inflationary trends and settlement patterns. Estimating
professional liability reserves is a complex process which is heavily dependent
on judgment and involves many uncertainties. As a result, reserve estimates
may vary significantly from the eventual outcome. The assumptions used in
establishing the Company's reserves are regularly reviewed and updated by
management as new data becomes available. Any adjustments necessary are
generally reflected in current operations.
The following table sets forth a reconciliation of beginning and
ending reserves for losses and LAE as shown in the Company's consolidated
financial statements for the years indicated. See also Note 9 to the Company's
consolidated financial statements.
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<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1997 1996 1995
---- ---- ----
(in thousands)
<S> <C> <C> <C>
Balance, beginning of year $219,919 $199,605 $188,544
Less reinsurance balances
recoverable (19,206) (14,186) (3,760)
-------- -------- --------
Net balance, beginning of
year 200,713 185,419 184,784
-------- -------- --------
Incurred related to:
Current year 83,466 65,986 63,027
Prior years (26,341) (17,618) (27,469)
-------- -------- --------
Total incurred 57,125 48,368 35,558
-------- -------- --------
Effect of change in
accounting method -- -- 12,310
Loss and loss adjustment
expense reserves assumed -- 4,119 --
-------- -------- --------
Paid related to:
Current year 10,512 4,352 3,053
Prior years 32,015 32,841 44,180
-------- -------- --------
Total paid 42,527 37,193 47,233
-------- -------- --------
Net balance, end of year 215,311 200,713 185,419
Plus reinsurance balances
recoverable 23,840 19,206 14,186
-------- -------- --------
Balance, end of year $239,151 $219,919 $199,605
======== ======== ========
</TABLE>
The following table presents the development of the net liability of
undiscounted reserves for losses and LAE for the calendar years 1988 through
1997. (Through 1994, the Company's losses and LAE reserves were discounted.
Effective January 1, 1995, this practice was discontinued). The amounts shown
for each year on the top line of the table present the Company's estimate of
its losses and LAE reserves as originally reported to stockholders. (The
losses and LAE reserves as originally reported are presented net of reinsurance
recoverables relating to unpaid losses through 1991, net of losses and LAE
reserve discount through 1994, and gross of such amounts thereafter). The net
liability- end of year line represents the undiscounted estimated amount of
unpaid losses and LAE for claims arising in all prior years that were unpaid at
the balance sheet date, including losses that had been incurred but not yet
reported, net of reinsurance ceded. The portion of the table labeled
"cumulative paid as of" shows the net cumulative payments for losses and LAE
made in succeeding years for losses incurred prior to the balance sheet date.
The next portion of the table shows the re-estimated amount of the previously
recorded loss and LAE reserves based on experience as of the end of each
succeeding year, followed by a line indicating the change from the original
estimate to the most current re-estimate.
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Analysis of Loss and Loss Adjustment Expense Reserve Development
(in thousands)
December 31,
<TABLE>
<CAPTION>
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997
---- ---- ---- ---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Loss & LAE Reserves as
originally reported $150,745 $162,509 $167,982 $183,603 $184,758 $191,220 $188,544 $199,605 $219,919 $239,151
Less reinsurance recoverable (2,403) (4,040) (3,760) (14,186) (19,206) (23,840)
Add pro forma change to
reflect elimination of
discount 43,637 41,161 32,781 27,839 16,568 12,616 12,310 - - -
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Net liability - end of year $194,382 $203,670 $200,763 $211,442 $198,923 $199,796 $197,094 $185,419 $200,713 $215,311
Cumulative paid as of:
One year later .............. 44,596 42,611 35,703 43,300 36,220 42,816 44,180 32,841 32,015
Two years later ............. 84,376 73,226 69,720 68,512 65,570 73,183 70,008 55,856
Three years later ........... 108,547 99,872 87,375 88,126 84,334 88,507 83,165
Four years later ............ 126,619 110,475 99,051 99,732 92,666 94,909
Five years later ............ 134,396 118,884 107,379 104,815 96,447
Six years later ............. 141,288 125,012 111,347 107,631
Seven years later ........... 146,704 128,772 113,718
Eight years later ........... 150,016 130,914
Nine years later ............ 151,368
Re-estimated net liability as
of:
End of year ................. 194,382 203,670 200,763 211,442 198,923 199,796 197,094 185,419 200,713 215,311
One year later .............. 206,473 198,911 192,046 183,353 171,318 173,013 169,625 167,778 174,372
Two years later ............. 202,528 191,402 172,650 167,450 152,998 158,403 158,756 141,779
Three years later ........... 191,995 173,376 161,494 151,492 145,128 149,654 143,556
Four years later ............ 180,919 165,398 146,942 147,193 136,749 139,493
Five years later ............ 175,759 155,570 144,384 140,589 132,043
Six years later ............. 169,167 154,533 138,998 137,978
Seven years later ........... 170,139 151,591 134,584
Eight years later ........... 168,731 153,135
Nine years later ............ 170,428
Net cumulative redundancy 23,954 50,535 61,179 73,464 66,880 60,303 53,538 43,640 26,341
</TABLE>
In evaluating the information in the table above, it should be noted
that each column includes the effects of changes in amounts for prior periods.
The table does not present accident year or policy year development data.
Conditions and trends that have affected the development of liabilities in the
past may not necessarily occur in the future. Accordingly, it may not be
appropriate to extrapolate future redundancies or deficiencies based on this
table.
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As shown in the reserve development table, positive reserve
development exists for each of the years 1988 through 1996. Such positive
reserve development is mainly attributable to (i) the Company's practice of
establishing its loss and loss adjustment expense reserves conservatively, as
it relates to immaturely developed accident years, to minimize potential
uncertainties, and (ii) lower than expected claims costs associated in part
with tort reform legislation enacted in Michigan between 1986 and 1994. Such
tort reform legislation shortened the statute of limitations, introduced a
statute of repose with a six year limitation for adults, modified expert
witness rules to require more qualified expert witnesses and capped
non-economic damages.
The following table presents a reconciliation of reserves of the
Company in accordance with statutory accounting practices ("SAP") with reserves
reflected in the consolidated financial statements prepared in accordance with
generally accepted accounting principles ("GAAP") as of December 31, 1997 and
1996.
Reconciliation of SAP Reserves with GAAP Reserves
(in thousands)
<TABLE>
<CAPTION>
December 31,
1997 1996
---- ----
<S> <C> <C>
Loss and LAE reserves - SAP basis $204,653 $190,055
Add:
Discount . . . . . . . . . . . . . . . . . . . . . . . . . . 10,658 10,658
Provision for reinsurance on unpaid
losses . . . . . . . . . . . . . . . . . . . . . . . . . . 23,840 19,206
-------- --------
Loss and LAE reserves - GAAP basis . . . . . . . . . . . . . $239,151 $219,919
======== ========
</TABLE>
For SAP reporting, loss reserves are discounted at a three percent
discount rate, as permitted by insurance regulatory authorities. For GAAP
reporting, the Company does not discount reserves. Under SAP, loss and LAE
reserves are presented net of the provision for reinsurance, whereas under
GAAP, loss and LAE reserves are presented gross of reinsurance and amounts due
from reinsurers are presented as an asset.
Investments:
The Company invests principally in debt securities such as United
States government obligations, U.S. government agency mortgage-backed
securities, tax-exempt municipal bonds, redeemable preferred stocks and
investment grade corporate bonds. Investment policy and the performance of
independent investment managers are reviewed quarterly by or on behalf of
Professionals Group's Board of Directors. The current investment policy
establishes a target duration and limits fixed income purchases (absent
specific authorization of Professionals Group's Board of Directors) to
securities rated BBB/Baa or better by Moody's Investor Services, Inc.
("Moody's"), Standard & Poor's, Duff & Phelps Inc. or Fitch Investors Service
Inc. The Company's independent investment
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manager selects specific bond issues within these guidelines. The Company's
investment policy limits holdings in common stocks and preferred stocks,
cumulatively, to twenty percent of the Company's statutory surplus.
In general, the investment policy of the Company is to maximize after
tax investment yield, subject to constraints on investment quality, maturity
and liquidity. The Company's investment policy establishes a range of
appropriate allocation among various asset classes. The precise allocation
varies depending on an evaluation of the economic environment and on the
Company's tax position. Currently, the Company's investment portfolio consists
primarily of United States government agency, corporate and municipal bonds.
As of December 31, 1997, only one of the rated securities in the Company's
fixed income portfolio was rated below investment grade (carrying value was
$816,000). See Item 7. "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
As of December 31, 1997 and 1996, all fixed maturity securities were
classified as available-for-sale and carried at estimated fair value. For these
securities, temporary unrealized gains and losses, net of deferred federal
income taxes, are reported directly through stockholders' equity, and have no
effect on net income. As of December 31, 1997 and 1996, the estimated fair
value of fixed maturity securities exceeded the aggregate amortized cost by $4.7
million and $298,000, respectively, and stockholders' equity was increased by
those amounts, reduced by $1.6 million and $101,000, respectively, in deferred
federal income taxes. The increase in net unrealized gains was due to slightly
lower interest rates at year end 1997 as compared to year end 1996. See also
Notes 4 and 6 to the Company's consolidated financial statements. The Company's
fixed maturity investment portfolio is sensitive to interest rate changes. As
of December 31, 1997, a one hundred basis point increase in market interest
rates would decrease the value of this portfolio by approximately three and
one-half percent, whereas a one hundred basis point decrease in market interest
rates would increase the value of this portfolio by approximately three percent.
Reinsurance:
Insurance companies purchase reinsurance to limit risk on individual
exposures, protect against catastrophic losses and increase their capacity to
write insurance. Reinsurance involves an insurance company transferring, or
ceding, all or a portion of its exposure on a given insurance policy to a
reinsurer. The reinsurer assumes the exposure in return for a portion of the
premium received by the insurance company. Reinsurance does not discharge the
insurer from its obligation to its insureds. If the reinsurer fails to meet
its obligations, the ceding insurer remains liable to pay the insured.
The Company cedes a material amount of its business to reinsurers to
spread risk and limit loss per exposure and to
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protect stockholders' equity from large or unusual loss activity. As of
December 31, 1997, the Company had both excess of loss reinsurance (i.e.,
reinsurance in which the Company has ceded to a reinsurer, and such reinsurer
has assumed, all or a portion of losses associated with a given policy in
excess of a specified retention level up to a predetermined limit) and "errors
and omissions" insurance (i.e., insurance which protects the Company against
losses in excess of policy limits claims).
The Company has various excess of loss and quota share reinsurance
agreements. As of December 31, 1997, the maximum current net retention on
business generated by Professionals Group's insurance subsidiaries, subject to
certain adjustments of risk on any single coverage per claim after reinsurance,
was $300,000. Effective January 1, 1998, the Company's net retention was
increased to $500,000 on all business. Individual losses are covered by the
excess of loss reinsurance on a per incident basis up to $5 million. The
"errors and omissions" insurance protects the Company against losses in excess
of policy limits claims up to $10 million, subject to a $500,000 retention for
each claim. See also Note 5 to the Company's consolidated financial
statements.
The following table identifies the Company's most significant
reinsurers, their percentage participation in the Company's aggregate reinsured
risk based upon premiums paid by the Company during 1997 and their respective
A.M. Best ratings as of December 31, 1997. No other single reinsurer's
percentage participation in 1997 exceeded 3% of total ceded reinsurance
premiums:
<TABLE>
<CAPTION>
1997 Total % of 1997
Ceded Ceded Total Ceded
A.M. Best Reinsurance Premiums Premiums
Rating(1) Balances Written Written
--------- ----------- ----------- -----------
(dollars in thousands)
<S> <C> <C> <C> <C>
Underwriters Reinsurance Company . . . . . . A+ $ 4,125 $ - -
TIG Reinsurance . . . . . . . . . . . . . . . A 7,299 3,858 36.6%
PMA Reinsurance Corporation . . . . . . . . . A+ 3,445 1,936 18.4%
Continental Casualty Company . . . . . . . . A 3,014 1,708 16.2%
Odyssey Reinsurance Company . . . . . . . . . A- 1,347 869 8.2%
Other . . . . . . . . . . . . . . . . . . . . -- 2,422 2,173 20.6%
------- ------ -------
$21,652 $10,544 100.0%
======= ======= ======
</TABLE>
- -----------------------------
(1) See "Glossary of Selected Insurance Terms" for a description of the
rating continuum utilized by A.M. Best. See also Note 5 to the
Company's consolidated financial statements.
-12-
<PAGE> 13
The Company, through its reinsurance intermediary, annually reviews
the financial stability of all of its reinsurers. This review includes a
ratings analysis of each reinsurer participating in a reinsurance contract. On
the basis of such review, as of December 31, 1997 and 1996, the Company
concluded that there was no material exposure to uncollectible reinsurance
balances payable to the Company by its reinsurers. The Company has not
experienced any material difficulties in collecting amounts due from reinsurers
(ceded reinsurance balances) and believes (i) that its reinsurance is
maintained with financially stable reinsurers and (ii) that any reinsurance
security maintained is adequate to protect its interests. However, the
inability of the Company to collect on its aggregate reinsurance recoverables,
or the inability of the Company's reinsurers to make payments under the terms
of reinsurance treaties (due to insolvency or otherwise), could have a material
adverse effect on the Company's future results of operations and financial
condition.
Prior to 1996, the Company did not assume business from other
insurance companies except as follows: In an effort to remediate the variances
in certain regulatory ratios of ProNational Casualty, and in order to allow
ProNational Casualty to assume PICOM's A.M. Best Rating, ProNational Casualty
and PICOM entered into a quota share reinsurance contract whereby not less than
90% of the insurance risks written by ProNational Casualty are reinsured by
PICOM. This reinsurance mechanism, which will not affect the Company's
consolidated results, is expected to stabilize the underwriting results of
ProNational Casualty. See "Regulation." In addition, on December 31, 1996,
the Company assumed all of the loss and loss adjustment expense reserves and
unearned premiums of American Medical Insurance Exchange. See "Subsidiaries."
During 1997, PICOM entered into an agreement with Michigan Lawyers
Mutual Insurance Company ("MLM") whereby PICOM ceded all of its Michigan lawyers
professional liability insurance policies in-force to MLM and reinsured 35% of
MLM's net premiums. As part of this arrangement MLM will provide certain
insurance support services to enable PICOM to introduce its lawyers
professional liability product into Illinois, Ohio and Indiana during 1998.
The assumed premiums earned and the assumed losses and loss adjustment expenses
incurred in connection with the MLM reinsurance agreement were $548,000 and
$494,000, respectively, for the year ended December 31, 1997.
Effective July 1, 1997, PICOM began assuming, on a quota-share basis,
40% of the net personal automobile and homeowners insurance risks of MEEMIC.
See "Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Liquidity and Capital Resources." The assumed
premiums earned and the assumed losses and loss adjustment expenses incurred in
connection with the MEEMIC reinsurance agreement were $20.1 million
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<PAGE> 14
and $13.1 million, respectively, for the year ended December 31, 1997.
Competition:
The Company competes with numerous insurance companies as well as
various self-insurance mechanisms. Principal competitors in the Midwest
consist of three customer-owned local insurance companies (Michigan Physicians
Mutual Liability Company, Illinois State Medical Inter-Insurance Exchange and
Michigan Hospital Association Insurance Company) and several national companies
(including The St. Paul Companies, The Medical Protective Company, American
International Group, MMI Companies, Cincinnati Insurance Company, and CNA
Insurance Companies). The majority of these competitors have substantially
greater financial resources than does the Company.
Competition in the medical malpractice insurance industry may take
several forms, including pricing, service quality, breadth and flexibility of
coverages, method of sale, and insurance carrier financial stability and
ratings. The Company competes through name recognition and reputation,
especially in its Midwest markets, by emphasizing a high level of customer
service to insureds, and by using local insurance agencies to sell and
distribute its insurance products. The Company has attempted to balance its
need for rate adjustments with the goal of maintaining market share in a
very competitive insurance market. Although the Company has maintained
profitability and is endeavoring to offset lower premiums charged through more
selective underwriting practices, there can be no assurance that these
practices will be successful in the long term.
The success of the Company may also be influenced by general economic
conditions in the geographic markets served by it. No assurance can be given
that favorable economic conditions will exist in such markets.
Regulation:
General. Insurance holding companies and insurance companies are
extensively regulated. Such regulation has had significant effect on the
operations of insurance holding companies and insurance companies in the past
and is expected to have significant effects in the future. Periodically,
legislation is considered and adopted which has resulted in, or that could
result in, further regulation or deregulation of insurance holding companies
and insurance companies. No assurance can be given as to whether any
-14-
<PAGE> 15
additional legislation will be adopted or as to the effect such legislation
would have on the business of the Company.
Insurance companies are subject to regulation by government agencies
in the states in which they are licensed. PICOM is licensed as a property and
casualty insurer in Michigan, Florida, Illinois, Indiana, Iowa, Kentucky,
Missouri, Ohio, Pennsylvania and Wisconsin. ProNational Casualty is licensed
as a property and casualty insurer in Illinois. The nature and extent of such
regulation vary from jurisdiction to jurisdiction, but typically involve prior
approval of the acquisition of control of an insurance company or of any
company controlling an insurance company, regulation of certain transactions
entered into by an insurance company with any of its affiliates, approval of
premium rates, forms and policies used for many lines of insurance, standards
of solvency and minimum amounts of capital and surplus which must be
maintained, establishment of reserves required to be maintained for unearned
premium, losses and loss adjustment expenses or for other purposes, limitations
on types and amounts of investments, restrictions on the size of risks which
may be insured by a single entity, licensing of insurers and agents, deposits
of securities for the benefit of policyholders, and the filing of periodic
reports with respect to financial condition and other matters. In addition,
state regulatory examiners perform periodic examinations of insurance
companies. Such regulation is generally intended for the protection of
policyholders rather than security holders.
PICOM and ProNational Casualty principally write medical malpractice
insurance and additional requirements are placed upon them to report detailed
information with regard to the settlements or judgments against their
respective insureds. In addition to the reporting to the states of medical
malpractice settlements and judgments, payments must also be reported to the
National Practitioners Data Bank ("Data Bank"). Penalties attach if reports to
the states and to the Data Bank are not made.
Every insurance company is subject to a periodic examination under the
authority of the insurance commissioner of its state of domicile. Any other
state interested in participating in a periodic examination may do so. The
last periodic examination of PICOM was based on its December 31, 1995 statutory
financial statements and a report was issued on October 15, 1996. As of
December 31, 1997, ProNational Casualty had yet to undergo a periodic
examination. Various states also conduct "market conduct examinations" which
are periodic, unscheduled examinations designed to monitor the compliance with
state laws and regulations concerning the filing of rates and forms. PICOM and
ProNational Casualty have not undergone a market conduct examination. Neither
PICOM nor ProNational Casualty was required to make any financial adjustments
or change any market conduct procedures as a result of any of these
examinations.
Insurance companies are also affected by a variety of state and
Federal legislative and regulatory measures and judicial decisions that define
and extend the risks and benefits for which
-15-
<PAGE> 16
insurance is sought and provided. In addition, individual state insurance
departments may prevent premium rates for some classes of insureds from
reflecting the level of risk assumed by the insurer for those classes. Such
developments may adversely affect the profitability of various lines of
insurance.
Professionals Group is subject to regulation as an insurance holding
company because of its ownership of PICOM and is required to file information
relating to its capital structure, ownership, and financial condition and
general business operations of its insurance subsidiaries. Similarly, and in
addition to being regulated as an insurance company, PICOM is subject to
regulation as an insurance holding company because of its ownership of
ProNational Casualty and it is also required to file information relating to
its capital structure, ownership, and financial condition and general business
operations of its insurance subsidiaries. As insurance holding companies,
Professionals Group and PICOM are also subject to special reporting and prior
approval requirements with respect to transactions among affiliates.
Regulation of the insurance industry is undergoing continuous change
and the ultimate effect of such changes cannot be predicted. Regulations now
affecting the Company may be modified at any time and new regulations affecting
the Company may be enacted. There is no assurance that such modifications will
not adversely affect the business of the Company. See "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Regulation."
Change or Acquisition of Control. PICOM is a Michigan stock, property
and casualty insurance company organized under the Michigan Insurance Code of
1956, as amended (the "Michigan Insurance Code"). ProNational Casualty is an
Illinois stock, property and casualty insurance company organized under the
Illinois Insurance Code. The Michigan Insurance Code and the Illinois
Insurance Code all provide that the acquisition or change of "control" of a
domestic insurer or of any person that controls a domestic insurer cannot be
consummated without the prior approval of the relevant insurance regulatory
authority. A person seeking to acquire control, directly or indirectly, of a
domestic insurer or of any person controlling a domestic insurer must generally
file with the relevant insurance regulatory authority an application for change
of control (commonly known as a "Form A") containing certain information
required by statute and published regulations and provide a copy of such Form A
to the domestic insurer. In each of Michigan and Illinois, control is
generally presumed to exist if any person, directly or indirectly, owns,
controls, holds the power to vote or holds proxies representing 10% or more of
the voting securities of any other person.
In addition, many state insurance regulatory laws contain provisions
that require pre-notification to state agencies of a change in control of a
non-domestic admitted insurer in that state. While such pre-notification
statutes do not authorize the state agency to disapprove the change of control,
such statutes do
-16-
<PAGE> 17
authorize issuance of a cease and desist order with respect to the non-domestic
admitted insurer if certain conditions exist such as undue market
concentration.
Insolvency Funds; Mandatory Pools. Most states require admitted
property and casualty insurers to become members of insolvency or guaranty
funds or associations which generally protect policyholders against the
insolvency of such insurers. Members of the fund or association must
contribute to the payment of certain claims made against insolvent insurers.
Maximum contributions required by law in any one year vary between 1% and 2% of
annual premium written by a member in that state. No assessments from guaranty
funds were charged to the insurance subsidiaries of Professionals Group in
1997, 1996 or 1995. Assessments from guaranty funds may, to a limited extent,
be recovered through future premium tax reductions.
Insurance companies are also required to participate in various
mandatory insurance facilities or in funding mandatory pools, which are
generally designed to provide insurance coverage for consumers who are unable
to obtain insurance in the voluntary insurance market. Pools are typically
found in insurance lines such as workers' compensation, homeowners and personal
automobile insurance. PICOM does not currently offer any of these insurance
lines directly, but does provide reinsurance to MEEMIC. Moreover, PICOM could
offer such insurance lines directly in the future. These pools typically
require all companies writing applicable lines of insurance in the state for
which the pool has been established to fund deficiencies experienced by the
pool based upon each company's relative premium writings in that state, with
any excess funding typically distributed to the participating companies on the
same basis. To the extent that these assessments are imposed on the insurance
subsidiaries of Professionals Group, they could have an adverse effect on
Professionals Group or its insurance subsidiaries.
Restrictions on Dividends. Insurance companies and self-insurance
trust funds are subject to various state and regulatory restrictions, generally
applicable to each insurer in its state of incorporation, which limit the
amount of dividends or distributions by an insurer to its stockholders or
policyholders. The restrictions are generally based on certain levels of
surplus, investment income and operating income, as determined under statutory
accounting practices.
The Michigan Insurance Code and the Illinois Insurance Code regulate
the distribution of dividends and other payments to a holding company by its
insurance subsidiaries. Under each of the Michigan Insurance Code and the
Illinois Insurance Code, an insurer may pay dividends or distribute cash or
other property so long as such dividends or distributions, together with all
other dividends or distributions made within the preceding year, do not exceed
the greater of (i) 10% of the insurer's policyholders' surplus as of December
31 of the preceding year or (ii) the net income, not including realized capital
gains, for the twelve-month period
-17-
<PAGE> 18
ending December 31 of the preceding year, with larger dividends payable only
upon prior regulatory approval. Such restrictions or any additional
subsequently imposed restrictions may in the future affect Professionals
Group's ability to fund its operations, pay principal and interest on its debt,
pay its expenses and pay any cash dividends to its stockholders. Future
dividends from Professionals Group's subsidiaries may also be limited by
business considerations.
