<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number 0-21223
PROFESSIONALS GROUP, INC.
(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, Okemos, Michigan 48864
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (517) 349-6500
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 [ ]
The number of shares outstanding of the registrant's common stock, no par value
per share, as of May 12, 1999 was 8,383,196.
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TABLE OF CONTENTS
<TABLE>
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PAGE NO.
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets at March 31, 1999 3
(Unaudited) and December 31, 1998
Condensed Consolidated Statements of Income for the Three 4
Months Ended March 31, 1999 and 1998 (Unaudited)
Condensed Consolidated Statements of Comprehensive Income for 5
the Three Months Ended March 31, 1999 and 1998 (Unaudited)
Condensed Consolidated Statements of Cash Flows for the Three 6
Months Ended March 31, 1999 and 1998 (Unaudited)
Notes to Condensed Consolidated Financial Statements (Unaudited) 7-10
Item 2. Management's Discussion and Analysis of Financial Condition and 11-17
Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk 17-19
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 20
Signatures 21
</TABLE>
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
PROFESSIONALS GROUP, INC.
AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
<TABLE>
<CAPTION>
March 31, December 31,
Assets 1999 1998
------ --------------- ---------------
(Unaudited)
<S> <C> <C>
Investments:
Fixed maturities available for sale, at fair value
(amortized cost: $627,119,000 and $646,864,000) $640,049,000 $669,118,000
Equity securities available for sale, at fair value
(cost: $4,068,000 and $4,035,000) 4,200,000 3,901,000
Short-term investments, at cost 56,873,000 17,593,000
Real estate, at cost, net of accumulated depreciation 415,000 421,000
--------------- ---------------
Total investments 701,537,000 691,033,000
Cash 2,963,000 379,000
Restricted cash 2,070,000 2,070,000
Premiums due from policyholders 36,538,000 27,580,000
Reinsurance balances 126,763,000 106,692,000
Accrued investment income 10,501,000 10,743,000
Deferred federal income taxes 26,380,000 24,501,000
Property and equipment, at cost, net of
accumulated depreciation 8,877,000 9,117,000
Prepaid reinsurance premiums 8,247,000 4,917,000
Deferred policy acquisition costs 1,002,000 1,500,000
Other assets 8,011,000 10,679,000
--------------- ---------------
Total assets $932,889,000 $889,211,000
=============== ===============
Liabilities and Shareholders' Equity
Liabilities:
Loss and loss adjustment expense reserves $556,110,000 $540,583,000
Reserve for extended reporting period claims 26,924,000 26,674,000
Unearned premiums 68,793,000 48,201,000
Long-term debt 20,000,000 20,000,000
Surplus contributions 10,094,000 10,094,000
Accrued expenses and other liabilities 27,918,000 21,562,000
--------------- ---------------
Total liabilities 709,839,000 667,114,000
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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;
8,383,196 and 8,383,924 shares issued and
outstanding in 1999 and 1998, respectively 8,383,000 8,384,000
Additional paid-in capital 34,284,000 33,982,000
Retained earnings 171,761,000 165,132,000
Accumulated other comprehensive income,
net of deferred federal income taxes 8,622,000 14,599,000
--------------- ---------------
Total shareholders' equity 223,050,000 222,097,000
--------------- ---------------
Total liabilities and shareholders' equity $932,889,000 $889,211,000
=============== ===============
</TABLE>
See accompanying notes to the unaudited condensed consolidated financial
statements.
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PROFESSIONALS GROUP, INC.
AND SUBSIDIARIES
Condensed Consolidated Statements of Income
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
------------------------------------
1999 1998
--------------- ---------------
(As Restated)
<S> <C> <C>
Revenues and other income:
Net premiums written $ 55,943,000 $ 48,000,000
Increase in unearned premiums, net of
prepaid reinsurance premiums (17,262,000) (10,221,000)
------------ ------------
Premiums earned, net 38,681,000 37,779,000
Net investment income 9,217,000 9,678,000
Net realized investment gains 1,721,000 4,038,000
Reinsurance experience refunds - 400,000
Other 1,047,000 706,000
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Total revenues and other income 50,666,000 52,601,000
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Expenses:
Losses and loss adjustment expenses, net 32,616,000 34,792,000
Increase in reserve for extended reporting
period claims 250,000 353,000
Policy acquisition and other underwriting expenses 8,379,000 8,567,000
Interest expense 290,000 360,000
Other 599,000 -
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Total expenses 42,134,000 44,072,000
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Income from operations before federal income taxes 8,532,000 8,529,000
Federal income taxes 1,877,000 2,209,000
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Net income $ 6,655,000 $ 6,320,000
============ ============
Net income per common share - basic $ 0.79 $ 0.76
============ ============
Net income per common share - assuming dilution $ 0.78 $ 0.76
============ ============
Weighted average shares outstanding - basic 8,383,706 8,353,330
============ ============
Weighted average shares outstanding - assuming dilution 8,521,345 8,360,012
============ ============
</TABLE>
See accompanying notes to the unaudited condensed consolidated financial
statements.