Risk-Based Capital. The National Association of Insurance
Commissioners (the "NAIC") has established risk-based capital ("RBC")
requirements to assist regulators in monitoring the financial strength and
stability of property and casualty insurers. Under the NAIC requirements,
regulatory compliance is determined by a ratio of an insurer's regulatory total
adjusted capital, as defined by the NAIC, to its authorized control level of
RBC, as defined by the NAIC. Insurers below specific ratios are classified
within certain levels, each of which requires specific corrective action. The
levels and ratios are as follows:
<TABLE>
<CAPTION>
Ratio of Total Adjusted Capital
to Authorized Control Level RBC
Level (Less Than or Equal To)
----- -------------------------------
<S> <C>
Company action level 2.0
Regulatory action level 1.5
Authorized control level 1.0
Mandatory control level 0.7
</TABLE>
PICOM and ProNational Casualty have calculated their ratios of total
adjusted capital to authorized control level RBC and each were in excess of 4:1
at December 31, 1997. At December 31, 1997, PICOM's total adjusted capital was
$99.7 million, and its authorized control level RBC was $23.1 million, and
ProNational Casualty's total adjusted capital was $10.2 million, and its
authorized control level RBC was less than $1.0 million.
NAIC-IRIS Ratios. The NAIC's Insurance Regulatory Information System
was developed by a committee of state insurance regulators and is primarily
intended to assist state insurance departments in executing their statutory
mandates to oversee the financial condition of insurers operating in their
respective states. IRIS identifies 11 industry ratios and specifies "usual
values" for each ratio. Departure from the usual values on four or more ratios
generally leads to inquiries from individual state insurance commissioners.
In 1997, 1996 and 1995, PICOM did not have any ratios which varied
from the "usual value" range.
-18-
<PAGE> 19
In 1995, ProNational Casualty had two ratios which varied from the
"usual value" range as follows:
<TABLE>
<CAPTION>
Ratio Usual Range ProNational Casualty Value
----- ----------- --------------------------
<S> <C> <C>
Two year over-all operating ratio up to 100% 125%
Change in surplus (10%) to 50% (26%)
</TABLE>
In 1996, ProNational Casualty had two ratios which varied from the
"usual value" range as follows:
<TABLE>
<CAPTION>
Ratio Usual Range ProNational Casualty Value
----- ----------- --------------------------
<S> <C> <C>
Two year over-all operating ratio up to 100% 122%
Change in net writings (33%) to 33% (99%)
</TABLE>
In 1997, ProNational Casualty had two ratios which varied from the
"usual value" range as follows:
<TABLE>
<CAPTION>
Ratio Usual Range ProNational Casualty Value
----- ----------- --------------------------
<S> <C> <C>
Change in Surplus (10%) to 50% 69%
Change in net writings (33%) to 33% (99%)
</TABLE>
At present, no inquiries have been received from any state insurance
commissioner as a result of the "unusual values" for ProNational Casualty. In
an effort to remediate such "unusual values", and in order to allow ProNational
Casualty to assume PICOM's A.M. Best Rating, ProNational Casualty and PICOM
entered into a quota share reinsurance contract whereby not less than 90% of
the insurance risks written by ProNational Casualty are reinsured by PICOM.
This reinsurance mechanism, which will not affect the Company's consolidated
results, is expected to stabilize the underwriting results of ProNational
Casualty.
Effect of Federal Legislation. Although the Federal government does
not directly regulate the business of insurance, Federal initiatives often
affect the insurance business in a variety of ways. Current and proposed
Federal measures which may significantly affect the insurance business include
Federal government participation in health care reform, product liability
claims, environmental regulation, pension regulation (ERISA), examination of
the taxation of insurers and reinsurers, minimum levels of liability insurance
and safety regulations.
Tort Reform. On a state level, several states, including Michigan,
have adopted tort reforms designed to moderate the risk
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<PAGE> 20
of practice to health care providers. Although such legislation is being
subjected to numerous constitutional challenges, it generally has a positive
impact by reducing malpractice losses. Such legislation also tends to result
in increased competition because it causes the particular state to be more
attractive to other insurance companies seeking to expand their markets. The
Company has seen an increase in competition in its markets due, in part, to the
passage of tort reform.
On the Federal level, attempts to reform the delivery of medical care
have contained provisions that could, if adopted, have a material impact on the
Company and its insurance products. An example of such a change is the concept
of "enterprise liability" that was contained in President Clinton's health care
proposal. Under the enterprise liability concept, doctors would not bear
individual liability for malpractice events with such liability being borne by
the hospital or other enterprise in which the doctor practices. If enterprise
liability or a similar concept were adopted, insurers such as PICOM could be at
a competitive disadvantage since their business is concentrated in individual
physician risks and larger, more established, companies already provide medical
malpractice insurance for the enterprise risks.
Subsidiaries:
Professionals Group has four direct wholly-owned subsidiaries and two
indirect wholly-owned subsidiaries. The direct wholly-owned subsidiaries are:
PICOM, PICOM Insurance Agency, Inc. ("PIA"), PICOM Financial Services
Corporation ("PFSC") and American Insurance Management Corporation ("AIMC").
The indirect wholly-owned entities, all of which are wholly-owned subsidiaries
of PICOM, are: PICOM Claims Services Corporation ("PCSC") and ProNational
Casualty.
PICOM is a stock, property and casualty insurer incorporated under the
laws of the State of Michigan in 1980. PICOM offers professional liability
insurance for physicians, surgeons, dentists, hospitals, other health care
providers and lawyers and law firms. The Company is licensed to provide such
insurance products in Michigan, Florida, Illinois, Indiana, Iowa, Kentucky,
Missouri, Ohio, Pennsylvania and Wisconsin. PIA is an inactive Michigan
insurance agency incorporated under the laws of the State of Michigan on March
31, 1981. PFSC is an inactive business corporation incorporated under the laws
of the State of Michigan on May 29, 1986. AIMC is an Indiana corporation that
serves as the attorney-in-fact for American Medical Insurance Exchange, an
inactive Indiana interinsurance reciprocal exchange. PCSC provides claims
management services on a fee for service basis and was incorporated under the
laws of the State of Michigan on December 10, 1985. ProNational Casualty is a
stock, property and casualty insurer incorporated under the laws of the State
of Illinois on December 5, 1994. ProNational Casualty provided medical
malpractice insurance to physicians and physician corporations in Illinois
through 1997.
-20-
<PAGE> 21
Employees:
The Company had 90 full-time employees and four part-time employees as
of December 31, 1997. None of these employees are covered by a collective
bargaining agreement. The Company believes that it enjoys good relations with
its personnel.
Forward-Looking Statements:
From time to time, the Company may publish forward-looking statements
relating to such matters as anticipated financial performance, business
prospects, new products and similar matters. The Private Securities Litigation
Reform Act of 1995 provides a safe harbor for forward- looking statements,
which are subject to risks and uncertainties. In order to avail itself of the
safe harbor, the Company notes that a variety of factors could cause its actual
results and experience to differ materially from the anticipated results or
other expectations expressed in its forward-looking statements. All of such
factors are difficult to predict and many are beyond the control of the
Company. These important factors include certain factors discussed elsewhere
herein (such as (i) future economic conditions in the regional and national
markets in which the Company competes; (ii) financial market conditions,
including, but not limited to, changes in interest rates; (iii) inflation; (iv)
estimates of loss reserves and trends in losses and LAE; (v) changing
competition; and (vii) adverse changes in applicable law, regulations or rules
governing insurance holding companies and insurance companies, and
environmental, tax or accounting matters) and the following:
Market Conditions May Impact Results and Operations. A majority of
the direct insurance premium revenues of the Company are derived from medical
malpractice risks. Many factors influence the financial results of the medical
malpractice insurance business, several of which are beyond the control of the
Company. The supply of medical malpractice insurance, or the industry's
underwriting capacity, is determined principally by the industry's level of
capitalization, historical underwriting results, returns on investment and
perceived premium rate adequacy. Historically, the financial performance of
the medical malpractice insurance industry has tended to fluctuate in cyclical
patterns characterized by periods of greater competition in pricing and
underwriting terms and conditions (a "soft insurance market") followed by
periods of capital shortage and lesser competition (a "hard insurance market").
For several years, the medical malpractice insurance industry and the Company
have faced a soft insurance market that has generally resulted in lower
premiums and reduced profitability. Although the Company is endeavoring to
offset lower premiums charged through more selective underwriting practices,
there can be no assurance that these practices will be successful. There can
be no assurances regarding whether or when market conditions will improve, or
the manner in which, or the extent to
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<PAGE> 22
which, changes in market conditions may impact the results and operations of
the Company.
Economic Conditions May Impact Results and Operations. Insurance
companies rely on the positive performance of their investment portfolios to
offset insurance losses and to enhance profitable results. Consequently,
prevailing economic conditions, particularly changes in market interest rates,
may significantly affect the operations of an insurance company that depend on
its net investment income. In addition, changes in interest rates also can
affect the value of an insurance company's interest-earning assets, which are
comprised of fixed and adjustable-rate investment securities. Generally, the
value of fixed-rate investment securities fluctuates inversely with changes in
interest rates. Changes in interest rates also can affect the average life of
investment securities. An insurance company is subject to reinvestment risk to
the extent that it is not able to reinvest prepayments at rates which are
comparable to the rates on the maturing investments.
Changes in market interest rates have resulted in significant changes
in the market value of the Company's portfolio of fixed maturity investments.
As of December 1997, such portfolio had a modified duration of approximately
four years and a market value that was $4.7 million more than the $308.9
million amortized cost of such portfolio. As of December 31, 1996, such
portfolio had a modified duration of approximately four years and a market
value that was $298,000 more than the $286.0 million amortized cost of such
portfolio. As of December 31, 1997, a one hundred basis point increase in
market interest rates would decrease the value of this portfolio by
approximately three and one-half percent, whereas a one hundred basis point
decrease in market interest rates would increase the value of this portfolio by
approximately three percent.
The success of the Company may also be influenced by general economic
and legal conditions in the geographic markets served by it and its respective
subsidiaries. No assurance can be given that favorable economic and legal
conditions will exist in such markets.
Health Care Industry Consolidation May Impact Results and Operations.
The Company derives a majority of its direct premium income from physicians and
other individual health care providers, physician groups, and smaller health
care facilities. The health care industry is undergoing rapid market driven
change and consolidation which may negatively impact the medical practice and
economic independence of physicians who are the primary customer base of the
Company. For example, the emergence of "managed care" has made it more
difficult for physicians to conduct a traditional fee-for-service practice and
has caused some physicians to leave private practice for employment with
medical systems or to join or contractually affiliate with managed care
organizations or practice management organizations. Such change and
consolidation may result in the elimination of, or a significant decrease in,
the role of the physician in the medical malpractice insurance purchasing
-22-
<PAGE> 23
decision. It could also result in greater emphasis on the role of professional
managers, who may seek to purchase insurance on a price competitive basis and
who may favor insurance companies that are larger and more highly rated than
the Company. In addition, such change and consolidation could reduce medical
malpractice premiums available to the Company as groups of insurance purchasers
generally retain more risk by accepting higher deductibles and self insured
retentions or by forming their own captive insurance mechanisms.
The movement from a traditional fee-for-service practice to the managed
care environment may also result in an increase in the liability profile of the
Company's insureds. The majority of the Company's insured physicians practice
in primary care specialties such as internal medicine, family practice, general
practice and pediatrics. In the managed care environment, these primary care
physicians are being required to take on the role of "gatekeeper" and control
the use of specialty care by controlling access to specialists and by
performing certain procedures that would customarily be performed by
specialists in a fee-for-service setting. These practice changes may result in
an increase in the claims frequency and severity experienced by primary care
physicians and by their insurance carrier.
Underwriting Losses and Reserves Based on Actuarial Assumptions. The
Company collects premiums for the insurance coverage it provides. Such premiums
are based upon certain actuarial and other assumptions. Although Professionals
Group's insurance subsidiaries employ actuarial assumptions that they believe
are reasonable, such assumptions are, by their nature, estimates. To the extent
that the actuarial and other assumptions used by the Company prove to be
incorrect, it may incur unanticipated underwriting losses on the risks that it
insures. Medical malpractice claims and expenses may be paid over a period of
ten years or more, which is longer than most property and casualty insurance.
Trends in losses may therefore be slow to appear and accordingly, the reaction
of the Company, in terms of modifying underwriting practices and changing
premium rates, may lag underlying loss trends. In addition, inflation may
increase the ultimate loss costs of Professionals Group.
The loss and loss adjustment expense reserves established by the
Company are estimates of amounts needed to pay reported and unreported claims
and related loss adjustment expenses. The estimates are based on assumptions
related to the ultimate cost of settling such claims. If the reserves of the
Company are inadequate, it will be required to increase its reserves and thus
reduce its net income or stockholders' equity in the period in which the
deficiency is identified. Unanticipated underwriting losses or materially
underestimated reserves could have a material adverse effect on the Company.
Reliance on Reinsurance. In order to reduce risk and to increase its
underwriting capacity, the Company obtains reinsurance from unaffiliated
reinsurers (including domestic and foreign
-23-
<PAGE> 24
companies), although it retains a portion of each risk reinsured. The Company
is subject to credit risk with respect to its reinsurers because reinsurance
does not relieve the Company of its original liability to its insureds for the
risks ceded to reinsurers. Although the Company believes that its reinsurance
is maintained with financially stable reinsurers and that any reinsurance
security maintained is adequate to protect its interests, the inability to
collect on its reinsurance recoverables, or the inability of its reinsurers to
make payments under the terms of reinsurance treaties (due to insolvency or
otherwise), could have a material adverse effect on its future results of
operations and financial position.
The amount and cost of reinsurance available to companies specializing
in medical professional liability insurance are subject, in large part, to
prevailing market conditions beyond the control of the Company. The ability of
the Company to provide professional liability insurance at competitive premium
rates and coverage limits on a continuing basis will depend in part upon its
ability to obtain adequate reinsurance in amounts and at rates that will not
adversely affect their competitive position. Although the Company anticipates
that it will continue to be able to obtain such reinsurance, there can be no
assurance that this will be the case.
Professionals Group is Dependent on Results and Operations of
Subsidiaries. Professionals Group is a legal entity separate and distinct from
its various subsidiaries. As a holding company with no significant operations
of its own, the principal sources of Professionals Group's funds are dividends
and other distributions from its subsidiaries, borrowings and sales of equity.
The rights of Professionals Group, and consequently its stockholders, to
participate in any distribution of assets of any of its subsidiaries is subject
to prior claims of policyholders, creditors and preferred stockholders, if any,
of such subsidiary (except to the extent claims of Professionals Group in its
capacity as a creditor are recognized), and to certain regulatory restrictions.
Consequently, Professionals Group's ability to fund its operations, and to pay
debts, expenses and cash dividends to its stockholders may be limited.
Professionals Group may engage in activities in addition to providing
insurance through its subsidiaries. Such activities could include activities
related to providing insurance, such as claims and risk management services,
and activities unrelated to insurance, such as medical practice management
services. To the extent that Professionals Group engages in activities that
are unrelated to medical malpractice insurance, it may have no or limited
experience or senior management expertise related to such new activities.
Potential Adverse Consequences of Acquisitions, Business Combinations
and Reinsurance Relationships. The Company has experienced significant growth
in premium volume as a result of acquisitions, business combinations and
reinsurance relationships. The Company intends to continue to pursue such
transactions and
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<PAGE> 25
relationships to the extent suitable candidates and acceptable terms may be
identified. The Company is unable to predict whether or when any candidate for
such a transaction or relationship will become available or the likelihood that
any such transaction or relationship will be completed. The Company competes
for acquisition, business combination, reinsurance and expansion opportunities
with many entities that have substantially greater resources. In addition,
such transactions and relationships may involve difficulties in the retention
of personnel, diversion of management's attention, unexpected legal
liabilities, and tax and accounting issues. There can be no assurance that the
Company will be able to successfully identify suitable candidates for such
transactions or relationships, complete any such transactions or relationships,
integrate acquired businesses into its operations, or expand into new markets.
Once integrated, such transactions or relationships may not achieve comparable
levels of revenues, profitability, or productivity as the existing business of
the Company or otherwise perform as expected.
On August 15, 1997, Professionals Group announced that it had signed a
definitive agreement to merge PICOM with Physicians Protective Trust Fund a
medical malpractice self-insurance trust fund located in Coral Gables, Florida
that provides medical malpractice insurance for physicians and physician
corporations in the State of Florida ("PPTF"). See "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources." The merger is expected to be
accounted for as a pooling of interests (which means Professionals Group will
carry forward to its accounts the assets and liabilities of PPTF at the
respective amounts reported by PPTF) and is expected to occur in the second
quarter of 1998, subject to regulatory and stockholder/policyholder approval.
Glossary of Selected Insurance Terms
A.M. Best Rating. A.M. Best Ratings are divided into "Secure" and
"Vulnerable" rating groups as follows. Secure Ratings: A++,A+ (Superior);
A,A- (Excellent); and B++,B+ (Very Good). Vulnerable Ratings: B,B-(Adequate);
C++,C+ (Fair); C,C- (Marginal); D (Very Vulnerable); E (Under State
Supervision); and F (In Liquidation).
Cede. To transfer to another insurer (the reinsurer) all or part of
the insurance risk underwritten by an insurer.
Claims-made policy. An insurance policy covering only those claims
which are reported during the policy period.
Combined ratio. The sum of the expense ratio and the loss and LAE
ratio.
Earned premium. The prorated portion of an insurance premium which is
no longer considered prepaid as a result of the elapsed time the insurance
policy has been in force. For example, after six months, $12,000 of a prepaid
$24,000 annual premium is considered earned premium.
Excess of loss reinsurance. A form of reinsurance in which the
insurer cedes to a reinsurer, and such reinsurer assumes, all
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<PAGE> 26
or a portion of losses in excess of a specified retention level up to a
predetermined limit.
Expense ratio. The ratio of underwriting expenses to net premiums
earned.
Incurred but not reported (IBNR). The liability for future payments
on losses which have occurred but have not yet been reported.
Loss adjustment expenses (LAE). The expenses of settling claims,
including legal and other fees.
Loss and LAE ratio. The ratio of incurred losses and loss adjustment
expenses to premiums earned. Losses include increases in reserves for extended
reporting period claims.
Net premiums written. Premiums retained by an insurer after deducting
premiums on business ceded to others.
Occurrence Policy. An insurance policy covering losses occurring
during the policy period, without regard to when the claim is reported to the
insurer.
Quota Share Reinsurance. A form of treaty or facultative reinsurance
in which the insurer cedes and the reinsurer assumes an agreed- upon percentage
of risks. Also known as proportional reinsurance.
Reinsurance. A procedure whereby an insurer remits or cedes a portion
of the premium to a reinsurer as payment to the reinsurer for assuming a
portion of the risk or liability under the policy. Reinsurance can be effected
by "treaties" under which all risks of a defined category, amount and type for
a primary insurer are covered, or on a "facultative" basis under which risks
are covered on an individual, contract-by-contract basis.
Reserves. Liability established by an insurer to reflect the
estimated cost of claim payments and loss adjustment expenses that the insurer
will ultimately be required to pay with respect to the insurance it has
underwritten.
Standard & Poor's ratings. Standard & Poor's Claims-Paying Ability
Ratings are divided into "Secure Range" and "Vulnerable Range" groupings as
follows. Secure Range: AAA (Superior); AA (Excellent); A (Good); and BBB
(Adequate). Vulnerable Range: BB (May be Adequate); B (Vulnerable); CCC
(Extremely Vulnerable); and R (Regulatory Action).
Statutory Accounting Practices (SAP). Those principles required by
state law which must be followed by insurers in submitting their financial
statements to state insurance departments.
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<PAGE> 27
Statutory surplus. The amount remaining after all liabilities of an
insurance company are subtracted from all of its admitted assets, applying
statutory accounting principles.
Item 2. Properties
The Company owns its principal executive offices in Okemos, Michigan
which houses the majority of its employees. The Company also owns, primarily
for investment purposes, an office building in Williamston, Michigan. The
Company leases office facilities in Lisle, Illinois, Indianapolis, Indiana and
Columbus, Ohio. The Company also leases operating equipment under cancelable
and noncancelable agreements.
Item 3. Legal Proceedings
There are no material legal proceedings to which Professionals Group
or any of its direct or indirect subsidiaries is a party or to which any of
their property is subject.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of Professionals Group's
stockholders during the fourth quarter of 1997.
Executive officers of registrant:
As of March 16, 1998, the executive officers of Professionals Group
consisted of the persons identified below. Executive officers are elected
annually by, and serve at the pleasure of, Professionals Group's Board of
Directors.
<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<S> <C> <C>
W. Peter McCabe, M.D. 58 Chairman
Victor T. Adamo, Esq., CPCU 50 President and Chief Executive Officer
R. Kevin Clinton, FCAS, MAAA 43 Vice President, Treasurer and Chief Financial Officer
Annette E. Flood, Esq., R.N. 39 Secretary
</TABLE>
W. Peter McCabe, M.D. has been the Chairman of the Board and a
director of Professionals Group since 1996. Dr. McCabe has been Chairman of
the Board and a director of PICOM since 1994 and 1980, respectively. Dr.
McCabe has been a director of Michigan Educational Employees Mutual Insurance
Company, a Michigan mutual insurance company that writes personal automobile
and homeowners coverages, since May 1997. He is board certified in Plastic
Surgery and a past President of the Michigan State Medical Society. Dr. McCabe
is engaged in private practice and serves on the medical staff of Saint John
Hospital, Detroit, Michigan. Dr. McCabe is a graduate of Harvard College and
Cornell University Medical School.
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<PAGE> 28
Victor T. Adamo, Esq., has been the President and Chief Executive
Officer and a director of Professionals Group since 1996, the President and a
director of PICOM since 1990, and the Chief Executive Officer of PICOM since
1987. Mr. Adamo also has been a director of Michigan Educational Employees
Mutual Insurance Company, a Michigan mutual insurance company that writes
personal automobile and homeowners coverages, since May 1997. Prior to joining
PICOM, Mr. Adamo was in private legal practice from 1975 to 1985 and
represented PICOM in corporate legal matters. Mr. Adamo is a graduate of The
University of Michigan and New York University School of Law and is a Chartered
Property Casualty Underwriter (CPCU). Mr. Adamo and Mr. R. Kevin Clinton are
the only current directors of Professionals Group who are also employees of
Professionals Group or a subsidiary of Professionals Group.
R. Kevin Clinton, FCAS, MAAA, has been the President and a director of
Michigan Educational Employees Mutual Insurance Company, a Michigan mutual
insurance company that writes personal automobile and homeowners coverages,
since May 1997. Mr. Clinton has been a Vice President and Chief Financial
Officer of Professionals Group since 1996 and a director of Professionals Group
since September 1997. Mr. Clinton served as Vice President, Treasurer and
Actuary of PICOM from 1990 through June 1997. Prior to becoming an officer of
PICOM, Mr. Clinton was PICOM's consulting actuary from 1986 to 1990. He
formerly served as the Actuary for the Michigan Insurance Bureau and in the
actuarial department of Michigan Mutual Insurance Company. Mr. Clinton is a
fellow of the Casualty Actuarial Society and a member of the American Academy
of Actuaries. Mr. Clinton is a graduate of The University of Michigan where he
received a B.A. degree in business administration and a M.A. in actuarial
science. Mr. Clinton and Mr. Victor T. Adamo are the only current directors of
Professionals Group who are also employees of Professionals Group or a
subsidiary of Professionals Group.
Annette E. Flood, Esq., R.N., has been the Secretary of Professionals
Group since 1996. Ms. Flood is Vice President, Corporate Secretary and Legal
Counsel of PICOM. Ms. Flood has been a director of Michigan Educational
Employees Mutual Insurance Company, a Michigan mutual insurance company that
writes personal automobile and homeowners coverages, since May 1997. Prior to
joining PICOM in 1992, Ms. Flood was employed by Lansing General Hospital,
Lansing, Michigan, from 1986 to 1992, most recently in the capacity of Vice
President, Legal Services and Quality Management. Prior to joining the Lansing
General Hospital staff, Ms. Flood was in the litigation section of the law firm
of Dykema Gossett PLLC, Lansing, Michigan. Ms. Flood has a B.A. degree in
nursing from The University of Michigan and a law degree from Wayne State
University Law School.