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PROFESSIONALS GROUP, INC.
AND SUBSIDIARIES
Condensed Consolidated Statements of Comprehensive Income
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
-----------------------------------
1999 1998
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(As Restated)
<S> <C> <C>
Net income $ 6,655,000 $ 6,320,000
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Other comprehensive income (loss):
Unrealized holding gains (losses) on securities arising
during the period (net of income taxes of $2,494,000
and $556,000 in 1999 and 1998, respectively) (4,841,000) 1,080,000
Less reclassification adjustment for realized gains
included in net income (net of income taxes of $585,000
and $1,373,000 in 1999 and 1998, respectively) (1,136,000) (2,665,000)
----------- -----------
Other comprehensive income (loss) (5,977,000) (1,585,000)
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Comprehensive income $ 678,000 $ 4,735,000
=========== ===========
</TABLE>
See accompanying notes to the unaudited condensed consolidated financial
statements.
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PROFESSIONALS GROUP, INC.
AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended March 31,
--------------------------------------
1999 1998
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(As Restated)
<S> <C> <C>
Net cash provided by operating activities $ 20,635,000 $ 8,135,000
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Cash flows from investing activities:
Proceeds from sale or maturity of short-term investments 307,577,000 226,500,000
Purchases of short-term investments (346,415,000) (219,075,000)
Proceeds from maturity of securities available for sale 2,325,000 1,454,000
Proceeds from sale of securities available for sale 120,657,000 74,871,000
Purchases of securities available for sale (102,096,000) (93,185,000)
Purchases of property and equipment (73,000) (104,000)
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Net cash used in investing activities (18,025,000) (9,539,000)
------------- -------------
Cash flows from financing activities - cash paid for
dissenter's rights (26,000) -
------------- -------------
Net increase (decrease) in cash 2,584,000 (1,404,000)
Cash, beginning of period 379,000 2,636,000
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Cash, end of period $ 2,963,000 $ 1,232,000
============= =============
</TABLE>
See accompanying notes to the unaudited condensed consolidated financial
statements.
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PROFESSIONALS GROUP, INC.
AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (Unaudited)
(1) Basis of Presentation
Professionals Group, Inc. ("Professionals Group," and with its direct
and indirect subsidiaries, the "Company") is a business corporation
that was incorporated under the laws of the State of Michigan on
January 31, 1996 and functions as an insurance holding company.
Professionals Group has four direct wholly-owned subsidiaries, three
indirect wholly-owned subsidiaries and one direct eighty percent owned
subsidiary. The direct wholly-owned subsidiaries are ProNational
Insurance Company ("ProNational"), PICOM Insurance Agency, Inc.
("PIA"), Professionals Group Services Corporation ("PGSC") and American
Insurance Management Corporation ("AIMC"). The indirect wholly-owned
entities, all of which are wholly-owned subsidiaries of ProNational,
are PICOM Claims Services Corporation ("PCSC"), ProNational Casualty
Company ("ProNational Casualty") and Physicians Protective Plan, Inc.
("PPP"). The direct eighty percent owned subsidiary is MedAdvantage,
Inc. ("MedAdvantage").
ProNational is a stock, property and casualty insurer that offers
professional liability insurance to providers of health care services
in Florida, Michigan, Illinois, Indiana, Kentucky, Ohio and
Pennsylvania. PIA is an inactive Michigan insurance agency. PGSC is a
Michigan business corporation that administers certain benefit plans
for ProNational employees. 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. ProNational
Casualty is a stock, property and casualty insurer that is currently
not issuing policies. PPP is a Florida insurance agency. MedAdvantage
provides credentialing verification services for medical service
providers.
As more fully described in Note 3 to the accompanying financial
statements, on July 1, 1998, Professionals Group consummated its merger
with Physicians Protective Trust Fund, a medical malpractice
self-insurance trust fund located in Coral Gables, Florida ("PPTF").
This transaction has been accounted for as a "pooling of interests"
business combination under generally accepted accounting principles,
whereby Professionals Group has carried forward to its accounts the
assets and liabilities of PPTF at their respective amounts as reported
by PPTF. As a result of this business combination, all prior period
financial information has been restated to reflect the combined
operations of Professionals Group and PPTF.