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<PAGE> 29
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Shares of common stock, no par value per share, of Professionals Group
have been traded in the over-the-counter market and listed for quotation on the
Nasdaq National Market tier of the Nasdaq Stock Market under the symbol "PICM"
since September 3, 1996. Prior to Professionals Group's acquisition of all of
the issued and outstanding shares of PICOM common stock effective August 31,
1996, PICOM common stock was traded in the over-the-counter market and was
listed for quotation on the Nasdaq National Market tier of the Nasdaq Stock
Market under the symbol "PICM." Although transactions in common stock, no par
value per share, of Professionals Group have been, and are expected to continue
to be, facilitated by market-makers, there can be no assurance that an
established or liquid trading market will continue.
The table below sets forth (i) for the periods prior to September 3,
1996, the high and low sale prices for PICOM common stock on the Nasdaq
National Market tier of the Nasdaq Stock Market, and (ii) for the periods since
September 3, 1996, the high and low sale prices for the common stock, no par
value per share, of Professionals Group on the Nasdaq National Market tier of
the Nasdaq Stock Market. In each case the quotations have been adjusted as if
the ten percent stock dividend paid by Professionals Group on December 16, 1996
had occurred prior to such quarters.
<TABLE>
<CAPTION>
Common Stock
------------------
High Low
---- ---
<S> <C> <C>
1997
- ----
First Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $25.25 $20.00
Second Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29.50 22.00
Third Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39.00 27.50
Fourth Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43.00 33.00
1996
- ----
First Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $23.41 $18.86
Second Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22.95 19.77
Third Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22.27 19.55
Fourth Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22.00 19.77
</TABLE>
As of March 16, 1998 there were 2,630 registered holders of shares of
common stock, no par value per share, of Professionals Group.
The holders of common stock, no par value per share, of Professionals
Group are entitled to receive such dividends as may be declared from time to
time by the Board of Directors of Professionals Group out of funds legally
available therefor. Professionals Group is not expected to declare cash
dividends on its common stock for the foreseeable future, as it is expected
that earnings of Professionals Group and its subsidiaries will be
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<PAGE> 30
retained and used for operations. Any future dividends will depend upon, among
other things, future financial results and requirements and contractual
restrictions applicable to Professionals Group or its subsidiaries, including a
covenant related to Professionals Group's bank term loan which prohibits the
payment of cash dividends on Professionals Group's common stock (except for
cash paid in lieu of fractional shares related to stock dividends declared).
Professionals Group declared a 10% stock dividend on November 21, 1996 which
was paid on December 16, 1996 to stockholders of record as of December 4, 1996.
No fractional shares of common stock were issued in payment of the stock
dividend. In lieu of fractional shares, cash of approximately $26,000 was paid
to stockholders.
The ability of Professionals Group to fund its operations and to pay
dividends on its common stock will be dependent upon its receipt of dividends,
loans or advances from its insurance company subsidiaries (particularly PICOM).
The ability of those subsidiaries to pay dividends is subject to regulatory
restrictions. Generally, these restrictions limit the amount of dividends such
subsidiaries can pay to their respective parent in any 12-month period to the
greater of statutory net income for the preceding year (excluding realized
gains and losses on sales of investments), or ten percent of policyholders'
surplus as of the end of the preceding year. As of January 1, 1998,
approximately $14.2 million of dividends could be paid by Professionals Group's
direct insurance subsidiaries without prior regulatory approval. In 1997 and
1996, Professionals Group's insurance subsidiaries paid cash dividends
aggregating $4.7 million and $3.5 million, respectively, to Professionals
Group. None of Professionals Group's insurance subsidiaries paid any cash
dividends in 1995. There can be no assurance as to any future dividends by
Professionals Group or any of its subsidiaries (see also Note 12 to the
Company's consolidated financial statements).
Item 6. Selected Financial Data
The following selected financial data are derived from the Company's
consolidated financial statements, except for selected statutory data, which
are presented in accordance with statutory accounting practices. The data
should be read in conjunction with the consolidated financial statements,
related notes and other financial information included elsewhere in this
report. (All such information is in thousands, except per share data.)
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<PAGE> 31
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Income Statement Data(1):
Gross premiums written $81,690 $64,771 $67,727 $51,110 $50,514
Net premiums written 71,146 55,464 55,151 48,778 48,177
Net premiums earned 71,968 56,687 55,684 48,490 48,192
Net investment income 18,719 15,741 14,729 13,379 12,363
Total revenues and other income 91,649 72,242 70,572 59,867 67,476
Losses and loss adjustment expenses(2)(4) 57,125 48,368 35,558 44,853 44,585
Total expenses 77,742 60,219 46,230 52,669 52,775
Income before cumulative effect of change in
accounting method 11,026 9,585 16,066 5,154 9,866
Cumulative effect of change in accounting
method(2) -- -- (8,125) -- --
------- ------- ------- ------- -------
Net income $11,026 $ 9,585 $ 7,941 $ 5,154 $ 9,866
======= ======= ======= ======= =======
Weighted average shares outstanding(3) 3,506 3,487 3,432 3,557 3,557
===== ===== ===== ===== =====
Weighted average shares outstanding -
assuming dilution(3) 3,508 3,487 3,432 3,557 3,557
===== ===== ===== ===== =====
Earnings per share(3):
Income before cumulative effect of change in
accounting method $ 3.15 $ 2.75 $4.68 $ 1.45 $ 2.77
Cumulative effect of change in accounting
method(2) -- -- (2.37) -- --
------ ------ ------ ------ ------
Net income per common share $ 3.15 $ 2.75 $ 2.31 $ 1.45 $ 2.77
====== ====== ====== ====== ======
Net income per common share -
assuming dilution $ 3.14 $ 2.75 $ 2.31 $ 1.45 $ 2.77
====== ====== ====== ====== ======
Cash dividends declared per share $ -- $ -- $ -- $ -- $ --
====== ====== ====== ====== ======
</TABLE>
<TABLE>
<CAPTION>
As of December 31,
---------------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Balance Sheet Data:
Total investments $342,561 $300,132 $280,607 $249,979 $253,133
Total assets 413,195 357,382 330,712 297,926 301,106
Loss and loss adjustment expense reserves(2) 239,151 219,919 199,605 188,544 191,221
Reserve for extended reporting period claims 15,300 14,795 14,082 12,738 12,238
Unearned premiums 21,665 21,945 23,122 24,557 24,347
Stockholders' equity 101,926 87,958 78,411 63,142 64,839
Book value per common share(3) 29.07 25.09 22.84 17.75 18.23
- --------------------------------
Years Ended
December 31,
---------------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
Selected Statutory Data:
Loss ratio(4) 80.1% 85.4% 71.5% 93.5% 94.1%
Expense ratio 23.7% 15.9% 17.3% 15.4% 15.8%
----- ------- ------- ------- -------
Combined ratio 103.8% 101.3% 88.8% 108.9% 109.9%
====== ======== ======= ======= =======
Statutory surplus $108,178 $80,572 $67,006 $47,149 $40,431
Net premiums written to statutory surplus .66x .74x .82x 1.03x 1.19x
Selected GAAP Data:
GAAP combined ratio(4) 106.5% 106.2% 83.0% 108.6% 109.5%
====== ====== ====== ====== ======
</TABLE>
- --------------------------------
(1) Effective January 1, 1995, the Company began writing a book of
business previously written by an Illinois insurance company.
Effective July 1, 1997, the Company began assuming 40% of the net
premiums of a Michigan insurance company.
(2) The Company discounted loss and loss adjustment expense reserves
through 1994. In 1993 the Company changed its loss and loss
adjustment expense reserve discount rate from 3.75% to 3%. This
reduction in reserve discount rate was treated as a change in
accounting estimate and resulted in a decrease in
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<PAGE> 32
net income of $2.0 million for 1993. The effects of such change in
the reserve discount rate, which was previously presented as a change
in accounting method, has been reclassified and presented as a change
in accounting estimate. Effective January 1, 1995, the Company
eliminated its practice of discounting loss and loss adjustment
expense reserves for GAAP reporting purposes, which was treated as a
change in accounting method.
(3) Weighted average shares outstanding are in thousands. Prior period
amounts have been restated for the effects of 10% stock dividends on
December 16, 1996 and December 1, 1994 and 1993, respectively.
(4) In 1995 the Company reduced its estimated liability for loss and loss
adjustment expense reserves by $12.3 million for redundancies. The
ratio includes the increase in reserve for extended reporting period
claims.
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The following discussion and analysis should be read in conjunction
with the consolidated financial statements and the notes thereto included
elsewhere in this report.
Financial Condition:
The Company's total assets were $413.2 million and $357.4 million as
of December 31, 1997 and 1996, respectively, an increase of 15.6%. The
increase in total assets as of December 31, 1997 was due mainly to bank
borrowings received that were used to fund the Company's purchase of a $21.5
million surplus note issued by MEEMIC (see "Liquidity and Capital Resources")
and to positive cash flows from operations.
Paid losses and loss adjustment expenses were $42.5 million in 1997,
as compared to $37.2 million in 1996 and $47.2 million in 1995. Paid losses
and loss adjustment expenses for 1997 were $5.3 million more than in 1996 due
mainly to the Company's reinsurance agreement with MEEMIC. See "Liquidity and
Capital Resources." Paid losses and loss adjustment expenses for 1996 were
$10.0 million less than in 1995 primarily due to the effect of tort reform
legislation enacted in Michigan during 1994. A pre-suit notification procedure
enacted as part of such tort reform legislation has enabled the Company to
investigate and resolve many claims in a less expensive manner. Since the
adoption of such legislation, the Company has been able to utilize its internal
claims management staff to a greater extent. In the years prior to the
adoption of such legislation, the Company had utilized, to a greater degree,
more expensive outside legal counsel to investigate and resolve claims. In
addition, paid losses and loss adjustment expenses were significantly higher in
1995 due to the high number of claims filed in 1994 just prior to the effective
date of such tort reform legislation.
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<PAGE> 33
As of December 31, 1997 and 1996, the Company had invested assets of
$342.6 million and $300.1 million, respectively. Such 14.1% increase in
invested assets resulted mainly from bank borrowings received that were used to
fund the Company's purchase of a $21.5 million surplus note from MEEMIC (see
"Liquidity and Capital Resources") and positive cash flows from operations. As
of December 31, 1997 and 1996, invested assets represented approximately 83%
and 84%, respectively, of the Company's total assets at those dates.
As of December 31, 1997 and 1996, the Company's investment portfolio
was dominated by fixed maturity securities and primarily consisted of U.S.
government and agency bonds, high-quality corporate bonds, mortgage-backed
securities, redeemable preferred stocks and tax-exempt U.S. municipal bonds.
As of December 31, 1997 and 1996, these fixed maturity securities aggregated
$313.6 million and $286.3 million, respectively. Approximately $288.2 million
of the fixed maturity portfolio was comprised of rated securities of which
99.7% were rated investment grade or better at December 31, 1997.
Approximately 87.1% of the non-rated fixed maturity portfolio was comprised of
the surplus note investment in MEEMIC.
The following table provides a profile of the Company's fixed maturity
portfolio by rating as of December 31, 1997:
<TABLE>
<CAPTION>
Fair Value (As Reflected Percent of
S&P/Moody's Rating on Balance Sheet Portfolio
------------------ ------------------------ ----------
(Amounts in thousands)
<S> <C> <C>
AAA/Aaa (including U.S.
Governments of $32,200) $173,673 55.4%
AA/Aa 61,773 19.7%
A/A 45,055 14.4%
BBB/Baa 7,654 2.4%
Not rated 24,662 7.8%
All other 816 0.3%
-------- -----
Total $313,633 100.0%
======== =====
</TABLE>
In December 1995, the Company reclassified all of its fixed maturity
securities previously classified as held-to-maturity to available- for-sale, as
permitted by the Special Report, "A Guide to Implementation of Statement 115 on
Accounting for Certain Investments in Debt and Equity Securities" issued by the
Financial Accounting Standards Board ("FASB"). This one-time reclassification
increased stockholders' equity by $511,000, net of deferred federal income
taxes, as of December 31, 1995. All fixed
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<PAGE> 34
maturity securities are classified as available-for-sale and are carried at
fair value as of December 31, 1997 and 1996.
The Company's fixed maturity investment portfolio is sensitive to
interest rate changes. As of December 31, 1997 and 1996, the fixed maturity
portfolio had net unrealized gains of approximately $4.7 million and $298,000,
respectively. The increase in net unrealized gains was due to slightly lower
interest rates at year end 1997 compared to year end 1996. As of December 31,
1997, the fixed maturity portfolio had a weighted average modified duration of
approximately four years. A one hundred basis point increase in market
interest rates would decrease the value of this portfolio by approximately
three and one-half percent, whereas a one hundred basis point decrease in
market interest rates would increase the value of this portfolio by
approximately three percent.
Equity securities as of December 31, 1997 and 1996 consisted primarily
of common stock held in Physicians Insurance Company of Wisconsin, Inc., an
unrelated stock insurance company providing professional liability insurance to
health care providers primarily in Wisconsin. As of December 31, 1997 and
1996, equity securities had net unrealized gains of $127,000 and $62,000,
respectively.
Results of Operations -- Year Ended December 31, 1997 Compared to Year Ended
December 31, 1996:
Professional liability related net premiums written were $51.0 million
in 1997, a decrease of 8.0% when compared to professional liability net
premiums written of $55.5 million in 1996. The decrease in professional
liability premiums reflects continued price-based competition, particularly in
the Michigan and Illinois insurance markets. The decrease in professional
liability premiums in 1997 was offset by the reinsurance premiums assumed from
MEEMIC, which increased net premiums written by $20.1 million. See "Liquidity
and Capital Resources."
During 1997 and 1996, the Company continued to balance its need for
rate adjustments with the goal of maintaining market share in very competitive
environments in Michigan, Illinois, Indiana and Ohio. Although the Company has
maintained profitability and is endeavoring to offset lower premiums charged
through more selective underwriting practices, there can be no assurance that
these practices will be successful in the long run.
Net investment income, excluding realized capital gains and losses,
was $18.7 million for 1997, an increase of 18.9% over net investment income of
$15.7 million for 1996. The increase in net investment income mainly resulted
from an increase in average invested assets associated with bank borrowings
received that were used to fund the Company's purchase of a $21.5 million
surplus note from MEEMIC (see "Liquidity and Capital Resources") and positive
cash flows from operations. The weighted average tax equivalent book yield of
the fixed maturity portfolio was 6.9% and 6.7% as of December 31, 1997 and
1996, respectively. During 1997, the Company
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<PAGE> 35
posted net realized investment losses of $207,000, whereas net realized
investment losses in 1996 were $473,000.
Loss and loss adjustment expense reserves are determined on the basis
of individual claims and actuarially determined estimates of future losses
based on the Company's past loss experience and projections as to future claims
frequency, severity, inflationary trends and settlement patterns. Estimating
professional liability reserves is a complex process which is heavily dependent
on judgment and involves many uncertainties. As a result, reserve estimates
may vary significantly from the eventual outcome. It has been the practice of
the Company to establish its loss and loss adjustment expense reserves
conservatively, as it relates to immaturely developed accident years, to
minimize potential uncertainties. Nevertheless, the Company's reserves have
been established within the range of acceptable values estimated by the
Company's consulting actuary and are recorded based on such actuarial
estimates. The assumptions used in establishing the Company's reserves are
regularly reviewed by management and revised as new data becomes available.
Any adjustments necessary are generally reflected in current operations.
Professional liability insurance incurred losses and loss adjustment
expenses (including the increase in reserve for extended reporting period
claims) for 1997 totaled $44.6 million, a decrease of 9.2%, as compared to
professional liability insurance incurred losses and loss adjustment expenses
of $49.1 million for 1996. As a percentage of premiums earned, the
professional liability insurance incurred loss and loss adjustment expense
ratio (including the increase in reserve for extended reporting period claims)
improved slightly to 85.9% in 1997, as compared to 86.6% in 1996. The Company
has continued to employ more selective underwriting practices during this time
of highly competitive market conditions. Accordingly, the professional
liability incurred loss and loss adjustment expense ratio has remained stable.
There can be no assurances, however, that these selective underwriting
practices will be successful in the long run.
Incurred losses and loss adjustment expenses related to the personal
automobile and homeowners insurance assumed from MEEMIC (the "personal
liability insurance") totaled $13.1 million for 1997. As a percentage of
premiums earned, such personal liability insurance generated an incurred loss
and loss adjustment expense ratio of 65.0% in 1997. The Company believes that
such personal liability insurance produced a low loss ratio primarily due to
less severe weather-related incidents in Michigan during 1997.
Policy acquisition and underwriting expenses were $19.0 million in
1997, a 70.7% increase over policy acquisition and underwriting expenses of
$11.1 million in 1996. As a percentage of premiums earned, the underwriting
expense ratio increased to 26.4% during 1997, from 19.6% during 1996. The
increase in such expenses was mainly due to $1.1 million of non-recurring
legal, accounting, investment banker and related expenses associated with the
Company's merger and acquisition activities, and $6.6 million of
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<PAGE> 36
ceding commission attributable to the MEEMIC reinsurance agreement. Additional
1997 expenses included start-up expenses associated with the Company's
expansion of business into Indiana and Ohio during 1997 and its planned
expansion into Florida and Pennsylvania during 1998. Interest expense of $1.1
million during 1997 resulted from the Company's bank borrowings of $22.5
million in April 1997. See "Liquidity and Capital Resources."
The Company recorded $2.9 million in federal income tax expense in
1997 as compared to $2.4 million in 1996. The Company's effective federal
income tax rate approximated 20.7% in 1997 compared to 20.3% in 1996. The
slight increase in the effective income tax rate is due mainly to certain
merger and acquisition expenses which are not deductible for federal income tax
purposes.
Net income for 1997 was $11.0 million, or $3.14 per share (assuming
dilution), on revenues of $91.6 million. This compares to net income of $9.6
million, or $2.75 per share (assuming dilution), on revenues of $72.2 million
in 1996. The favorable 1997 earnings were attributable to the factors
described above.
Results of Operations -- Year Ended December 31, 1996 Compared to Year Ended
December 31, 1995:
Professional liability net premiums written were $55.5 million in
1996, an increase of 0.6% when compared to professional liability net premiums
written of $55.2 million in 1995. The increase in professional liability net
premiums written was primarily due to $1.1 million in additional net premiums
written by the Company's expansion of business into Indiana and Ohio. This
increase was partially offset by decreases in professional liability premiums
in the Company's Michigan and Illinois insurance markets.
During 1996 and 1995, the Company continued to balance its need for
rate adjustments with the goal of maintaining market share in very competitive
environments in Michigan, Illinois, Indiana and Ohio. Although the Company has
maintained profitability and is endeavoring to offset lower premiums charged
through more selective underwriting practices, there can be no assurance that
these practices will be successful in the long run.
Net investment income, excluding realized capital gains and losses,
was $15.7 million for 1996, an increase of 6.9% over net investment income of
$14.7 million for 1995. Net investment income increased, despite a significant
shift in the Company's investment portfolio towards municipal bonds (which, due
to their tax-exempt status, offer lower pre-tax yields), due principally to the
increases in invested assets associated with positive cash flows from
operations. The weighted average tax equivalent book yield of the Company's
fixed maturity portfolio was 6.7% and 6.5% as of December 31, 1996 and 1995,
respectively. During 1996, the Company posted net realized investment losses
of $473,000, whereas net realized investment losses in 1995 were negligible.
The net realized investment losses posted in 1996 resulted from the
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<PAGE> 37
Company's repositioning of its fixed maturity portfolio to increase after-tax
yield.
Professional liability insurance incurred losses and loss adjustment
expenses (including the increase in reserve for extended reporting period
claims) for 1996 totaled $49.1 million, an increase of 33.0% over incurred
losses and loss adjustment expenses of $36.9 million for 1995. As a percentage
of premiums earned, the professional liability insurance incurred loss and loss
adjustment expense ratio (including the increase in reserve for extended
reporting period claims) was 86.6% in 1996 compared to 66.3% in 1995. The loss
and loss adjustment expense ratio was 22.1 percentage points lower in 1995 due
to the Company's $12.3 million reserve reduction at year-end 1995. Such
reserve reduction (which reduced the reserves relating to accident years
1986-1993 and reflected lower incurred losses than had been originally reserved
for) was made possible by the favorable development of prior years' loss
reserves. The factors leading to such favorable development were (i) the
Company's practice of establishing its loss and loss adjustment expense
reserves conservatively, as it relates to immaturely developed accident years,
to minimize potential uncertainties, and (ii) lower than expected claims
costs associated in part with tort reform legislation enacted in Michigan
between 1986 and 1994. Such tort reform legislation shortened the statute of
limitations, introduced a statute of repose with a six year limitation for
adults, modified expert witness rules to require more qualified expert
witnesses and capped non-economic damages.
At year-end 1994, the Company's loss and loss adjustment expense
reserves were discounted using a three percent interest rate assumption.
Effective January 1, 1995, the practice of discounting reserves for financial
reporting was eliminated and, accordingly, loss and loss adjustment expense
reserves have been established on an undiscounted basis thereafter (a more
conservative accounting practice used by most publicly-traded insurance
companies).
Policy acquisition and underwriting expenses were $11.1 million in
1996, a 19.4% increase over policy acquisition and underwriting expenses of
$9.3 million in 1995. As a percentage of premiums earned, the underwriting
expense ratio was 19.6% in 1996, up from the underwriting expense ratio of
16.8% in 1995. The increase in such expenses in 1996 relative to 1995 is
attributable to non-recurring legal, accounting and related expenses associated
with the formation of the Professionals Group holding company system, a
one-time stock bonus paid to directors, officers and employees in 1996 and
start-up expenses associated with the Company's expansion of business into
Indiana and Ohio.
The Company recorded $2.4 million in Federal income tax expense in
1996 as compared to $8.3 million in 1995. The Company's effective Federal
income tax rate approximated 20.3% in 1996 compared to 34.0% in 1995. The
decrease in the effective income tax rate is due to the Company's increased
holdings in tax-exempt
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<PAGE> 38
municipal bonds which caused a $1.0 million or 8.3% decrease in the expense and
effective rate, respectively, as well as a revision to the estimate of the
prior years' tax liability which caused a $913,000 or 7.6% decrease in the
expense and effective rate, respectively. These decreases were partially
offset by adjustments for other items, including dividends received deductions
and non-deductible meals and entertainment, respectively, in an aggregate
amount of $263,000 or 2.2% of the effective rate. The prior years' tax
liability adjustment related to an overestimated tax accrual that was revised
with the 1995 Federal tax return filing.
Net income for 1996 was $9.6 million, or $2.75 per share (assuming
dilution), on revenues of $72.2 million. This compares to net income of $7.9
million, or $2.31 per share (assuming dilution), on revenues of $70.6 million
in 1995. The favorable 1996 earnings were attributable to the factors
described above. Net income for 1995 was reduced by $8.1 million (net of
deferred federal income taxes), or $2.37 per share (assuming dilution), as a
result of a cumulative effect change in accounting method associated with the
elimination of the Company's practice of discounting its loss and loss
adjustment expense reserves during 1995.
Liquidity and Capital Resources:
Liquidity describes the ability to generate sufficient cash flows to
meet the cash requirements of continuing operations. Liquidity, in the context
of insurance operations, is typically determined by two distinct operations:
underwriting and investing. Net cash flows from underwriting operations are
used to build an investment portfolio, which in turn produces future cash from
investment income. The Company continuously monitors available cash and
short-term investment balances in relation to projected cash needs to maintain
adequate balances for current payments while maximizing cash available for
longer term investment opportunities.
The payment of losses, loss adjustment expenses and operating expenses
in the ordinary course of business represents the Company's principal need for
liquid funds. Payments for losses and loss adjustment expenses are distributed
fairly evenly throughout the year. Payments for reinsurance are made within
thirty days subsequent to the end of each quarter, with adjustments made after
each reinsurance year. Historically, cash used to pay for these items has been
provided by operations. In 1997, the Company used a portion of its cash flow
from operations to fund its purchase of a new home office facility, including
furniture and equipment, for $7.1 million. As of December 31, 1997, no
material commitments for capital expenditures existed, and management believes
the Company's present liquidity, together with its expected cash flow from
operations, will be sufficient to fund any future potential commitments for
capital expenditures.
The ability of Professionals Group to fund its operations and to pay
dividends on its common stock will be dependent upon its receipt of dividends,
loans or advances from its insurance company
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<PAGE> 39
subsidiaries (particularly PICOM). The ability of those subsidiaries to pay
dividends is subject to regulatory restrictions. Generally, these restrictions
limit the amount of dividends such subsidiaries can pay to their respective
parent in any 12-month period to the greater of statutory net income for the
preceding year (excluding realized gains and losses on sales of investments),
or ten percent of policyholders' surplus as of the end of the preceding year.
As of January 1, 1998, approximately $14.2 million of dividends could be paid
by Professionals Group's direct insurance subsidiaries without prior regulatory
approval. In 1997 and 1996, Professionals Group's insurance subsidiaries paid
cash dividends aggregating $4.7 million and $3.5 million, respectively, to
Professionals Group. None of Professionals Group's insurance subsidiaries paid
any cash dividends in 1995. There can be no assurance as to any future
dividends by Professionals Group or any of its subsidiaries (see also Note 12
to the Company's consolidated financial statements).
In April 1997, Professionals Group borrowed $22.5 million under a
seven-year unsecured bank term loan, bearing interest at an adjustable rate of
LIBOR plus 62.5 basis points (the "Credit Agreement"). Under the Credit
Agreement, interest, which accrued at the rate of 6.40% per annum as of
December 31, 1997, is payable quarterly and principal is payable in
installments on April 30 of each year as follows: 1998 - $2,500,000; 1999 -
$2,500,000; 2000 - $3,000,000; 2001 - $3,000,000; 2002 - $3,500,000; 2003 -
$3,500,000; and 2004 - $4,500,000. Professionals Group used $20.0 million of
the proceeds of this loan to make a capital contribution to PICOM, which in
turn, used the proceeds to purchase a $21.5 million Surplus Note from MEEMIC.
The Credit Agreement prohibits the payment of cash dividends on
Professionals Group's common stock (except for cash paid in lieu of fractional
shares related to stock dividends declared). It also required the Company to,
among other things, maintain total consolidated stockholders' equity of at
least $80.0 million plus 50% of the preceding fiscal year's consolidated net
income, maintain a ratio of debt to equity of not more than 0.5:1 and maintain
a fixed charges coverage ratio and an interest coverage ratio (as defined in
the Credit Agreement) of not less than 1.5:1 and 2.5:1, respectively. The
Company was in compliance with, or has received waivers of, all required
covenants at December 31, 1997.
In April 1997, the Company completed certain transactions with MEEMIC
involving the Company's purchase of a twelve-year, $21.5 million surplus note
from MEEMIC, bearing interest at 8.5% per annum (the "MEEMIC Surplus Note") and
its reinsuring, on a quota-share basis, 40% of MEEMIC's net premiums beginning
July 1, 1997. In connection with these transactions (i) the Company agreed to
provide MEEMIC with information systems services and certain consulting services
under a management services agreement for a base fee of $2.0 million; (ii)
Professionals Group nominees were elected to all positions on the Board of
Directors of MEEMIC; and (iii) the Company agreed to assist MEEMIC in acquiring
the net
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<PAGE> 40
assets of Michigan Educators Insurance Agency, Inc. ("MEIA"), the exclusive
distributor of MEEMIC insurance products.
On September 22, 1997, MEEMIC Insurance Services Corporation (MEEMIC
Services Corp.), a newly formed subsidiary of MEEMIC, purchased the net assets
of MEIA. The purchase price equaled 3.75% of premiums written by MEEMIC
Services Corp. through July 2004, subject to a guaranteed minimum purchase
price of $43.0 million. To fund this purchase, MEEMIC Services Corp. paid cash
of $22.5 million (utilizing the proceeds of the MEEMIC Surplus Note), and
agreed to pay $20.5 million to MEIA as additional consideration through 2004, as
provided for in the purchase agreement. MEEMIC guaranteed payment of the first
$3.0 million and Professionals Group guaranteed payment of the final $17.5
million (payable in years 2001-2004) of such additional consideration. The
Company believes the likelihood that the guarantee would become payable is
minimal.
The Company assisted MEEMIC in MEEMIC's acquisition of the net assets
of MEIA for the reasons that follow: The Company believes that by virtue of
such acquisition, MEEMIC acquired greater control over the distribution and
pricing of its insurance products. The Company anticipates that such control
will enable MEEMIC to increase the volume of its insurance business. Given the
terms of the Company's reinsurance agreement with MEEMIC, an increase in the
volume of MEEMIC's insurance business will increase the amounts of insurance
and insurance premiums ceded to PICOM.
At a future date, the Company and MEEMIC expect to pursue
demutualization of MEEMIC. Such demutualization would be subject to regulatory
approval by the Michigan Commissioner of Insurance and approval by MEEMIC's
policyholders. No specific timetable has been set for demutualization and
there can be no assurances that MEEMIC will be demutualized.
On August 15, 1997, Professionals Group announced a definitive
agreement to merge PICOM with Physicians Protective Trust Fund. The terms of
such merger, which were amended and restated on October 3, 1997 pursuant to a
First Amended and Restated Agreement and Plan of Merger dated as of October 3,
1997 by and among Professionals Group, PICOM and PPTF (the "Merger Agreement"),
contemplate the combining of the operations of PICOM and PPTF, through the
conversion, subject to dissenters' rights, of all membership rights of members
of PPTF into an aggregate of 4,089,160 shares of common stock of Professionals
Group. The contemplated merger is expected to be accounted for as a pooling of
interests (which means Professionals Group will carry forward to its accounts
the assets and liabilities of PPTF at the respective amounts reported by PPTF)
and is expected to occur in the second quarter of 1998, subject to regulatory
and stockholder/policyholder approval.
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<PAGE> 41
Professionals Group was incorporated in January 1996 for the purpose
of serving as the holding company for PICOM and its subsidiaries. Effective
August 31, 1996, Professionals Group acquired all of the issued and outstanding
shares of PICOM common stock through the merger of a wholly-owned insurance
company subsidiary of Professionals Group with and into PICOM (the
"Reorganization"). By virtue of the Reorganization, each issued and
outstanding share of PICOM common stock was converted into one share of common
stock, no par value per share, of Professionals Group and PICOM became a
wholly-owned subsidiary of Professionals Group.
In May 1996, and in a transaction valued at approximately $1.2 million,
PICOM acquired all of the issued and outstanding shares of American Insurance
Management Corporation, a privately held Indiana corporation that serves as the
attorney-in-fact for American Medical Insurance Exchange, an inactive Indiana
interinsurance reciprocal exchange. While the acquisition was accounted for as
a purchase, the effect of the acquisition was not material to the Company's
consolidated results of operations (see also Note 12 to the Company's
consolidated financial statements).
On July 5, 1995, PICOM repurchased 254,823 shares of its common stock
(approximately 7.9% of the then issued and outstanding shares of PICOM Common
Stock) owned by Physicians Insurance Company of Ohio at a price of $17 per
share. During 1995, PICOM negotiated a reciprocal stock purchase agreement
with Physicians Insurance Company of Wisconsin, Inc. ("PIC-WIS"). Under the
agreement, PICOM acquired 1,583 shares of PIC-WIS common stock (representing
6.8% of the then outstanding shares of PIC-WIS common stock) for $2.5 million
and PIC-WIS purchased 131,579 shares of PICOM common stock (representing 4.2%
of the then issued and outstanding shares of PICOM common stock) for $2.5
million. The transaction replaced more than one-half of the equity used to
accomplish the previously reported repurchase of shares of PICOM common stock
held by Physicians Insurance Company of Ohio.
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<PAGE> 42
Impact of Inflation and Changing Prices:
The consolidated financial statements and related data presented
herein have been prepared in accordance with generally accepted accounting
principles which require the measurement of financial position and operating
results in terms of historical dollars without considering changes in the
relative purchasing power of money over time due to inflation. The primary
assets and liabilities of the Company are monetary in nature. As a result,
interest rates have a more significant impact on the Company's performance than
the effects of general levels of inflation. Interest rates do not necessarily
move in the same direction or magnitude as the cost of paying losses and loss
adjustment expenses. Moreover, increases in market interest rates, which often
occur during periods of high inflation, reduce the fair value of the Company's
fixed maturity securities. Conversely, reductions in market interest rates
increase the fair value of fixed maturity securities.
Inflation increases the costs of settling insurance claims over time.
Because insurance premiums are established before the amount of losses and loss
adjustment expenses, and the extent to which inflation may affect such
expenses, are known, the Company attempts to anticipate the future impact of
inflation when establishing rate levels. The Company may be limited in raising
its premium levels for competitive and regulatory reasons, in which case the
Company, rather than its insureds, would be required to absorb the effects of
inflation. Future economic changes which result in prolonged and increasing
levels of inflation could cause increases in the dollar amount of loss and loss
adjustment expense reserves and thereby adversely affect future reserve
development. To minimize such risk, the Company maintains what management
considers to be strong and adequate reinsurance, conducts regular actuarial
reviews of reserves and maintains adequate asset liquidity.
Reinsurance:
In the normal course of business, the Company seeks to reduce the loss
that may arise from events that cause unfavorable underwriting results, provide
additional capacity for growth and protect stockholders' equity by reinsuring
certain levels of risk in various areas of exposure with other insurance
enterprises or reinsurers. At the present time, the Company has both excess of
loss reinsurance and errors and omissions insurance. Although reinsurance
agreements contractually obligate the Company's reinsurers to reimburse the
Company for their proportionate share of losses, they do not discharge the
primary liability of the Company. The Company is contingently liable for the
ceded amount of reserves for unpaid losses and loss adjustment expenses and
unearned premiums in the event the assuming insurance organizations are unable
to meet their contractual obligations. See "Item 1. Business--Reinsurance."
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<PAGE> 43
The following table provides certain information for the year ended
December 31, 1997, with respect to the Company's reinsurers (see also Note 5 to
the consolidated financial statements for amounts recoverable from the
Company's reinsurers):
<TABLE>
<CAPTION>
Reinsurance Premium
Reinsurer Ceded A.M. Best Rating
--------- ------------------- ----------------
(Amounts in thousands)
<S> <C> <C>
TIG Reinsurance $3,858 A
PMA Reinsurance Corporation 1,936 A+
Continental Casualty Company 1,708 A
Odyssey Reinsurance Company 869 A-
Other 2,173 --
-------
$10,544
=======
</TABLE>
The Company continually reviews its reinsurers, considering a number
of factors, the most critical of which is their financial stability. Based on
these reviews, the Company evaluates its position with its reinsurers with
respect to existing and future reinsurance. To date, the Company has not
experienced any material difficulty in collecting reinsurance recoverables. No
assurance can be given, however, regarding the future ability of any of the
Company's reinsurers to meet their future obligations. See "Item 1.
Business--Reinsurance."
During 1997, PICOM entered into an agreement with Michigan Lawyers
Mutual Insurance Company, whereby PICOM ceded all of its Michigan lawyers
professional liability insurance policies in-force to MLM and reinsured 35% of
MLM's net premiums. As part of this arrangement MLM will provide certain
insurance support services to enable PICOM to introduce its lawyers
professional liability product into Illinois, Ohio and Indiana during 1998.
The assumed premiums earned and the assumed losses and loss adjustment expenses
incurred in connection with the MLM reinsurance agreement were $548,000 and
$494,000, respectively, for the year ended December 31, 1997.
Effective July 1, 1997, PICOM began assuming, on a quota-share basis,
40% of the net personal automobile and homeowners insurance risks of MEEMIC.
The assumed premiums earned and the assumed losses and loss adjustment expenses
incurred in connection with the MEEMIC reinsurance agreement were $20.1 million
and $13.1 million, respectively, for the year ended December 31, 1997.
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<PAGE> 44
Regulation:
Certain regulations that affect the Company's insurance subsidiaries
are promulgated by the National Association of Insurance Commissioners, which
is an association of state insurance commissioners, regulators and support
staff that acts as a coordinating body for the state insurance regulatory
process. The NAIC has established risk-based-capital requirements to assist
regulators in monitoring the financial strength and stability of property and
casualty insurers. Under the NAIC requirements, regulatory compliance is
determined by a ratio of an insurance company's regulatory total adjusted
capital, as defined by the NAIC, to its authorized control level of RBC, as
defined by the NAIC. Companies below specific ratios are classified within
certain levels, each of which requires specific corrective action. As of
December 31, 1997 and 1996, PICOM and ProNational Casualty were in compliance
with such ratios and were not required to take any corrective action. See
"Item 1. Business--Regulation."
The NAIC has proposed a new model investment law that may affect the
statutory carrying values of certain investments. Additionally, the NAIC has
undertaken a project to codify statutory accounting practices, which, if
completed and adopted, may affect the statutory carrying value of assets and
liabilities. It is not certain, nor is it possible to predict what impact these
projects will have on the Company's insurance subsidiaries, in the event the
projects are adopted by the NAIC. See "Item 1. Business--Regulation."
Effects of New Accounting Pronouncements:
The Financial Accounting Standards Board has issued Statement of
Financial Accounting Standards ("SFAS") No. 128 "Earnings Per Share" which is
effective for financial statements issued for both interim and annual periods
ending after December 15, 1997. Earlier application is not permitted. This
standard replaces the presentation of primary earnings per share with a
presentation of basic earnings per share and also requires dual presentation of
basic and diluted earnings per share for all entities with complex capital
structures. The Company adopted SFAS No. 128, as required, in the fourth
quarter of 1997 and all prior interim and annual period earnings per share data
presented herein has been restated to conform with the provisions of SFAS No.
128. The impact of the adoption of SFAS No. 128 was not material to previously
reported earnings per share amounts.
The FASB has also issued SFAS No. 130 "Reporting Comprehensive
Income," which is effective for fiscal years beginning after December 15, 1997.
This standard requires that an enterprise (a) classify items of other
comprehensive income by their nature in a financial statement and (b) display
the accumulated balance of other comprehensive income separately from retained
earnings and additional paid-in capital in the equity section of a statement of
financial position. The adoption of SFAS No. 130 is not expected to have a
material effect on the Company's consolidated results of operations or
financial condition.
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<PAGE> 45
The FASB has issued SFAS No. 131 "Disclosures About Segments of an
Enterprise and Related Information," which is effective for fiscal years
beginning after December 15, 1997. This standard requires that an enterprise
report financial and descriptive information about its reportable operating
segments. Operating segments are components of an enterprise about which
separate financial information is available that is evaluated regularly by the
chief operating decision maker in deciding how to allocate resources and in
assessing performance. Generally, financial information is required to be
reported on the basis that it is used internally for evaluating segment
performance and deciding how to allocate resources to segments. The Company
has not determined what effects the adoption of SFAS No. 131 will have on its
consolidated results of operations or financial condition.
Year 2000 Compliance:
The Company has completed an assessment of its computer programs and
has determined that portions of its software will have to be modified
or replaced to facilitate the continued operation of its computers
in the year 2000 and thereafter. Such modifications and replacements, which
are not expected to exceed $500,000, will be expensed as incurred. To date, the
Company has incurred and expensed approximately $150,000 (primarily for such
assessment, the development of a modification plan, and the development of
modifications to existing software).
The Company expects to complete its contemplated modifications and
replacements not later than March 31, 1999, which is prior to any anticipated
impact on the Company's operating systems. The Company believes that with
timely modifications to existing software and conversions to new software, Year
2000 compliance will not pose significant operational problems or have a
material impact on the operations of the Company.
The costs and timing of the modifications and replacements currently
contemplated by the Company are based on management's best estimates, which
were derived utilizing numerous assumptions of future events, including the
continued availability of certain resources and other factors. However, there
can be no guarantee that these estimates will be achieved and actual results
could differ materially from those anticipated. Specific factors that might
cause such material differences include, but are not limited to, the
availability and cost of personnel trained in this area and the ability to
locate and correct all relevant computer codes.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
By virtue of General Instruction 1 to Item 305 of Regulation S-K, and
because it is neither a bank nor a thrift and its market capitalization on
January 28, 1997 did not exceed $2.5 billion, the Company is not required at
this time to provide disclosures under this Item 7A.
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<PAGE> 46
ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
PROFESSIONALS INSURANCE COMPANY MANAGEMENT GROUP
AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 1997 and 1996
<TABLE>
<CAPTION>
Assets 1997 1996
------ ---- ----
(In thousands, except share data)
<S> <C> <C>
Investments (note 4):
Available for sale, at fair value:
Fixed maturities (amortized cost $308,941 and $285,976 in 1997 and
1996, respectively) $313,633 $286,274
Equity securities (cost $2,704 and $2,630 in 1997 and 1996,
respectively) 2,831 2,692
Short-term investments, at cost, which approximates fair value 25,655 10,711
Real estate, at cost, net of accumulated depreciation of $90 and $69 in
1997 and 1996, respectively 442 455
-------- --------
Total investments 342,561 300,132
Cash 2,176 2,023
Premiums due from policyholders 7,051 7,268
Reinsurance balances (note 5) 24,257 17,550
Accrued investment income 4,785 3,885
Prepaid reinsurance premiums (note 5) 664 122
Deferred federal income taxes (note 6) 15,003 17,301
Property and equipment, at cost, net of accumulated depreciation (note 7) 9,060 2,459
Deferred policy acquisition costs (note 8) 1,376 998
Other assets (note 16) 6,262 5,644
-------- --------
Total assets $413,195 $357,382
======== ========
Liabilities and Shareholders' Equity
Liabilities:
Loss and loss adjustment expense reserves (note 9) $239,151 $219,919
Reserve for extended reporting period claims 15,300 14,795
Unearned premiums 21,665 21,945
Drafts outstanding 1,991 2,540
Long-term debt (note 10) 22,500 --
Balance due on purchased book of business 1,446 2,200
Accrued expenses and other liabilities 9,216 8,025
-------- --------
Total liabilities 311,269 269,424
-------- --------
Shareholders' equity (notes 12 and 14):
Preferred stock, no par value; 5,000,000 shares authorized; no shares
issued and outstanding -- --
Common stock, no par value; 25,000,000 shares authorized; 3,505,750 shares
issued and outstanding in 1997 and 1996 3,506 3,506
Additional paid-in capital 14,569 14,569
Retained earnings 80,671 69,645
Net unrealized appreciation on investments, net of deferred federal
income taxes 3,180 238
-------- --------
Total shareholders' equity 101,926 87,958
-------- --------
Commitments and contingencies (notes 5, 16 and 19)
Total liabilities and shareholders' equity $413,195 $357,382
======== ========
</TABLE>
See accompanying notes to the consolidated financial statements.
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<PAGE> 47
PROFESSIONALS INSURANCE COMPANY MANAGEMENT GROUP
AND SUBSIDIARIES
Consolidated Statements of Income
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1997 1996 1995
---- ---- ----
(In thousands, except per share data)
<S> <C> <C> <C>
Revenues and other income:
Premiums written, including $21,871 and $563 of premiums assumed in 1997
and 1996, respectively (note 5) $ 81,690 64,771 67,727
Premiums ceded (note 5) (10,544) (9,307) (12,576)
-------- -------- --------
Net premiums written 71,146 55,464 55,151
Decrease in unearned premiums, net of prepaid reinsurance premiums 822 1,223 533
-------- -------- --------
Premiums earned, net 71,968 56,687 55,684
Net investment income (note 4) 18,719 15,741 14,729
Net realized investment losses (note 4) (207) (473) (6)
Other 1,169 287 165
-------- -------- --------
Total revenues and other income 91,649 72,242 70,572
-------- -------- --------
Expenses:
Losses and loss adjustment expenses, net (notes 5 and 9) 57,125 48,368 35,558
Increase in reserve for extended reporting period claims 505 713 1,344
Policy acquisition and other underwriting expenses 19,014 11,138 9,328
Interest expense 1,098 -- --
-------- -------- --------
Total expenses 77,742 60,219 46,230
-------- -------- --------
Income from operations before federal income taxes and cumulative
effect of change in accounting method 13,907 12,023 24,342
Federal income taxes (note 6) 2,881 2,438 8,276
-------- -------- --------
Income before cumulative effect of change in accounting method 11,026 9,585 16,066
Cumulative effect of change in accounting method - elimination of loss and loss
adjustment expense reserve discount, net of deferred federal income
tax benefit of $4,185 (note 9) -- -- (8,125)
-------- -------- --------
Net income (note 14) $ 11,026 9,585 7,941
======== ======== ========
Net income per common share:
Income before cumulative effect of change in accounting method $ 3.15 2.75 4.68
Cumulative effect of change in accounting method -- -- (2.37)
-------- -------- --------
Net income per common share $ 3.15 2.75 2.31
======== ======== ========
Net income per common share - assuming dilution:
Income before cumulative effect of change in accounting method $ 3.14 2.75 4.68
Cumulative effect of change in accounting method -- -- (2.37)
-------- -------- --------
Net income per common share - assuming dilution $ 3.14 2.75 2.31
======== ======== ========
</TABLE>
See accompanying notes to the consolidated financial statements.
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<PAGE> 48
PROFESSIONALS INSURANCE COMPANY MANAGEMENT GROUP
AND SUBSIDIARIES
Consolidated Statements of Shareholders' Equity
Years ended December 31, 1997, 1996 and 1995
<TABLE>
<CAPTION>
Net Unrealized
Appreciation
(Depreciation)
on
Common Stock Investments,
------------------------------------- Net of
Shares Additional Deferred
------------------------ Paid-in Retained Federal
Issued In Treasury Amount Capital Earnings Income Taxes
------ ----------- ------ ------- -------- ------------
(In thousands, except share data)
<S> <C> <C> <C> <C> <C> <C>
Balances, December 31, 1994 3,238,959 -- $ 3,239 8,181 59,053 (7,331)
Net income -- -- -- -- 7,941 --
Purchase of treasury shares, at cost (note 12) -- 254,823 -- -- -- --
Sale of treasury shares (note 4) -- (131,579) -- 236 -- --
Net appreciation on debt securities transferred
from held-to-maturity classification (note 4) -- -- -- -- -- 511
Net appreciation on debt and equity securities -- -- -- -- -- 8,702
---------- ---------- ---------- ---------- ---------- ----------
Balances, December 31, 1995 3,238,959 123,244 3,239 8,417 66,994 1,882
Net income -- -- -- -- 9,585 --
Issuance of common stock (note 1) 1 -- -- -- -- --
Issuance of treasury shares as stock bonus -- (28,430) -- 207 -- --
(note 12)
Issuance of treasury shares in purchase of
subsidiary (note 12) -- (44,000) -- 178 -- --
Retirement and cancellation of treasury (50,814) (50,814) (51) (823) -- --
shares (note 12)
Issuance of 10% stock dividend 317,604 -- 318 6,590 (6,934) --
Net depreciation on debt and equity securities -- -- -- -- -- (1,644)
---------- ---------- ---------- ---------- ---------- ----------
Balances, December 31, 1996 3,505,750 -- 3,506 14,569 69,645 238
Net income -- -- -- -- 11,026 --
Net appreciation on debt and equity securities -- -- -- -- -- 2,942
---------- ---------- ---------- ---------- ---------- ----------
Balances, December 31, 1997 3,505,750 -- $ 3,506 14,569 80,671 3,180
========== ========== ========== ========== ========== ==========
<CAPTION>
Cost of
Common Total
Stock in Shareholders'
Treasury Equity
-------- ------
<S> <C> <C>
Balances, December 31, 1994 -- 63,142
Net income -- 7,941
Purchase of treasury shares, at cost (note 12) (4,385) (4,385)
Sale of treasury shares (note 4) 2,264 2,500
Net appreciation on debt securities transferred
from held-to-maturity classification (note 4) -- 511
Net appreciation on debt and equity securities -- 8,702
---------- ----------
Balances, December 31, 1995 (2,121) 78,411
Net income -- 9,585
Issuance of common stock (note 1) -- --
Issuance of treasury shares as stock bonus 490 697
(note 12)
Issuance of treasury shares in purchase of
subsidiary (note 12) 757 935
Retirement and cancellation of treasury 874 --
shares (note 12)
Issuance of 10% stock dividend -- (26)
Net depreciation on debt and equity securities -- (1,644)
---------- ----------
Balances, December 31, 1996 -- 87,958
---------- ----------
Net income -- 11,026
Net appreciation on debt and equity securities -- 2,942
---------- ----------
Balances, December 31, 1997 -- 101,926
========== ==========
</TABLE>
See accompanying notes to the consolidated financial statements.