The accompanying unaudited condensed consolidated financial statements
of the Company have been prepared in conformity with generally accepted
accounting principles and with the instructions for Form 10-Q and Rule
10-01 of Regulation S-X as they apply to interim
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<PAGE> 8
PROFESSIONALS GROUP, INC.
AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (Unaudited), Continued
(1) Basis of Presentation, continued
financial information. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting
principles for complete financial statements. All significant
intercompany transactions have been eliminated in consolidation.
In the opinion of management, all adjustments (consisting of normal
recurring adjustments) considered necessary for a fair presentation of
financial position and results of operations have been included. The
operating results for the three month period ended March 31, 1999 are
not necessarily indicative of the results to be expected for the year
ending December 31, 1999.
(2) 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 and stock awards) outstanding during each period after
giving effect to stock dividends and treasury shares, calculated on a
daily basis.
(3) Business Combination
On July 1, 1998, Professionals Group consummated its merger with PPTF.
Pursuant to the merger agreement, Professionals Group issued 4,087,525
shares of Professionals Group common stock to the eligible members of
PPTF and paid cash of approximately $67,000 in lieu of fractional
shares. Additionally, 30,594 shares (representing 20% of the 153,000
total shares to be issued over a period of five years) of Professionals
Group common stock were issued to directors and management of PPTF, as
contemplated by the merger agreement. The transaction has been
accounted for as a "pooling of interests" business combination under
generally accepted accounting principles, whereby Professionals Group
has carried forward to its accounts the assets and liabilities of PPTF
at their respective amounts as reported by PPTF. As a result of this
business combination, all prior period financial information has been
restated to reflect the combined operations of Professionals Group and
PPTF.
-8-
<PAGE> 9
PROFESSIONALS GROUP, INC.
AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (Unaudited), Continued
(4) Related Party Transactions
On April 20, 1999, the Securities and Exchange Commission declared
effective the registration statement on Form S-1 filed by Michigan
Educational Employees Mutual Insurance Company ("MEEMIC"), through the
newly formed MEEMIC Holdings, Inc., for the purpose of registering
shares of its common stock to be issued in connection with the proposed
demutualization of MEEMIC. Subject to the approval of the policyholders
of MEEMIC, at a policyholder meeting to be held on May 25, 1999, MEEMIC
would convert to a stock insurance company and become a wholly owned
subsidiary of MEEMIC Holdings, Inc., using a subscription rights method
of demutualization. MEEMIC's plan of demutualization contemplates the
conversion of the $21.5 million Surplus Note of MEEMIC owned by
Professionals Group into shares of MEEMIC Holdings, Inc. and the
purchase by Professionals Group, as the standby purchaser, of any
unexercised subscription rights. After the completion of MEEMIC's plan
of demutualization, Professionals Group expects to own at least 51% of
the stock of MEEMIC Holdings, Inc. The registration statement of MEEMIC
Holdings, Inc. (registration statement no. 333-66671) should be
consulted for a description of the proposed demutualization of MEEMIC
and the expected role of Professionals Group.
(5) Segment Information
The Company is organized and operates principally in the property and
casualty insurance industry and has three reportable segments -
professional liability lines property and casualty insurance, personal
lines property and casualty insurance and investment operations. The
accounting policies of the segments are the same as those described in
the basis of presentation footnote of the Company's consolidated
financial statements included in its Annual Report on Form 10-K for the
year ended December 31, 1998. Revenue is primarily from unaffiliated
customers. Identifiable assets by segment are those assets, including
investment securities, used in the Company's operations. Corporate and
other identifiable assets are principally cash and marketable
securities. Segment information, for which results are regularly
reviewed by Company management in making decisions about resources to
be allocated to the segments and assess their performance, is
summarized as follows:
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<PAGE> 10
PROFESSIONALS GROUP, INC.
AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (Unaudited), Continued
(5) Segment Information, continued
<TABLE>
<CAPTION>
Three months ended March 31,
---------------------------
1999 1998
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(in thousands)
<S> <C> <C>
REVENUES:
Professional liability lines $ 27,520 $ 27,736
Personal lines 11,679 10,936
Investment operations 10,938 13,716
Corporate and other 529 213
--------- ---------
Total revenues $ 50,666 $ 52,601
========= =========
INCOME BEFORE INCOME TAXES:
Professional liability lines $ (3,487) $ (5,409)
Personal lines 1,441 369
Investment operations 10,938 13,716
Corporate and other (360) (147)
--------- ---------
Total income before income taxes $ 8,532 $ 8,529
========= =========
IDENTIFIABLE ASSETS:
Property and casualty insurance $ 921,388 $ 860,123
Corporate and other 11,501 13,595
--------- ---------
Total identifiable assets $ 932,889 $ 873,718
========= =========
</TABLE>
-10-
<PAGE> 11
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion and analysis should be read in conjunction with
the condensed consolidated financial statements and the notes thereto included
elsewhere in this report and the Company's Annual Report on Form 10-K for the
year ended December 31, 1998. The following discussion of the financial
condition and results of operations of the Company contains certain
forward-looking statements relating to anticipated future financial conditions
and operating results of the Company and its current business plans. In the
future, the financial condition and operating results of the Company could
differ materially from those discussed herein and its current business plans
could be altered in response to market conditions and other factors beyond the
Company's control. Important factors that could cause or contribute to such
differences or changes include those discussed in the Company's Annual Report on
Form 10-K for the year ended December 31, 1998. (See the disclosures under "Item
1. Business - Forward Looking Statements" and under "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations.")
Financial Condition -- March 31, 1999 Compared to December 31, 1998:
On July 1, 1998, Professionals Group consummated its merger with
Physicians Protective Trust Fund, a medical malpractice self-insurance trust
fund located in Coral Gables, Florida ("PPTF"). The transaction has been
accounted for as a "pooling of interests" business combination under generally
accepted accounting principles, whereby Professionals Group has carried forward
to its accounts the assets and liabilities of PPTF at their respective amounts
as reported by PPTF. As a result of this business combination, all prior period
financial information has been restated to reflect the combined operations of
Professionals Group and PPTF (see also Note 3 to the Company's condensed
consolidated financial statements contained herein).
Total assets increased by $43.7 million, or 4.9%, to $932.9 million at
March 31, 1999, compared to $889.2 million at December 31, 1998, primarily due
to increases in invested assets, reinsurance balances, premiums due from
policyholders and prepaid reinsurance premiums. Invested assets increased 1.5%
to $701.5 million, or approximately 75% of the Company's total assets at March
31, 1999. This compares to invested assets of $691.0 million, or approximately
78% of the Company's total assets at December 31, 1998. The increase in invested
assets was primarily due to positive cash flows from operations. Reinsurance
balances have increased due to increased business in states which have higher
limits, resulting in higher reinsurance coverage, therefore the reinsurance
recoverables have continued to increase. The increases in premiums due from
policyholders and prepaid reinsurance premiums reflect the timing of renewals
for the Company's Illinois professional liability book of business, which have a
common renewal date of January 1.
The Company's investment portfolio continues to be dominated by fixed
maturity securities at March 31, 1999, and primarily consists of U.S. government
and agency bonds, high-quality corporate bonds, mortgage-backed securities,
redeemable preferred stocks and tax-exempt U.S. municipal bonds. The entire
fixed maturity
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<PAGE> 12
portfolio, which is classified as available-for-sale, and is carried at fair
value, is sensitive to interest rate changes. At March 31, 1999, the fixed
maturity portfolio had a fair value that was $12.9 million more than the $627.1
million amortized cost of such portfolio. At December 31, 1998, the fixed
maturity portfolio had a fair value that was $22.3 million higher than the
$646.9 million amortized cost of such portfolio. The reduction of fair value
resulted from higher interest rates, particularly in the U.S. Treasury sector.
Loss and loss adjustment expense reserves represented approximately 78%
and 81% of the Company's consolidated liabilities at March 31, 1999 and December
31, 1998, respectively. These 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. The Company's carried reserves have been established within the
range of acceptable values periodically 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.
Loss and loss adjustment expense reserves increased by $15.5 million, or
2.9%, to $556.1 million at March 31, 1999, from $540.6 million at December 31,
1998. This increase was primarily attributable to increased business in states
which have higher limits, therefore loss and loss adjustment expense reserves
have continued to increase.
The unearned premium reserve increased by $20.6 million, or 42.7%, to
$68.8 million at March 31, 1999, from $48.2 million at December 31, 1998. The
increase was due mainly to the timing of renewals for the Company's Illinois
professional liability book of business, which have a common renewal date of
January 1.
Shareholders' equity increased by less than 1.0% to $223.1 million at
March 31, 1999, compared to $222.1 million at December 31, 1998. The increase in
shareholders' equity was due to net income of $6.7 million and other increases
in shareholders' equity of $0.3 million, which were offset by a decrease in
accumulated other comprehensive income, consisting of unrealized losses on the
investment portfolio of $6.0 million during the three month period ended March
31, 1999. The Company expects to use retained earnings to increase its capital
base and finance future growth and, therefore, there can be no assurance as to
any future cash dividends by the Company.