-48-
<PAGE> 49
PROFESSIONALS INSURANCE COMPANY MANAGEMENT GROUP
AND SUBSIDIARIES
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1997 1996 1995
---- ---- ----
(In thousands)
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $ 11,026 9,585 7,941
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization 2,525 2,423 1,056
Realized losses on investments 207 473 6
Deferred federal income taxes 782 1,834 5,250
Stock bonus -- 697 --
Changes in assets and liabilities:
Premiums due from policyholders 217 350 558
Reinsurance recoverables (6,707) (5,286) (8,809)
Accrued investment income (900) (273) (615)
Prepaid reinsurance premiums (542) (46) 902
Deferred policy acquisition costs (378) 94 20
Other assets (1,342) (1,137) (331)
Loss and loss adjustment expense reserves 19,232 20,314 11,061
Reserve for extended reporting period claims 505 713 1,344
Unearned premiums (280) (1,177) (1,435)
Drafts outstanding (549) (905) (18)
Accrued expenses and other liabilities 1,191 1,877 667
--------- --------- ---------
Net cash provided by operating activities 24,987 29,536 17,597
--------- --------- ---------
Cash flows from investing activities:
Proceeds from sale or maturity of short-term investments 373,238 293,643 658,437
Purchases of short-term investments (387,690) (286,325) (634,287)
Proceeds from maturity of securities available-for-sale 2,620 2,000 43,847
Proceeds from sale of securities available-for-sale 61,829 97,188 115,684
Purchases of securities available-for-sale (89,121) (130,506) (216,175)
Proceeds from maturity of securities held-to-maturity -- -- 27,686
Proceeds from sale of securities held-to-maturity -- -- 758
Purchases of securities held-to-maturity -- -- (12,861)
Payable for securities -- (3,205) 3,205
Purchases of property and equipment (7,456) (667) (774)
Payment on liability for purchased book of business (754) (894) (893)
--------- --------- ---------
Net cash used in investing activities (47,334) (28,766) (15,373)
--------- --------- ---------
Cash flows from financing activities:
Proceeds from issuance of long-term debt 22,500 -- --
Purchase of treasury shares -- -- (4,385)
Sale of treasury shares -- -- 2,500
Cash paid in lieu of fractional shares -- (26) --
--------- --------- ---------
Net cash provided by (used in) financing activities 22,500 (26) (1,885)
--------- --------- ---------
Net increase in cash 153 744 339
Cash, beginning of year 2,023 1,279 940
--------- --------- ---------
Cash, end of year $ 2,176 2,023 1,279
========= ========= =========
Supplemental disclosure of cash flow information:
Federal income taxes paid (recovered) $ 2,000 1,593 (159)
Interest paid 730 -- --
Supplemental schedule of noncash investing and financing activities:
Purchase of book of business (note 16):
Intangible assets acquired $ -- (400) (3,587)
Amount due -- 400 3,587
Issuance of treasury shares as stock bonus (note 12) -- 697 --
Issuance of treasury shares for acquired company (note 12) -- 935 --
</TABLE>
See accompanying notes to the consolidated financial statements.
-49-
<PAGE> 50
PROFESSIONALS INSURANCE COMPANY MANAGEMENT GROUP
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1997, 1996 and 1995
(1) Description of Business
General
Professionals Insurance Company Management Group (Professionals Group) is
an insurance holding company incorporated under Michigan law on January
31, 1996. Professionals Group owns all of the issued and outstanding
common stock of PICOM Insurance Company (PICOM), a stock insurance
company incorporated under Michigan law. Professionals Group and
subsidiaries are collectively referred to as "the Company."
Effective August 31, 1996, and pursuant to a Reorganization Agreement
dated May 13, 1996 (the Reorganization Agreement), and an Agreement and
Plan of Merger dated May 13, 1996 (Plan of Merger), among Professionals
Group, PICOM Interim Insurance Company, a stock insurance company
incorporated under Michigan law and a wholly owned subsidiary of
Professionals Group (INSCO) and PICOM, Professionals Group acquired all
of the outstanding capital stock of PICOM through the merger of INSCO
with and into PICOM (the Merger). As a result of the Merger: (1) INSCO
was merged into PICOM and INSCO ceased to exist; (2) PICOM, as the
surviving corporation, became a wholly owned subsidiary of Professionals
Group; (3) each issued and outstanding share of common stock of PICOM
(representing 3,188,145 shares) was converted into one share of common
stock of Professionals Group, and (4) all of the issued and outstanding
shares of INSCO held by Professionals Group were converted into shares of
common stock of PICOM.
The Merger has been accounted for in a manner similar to a pooling of
interests, whereby Professionals Group has carried forward to its
accounts the assets and liabilities of PICOM at their respective amounts
as reported by PICOM.
PICOM is a Michigan-domiciled property and casualty insurance company
licensed in eight states which provides professional liability insurance
for physicians, surgeons, dentists, hospitals, other health care
providers and lawyers and law firms.
Following is a description of the most significant risks facing
property/casualty insurers and how the Company mitigates those risks:
Legal/Regulatory Risk is the risk that the legal or regulatory
environment in which an insurer operates will change and create
additional costs or expenses not anticipated by the insurer in pricing
its products. That is, regulatory initiatives designed to reduce insurer
profits or new legal theories may create costs for the insurer beyond
those recorded in the financial statements. The Company mitigates this
risk through underwriting and loss adjusting practices which identify and
minimize the adverse impact of this risk.
-50-
<PAGE> 51
PROFESSIONALS INSURANCE COMPANY MANAGEMENT GROUP
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(1) Description of Business, Continued
Credit Risk is the risk that issuers of securities owned by the Company
will default or other parties, including reinsurers, which owe the
Company money will not pay. Also, the Company writes a significant amount
of business under which policyholders reimburse the Company for policy
deductibles. The Company minimizes this risk by adhering to a
conservative investment strategy, by maintaining sound reinsurance and
credit and collection practices and by providing for any amounts deemed
uncollectible.
Interest Rate Risk is the risk that interest rates will change and cause
a decrease in the value of an insurer's investments. The Company
mitigates this risk by attempting to approximately match the maturity
schedule of its assets with the expected payout of its liabilities. To
the extent that liabilities come due more quickly than assets mature, an
insurer would have to sell assets prior to maturity and recognize a gain
or loss. At December 31, 1997, the estimated market value of the
Company's bond portfolio was greater than its amortized cost.
In preparing the consolidated financial statements, management is
required to make estimates and assumptions that affect the reported
amounts of assets and liabilities as of the dates of the balance sheets
and revenues and expenses for the periods then ended. Actual results may
differ from those estimates.
The most significant estimates that are susceptible to significant change
in the near term relate to the determination of the loss and loss
adjustment expense reserves and the reserve for extended reporting period
claims. Although considerable variability is inherent in these estimates,
management believes that the reserves are adequate. The estimates are
reviewed regularly and adjusted as necessary. Such adjustments are
generally reflected in current operations. Other material estimates that
are susceptible to significant change in the near term relate to the
recoverability of deferred federal income tax assets.
(2) Principles of Consolidation
The accompanying consolidated financial statements include the accounts
of Professionals Group, and the following wholly owned subsidiaries:
PICOM, including PICOM's two wholly owned subsidiaries, PICOM Claims
Services Corporation - a provider of claims processing services to a
nonaffiliated professional liability company and ProNational Casualty
Company (ProNational Casualty), formerly PICOM Insurance Company of
Illinois - an Illinois-domiciled property and casualty insurance company
which provided professional liability insurance for physicians and
surgeons in the State of Illinois through 1997. ProNational Casualty was
formed in December 1994 to write the book of business purchased effective
January 1, 1995 (see note 16).
PICOM Financial Services Corporation - an inactive financial services
company.
PICOM Insurance Agency, Inc. - an inactive insurance agency.
American Insurance Management Corporation - an Indiana Corporation that
serves as the attorney-in-fact for American Medical Insurance Exchange,
an inactive Indiana interinsurance reciprocal exchange.
All significant intercompany transactions and balances have been
eliminated in consolidation.
-51-
<PAGE> 52
PROFESSIONALS INSURANCE COMPANY MANAGEMENT GROUP
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(3) Summary of Significant Accounting Policies
(a) Basis of Presentation
The consolidated financial statements have been prepared in
accordance with generally accepted accounting principles (GAAP),
which vary in certain respects from statutory accounting practices
(SAP) followed in reporting to insurance regulatory authorities
(see note 14 for the effects of such differences).
(b) Investments
Investment securities are classified upon acquisition into one of
three categories: trading, available-for-sale or held-to-maturity.
Trading securities are bought and held principally for the purpose
of selling them in the near term. Held-to-maturity securities are
those securities the Company has the positive intent and ability
to hold until maturity. At December 31, 1997 and 1996, all of the
Company's securities are classified as available-for-sale and are
those securities that would be available to be sold in response to
the Company's liquidity needs, changes in market interest rates
and asset-liability management strategies, among others.
Available-for-sale securities are recorded at fair value, whereas
held-to-maturity securities are recorded at amortized cost.
Unrealized gains and losses, net of the related income tax effect,
on available-for-sale securities are excluded from income and
reported in the separate component of shareholders' equity.
Transfers of securities between categories are recorded at fair
value at the date of transfer. Unrealized gains and losses
associated with transfers of securities from held-to-maturity to
available-for-sale are recorded in the separate component of
shareholders' equity.
A decline in the fair value of an available-for-sale or
held-to-maturity security below cost that is deemed other than
temporary results in a charge to income, resulting in the
establishment of a new cost basis for the security. All declines
in fair values of the Company's investment securities in 1997,
1996 or 1995 were deemed to be temporary.
Investments in preferred stock and common stock of nonaffiliates
are stated at fair value. Fair values are based on quoted market
prices or dealer quotes. If a quoted market price is not
available, fair value is estimated using quoted market prices for
similar securities.
Short-term investments, which consist principally of commercial
paper, money market funds and U.S. government securities, are
stated at cost, which approximates fair value.
Premiums and discounts are amortized or accreted, respectively,
over the life of the related debt security as an adjustment to
yield using the yield-to-maturity method. Dividends and interest
income are recognized when earned. Realized gains and losses are
included in earnings and are derived using the
specific-identification method for determining the cost of
securities sold.
-52-
<PAGE> 53
PROFESSIONALS INSURANCE COMPANY MANAGEMENT GROUP
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(3) Summary of Significant Accounting Policies, Continued
(c) Revenue Recognition
Insurance premium income is recognized on a monthly pro rata basis
over the respective terms of the policies in-force and unearned
premiums represent the portion of premiums written which is
applicable to the unexpired terms of the policies in-force.
Reinsurance arrangements are prospective contracts for which
prepaid reinsurance premiums are amortized ratably over the
related policy terms based on the estimated ultimate amounts to be
paid.
(d) Loss and Loss Adjustment Expense Reserves
Loss and loss adjustment expense reserves represent the
accumulation of individual case estimates for reported losses and
loss adjustment expenses, bulk adjustments to case estimates and
actuarial estimates for incurred but not reported losses and loss
adjustment expenses, based upon the Company's actual experience,
assumptions and projections as to claims frequency, severity,
inflationary trends and settlement payments. The reserve for loss
and loss adjustment expenses is intended to cover the ultimate net
cost of all losses and loss adjustment expenses incurred but
unsettled through the balance sheet date. The reserve is stated
gross of reinsurance ceded.
Through December 31, 1994, the Company discounted loss and loss
adjustment expense reserves to present value. Effective January 1,
1995, the Company eliminated its practice of discounting, a change
in method of accounting (see note 9).
(e) Reserve for Extended Reporting Period Claims
The reserve for extended reporting period claims coverage is
recorded during the term of the original claims-made policy,
utilizing the pure-premium approach, in amounts adequate to pay
for estimated future claims reported subsequent to a current
policyholders' death, disability or retirement. Changes in this
reserve are charged or credited to income.
(f) Property and Equipment and Depreciation
Property and equipment are recorded at cost, net of accumulated
depreciation. Depreciation is computed on the straight-line method
over periods ranging from 4 to 25 years. Maintenance, repairs and
minor renewals are charged to expense as incurred.
The cost and related accumulated depreciation of assets sold are
removed from the related accounts and the resulting gain or loss
is reflected in income.
(g) Deferred Policy Acquisition Costs
Policy acquisition costs, specifically commissions, are deferred,
subject to ultimate recoverability from future income, including
investment income and amortized to expense over the period in
which related premiums are earned.
-53-
<PAGE> 54
PROFESSIONALS INSURANCE COMPANY MANAGEMENT GROUP
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(3) Summary of Significant Accounting Policies, Continued
(h) Federal Income Taxes
Deferred federal income tax assets and liabilities are recognized
for the expected future tax consequences attributable to
differences between the financial statement carrying amount of
existing assets and liabilities and their respective tax bases.
Deferred tax assets and liabilities are measured using enacted tax
rates expected to apply to taxable income in the years in which
these temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that
includes the enactment date.
(i) Intangible Assets
Intangible assets are comprised mainly of goodwill, which
represents the excess of cost over the fair value of assets
acquired, and the cost of a purchased book of business (see note
16), both of which are being amortized on a straight-line basis
over ten years. The carrying value of intangible assets is
periodically reviewed by the Company based on the expected future
undiscounted operating cash flows of the related item. Based upon
its most recent analysis, the Company believes that no material
impairment of intangible assets exists at December 31, 1997.
(j) Stock-Based Compensation
As more fully described in note 13, the Company records
compensation expense for stock options only if the market price of
the Company's stock, on the date of grant, exceeds the amount an
individual must pay to acquire the stock.
(k) Net Income Per Share
Net income per share is computed by dividing net income by the
weighted average number of shares of common stock and common stock
equivalents (stock options) outstanding during each year after
giving effect to stock dividends and treasury shares.
The Company adopted Statement of Financial Accounting Standards
No. 128 "Earnings Per Share" (SFAS No. 128) during the fourth
quarter of 1997. All income per share amounts presented herein
have been restated to conform with the provisions of SFAS No. 128.
A reconciliation of the numerators and denominators of the "income
per share" and "income per share - assuming dilution" computations
for "income before cumulative effect of change in accounting
method" are presented below:
-54-
<PAGE> 55
PROFESSIONALS INSURANCE COMPANY MANAGEMENT GROUP
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(3) Summary of Significant Accounting Policies, Continued
<TABLE>
<CAPTION>
Income Shares Per-Share
(Numerator) (Denominator) Amount
----------- ------------- ------
<S> <C> <C> <C>
For the Year Ended December 31, 1997:
Income before cumulative effect of change in
accounting method $ 11,026,000
---------------
Income per share 11,026,000 3,505,750 3.15
====
Effect of dilutive securities - stock options - 2,011
--------------- -------------
Income per share - assuming dilution $ 11,026,000 3,507,761 3.14
=============== ============= ====
For the Year Ended December 31, 1996:
Income before cumulative effect of change in
accounting method $ 9,585,000
---------------
Income per share 9,585,000 3,486,698 2.75
====
Effect of dilutive securities - stock options - 25
--------------- -------------
Income per share - assuming dilution $ 9,585,000 3,486,723 2.75
=============== ============= ====
For the Year Ended December 31, 1995:
Income before cumulative effect of change in
accounting method $ 16,066,000
---------------
Income per share 16,066,000 3,432,339 4.68
====
Effect of dilutive securities - stock options - -
--------------- ------------
Income per share - assuming dilution $ 16,066,000 3,432,339 4.68
=============== ============= ====
</TABLE>
-55-
<PAGE> 56
PROFESSIONALS INSURANCE COMPANY MANAGEMENT GROUP
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(4) Investments
In November 1995, the Financial Accounting Standards Board issued a Guide
to Implementation of Statement 115 on Accounting for Certain Investments
in Debt and Equity Securities. This guide allowed companies to reassess
the appropriateness of the classification of securities as of the date of
the implementation guide, but no later than December 31, 1995. As a
result, the Company made a one-time transfer of approximately $77,893,000
in investment securities previously classified as held-to-maturity to the
available-for-sale classification. The effect of such reclassification
increased shareholders' equity by $511,000, net of deferred federal
income taxes.
A summary of amortized cost, gross unrealized gains and losses and
estimated fair value of investments in securities as of December 31, 1997
and 1996, follows:
<TABLE>
<CAPTION>
1997
-----------------------------------------------------
Estimated
Amortized Gross Unrealized Fair
Cost Gains Losses Value
---- ----- ------ -----
(In thousands)
<S> <C> <C> <C> <C>
Fixed maturities available for sale:
U.S. Treasury securities and obligations of
U.S. government corporations and agencies $ 31,774 431 5 32,200
Debt securities issued by states of the United
States and political subdivisions of the 105,045 2,345 1 107,389
states
Debt securities issued by foreign governments 691 177 -- 868
Corporate debt securities 74,558 738 33 75,263
Mortgage-backed securities:
Government 69,552 530 159 69,923
Other 12,746 126 5 12,867
Redeemable preferred stocks 14,575 548 -- 15,123
-------- -------- -------- --------
$308,941 4,895 203 313,633
======== ======== ======== ========
Equity securities available for sale -
common stocks $ 2,704 132 5 2,831
======== ======== ======== ========
<CAPTION>
1996
----------------------------------------------------
<S> <C> <C> <C> <C>
Fixed maturities available for sale:
U.S. Treasury securities and obligations of
U.S. government corporations and agencies $ 52,065 342 394 52,013
Debt securities issued by states of the United
States and political subdivisions of the 95,433 581 258 95,756
states
Debt securities issued by foreign governments 690 150 -- 840
Corporate debt securities 46,356 345 375 46,326
Mortgage-backed securities:
Government 68,752 466 788 68,430
Other 15,684 168 41 15,811
Redeemable preferred stocks 6,996 104 2 7,098
-------- -------- -------- --------
$285,976 2,156 1,858 286,274
======== ======== ======== ========
Equity securities available for sale -
common stocks $ 2,630 67 5 2,692
======== ======== ======== ========
</TABLE>
-56-
<PAGE> 57
PROFESSIONALS INSURANCE COMPANY MANAGEMENT GROUP
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(4) Investments, Continued
The amortized cost and estimated fair value of fixed maturities at
December 31, 1997, by contractual maturity, are shown below. Expected
maturities on certain corporate and mortgage-backed securities may differ
from contractual maturities because borrowers may have the right to call
or prepay obligations with or without call or prepayment penalties.
<TABLE>
<CAPTION>
Estimated
Amortized Fair
Cost Value
---- -----
(In thousands)
<S> <C> <C>
Due in one year or less $ 4,992 5,005
Due after one year through five years 90,641 91,470
Due after five years through ten years 75,372 77,354
Due after ten years 41,063 41,891
-------- --------
212,068 215,720
Mortgage-backed securities:
Government 69,552 69,923
Other 12,746 12,867
Redeemable preferred stocks 14,575 15,123
-------- --------
$308,941 313,633
======== ========
</TABLE>
Proceeds and related gross realized gains and gross realized losses on
sales of fixed maturities follow:
<TABLE>
<CAPTION>
Years Ended December 31,
---------------------------------
1997 1996 1995
---- ---- ----
(In thousands)
<S> <C> <C> <C>
Proceeds $ 61,825 97,127 116,441
======== ======== ========
Gross realized gains $ 418 319 1,672
Gross realized losses (597) (807) (1,345)
-------- -------- --------
Net realized gains (losses) $ (179) (488) 327
======== ======== ========
</TABLE>
-57-
<PAGE> 58
PROFESSIONALS INSURANCE COMPANY MANAGEMENT GROUP
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(4) Investments, Continued
A summary of the sources of net investment income follows:
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------
1997 1996 1995
---- ---- ----
(In thousands)
<S> <C> <C> <C>
Fixed maturities $18,421 15,548 11,920
Equity securities 100 32 2
Short-term investments and cash and cash
equivalents 815 860 3,176
Real estate 147 87 70
Other investment assets 109 143 477
------- ------- -------
Total investment income 19,592 16,670 15,645
Less investment expenses 873 929 916
------- ------- -------
Net investment income $18,719 15,741 14,729
======= ======= =======
</TABLE>
Realized gains (losses) and increases (decreases) in net unrealized
gains (losses) follow:
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------------
1997 1996 1995
---- ---- ----
(In thousands)
<S> <C> <C> <C>
Net realized gains (losses):
Fixed maturities $ (179) (488) 327
Equity securities (28) 15 (333)
------- ------- -------
Net realized losses $ (207) (473) (6)
======= ======= =======
Change in net unrealized gains (losses):
Fixed maturities $ 4,394 (2,552) 19,356
Equity securities 65 29 22
------- ------- -------
Total change in net unrealized gains
(losses) $ 4,459 (2,523) 19,378
======= ======= =======
</TABLE>
On December 28, 1995, under a reciprocal stock purchase agreement with
Physicians Insurance Company of Wisconsin, Inc. (PIC-Wis), the Company
acquired 1,583 shares of PIC-Wis' common stock (representing 6.77% of
PIC-Wis' outstanding stock) for $2,500,000, and PIC-Wis acquired 131,579
shares of the Company's common stock (representing 4.2% of the Company's
outstanding stock) for $2,500,000.
At December 31, 1997, U.S. Treasury notes and certificates of deposit
with a carrying value of $3,395,000 were on deposit with regulatory
authorities, as required by law.
-58-
<PAGE> 59
PROFESSIONALS INSURANCE COMPANY MANAGEMENT GROUP
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(5) Reinsurance
In the normal course of business, the Company seeks to reduce the loss
that may arise from events that cause unfavorable underwriting results by
reinsuring certain levels of risk in various areas of exposure with other
insurance enterprises or reinsurers. Amounts receivable from reinsurers
are estimated in a manner consistent with the claim liability associated
with the reinsured policy. Although reinsurance agreements contractually
obligate the Company's reinsurers to reimburse the Company for their
proportionate share of losses, they do not discharge the primary
liability of the Company. The Company remains liable for the ceded amount
of reserves for unpaid losses and loss adjustment expenses and unearned
premiums in the event the assuming insurance organizations are unable to
meet their contractual obligations.
The Company has various excess of loss and quota share reinsurance
agreements. As of December 31, 1997, the maximum current net retention on
business generated by Professionals Group's insurance subsidiaries,
subject to certain adjustments of risk on any single coverage per claim
after reinsurance, was $300,000. Effective January 1, 1998, the Company's
net retention was increased to $500,000 on all business.
The Company continually reviews its reinsurers, considering a number of
factors, the most critical of which is their financial stability. Based
on these reviews, the Company evaluates its position with reinsurers with
respect to existing and future reinsurance.
The Company first assumed business from other insurance companies on
December 31, 1996, when it assumed all of the loss and loss adjustment
expense reserves and unearned premiums of American Medical Insurance
Exchange (AMIE). Effective July 1, 1997, PICOM began assuming, on a
quota-share basis, 40% of Michigan Educational Employees Mutual Insurance
Company's (MEEMIC) net business (see note 19).
At December 31, 1997, amounts related to reinsurance balances and prepaid
reinsurance premiums follow:
<TABLE>
<CAPTION>
Prepaid
Reinsurance Reinsurance
Balances Premiums
-------- --------
(In thousands)
<S> <C> <C>
TIG Reinsurance $ 7,299 242
Underwriters Reinsurance Company 4,125 --
PMA Reinsurance Corporation 3,445 179
Continental Casualty Company 3,014 143
Michigan Educational Employees Mutual Insurance Company 2,003 --
Odyssey Reinsurance Company 1,347 100
Other 3,024 --
------- -------
$24,257 664
======= =======
</TABLE>
-59-
<PAGE> 60
PROFESSIONALS INSURANCE COMPANY MANAGEMENT GROUP
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(5) Reinsurance, Continued
Reinsurance balances consisted of amounts related to:
<TABLE>
<CAPTION>
December 31,
-----------------------
1997 1996
---- ----
(In thousands)
<S> <C> <C>
Recoverables:
Paid losses and loss adjustment expenses $ 267 41
Unpaid losses and loss adjustment expenses 23,840 19,206
-------- --------
Total reinsurance recoverables 24,107 19,247
Ceded reinsurance premiums payable (2,841) (2,059)
Assumed reinsurance premiums receivable 6,278 --
Ceded reinsurance commissions receivable 386 362
Assumed reinsurance commissions payable (3,673) --
-------- --------
$ 24,257 17,550
======== ========
</TABLE>
Premiums earned and losses and loss adjustment expenses are net of the
following reinsurance ceded amounts:
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------------
1997 1996 1995
---- ---- ----
(In thousands)
<S> <C> <C> <C>
Premiums earned $10,002 9,261 13,478
Losses and loss adjustment expenses 5,687 6,356 11,475
</TABLE>
Premiums earned and losses and loss adjustment expenses have been
increased by the following reinsurance assumed amounts for the year ended
December 31, 1997:
<TABLE>
<CAPTION>
MEEMIC Other
------ -----
(in thousands)
<S> <C> <C>
Premiums earned $20,115 756
Losses and loss adjustment expenses 13,078 717
</TABLE>
-60-
<PAGE> 61
PROFESSIONALS INSURANCE COMPANY MANAGEMENT GROUP
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(6) Federal Income Taxes
Professionals Group, together with its subsidiaries, files a consolidated
federal income tax return. Income tax expense is computed under the
liability method, whereby deferred income taxes reflect the estimated
future tax effects of temporary differences between the carrying value of
assets and liabilities for financial reporting purposes and those for
income tax purposes. A valuation allowance is then required to be
established to reduce a deferred tax asset if it is "more likely than
not" that the related tax benefits will not be realized.
The provision for federal income taxes consists of the following:
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------------
1997 1996 1995
---- ---- ----
(In thousands)
<S> <C> <C> <C>
Current $2,099 604 (1,159)
Deferred 782 1,834 9,435
------ ------ ------
$2,881 2,438 8,276
====== ====== ======
</TABLE>
The significant components of federal income tax expense (benefit) are as
follows:
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------------------
1997 1996 1995
---- ---- ----
(In thousands)
<S> <C> <C> <C>
Continuing operations $2,881 2,438 8,276
Accounting change -- -- (4,185)
Shareholders' equity 1,517 (840) 4,740
------ ------ ------
$4,398 1,598 8,831
====== ====== ======
</TABLE>
Actual federal income taxes vary from amounts computed by applying the
current federal income tax rate of 34% to income or loss before federal
income taxes. For the years ended December 31, 1997, 1996 and 1995, the
reasons for these differences, and the tax effects thereof, are as
follows:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
(In thousands)
<S> <C> <C> <C>
Expected tax expense $ 4,728 4,088 8,276
Dividends received deduction (138) (11) --
Tax-exempt interest (1,395) (1,000) (65)
Adjustment to prior years' tax liability (399) (913) --
Other, net 85 274 65
------- ------- -------
Actual tax expense $ 2,881 2,438 8,276
======= ======= =======
</TABLE>
-61-
<PAGE> 62
PROFESSIONALS INSURANCE COMPANY MANAGEMENT GROUP
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(6) Federal Income Taxes, Continued
The tax effects of temporary differences that give rise to deferred
federal income tax assets and deferred federal income tax liabilities
follow:
<TABLE>
<CAPTION>
December 31,
------------------
1997 1996
---- ----
(In thousands)
<S> <C> <C>
Deferred federal income tax assets arising from:
Loss and loss adjustment expense reserves $16,027 14,704
Unearned premium reserves 1,428 1,484
Alternative minimum tax credits -- 1,656
Other 231 194
------- -------
Total deferred federal income tax assets 17,686 18,038
------- -------
Deferred federal income tax liabilities arising from:
Deferred policy acquisition costs 468 339
Net unrealized gains on investments 1,640 123
Other 575 275
------- -------
Total deferred federal income tax liabilities 2,683 737
------- -------
Net deferred federal income taxes $15,003 17,301
======= =======
</TABLE>
In assessing the realizability of deferred federal income tax assets,
management considers whether it is more likely than not that some portion
of the deferred federal income tax assets will not be realized. Because
of the carryforward provisions of the Internal Revenue Code, the
expectation that temporary differences will reverse during periods in
which taxable income is generated, and the fact that the Company has not
incurred an operating loss for either financial or federal income tax
reporting purposes since 1987, management believes it is more likely than
not that the Company will fully realize the net deferred federal income
tax assets. Accordingly, no valuation allowance has been established.
(7) Property and Equipment
At December 31, 1997 and 1996, property and equipment consisted of the
following:
<TABLE>
<CAPTION>
1997 1996
---- ----
(In thousands)
<S> <C> <C>
Real estate $ 6,739 1,998
Data processing equipment, including software 2,424 2,008
Furniture, fixtures and equipment 2,839 1,210
-------- --------
12,002 5,216
Accumulated depreciation (2,942) (2,757)
-------- --------
Total property and equipment $ 9,060 2,459
======== ========
</TABLE>
-62-
<PAGE> 63
PROFESSIONALS INSURANCE COMPANY MANAGEMENT GROUP
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(8) Deferred Policy Acquisition Costs
Changes in deferred policy acquisition costs are summarized as follows:
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------
1997 1996 1995
---- ---- ----
(In thousands)
<S> <C> <C> <C>
Net asset balance, beginning of year $ 998 1,092 1,112
------- ------- -------
Amounts deferred:
Agent commissions and ceding commission
expense 3,539 2,873 3,181
Ceding commission income (1,323) (1,229) (1,543)
------- ------- -------
Net amounts deferred 2,216 1,644 1,638
Net amortization (1,838) (1,738) (1,658)
------- ------- -------
Net asset balance, end of year $ 1,376 998 1,092
======= ======= =======
</TABLE>
(9) Loss and Loss Adjustment Expense Reserves
Prior to 1995, loss and loss adjustment expense reserves were discounted
to reflect anticipated investment income. Discounts were based on
historical payment patterns and assumed an interest rate at or below the
Company's investment yield, which was the same rate used for statutory
reporting purposes.
Effective January 1, 1995, the Company eliminated its practice of
discounting loss and loss adjustment expense reserves for GAAP reporting
purposes, a change in method of accounting. The Company believes it is
preferable not to discount reserves because it is more conservative and
is practiced by most publicly held insurers. This change in method of
accounting resulted in a one-time cumulative charge of $8,125,000, net of
deferred federal income taxes, as of January 1, 1995.
-63-
<PAGE> 64
PROFESSIONALS INSURANCE COMPANY MANAGEMENT GROUP
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(9) Loss and Loss Adjustment Expense Reserves, Continued
Activity in loss and loss adjustment expense reserves is summarized as
follows:
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------------------
1997 1996 1995
---- ---- ----
(In thousands)
<S> <C> <C> <C>
Balance, beginning of year $ 219,919 199,605 188,544
Less reinsurance balances recoverable (19,206) (14,186) (3,760)
--------- --------- ---------
Net balance, beginning of year 200,713 185,419 184,784
--------- --------- ---------
Incurred related to:
Current year 83,466 65,986 63,027
Prior years (26,341) (17,618) (27,469)
--------- --------- ---------
Total incurred 57,125 48,368 35,558
--------- --------- ---------
Effect of change in accounting method -- -- 12,310
Loss and loss adjustment expense reserves assumed
(see note 5) -- 4,119 --
--------- --------- ---------
Paid related to:
Current year 10,512 4,352 3,053
Prior years 32,015 32,841 44,180
--------- --------- ---------
Total paid 42,527 37,193 47,233
--------- --------- ---------
Net balance, end of year 215,311 200,713 185,419
Plus reinsurance balances recoverable 23,840 19,206 14,186
--------- --------- ---------
Balance, end of year $ 239,151 219,919 199,605
========= ========= =========
</TABLE>
The Company establishes conservative reserves for the most recent
accident years and adjusts the reserves as new information becomes
available. This reserving practice has resulted in favorable development
in estimates of prior years' reserves.
(10) Long-Term Debt
On April 4, 1997, Professionals Group borrowed $22.5 million under a
seven-year unsecured bank term loan, bearing interest at an adjustable
rate of LIBOR plus 62.5 basis points (6.40% at December 31, 1997), and
payable quarterly (the "Credit Agreement"). Principal payments are due on
April 30, as follows: 1998 - $2,500,000; 1999 - $2,500,000; 2000 -
$3,000,000; 2001 - $3,000,000; 2002 - $3,500,000; 2003 - $3,500,000; and
2004 - $4,500,000.
-64-
<PAGE> 65
PROFESSIONALS INSURANCE COMPANY MANAGEMENT GROUP
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(10) Long-Term Debt, Continued
The Credit Agreement contains a covenant which prohibits the payment of
cash dividends on Professionals Group's common stock (except for cash
paid in lieu of fractional shares related to stock dividends declared).
Additional covenants also require the Company to, among other things,
maintain total consolidated shareholders' equity of at least $80.0
million plus 50% of the preceding fiscal year's consolidated net income,
maintain a fixed charges ratio and an interest coverage ratio (as defined
by the Credit Agreement) of not less than 1.5:1 and 2.5:1, respectively.
The Company was in compliance with, or has received waivers of, all
required covenants at December 31, 1997.
(11) Employee Benefit Plans
The Company currently maintains two defined contribution employee benefit
plans--a 401(k) plan and a money purchase plan--which cover substantially
all employees meeting certain eligibility requirements.
With respect to the 401(k) plan, the Company annually contributes 5% of
an employee's salary and matches employee contributions up to 5% of an
employee's salary. During 1997, 1996 and 1995, the Company's expense
under the 401(k) plan was $370,000, $295,000 and $261,000, respectively.
With respect to the money purchase plan, the Company annually contributes
3% of an employee's salary up to a prescribed maximum, plus 5% of the
excess of an employee's salary over the prescribed maximum. During 1997,
1996 and 1995, the Company's expense under the money purchase plan was
$145,000, $112,000 and $114,000, respectively.
The Company has a stock purchase plan through which employees and
directors of the Company and its wholly owned subsidiaries may purchase
the Company's common stock by means of payroll deduction. Pursuant to
this plan, the Company may elect to match participant purchases, which it
is currently matching at the rate of $1.25 (of which $1.00 is used to
purchase the Company's common stock and $0.25 is applied to income taxes)
for each $1.00 of participant purchases up to a maximum participant
purchase of $6,000 per year. In 1997, 1996 and 1995, the Company incurred
expenses of $250,000, $215,000 and $82,000, respectively, under this
plan.
(12) Shareholders' Equity
Approximately $363.8 million of consolidated assets represents assets of
the Company's insurance operations that may not be transferred to
Professionals Group in the form of dividends, loans or advances without
prior regulatory approval. The amount of dividends that Professionals
Group's insurance subsidiaries can pay to Professionals Group in any
12-month period is limited to the greater of statutory net income for the
preceding year, excluding realized gains (losses) on sales of
investments, or 10% of policyholders' surplus as of the preceding
year-end. As of January 1, 1998, approximately $14,185,000 could be paid
by Professionals Group's insurance subsidiaries without prior regulatory
approval. In 1997 and 1996, Professionals Group's insurance subsidiaries
paid dividends of $4,717,049 and $3,530,334, respectively. In 1995,
Professionals Group's insurance subsidiaries did not pay any dividends.
-65-
<PAGE> 66
PROFESSIONALS INSURANCE COMPANY MANAGEMENT GROUP
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(12) Shareholders' Equity, Continued
On February 28, 1996, the Company awarded 28,430 shares of common stock
held in treasury to directors, officers and employees of the Company as a
one-time stock bonus. Compensation expense for this stock bonus
approximated $697,000, which was charged to policy acquisition and other
underwriting expenses.
On May 1, 1996, in a transaction approximating $1,244,000, the Company
paid $309,000 and issued 44,000 shares of common stock held in treasury
(valued at $935,000) in exchange for all of the issued and outstanding
shares of American Insurance Management Corporation. The acquisition was
accounted for as a purchase. The effect of the acquisition was not
material to the Company's consolidated results of operations.
As a result of the merger on August 31, 1996 (see note 1), the remaining
50,814 shares of the Company's common stock held in treasury were
canceled and retired at cost.
On November 21, 1996, the Company declared a 10% stock dividend, issued
on December 16, 1996 to shareholders of record as of December 4, 1996.
All per-share information in the accompanying consolidated financial
statements has been adjusted to give retroactive effect to this stock
dividend.
Effective July 5, 1995, the Company purchased 254,823 shares of its
common stock (approximately 7.9% of its then-issued and outstanding
shares) from Physicians Insurance Company of Ohio for $4,331,991 ($17 per
share), plus $53,000 for advisory and finder fees. These shares, net of
131,579 shares sold in December 1995 (see note 4), were held as treasury
stock available for resale at December 31, 1995.
(13) Stock Options and Awards
The Company has established the 1996 Long-Term Stock Incentive Plan (the
"Incentive Plan") under which, subject to adjustment, 300,000 shares of
the Company's common stock are available to grant incentive and
non-qualified stock options, stock appreciation rights (SARs), restricted
stock, restricted stock units, performance awards, dividend equivalents
and other stock-based awards to employees of, including any officer or
officer-director, or consultants to the Company and its subsidiaries. All
terms and conditions of any grants under the Incentive Plan are at the
discretion of the Compensation Committee of the Company's Board of
Directors. During 1997, 146,500 options were granted at the market price
of the Company's common stock on the date of grant. These options vest
and become exercisable over five years beginning in 1998, and expire in
2007. No charges to operations are recorded with respect to
authorization, grant or exercise of options. Proceeds received upon
exercise are credited to shareholder's equity. During 1996, no grants
were made under the Incentive Plan.
-66-
<PAGE> 67
PROFESSIONALS INSURANCE COMPANY MANAGEMENT GROUP
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(13) Stock Options and Awards, Continued
The Company has also established the 1996 Non-Employee Directors Stock
Option Plan (the "Directors Plan") under which, subject to adjustment,
non-qualified options for 50,000 shares of the Company's common stock may
be granted to non-employee directors (maximum of 5,000 shares to one
individual) of the Company. Options are granted at the market price of
the Company's common stock on the date of grant. Options become
exercisable one year from the date of grant and expire seven years from
the date of grant. No charges to operations are recorded with respect to
authorization, grant or exercise of options. Proceeds received upon
exercise are credited to shareholders' equity. During both 1997 and 1996,
stock options totaling 4,500 shares of the Company's common stock had
been granted under the Directors Plan at exercise prices of $25.28 and
$21.63, respectively. No options were exercised or canceled during 1997
or 1996.
Information regarding the Incentive Plan for 1997 follows:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
---------------------------------------- ---------------------
Weighted
Weighted Average Number Weighted
Average Remaining Exercisable Average
Exercise Contractual At December Exercise
Shares Price Life 31, 1997 Price
------ ----- ---- -------- -----
<S> <C> <C> <C> <C> <C>
Options outstanding, beginning of year -- $ -- -- -- --
Options granted 146,500 37.00 9 years -- --
-------
Options outstanding, end of year 146,500 $ 37.00 9 years -- --
======= ======== ===== =====
Range of exercise prices for options outstanding, end of year $ 37.00
========
Options available for grant, end of year 153,500
========
Weighted average fair value of options granted during the year $ 21.14
========
</TABLE>
-67-
<PAGE> 68
PROFESSIONALS INSURANCE COMPANY MANAGEMENT GROUP
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(13) Stock Options and Awards, Continued
Information regarding the Directors Plan for 1997 follows:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
--------------------------------------- -------------------------
Weighted
Weighted Average Number Weighted
Average Remaining Exercisable Average
Exercise Contractual At December Exercise
Shares Price Life 31, 1997 Price
------ ----- ---- -------- -----
<S> <C> <C> <C> <C> <C>
Options outstanding, beginning of year 4,500 $ 21.63 7 years - $ -
Stock dividend adjustment 450 - 7 years - -
Options granted 4,500 25.28 7 years - -
-----
Options outstanding, end of year 9,450 $ 22.34 6.5 years 4,950 $19.66
===== ========= ======= =======
Range of exercise prices for options
outstanding, end of year $19.66 - $25.28
===============
Options available for grant, end of
year 40,550
======
Weighted average fair value of
options granted during the year $12.90
======
</TABLE>
The Financial Accounting Standards Board has issued Statement of
Financial Accounting Standards No. 123 "Accounting for Stock-Based
Compensation" (SFAS No. 123). This standard prescribes a method of
accounting for stock-based compensation that recognizes compensation cost
based on the fair value of options at grant date. In lieu of applying
this fair value based method, a company may elect to disclose only the
proforma effects of such application in the footnotes to its financial
statements.
The Company has elected the disclosure-only provisions of SFAS No. 123.
Accordingly, had compensation cost for the Directors and Incentive Plans
been based on the fair value of options at grant date, the Company's 1997
net income (in thousands) and net income per common share - assuming
dilution would have been reduced to the proforma amounts below:
Net income:
As reported $ 11,026
Proforma 8,524
Net income per common share - assuming dilution:
As reported $ 3.14
Proforma 2.43
-68-
<PAGE> 69
PROFESSIONALS INSURANCE COMPANY MANAGEMENT GROUP
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(13) Stock Options and Awards, Continued
The fair value of options at date of grant was estimated using the
Black-Scholes option pricing model with the following weighted average
assumptions used for grants in 1997: dividend yield of 0%; expected
volatility of 35.7%; risk free interest rate of 6.29% and 6.62% for the
Incentive Plan and Directors Plan, respectively; and expected lives of 9
years and 7 years for the Incentive Plan and Directors Plan,
respectively. The proforma effect on net income for 1997 is not
representative of the proforma effect on net income for future years
because additional stock option awards could be made in future years.
(14) Statutory Insurance Accounting Practices
PICOM and ProNational Casualty are required to file financial statements
prepared in accordance with SAP prescribed or permitted by Michigan and
Illinois with their respective domiciliary states. The only material
statutory accounting method utilized by PICOM that is permitted rather
than prescribed is PICOM's discounting of its loss and loss adjustment
expense reserves through December 31, 1994 and discounting of loss
reserves only thereafter. The impact of such permitted practice is to
increase the statutory policyholders' surplus of PICOM by approximately
$10,658,000 at both December 31, 1997 and 1996, respectively. ProNational
Casualty does not utilize any permitted accounting practices.
Accounting practices used to prepare statutory-basis financial statements
differ in some respects from GAAP. A reconciliation of statutory capital
and surplus at December 31, 1997 and 1996, and statutory net income for
the years ended December 31, 1997, 1996 and 1995, of PICOM and
ProNational Casualty, as applicable (as filed with their respective
insurance regulatory authorities), to the amounts shown in the
accompanying consolidated financial statements follows:
<TABLE>
<CAPTION>
December 31,
------------------------
1997 1996
--------- ---------
(In thousands)
<S> <C> <C>
Statutory capital and surplus $ 108,178 80,572
Add (deduct) adjustments to statutory capital and surplus to
convert to GAAP:
Net unrealized appreciation on securities available for sale 4,710 293
Deferred policy acquisition costs 1,376 998
Deferred federal income taxes 15,003 17,301
Non-admitted assets 2,378 813
Loss and loss adjustment expense reserve discount (10,658) (10,658)
Liabilities for GAAP in excess of SAP (2,250) (2,700)
Provision for unauthorized reinsurance 887 524
Accumulated intercompany dividends 6,717 2,000
Accumulated deficit attributable to Professionals Group (4,035) (1,287)
Intercompany paid-in capital (20,000) --
Other, net (380) 102
--------- ---------
Total shareholders' equity per accompanying consolidated balance
sheets $ 101,926 87,958
========= =========
</TABLE>
-69-
<PAGE> 70
PROFESSIONALS INSURANCE COMPANY MANAGEMENT GROUP
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(14) Statutory Insurance Accounting Practices, Continued
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------
1997 1996 1995
---- ---- ----
(In thousands)
<S> <C> <C> <C>
Statutory net income $ 13,719 14,238 22,201
Add (deduct) adjustments to statutory net
income to convert to GAAP:
Deferred federal income tax expense (782) (1,834) (9,435)
Change in loss and loss adjustment expense
reserve discount -- (1,265) 1,925
Change in liabilities for GAAP in excess of
SAP 450 -- 1,000
Cumulative effect of change in accounting
methods -- -- (8,125)
Other, net 437 (245) 371
-------- -------- --------
Combined net income of insurance companies
based on GAAP 13,824 10,894 7,937
Net income (loss) attributable to non-insurance
subsidiaries (50) (22) 4
Net loss attributable to Professionals Group (2,748) (1,287) --
-------- -------- --------
Net income per accompanying consolidated
statements of income $ 11,026 9,585 7,941
======== ======== ========
</TABLE>
Certain regulations that affect PICOM, ProNational Casualty and the
insurance industry are promulgated by the National Association of
Insurance Commissioners (NAIC), which is an association of state
insurance commissioners, regulators and support staff that acts as a
coordinating body for the state insurance regulatory process. The NAIC
has established risk-based capital (RBC) requirements to assist
regulators in monitoring the financial strength and stability of property
and casualty insurers. Under the NAIC requirements, each insurer must
maintain its total capital and surplus above a calculated minimum
threshold or take corrective measures to achieve that threshold. PICOM
and ProNational Casualty have calculated their RBC levels based on these
requirements and have determined that they passed the RBC test and have
capital and surplus in excess of the minimum threshold.
(15) Concentrations and Credit Risk
The Company writes approximately 85% of its premiums through independent
agents and approximately 15% of its premiums directly. In 1997, 1996 and
1995, the top ten agents produced, in aggregate, approximately 55%, 58%
and 55%, respectively, and one agent individually produced approximately
10% of the Company's direct written premiums.
-70-
<PAGE> 71
PROFESSIONALS INSURANCE COMPANY MANAGEMENT GROUP
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(15) Concentrations and Credit Risk, Continued
All premiums are directly billed to policyholders and premiums due are
secured by the related unearned premiums. When insureds fail to pay their
premiums, coverage is canceled. The Company requires policyholders to
remit a minimum of 20% to 40% of the premium at policy origination date.
Subsequent scheduled payments are monitored to prevent the Company from
providing coverage beyond the date for which payment has been received.
In the opinion of management, the amounts carried on the accompanying
consolidated balance sheets are collectible.
(16) Commitments
Effective January 1, 1995, PICOM purchased the right to solicit and write
medical professional liability insurance in Illinois that was formerly
written by another Illinois insurance company. The purchase price, which
is a percentage of annualized gross premiums written through 1999, will
be a minimum of $3,452,954, plus $134,000 attributable to a non-compete
covenant. To the extent the ultimate purchase price exceeds the minimum,
such excess will be capitalized. During 1996, the actual purchase price
was estimated to exceed the minimum. As a result, an additional $400,000
was capitalized in 1996. The adjusted purchase price of $3,986,954, net
of accumulated amortization of $1,126,000 and $717,000, was recorded as
an intangible asset at December 31, 1997 and 1996, respectively.
(17) Quarterly Financial Data (Unaudited)
The unaudited operating results by quarter for 1997 and 1996, are
summarized below:
<TABLE>
<CAPTION>
Net Income
Total Income Per Common
Revenues Before Share-
and Other Income Net Assuming
Income Taxes Income Dilution
------ ----- ------ --------
(In thousands, except per-share data)
<S> <C> <C> <C> <C>
1997:
1st $16,581 3,462 2,621 0.75
2nd 18,050 3,681 2,677 0.76
3rd 28,255 3,700 2,975 0.85
4th 28,763 3,064 2,753 0.78
------- ------- ------- ====
Year $91,649 13,907 11,026
======= ======= =======
</TABLE>
-71-
<PAGE> 72
PROFESSIONALS INSURANCE COMPANY MANAGEMENT GROUP
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(17) Quarterly Financial Data (Unaudited), Continued
<TABLE>
<CAPTION>
Net Income
Total Income Per Common
Revenues Before Share -
and Other Income Net Assuming
Income Taxes Income Dilution
------ ----- ------ --------
(In thousands, except per-share data)
<S> <C> <C> <C> <C>
1996:
1st $18,275 3,166 2,328 0.68
2nd 17,649 2,761 2,158 0.62
3rd 17,925 3,251 2,396 0.68
4th 18,393 2,845 2,703 0.77
------- ------ ----- ====
Year $72,242 12,023 9,585
======= ====== =====
</TABLE>
(18) Fair Value of Financial Instruments
SFAS No. 107, Disclosures About Fair Value of Financial Instruments,
requires disclosures of fair-value information about financial
instruments, whether or not recognized in the balance sheet, for which it
is practicable to estimate the value. In situations where quoted
market prices are not available, fair values are to be based on estimates
using present value or other valuation techniques. SFAS No. 107 excludes
certain financial instruments and all nonfinancial instruments from its
disclosure requirements.
Under SFAS No. 107, the Company's investment securities, cash, short-term
investments, long-term debt, drafts outstanding and balance due on
purchased book of business constitute financial instruments. The carrying
amounts of all financial instruments--other than investment securities,
which are presented in note 4--approximated their fair values at December
31, 1997 and 1996.
(19) Related Party Transactions
In April 1997, the Company completed an agreement with Michigan
Educational Employees Mutual Insurance Company ("MEEMIC"), a
Michigan-domiciled specialty writer of personal automobile and homeowners
coverages for teachers and other members of the educational community in
Michigan, whereby: (i) PICOM purchased a twelve-year, $21.5 million
surplus note ("Surplus Note") from MEEMIC, bearing interest at 8.5% per
annum; (ii) PICOM reinsures 40% of MEEMIC's net premiums beginning July 1,
1997; (iii) Professionals Group provides MEEMIC with information
systems services and certain consulting services under a management
services agreement for a base fee of $2.0 million per year; and (iv)
Professionals Group nominees were elected to all MEEMIC Board positions.
The Company also agreed to assist MEEMIC in acquiring the net assets of
Michigan Educators Insurance Agency, Inc. ("MEIA"), the exclusive
distributor of MEEMIC insurance products.
-72-
<PAGE> 73
PROFESSIONALS INSURANCE COMPANY MANAGEMENT GROUP
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(19) Related Party Transactions, Continued
On September 22, 1997, MEEMIC Insurance Services Corporation (Services
Corp.), a newly formed subsidiary of MEEMIC, purchased the net assets of
MEIA. The purchase price equals 3.75% of premiums written by Services
Corp. through July 2004, subject to a guaranteed minimum purchase price of
$43.0 million. To fund this purchase, Services Corp. paid cash of $22.5
million (utilizing the proceeds of the Surplus Note), and agreed to pay
$20.5 million to MEIA as additional consideration through 2004, as
provided for in the purchase agreement. MEEMIC guaranteed payment of the
first $3.0 million and Professionals Group guaranteed payment of the final
$17.5 million (payable in years 2001-2004) of the purchase price. The
Company believes the likelihood that its guarantee will become payable is
minimal.
At a future date, Professionals Group and MEEMIC expect to pursue
demutualization of MEEMIC. Such demutualization would be subject to
regulatory approval by the Michigan Commissioner of Insurance, approval by
MEEMIC's policyholders and approval by Professionals Group's shareholders.
No specific timetable has been set for demutualization and there can be no
assurances that MEEMIC will be demutualized.
On August 15, 1997, Professionals Group announced a definitive agreement
to merge PICOM with Physicians Protective Trust Fund, a medical
malpractice self-insurance trust fund located in Coral Gables, Florida
("PPTF"). PPTF is a provider of medical malpractice insurance for
physicians and physician corporations in the State of Florida. This
agreement was amended and restated on October 3, 1997, and pursuant to the
amended and restated agreement, Professionals Group will issue 4,089,160
shares of Professionals Group common stock to the eligible members of
PPTF and 153,000 shares to directors and management of PPTF upon
consummation of the merger. The transaction is expected to be accounted
for as a pooling of interests, whereby Professionals Group will carry
forward to its accounts the assets and liabilities of PPTF at their
respective amounts as reported by PPTF. The closing of the merger is
expected to occur in the second quarter of 1998, subject to regulatory and
shareholder/policyholder approval.
-73-
<PAGE> 74
Independent Auditors' Report
The Board of Directors and Shareholders
Professionals Insurance Company Management Group:
We have audited the accompanying consolidated balance sheets of Professionals
Insurance Company Management Group and subsidiaries as of December 31, 1997 and
1996, and the related consolidated statements of income, shareholders' equity
and cash flows for each of the years in the three year period ended December 31,
1997. In connection with our audits of the consolidated financial statements, we
also have audited the financial statement schedule as of and for the periods
ended December 31, 1997 and 1996. These consolidated financial statements and
financial statement schedule are the responsibility of the Company's management.
Our responsibility is to express an opinion on these consolidated financial
statements and financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform our audits 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 consolidated financial position of
Professionals Insurance Company Management Group and subsidiaries as of December
31, 1997 and 1996, and the consolidated results of their operations and their
cash flows for each of the years in the three year period ended December 31,
1997 in conformity with generally accepted accounting principles. Also in our
opinion, the related financial statement schedule, when considered in relation
to the basic consolidated financial statements taken as a whole, presents
fairly, in all material respects, the information set forth therein.
As discussed in notes 3 and 9 to the consolidated financial statements, the
Company changed its method of accounting for loss and loss adjustment expense
reserves to eliminate discounting of such reserves in 1995.
KPMG Peat Marwick LLP
East Lansing, Michigan
February 27, 1998
-74-
<PAGE> 75
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
PROFESSIONALS INSURANCE COMPANY MANAGEMENT GROUP (PARENT COMPANY)
CONDENSED BALANCE SHEETS
December 31, 1997 and 1996
(In thousands)
<TABLE>
<CAPTION>
1997 1996
---- -----
<S> <C> <C>
Assets:
Investment in subsidiaries $120,486 $ 87,271
Short-term investments, at cost, which
approximates fair value 3,866 2,030
Cash 3 -
Other assets 1,336 -
-------- --------
Total assets $125,691 $ 89,301
======== ========
Liabilities and Shareholders' Equity:
Liabilities:
Long-term debt $ 22,500 $ -
Accrued expenses and other liabilities 1,265 1,343
-------- --------
23,765 1,343
-------- --------
Shareholders' Equity:
Preferred stock, no par value; 5,000,000 shares
authorized; no shares issued and outstanding - -
Common stock, no par value; 25,000,000 shares
authorized; 3,505,750 shares issued and
outstanding in 1997 and 1996 3,506 3,506
Additional paid-in capital 14,569 14,569
Retained earnings 80,671 69,645
Net unrealized appreciation on investments,
net of deferred taxes 3,180 238
-------- --------
Total shareholders' equity 101,926 87,958
-------- --------
Total liabilities and shareholders' equity $125,691 $ 89,301
======== ========
</TABLE>
These condensed financial statements should be read in conjunction with the
accompanying consolidated financial statements and notes thereto of
Professionals Insurance Company Management Group and subsidiaries.
See accompanying notes to the condensed financial information of registrant.
-75-
<PAGE> 76
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT, CONTINUED
PROFESSIONALS INSURANCE COMPANY MANAGEMENT GROUP (PARENT COMPANY)
CONDENSED STATEMENTS OF INCOME
Periods Ended December 31, 1997 and 1996
(In thousands)
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Revenues:
Dividend income from subsidiary $ 4,717 $ 3,530
Investment income 106 30
Other income 1,005 -
-------- ---------
Total revenues 5,828 3,560
-------- ---------
Expenses:
Operating and administrative 2,761 1,317
Interest expense 1,098 30
-------- ---------
Total expenses 3,859 1,347
-------- ---------
Income before federal income taxes and
equity in undistributed income of subsidiaries 1,969 2,213
Federal income taxes - -
-------- ---------
Income before equity in undistributed income
of subsidiaries 1,969 2,213
Equity in undistributed income of subsidiaries 9,057 4,823
-------- ---------
Net income $ 11,026 $ 7,036
======== =========
</TABLE>
These condensed financial statements should be read in conjunction with the
accompanying consolidated financial statements and notes thereto of
Professionals Insurance Company Management Group and subsidiaries.
See accompanying notes to the condensed financial information of registrant.
-76-
<PAGE> 77
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT, CONTINUED
PROFESSIONALS INSURANCE COMPANY MANAGEMENT GROUP (PARENT COMPANY)
CONDENSED STATEMENTS OF CASH FLOWS
Periods Ended December 31, 1997 and 1996
(In thousands)
<TABLE>
<CAPTION>
1997 1996
---- ----
Cash flows from operating activities:
<S> <C> <C>
Net income $ 11,026 $ 7,036
Adjustments to reconcile net income to net cash
provided by operating activities:
Equity in undistributed income of subsidiaries (9,057) (4,823)
Dividend of investment from subsidiary (1,217) -
Amortization 183 -
Increase in other assets (1,594) -
Increase (decrease) in accrued expenses
and other liabilities (78) 1,343
--------- --------
Net cash provided by (used in) operating activities (737) 3,556
--------- --------
Cash flows from investing activities:
Proceeds from sale or maturity of short-term
investments 32,578 6,048
Purchases of short-term investments (34,338) (8,078)
Capital contribution to consolidated
subsidiary (20,000) (1,500)
--------- --------
Net cash used in investing activities (21,760) (3,530)
--------- --------
Cash flows from financing activities:
Proceeds from issuance of note payable - 1,500
Payments on note payable - (1,500)
Cash paid in lieu of fractional shares - (26)
Proceeds from issuance of long-term debt 22,500 -
--------- --------
Net cash provided by (used in) financing activities 22,500 (26)
--------- --------
Net change in cash 3 -
Cash, beginning of year $ - -
--------- --------
Cash, end of year $ 3 $ -
========= ========
</TABLE>
These condensed financial statements should be read in conjunction with the
accompanying consolidated financial statements and notes thereto of
Professionals Insurance Company Management Group and subsidiaries.
See accompanying notes to the condensed financial information of registrant.
-77-
<PAGE> 78
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT, CONTINUED
PROFESSIONALS INSURANCE COMPANY MANAGEMENT GROUP (PARENT COMPANY)
NOTES TO CONDENSED FINANCIAL INFORMATION OF REGISTRANT
Periods Ended December 31, 1997 and 1996
(1) Description of Business
Professionals Insurance Company Management Group (Professionals Group) is
an insurance holding company incorporated under Michigan law on January
31, 1996. Accordingly, 1996 condensed financial information for
Professionals Group is only being presented from the period January 31,
1996 (date of inception) through December 31, 1996.
Professionals Group owns all of the issued and outstanding common stock
of the following entities:
PICOM Insurance Company - a stock insurance company incorporated under
Michigan law.
PICOM Financial Services Corporation - an inactive financial services
company.
PICOM Insurance Agency, Inc. - an inactive insurance agency.
American Insurance Management Corporation - an Indiana corporation that
serves as the attorney-in-fact for American Medical Insurance Exchange,
an inactive Indiana interinsurance reciprocal exchange.
(2) Federal Income Taxes
Under terms of Professionals Group's tax sharing agreement with its
subsidiaries, income tax provisions for the individual companies are
computed on a separate company basis.
-78-
<PAGE> 79
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
Not applicable.
PART III
Item 10. Directors and Executive Officers of the Registrant
The information called for by this item with respect to the directors
of Professionals Group will be reported in Professionals Group's Notice of
Annual Meeting of Stockholders and Proxy Statement for its 1998 Annual Meeting
of Stockholders under the captions "Management and Operations After the
Transactions -- Directors," and "-- Executive Officers," and "Information
Regarding the Professionals Group Annual Meeting -- Election of Directors."
Such information is herein incorporated by reference.
Information regarding the executive officers of Professionals Group is
reported in Part I on this Annual Report on Form 10-K pursuant to General
Instruction G to Form 10-K.
Section 16(a) of the Exchange Act requires Professionals Group's
directors and executive officers, and persons who own more than 10% of a
registered class of Professionals Group's equity securities, to file with the
Securities and Exchange Commission initial reports of ownership and reports of
changes in ownership of Professionals Group common stock and other equity
securities of Professionals Group. Officers, directors and greater than 10%
stockholders are required by the Securities and Exchange Commission regulation
to furnish Professionals Group with copies of all Section 16(a) forms they
file.
To Professionals Group's knowledge, based solely on a review of the
copies of such reports furnished to Professionals Group and written
representations that no other reports were required, all Section 16(a) filing
requirements applicable to its officers, directors and greater than 10 percent
beneficial owners were complied with during the year ended December 31, 1997,
except for Isaac J. Powell, M.D., who inadvertently failed to file on a timely
basis a Form 4 in September reporting his purchase of Professionals Group
common stock on August 25, 1997. A Form 5 was subsequently filed in February
1998 reporting the purchase of such shares.
Item 11. Executive Compensation
The information called for by this item with respect to executive
compensation of Professionals Group will be reported in
-79-
<PAGE> 80
Professionals Group's Notice of Annual Meeting of Stockholders and Proxy
Statement for its 1998 Annual Meeting of Stockholders under the caption
"Information Regarding the Professionals Group Annual Meeting -- Management
Remuneration," "--Stock Purchase Plan" and "--Employment Severance Compensation
Plans." Such information is herein incorporated by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information called for by this item with respect to the security
ownership of certain beneficial owners and management of Professionals Group
will be reported in Professionals Group's Notice of Annual Meeting of
Stockholders and Proxy Statement for its 1998 Annual Meeting of Stockholders
under the caption "Beneficial Ownership of Professionals Group Common Stock."
Such information is herein incorporated by reference.
Item 13. Certain Relationships and Related Transactions
The information called for by this item with respect to certain
relationships and related transactions of Professionals Group will be reported
in Professionals Group's Notice of Annual Meeting of Stockholders and Proxy
Statement for its 1998 Annual Meeting of Stockholders under the caption
"Information Regarding the Professionals Group Annual Meeting -- Director
Compensation and Benefits," "--Compensation Committee Interlocks and Insider
Participation," and "--Related Party Transactions." Such information is herein
incorporated by reference.
-80-
<PAGE> 81
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
Exhibits:
<TABLE>
<CAPTION>
Item 601
Regulation S-K
Exhibit Reference
Number Exhibit Description
----------------- -------------------
<S> <C>
(2)(a)(/(10)(a) First Amended and Restated Agreement and Plan of Merger dated as of
October 3, 1997 by and among the registrant, PICOM Insurance Company and
Physicians Protective Trust Fund (incorporated by reference to Exhibit 2
of the registrant's Current Report on Form 8-K dated October 3, 1997 filed
with the Securities and Exchange Commission on October 10, 1997 (file no.
0-21223)).
(3)(a)/(4)(a) First Amended and Restated Articles of Incorporation of Professionals
Insurance Company Management Group and all amendments thereto
(incorporated by reference to Exhibit (3)(a)/(4)(a) of the initial filing
of the registrant's Registration Statement on Form S-4 as filed with the
Securities and Exchange Commission on April 3, 1996 (registration no.
333-3138)).
(3)(b)/(4)(b) By-laws of Professionals Insurance Company Management Group (incorporated
by reference to Exhibit (3)(b)/(4)(b) of the initial filing of the
registrant's Registration Statement on Form S-4 as filed with the
Securities and Exchange Commission on April 3, 1996 (registration no.
333-3138)).
(4)(c) Specimen certificate for Professionals Insurance Company Management
Group's common stock (incorporated by reference to Exhibit 4(c) of the
Quarterly Report on Form 10-Q for the quarterly period ended September 30,
1996 as filed with the Securities and Exchange Commission on November 12,
1996 (file no. 0-21223)).
</TABLE>
-81-
<PAGE> 82
<TABLE>
<CAPTION>
Item 601
Regulation S-K
Exhibit Reference
Number Exhibit Description
----------------- -------------------
<S> <C>
(4)(d) Specimen stock option issued under the Professionals Insurance Company
Management Group 1996 Non-Employee Directors Stock Option Plan
(incorporated by reference to Exhibit 4(d) of the Quarterly Report on Form
10-Q for the quarterly period ended September 30, 1996 filed with the
Securities and Exchange Commission on November 12, 1996 (file no. 0-
21223)).
(4)(e) Specimen stock option issued under the Professionals Insurance Company
Management Group 1996 Long Term Incentive Plan.*
(10)(b) Credit Agreement dated April 4, 1997 for $22.5 million between the
registrant and LaSalle National Bank (incorporated by reference to
Exhibit (10)(a) of the registrant's Quarterly Report on Form 10-Q for the
quarterly period ended March 31, 1997 as filed with the Securities and
Exchange Commission on May 12, 1997 (file no. 0-21223)).
(10)(c) Professionals Insurance Company Management Group 1996 Long Term Incentive
Plan (incorporated by reference to Exhibit 10(c) of Amendment No. 1 to the
registrant's Registration Statement on Form S-4 as filed with the
Securities and Exchange Commission on June 11, 1996 (registration no.
333-3138)).
(10)(d) Professionals Insurance Company Management Group 1996 Non-Employee
Directors Stock Option Plan (incorporated by reference to Exhibit 10(d) of
Amendment No. 1 to the registrant's Registration Statement on Form S-4 as
filed with the Securities and Exchange Commission on June 11, 1996
(registration no. 333-3138)).
(10)(e) Professionals Insurance Company Management Group Stock Purchase Plan
(incorporated by reference to Exhibit 10(e) of the initial filing of the
registrant's Registration Statement on Form S-4 as filed with the
Securities and Exchange Commission on April 3, 1996 (registration no.
333-3138)).
</TABLE>
-82-
<PAGE> 83
<TABLE>
<CAPTION>
Item 601
Regulation S-K
Exhibit Reference
Number Exhibit Description
----------------- -------------------
<S> <C>
(10)(f) PICOM Insurance Company Employees' Savings and Retirement Plan
(incorporated by reference to Exhibit (10)(d) of the initial filing of the
registrant's Annual Report on Form 10-K for the year ended December 31,
1996 as filed with the Securities and Exchange Commission on March 28,
1997 (file no. 0-21223)).
(10)(g) PICOM Insurance Company Pension Plan (incorporated by reference to Exhibit
(10)(e) of the initial filing of the registrant's Annual Report on Form
10-K for the year ended December 31, 1996 as filed with the Securities and
Exchange Commission on March 28, 1997 (file no. 0-21223)).
(10)(h) PICOM Insurance Company Key Employee Retention Plan (incorporated by
reference to Exhibit (99)(e) of the initial filing of the registrant's
Registration Statement on Form S-4 filed with the Securities and Exchange
Commission on April 3, 1996 (registration no. 333-3138)).
(10)(i) PICOM Insurance Company Employee Retention Plan (incorporated by reference
to Exhibit (99)(f) of the initial filing of the registrant's Registration
Statement on Form S-4 filed with the Securities and Exchange Commission on
April 3, 1996 (registration no. 333-3138)).
(10)(j) Adverse Development Stop Loss Reinsurance Contract between Physicians
Protective Trust Fund (the "Reassured") and PICOM Insurance Company (the
"Reinsurer") effective February 1, 1998, 12:01 a.m. Eastern Standard Time
(incorporated by reference to Exhibit 10 of the registrant's Current
Report on Form 8-K dated October 27, 1997 filed with the Securities and
Exchange Commission on October 31, 1997 (file no. 0-21223)).
(11) No statement re computation of per share earnings is required to be filed
because the computations can be clearly determined from the materials
contained herein.
</TABLE>
-83-
<PAGE> 84
<TABLE>
<CAPTION>
Item 601
Regulation S-K
Exhibit Reference
Number Exhibit Description
----------------- -------------------
<S> <C>
(21) List of subsidiaries of the registrant (incorporated by reference to
Exhibit 21 of the registrant's Annual Report on Form 10-K for the year
ended December 31, 1996 as filed with the Securities and Exchange
Commission on March 28, 1997 (file no. 0-21223)).
(23) Consent of KPMG Peat Marwick LLP, independent certified public
accountants.*
(24) Powers of attorney.*
(27) Financial Data Schedule of registrant.*
- --------------------------
</TABLE>
* Filed herewith.
Management contracts and compensatory plans or arrangements:
The management contracts and compensatory plans or arrangements
required to be filed as exhibits and included in such list of exhibits are as
follows:
Exhibit (4)(d) Specimen stock option issued under the Professionals
Insurance Company Management Group 1996 Non-Employee Directors Stock
Option Plan.
Exhibit (4)(e) Specimen stock option issued under the Professionals
Insurance Company Management Group 1996 Long Term Incentive Plan.
Exhibit (10)(c) Professionals Insurance Company Management Group 1996
Long-Term Incentive Plan.
Exhibit (10)(d) Professionals Insurance Company Management Group 1996
Non-Employee Directors Stock Option Plan.
Exhibit (10)(e) Professionals Insurance Company Management Group Stock
Purchase Plan.
Exhibit (10)(f) PICOM Insurance Company Employees' Savings and
Retirement Plan.
Exhibit (10)(g) PICOM Insurance Company Pension Plan.
Exhibit (10)(h) PICOM Insurance Company Key Employee Retention Plan.
Exhibit (10)(i) PICOM Insurance Company Employee Retention Plan.
-84-
<PAGE> 85
Index to Financial Statements and Financial Statement Schedules:
<TABLE>
<CAPTION>
10-K
Report
page(s)
-------
<S> <C>
Financial Statements:
Consolidated balance sheets as of December 31, 1997 and 1996 . . . . . . . . . . . . . 46
Consolidated statements of income for each of the years ended December 31, 1997, 1996
and 1995 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47
Consolidated statements of shareholders' equity for each of the years ended December
31, 1997, 1996 and 1995 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48
Consolidated statements of cash flows for each of the years ended December 31, 1997,
1996 and 1995 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49
Notes to consolidated financial statements . . . . . . . . . . . . . . . . . . . . . . 50
Report of independent auditors . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74
Financial Statement Schedules:
II. Condensed financial information of registrant 75
</TABLE>
- -------------------
All other schedules for which provision is made in Regulation S-X either (i)
are not required under the related instructions or are inapplicable and,
therefore, have been omitted, or (ii) the information required is included in
the consolidated financial statements or the notes thereto that are a part
hereof.
Reports on Form 8-K:
The Company filed a Current Report on Form 8-K dated October 3, 1997,
in connection with the execution of a First Amended and Restated Agreement and
Plan of Merger dated October 3, 1997, by and among Professionals Group, PICOM
and Physicians Protective Trust Fund, a medical malpractice self-insurance
trust fund, located in Coral Gables, Florida ("PPTF").
The Company filed a Current Report on Form 8-K dated October 27, 1997,
in connection with the execution of an Adverse Development Stop Loss
Reinsurance Contract between PPTF and PICOM, effective February 1, 1998.
No other reports were filed during the three months ended December 31,
1997.
-85-
<PAGE> 86
SIGNATURES
Pursuant to the requirements of Section 13 or 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.
Professionals Insurance Company
Management Group
Date: March 26, 1998 By: /s/ Victor T. Adamo
--------------------------------
Victor T. Adamo
President and
Chief Executive Officer
(Principal Executive Officer)
By: /s/ R. Kevin Clinton
--------------------------------
R. Kevin Clinton
Vice President, Treasurer and
Chief Financial Officer
(Principal Financial Officer
and Principal Accounting
Officer)
-86-
<PAGE> 87
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
Director, President and
and Chief Executive
/s/ Victor T. Adamo Officer (Principal March 26, 1998
- ---------------------- Executive Officer)
Victor T. Adamo
Director, Vice
/s/ R. Kevin Clinton President, Treasurer March 26, 1998
- ---------------------- and Chief Financial
R. Kevin Clinton Officer (Principal
Financial Officer
and Principal
Accounting Officer)
Jerry D. Campbell* Director March 26, 1998
- ----------------------
Jerry D. Campbell
John F. Dodge, Jr.* Director March 26, 1998
- ----------------------
John F. Dodge, Jr.
H. Harvey Gass* Director March 26, 1998
- ----------------------
H. Harvey Gass
W. Peter McCabe* Director March 26, 1998
- ----------------------
W. Peter McCabe
John F. McCaffrey* Director March 26, 1998
- ----------------------
John F. McCaffrey
Isaac J. Powell* Director March 26, 1998
- ----------------------
Isaac J. Powell
Ann F. Putallaz* Director March 26, 1998
- ----------------------
Ann F. Putallaz
Donald S. Young* Director March 26, 1998
- ----------------------
Donald S. Young
William H. Woodhams* Director March 26, 1998
- ----------------------
William H. Woodhams
*By: /s/ Victor T. Adamo
-----------------------------
Victor T. Adamo, as attorney-in-fact for the persons indicated
</TABLE>
-87-
<PAGE> 88
Exhibit Index
-------------
<TABLE>
<CAPTION>
Exhibit No. Exhibit Description
----------- -------------------
<S> <C>
(2)(a)(/(10)(a) First Amended and Restated Agreement and Plan of Merger dated as of
October 3, 1997 by and among the registrant, PICOM Insurance Company and
Physicians Protective Trust Fund (incorporated by reference to Exhibit 2
of the registrant's Current Report on Form 8-K dated October 3, 1997 filed
with the Securities and Exchange Commission on October 10, 1997 (file no.
0-21223)).
(3)(a)/(4)(a) First Amended and Restated Articles of Incorporation of Professionals
Insurance Company Management Group and all amendments thereto
(incorporated by reference to Exhibit (3)(a)/(4)(a) of the initial filing
of the registrant's Registration Statement on Form S-4 as filed with the
Securities and Exchange Commission on April 3, 1996 (registration no.
333-3138)).
(3)(b)/(4)(b) By-laws of Professionals Insurance Company Management Group (incorporated
by reference to Exhibit (3)(b)/(4)(b) of the initial filing of the
registrant's Registration Statement on Form S-4 as filed with the
Securities and Exchange Commission on April 3, 1996 (registration no.
333-3138)).
(4)(c) Specimen certificate for Professionals Insurance Company Management
Group's common stock (incorporated by reference to Exhibit 4(c) of the
Quarterly Report on Form 10-Q for the quarterly period ended September 30,
1996 as filed with the Securities and Exchange Commission on November 12,
1996 (file no. 0-21223)).
</TABLE>
<PAGE> 89
<TABLE>
<CAPTION>
Exhibit No. Exhibit Description
----------- -------------------
<S> <C>
(4)(d) Specimen stock option issued under the Professionals Insurance Company
Management Group 1996 Non-Employee Directors Stock Option Plan
(incorporated by reference to Exhibit 4(d) of the Quarterly Report on Form
10-Q for the quarterly period ended September 30, 1996 filed with the
Securities and Exchange Commission on November 12, 1996 (file no. 0-
21223)).
(4)(e) Specimen stock option issued under the Professionals Insurance Company
Management Group 1996 Long Term Incentive Plan.*
(10)(b) Credit Agreement dated April 4, 1997 for $22.5 million between the
registrant and LaSalle National Bank (incorporated by reference to
Exhibit (10)(a) of the registrant's Quarterly Report on Form 10-Q for the
quarterly period ended March 31, 1997 as filed with the Securities and
Exchange Commission on May 12, 1997 (file no. 0-21223)).
(10)(c) Professionals Insurance Company Management Group 1996 Long Term Incentive
Plan (incorporated by reference to Exhibit 10(c) of Amendment No. 1 to the
registrant's Registration Statement on Form S-4 as filed with the
Securities and Exchange Commission on June 11, 1996 (registration no.
333-3138)).
(10)(d) Professionals Insurance Company Management Group 1996 Non-Employee
Directors Stock Option Plan (incorporated by reference to Exhibit 10(d) of
Amendment No. 1 to the registrant's Registration Statement on Form S-4 as
filed with the Securities and Exchange Commission on June 11, 1996
(registration no. 333-3138)).
(10)(e) Professionals Insurance Company Management Group Stock Purchase Plan
(incorporated by reference to Exhibit 10(e) of the initial filing of the
registrant's Registration Statement on Form S-4 as filed with the
Securities and Exchange Commission on April 3, 1996 (registration no.
333-3138)).
</TABLE>
<PAGE> 90
<TABLE>
<CAPTION>
Exhibit No. Exhibit Description
----------- -------------------
<S> <C>
(10)(f) PICOM Insurance Company Employees' Savings and Retirement Plan
(incorporated by reference to Exhibit (10)(d) of the initial filing of the
registrant's Annual Report on Form 10-K for the year ended December 31,
1996 as filed with the Securities and Exchange Commission on March 28,
1997 (file no. 0-21223)).
(10)(g) PICOM Insurance Company Pension Plan (incorporated by reference to Exhibit
(10)(e) of the initial filing of the registrant's Annual Report on Form
10-K for the year ended December 31, 1996 as filed with the Securities and
Exchange Commission on March 28, 1997 (file no. 0-21223)).
(10)(h) PICOM Insurance Company Key Employee Retention Plan (incorporated by
reference to Exhibit (99)(e) of the initial filing of the registrant's
Registration Statement on Form S-4 filed with the Securities and Exchange
Commission on April 3, 1996 (registration no. 333-3138)).
(10)(i) PICOM Insurance Company Employee Retention Plan (incorporated by reference
to Exhibit (99)(f) of the initial filing of the registrant's Registration
Statement on Form S-4 filed with the Securities and Exchange Commission on
April 3, 1996 (registration no. 333-3138)).
(10)(j) Adverse Development Stop Loss Reinsurance Contract between Physicians
Protective Trust Fund (the "Reassured") and PICOM Insurance Company (the
"Reinsurer") effective February 1, 1998, 12:01 a.m. Eastern Standard Time
(incorporated by reference to Exhibit 10 of the registrant's Current
Report on Form 8-K dated October 27, 1997 filed with the Securities and
Exchange Commission on October 31, 1997 (file no. 0-21223)).
(11) No statement re computation of per share earnings is required to be filed
because the computations can be clearly determined from the materials
contained herein.
</TABLE>
<PAGE> 91
<TABLE>
<CAPTION>
Exhibit No. Exhibit Description
----------- -------------------
<S> <C>
(21) List of subsidiaries of the registrant (incorporated by reference to
Exhibit 21 of the registrant's Annual Report on Form 10-K for the year
ended December 31, 1996 as filed with the Securities and Exchange
Commission on March 28, 1997 (file no. 0-21223)).
(23) Consent of KPMG Peat Marwick LLP, independent certified public
accountants.*
(24) Powers of attorney.*
(27) Financial Data Schedule of registrant.*
- --------------------------
</TABLE>
* Filed herewith.
<PAGE> 1
EXHIBIT 4(e)
STOCK OPTION CERTIFICATE
OPTIONS TO PURCHASE SHARES OF COMMON STOCK
VOID AFTER EXPIRATION DATE
PROFESSIONALS INSURANCE COMPANY MANAGEMENT GROUP
NO. LTIP-____ ________ OPTIONS
THIS CERTIFIES THAT, FOR VALUE RECEIVED _______________ (the
"Participant") is the owner of ________________________ (_______) Options to
Purchase Shares of Common Stock (the "Options"). Each outstanding vested
Option initially entitles the Participant to purchase, subject to the terms and
conditions set forth in this Stock Option Certificate and the Professionals
Insurance Company Management Group 1996 Long Term Incentive Plan (the "Plan"),
one fully paid and nonassessable share of common stock, no par value per share
("Common Stock"), of Professionals Insurance Company Management Group, a
Michigan corporation (the "Company"). Each vested Option shall be exercisable
at any time from the time such Option vested and prior to the "Expiration Date"
(as hereinafter defined), upon the presentation and surrender of this Stock
Option Certificate to the Company in accordance with Section 6(b)(ii)(A)-(B) of
the Plan, accompanied by payment of $_______ for such share of Common Stock,
subject to adjustment (the "Purchase Price"), in lawful money of the United
States of America in cash or by check made payable to the Company; provided,
however, that payment of the Purchase Price, or any portion thereof, may be
made other than in cash or by such check in accordance with Section 8 of this
Stock Option Certificate.
1. Type of Option. The Options evidenced by this Stock Option
Certificate are not intended to be and shall not be treated as incentive stock
options under Section 422 of the Internal Revenue Code of 1986, as amended.
2. Options Subject to Plan. This Stock Option Certificate and
all of the Options evidenced by this Stock Option Certificate are subject to,
and the Participant agrees to be bound by, all of the terms and conditions of
the Plan as now in effect and as hereafter amended from time to time in
accordance with its terms. All capitalized terms not otherwise defined in this
Stock Option Certificate are defined in this Stock Option Certificate as in the
Plan. In the event of any inconsistency between the terms of this Stock Option
Certificate or the Options and the terms of the Plan, the terms of the Plan
shall control. A copy of the Plan in its present form is available for
inspection during business hours by the Participant at the Company's principal
office. Pursuant to the Plan, the Board or the Committee vested with
conclusive authority to administer the Plan (which incudes, among other things,
the authority to determine the terms and conditions of the Stock Option
Certificate and all of the Options evidenced by this Stock Option Certificate
and to amend the same).
<PAGE> 2
3. Vesting, Expiration and Termination.
a. The grant and allocation of Options evidenced by this
Stock Option Certificate is provisional and subject to the requirements of the
Plan and this Stock Option Certificate. All of the Options evidenced by this
Stock Option Certificate shall be subject to termination and forfeiture as
provided in the Plan and this Stock Option Certificate, and none of such
Options shall be exercisable unless and until vested. All Options evidenced by
this Stock Option Certificate that do not vest or are terminated pursuant to
the terms of the Plan and this Stock Option Certificate shall be canceled and
forfeited. The term "Expiration Date" shall mean 5:00 p.m. (Detroit, Michigan
time) on February 12, 2007; provided, however, that if February 12, 2007 shall
in the State of Michigan be a holiday or a day on which the banks are
authorized to close, then the Expiration Date shall be 5:00 P.M. (Detroit,
Michigan time) the next following day which in the State of Michigan is not a
holiday or a day on which banks are authorized to close.
b. The Options evidenced by this Stock Option
Certificate shall vest in accordance with the schedule that follows: (i)
one-fifth of such Options shall vest at 5:00 p.m. (Detroit, Michigan time) on
February 12, 1998; (ii) one-fifth of such Options shall vest at 5:00 p.m.
(Detroit, Michigan time) on February 12, 1999; (iii) one-fifth of such Options
shall vest at 5:00 p.m. (Detroit, Michigan time) on February 12, 2000; (iv)
one-fifth of such Options shall vest at 5:00 p.m. (Detroit, Michigan time) on
February 12, 2001; and (v) one-fifth of such Options shall vest at 5:00 p.m.
(Detroit, Michigan time) on February 12, 2002. Notwithstanding anything to the
contrary express or implied in this Stock Option Certificate, and provided
Participant is then in the employ of the Company or any Affiliate, all of the
Options evidenced by this Stock Option Certificate shall automatically vest
upon a Change in Control of the Company as defined and provided for in the
Plan; provided, however, that the transactions contemplated by the First
Amended and Restated Agreement and Plan of Merger dated as of October 3, 1997
by and among the Company, PICOM Insurance Company and Physicians Protective
Trust Fund shall not constitute such a Change in Control of the Company.
4. Termination Provisions.
a. If the Participant's employment by, or consulting
arrangement with, the Company or any Affiliate terminates for any reason
(including termination by reason of the fact that an entity is no longer an
Affiliate) other than the Participant's death, the Participant may thereafter
exercise those Options evidenced by this Stock Option Certificate that have
vested as provided below, except that the Committee may terminate the
unexercised vested Options and the unvested Options concurrently with or at any
time following termination of such employment or consulting arrangement
(including termination of employment upon a change of status from employee to
consultant) if it shall determine that the Participant has engaged in any
activity detrimental to the interests of the Company or an Affiliate. If such
termination is voluntary on the part of the Participant (other than by reason
of retirement on or after the
<PAGE> 3
normal retirement date), the Options evidenced by this Stock Option Certificate
that have vested may be exercised only within ten days after the date of
termination. If such termination is involuntary on the part of the
Participant, or if the Participant retires on or after normal retirement date,
or if the Participant's employment or consulting arrangement is terminated by
reason of the Participant's Disability, the Options evidenced by this Stock
Option Certificate that have vested may be exercised within three months after
the date of termination or retirement. For purposes of the foregoing, the
Participant's employment or consulting arrangement shall not be considered
terminated (i) in the case of approved sick leave or other bona fide leave of
absence (not to exceed one year), (ii) in the case of a transfer of employment
or the consulting arrangement among the Company and Affiliates, or (iii) by
virtue of a change of status from employee to consultant or from consultant to
employee, except as provided above.
b. If the Participant dies at a time when entitled to
exercise the Options evidenced by this Stock Option Certificate, then those
Options that were vested and exercisable immediately prior to the Participant's
death may be exercised at any time or times within one year after the
Participant's death. Except as so exercised, such Options shall expire at the
end of such one year period. The Company may decline to deliver any of such
shares of Common Stock to a designated beneficiary until it receives indemnity
against claims of third parties satisfactory to the Company.
c. Any Options evidenced by this Stock Option
Certificate may be exercised only if and to the extent such Option was vested
and was exercisable at the date of termination of the Participant's employment
or consulting arrangement, and no Option may be exercised at any time when such
Option would not have been vested or exercisable had the Participant's
employment or consulting arrangement continued.
5. Restrictions on Transferability. Except as the Plan may
otherwise provide or as the Committee may otherwise determine, neither this
Stock Option Certificate nor any of the Stock Options evidenced by this Stock
Option Certificate may be sold, encumbered, pledged, alienated, attached,
assigned, or otherwise transferred in any manner, and any attempt to do any of
the foregoing shall be void and unenforceable against the Company.
6. Adjustments and Corporate Reorganizations. In the event of
certain contingencies provided for in the Plan, the Purchase Price, the number
of Options evidenced by this Stock Option Certificate and the number of shares
of Common Stock subject to purchase upon the exercise of each of such Options
may be modified or adjusted, all as provided in the Plan.
7. No Rights in Stock Before Issuance and Delivery. The
Participant does not have any right to continued employment by the Company or
an Affiliate for any period by virtue of the granting or receipt of this Stock
Option Certificate or any of the Options evidenced by this Stock Option
Certificate. No person shall be entitled to the privileges of stock ownership
in respect of any
<PAGE> 4
shares of Common Stock issuable upon exercise of any of the Options evidenced
by this Stock Option Certificate, including, without limitation, the right to
vote or to receive dividends or other distributions, or to receive any notice
of any proceedings of the Company (except as provided in the Plan), unless and
until such shares of Common Stock have been issued to such person as fully paid
shares.
8. Alternative Payment with Stock.
a. Payment of the Purchase Price, or any portion
thereof, may be made with shares of stock of the same class as the shares then
subject to a vested Option, if shares of that class are then "Publicly Traded"
(i.e., if stock of that class is listed or admitted to unlisted trading
privileges on a national securities exchange or on the Nasdaq National Market
or if sales or bid and offer quotations are reported for that class of stock in
the automated quotation system operated by the National Association of
Securities Dealers, Inc.). Such shares will be credited toward such purchase
price on the valuation basis set forth below, in which event the stock
certificates evidencing the shares so to be used shall accompany the notice of
exercise and shall be duly endorsed or accompanied by duly executed stock
powers to transfer the same to the Company; provided, however, that such
payment in stock instead of cash shall not be effective and shall be rejected
by the Company if (i) the Company is then prohibited from purchasing or
acquiring shares of the class of its stock thus tendered to it, or (ii) the
right or power of the Participant exercising such vested Option to deliver such
shares in payment of the Purchase Price is subject to the prior interests of
any other person or entity (excepting the Company), as indicated by legends
upon the certificate(s) or as known to the Company. For credit toward the
Purchase Price, shares so surrendered shall be valued at their Fair Market
Value (as hereinafter defined) as of the day immediately preceding the delivery
to the Company of the certificate(s) evidencing such shares. If the Company
rejects the payment in stock, the tendered notice of exercise shall not be
effective unless promptly after being notified of such rejection the
Participant exercising such vested Option pays the Purchase Price in acceptable
form. If and while payment of the Purchase Price with stock is permitted in
accordance with the foregoing provisions, the Participant then entitled to
exercise any vested Options may, in lieu of using previously outstanding shares
therefor, use the shares as to which such vested Options are then being
exercised, in which case the notice of exercise need not be accompanied by any
stock certificates but shall include a statement directing the Company to
withhold so many of the shares that would otherwise have been delivered upon
that exercise of such vested Options as equals the number of shares that would
have been transferred to the Company if the Purchase Price had been paid with
previously issued stock.
b. Payment of the Purchase Price, or any portion
thereof, may also be made through any other form of "cashless exercise"
acceptable to Company (including, without limitation, financing through a
brokerage account pursuant to Section 220.3(e)(4) of Regulation T, as amended).
<PAGE> 5
c. The term "Fair Market Value" shall mean the closing
price of stock of that class as of the day in question (or, if such day is not
a trading day in the principal securities market or markets for such stock, on
the nearest preceding trading day), as reported with respect to the market (or
the composite of markets, if more than one) in which shares of such stock are
then traded, or, if no such closing prices are reported, on the basis of the
mean between the high bid and low asking prices that day on the principal
market or quotation system on which shares of such stock are then quoted, or,
if not so quoted, as furnished by a professional securities dealer making
market in such stock selected by or under authority of the Board.
9. Requirements of Law.
a. The Participant represents and agrees that, unless a
registration statement under the Securities Act of 1933, as amended, is in
effect as to shares purchased upon any exercise of any of the Options evidenced
by this Stock Option Certificate, (i) any and all shares so purchased shall be
acquired for the Participant's personal account and not with a view to or for
sale in connection with any distribution, and (b) each notice of the exercise
of any of such Options shall be accompanied by a representation and warranty in
writing, signed by the Participant, that such shares are being so acquired in
good faith for the Participant's personal account and not with a view to or for
sale in connection with any distribution.
b. No certificate or certificates for shares purchased
upon exercise of any of the Options evidenced by this Stock Option Certificate
shall be issued and delivered unless and until, in the opinion of legal counsel
for the Company, such securities may be issued and delivered without causing
the Company to be in violation of or incur any liability under any federal,
state or other securities law or any other requirement of law or of any
regulatory body having jurisdiction over the Company.
c. The Company shall not be obligated to deliver any
securities pursuant to any exercise of any of the Options represented by this
Stock Option Certificate unless a registration statement under the Securities
Act of 1933, as amended, with respect to such securities is effective or an
exemption thereunder is available. The Options represented by this Stock
Option Certificate shall not be exercisable by a Participant in any state where
such exercise would be unlawful.
10. Notices. Any notice to be given to the Company shall be
addressed to the Company in care of its Secretary at its principal office, and
any notice to be given to the Participant shall be addressed to the Participant
at the address set forth beneath the Participant's signature hereto or at such
other address as the Participant may hereafter designate in writing to the
Company. Any such notice shall be deemed duly given when enclosed in a
properly sealed envelope or wrapper addressed as aforesaid, registered or
certified, and deposited, postage and registry or certification fees prepaid,
in a post office or branch post office regularly maintained by the United
States Postal Service.
<PAGE> 6
11. Ownership. Prior to due presentment for registration of
transfer of this Stock Option Certificate and the Options evidenced by this
Stock Option Certificate, the Company may deem and treat the Participant as the
absolute owner of this Stock Option Certificate and of each of such Options
(notwithstanding any notations of ownership or writing hereon made by anyone
other than a duly authorized officer of the Company) for all purposes and shall
not be affected by any notice to the contrary, except as provided in the Plan.
12. Applicable Law. This Stock Option Certificate (i) shall be
governed by and construed in accordance with the laws of the State of Michigan
without giving effect to conflict of laws, and (ii) is not valid unless it has
been manually signed by the Participant and on behalf of the Company by its
President and its Secretary.
IN WITNESS WHEREOF, this Stock Option Certificate has been executed as
of September 20, 1997 by the Participant and on behalf of the Company.
Participant: COMPANY:
Professionals Insurance Company
Management Group
_________________________ By: __________________________
Name: Victor T. Adamo
Address: Its: Chief Executive Officer
Tax I.D. No.: And By: __________________________
Annette E. Flood
Its: Secretary
<PAGE> 1
EXHIBIT 23
The Board of Directors
Professionals Insurance Company Management Group:
We consent to incorporation by reference in the registration statements (Nos.
333-34359 and 333-34361) on Forms S-8 of Professionals Insurance Company
Management Group of our report dated February 27, 1998, relating to the
consolidated balance sheets of Professionals Insurance Company Management Group
and subsidiaries as of December 31, 1997, and 1996, and the related consolidated
statements of income, shareholders' equity, and cash flows for each of the years
in the three-year period ended December 31, 1997, and the related financial
statement schedule, which report appears in the December 31,
1997, annual report on Form 10-K of Professionals Insurance Company
Management Group.
KPMG Peat Marwick L.L.P.
East Lansing, Michigan
March 26, 1998
<PAGE> 1
EXHIBIT (24)
PROFESSIONALS INSURANCE COMPANY MANAGEMENT GROUP
KNOW ALL MEN by these presents that each of the undersigned hereby
make, constitute and appoint W. Peter McCabe, Victor T. Adamo, R. Kevin Clinton
and Annette E. Flood, and each of them, the true and lawful attorney-in-fact of
the undersigned, with full power of substitution and revocation, for and in the
name, place and stead of the undersigned, to execute, deliver and file (with
the Securities and Exchange Commission or any other appropriate governmental
authority) the Annual Report on Form 10-K of Professionals Insurance Company
Management Group for the year ended December 31, 1997, and any and all
amendments thereto; such Form 10-K and each such amendment to be in such form
and to contain such terms and provisions as said attorney or substitute shall
deem necessary or desirable; giving and granting unto said attorney, or to such
person or persons as in any case may be appointed pursuant to the power of
substitution herein given, full power and authority to do and perform any and
every act and thing whatsoever requisite, necessary or, in the opinion of said
attorney or substitute, able to be done in and about the premises as fully and
to all intents and purposes as the undersigned might or could do if personally
present, hereby ratifying and confirming all that said attorney for such
substitute shall lawfully do or cause to be done by virtue hereof.
IN WITNESS WHEREOF, each of the undersigned has duly executed this
instrument as of the 20th day of March, 1998.
/s/ Victor T. Adamo /s/ W. Peter McCabe
- -------------------------------- --------------------------------
Victor T. Adamo W. Peter McCabe
/s/ Jerry D. Campbell /s/ John F. McCaffery
- -------------------------------- --------------------------------
Jerry D. Campbell John F. McCaffery
/s/ R. Kevin Clinton /s/ Isaac J. Powell
- -------------------------------- --------------------------------
R. Kevin Clinton Isaac J. Powell
/s/ John F. Dodge, Jr. /s/ Ann F. Putallaz
- -------------------------------- --------------------------------
John F. Dodge, Jr. Ann F. Putallaz
/s/ H. Harvey Gass /s/ Donald S. Young
- -------------------------------- --------------------------------
H. Harvey Gass Donald S. Young
/s/ William H. Woodhams
--------------------------------
William H. Woodhams
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED FINANCIAL STATEMENTS OF PROFESSIONALS INSURANCE COMPANY MANAGEMENT
GROUP AS OF DECEMBER 31, 1997 AND FOR THE YEAR THEN ENDED (IN THOUSANDS).
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<DEBT-HELD-FOR-SALE> 313,633
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 2,831
<MORTGAGE> 0
<REAL-ESTATE> 442
<TOTAL-INVEST> 342,561
<CASH> 2,176
<RECOVER-REINSURE> 267
<DEFERRED-ACQUISITION> 1,376
<TOTAL-ASSETS> 413,195
<POLICY-LOSSES> 239,151
<UNEARNED-PREMIUMS> 21,665
<POLICY-OTHER> 15,300
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 22,500
0
0
<COMMON> 3,506
<OTHER-SE> 98,420
<TOTAL-LIABILITY-AND-EQUITY> 413,195
71,968
<INVESTMENT-INCOME> 18,719
<INVESTMENT-GAINS> (207)
<OTHER-INCOME> 1,169
<BENEFITS> 57,630
<UNDERWRITING-AMORTIZATION> 0
<UNDERWRITING-OTHER> 20,112
<INCOME-PRETAX> 13,907
<INCOME-TAX> 2,881
<INCOME-CONTINUING> 11,026
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 11,026
<EPS-PRIMARY> 3.15
<EPS-DILUTED> 3.14
<RESERVE-OPEN> 219,919
<PROVISION-CURRENT> 83,466
<PROVISION-PRIOR> (26,341)
<PAYMENTS-CURRENT> 10,512
<PAYMENTS-PRIOR> 32,015
<RESERVE-CLOSE> 239,151
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