Results of Operations -- Three Months Ended March 31, 1999 Compared to Three
Months Ended March 31, 1998:
Total net premiums written were $55.9 million for the three months ended
March 31, 1999, an increase of $7.9 million, or 16.5%, compared to net premiums
written of $48.0 million for the three months ended March 31, 1998. Professional
liability related net premiums written were $44.8
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<PAGE> 13
million for the three months ended March 31, 1999, an increase of $7.2 million,
or 19.2%, compared to net premiums written of $37.6 million for the three months
ended March 31, 1998. The increase in professional liability net premiums
written was mainly due to Florida policies issued in the last half of 1997 that
had a one-time coverage term of eighteen months to convert policy renewal dates
from a common renewal date of January 1. The issuance of these eighteen month
policies in 1997 resulted in a decrease in premiums written in 1998 because
these policies were not renewed until 1999. The increase in professional
liability net premiums written was offset somewhat by continued price-based
competition. The reinsurance premiums assumed from MEEMIC were $11.1 million for
the three months ended March 31, 1999, an increase of $0.7 million, or 6.9%,
compared to net premiums written of $10.4 million for the three months ended
March 31, 1998.
Total net premiums earned were $38.7 million for the three months ended
March 31, 1999, an increase of $0.9 million, or 2.4%, compared to net premiums
earned of $37.8 million for the three months ended March 31, 1998. Net earned
premiums increased primarily as a result of the reinsurance assumed from MEEMIC.
Professional liability net earned premiums also increased due to increased
business in Ohio and Pennsylvania and expansion of business into Kentucky, which
was offset somewhat by lower earned premium income in Michigan and Florida
resulting from price-based competition.
The Company continued to balance its need for rate adjustments with a goal
of maintaining market share in very competitive environments in Florida,
Michigan, Illinois, Indiana, Kentucky, Ohio and Pennsylvania. 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 in the long run.
Net investment income, excluding realized investment gains, was $9.2
million for the three months ended March 31, 1999, a decrease of $0.5 million,
or 4.8%, compared to net investment income of $9.7 million for the three months
ended March 31, 1998. The decrease in net investment income resulted as average
fixed maturity invested assets were lower during the three months ended March
31, 1999 compared to the three months ended March 31, 1998 and due to lower
prevailing interest rates, particularly in the spread-products sector. The
weighted average tax equivalent book yield of the fixed maturity portfolio was
6.8% and 6.9% as of March 31, 1999 and 1998, respectively. Net realized
investment gains were $1.7 million and $4.0 million during the three months
ended March 31, 1999 and 1998, respectively. The significant amount of
investment gains recorded in the first quarter of 1998 was attributable to the
sale of a majority of the Company's common stock portfolio due to the Company's
desire to maximize after-tax investment yield in 1998 and future years.
Total incurred losses and loss adjustment expenses (including the increase
in reserve for extended reporting period claims) totaled $32.9 million for the
three months ended March 31, 1999, a decrease of $2.3 million, or 6.5%, compared
to $35.2 million for the same period of 1998. As a percentage of premiums
earned, the total incurred loss and loss adjustment expense ratio (including the
increase in reserve for extended reporting period claims) decreased to 85.0% for
the three months
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<PAGE> 14
ended March 31, 1999, compared to 93.0% for the same period of 1998. This
decrease arose from both the professional liability and MEEMIC books of
business, as further discussed below.
Professional liability insurance incurred losses and loss adjustment
expenses (including the increase in reserve for extended reporting period
claims) totaled $26.1 million for the three months ended March 31, 1999, a
decrease of $1.7 million, or 6.2%, compared to $27.8 million for the three
months ended March 31, 1998. 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)
decreased to 94.8% for the three months ended March 31, 1999, compared to 101.8%
for the same period of 1998. The professional liability insurance incurred loss
and loss adjustment expense ratio has decreased due mainly to reinsurance
benefits derived from a stop loss reinsurance contract entered into for the 1999
accident year and favorable development of prior years' loss reserves related to
the Company's book of business in the Midwest. The stop loss reinsurance
contract has reduced the loss and loss adjustment expense ratio by approximately
7.0 percentage points.
Incurred losses and loss adjustment expenses related to the personal
automobile and homeowners insurance assumed from MEEMIC (the "personal liability
insurance") totaled $6.8 million for the three months ended March 31, 1999, a
decrease of $0.5 million, or 7.5%, compared to $7.3 million for the same period
of 1998. As a percentage of premiums earned, the personal liability insurance
generated an incurred loss and loss adjustment expense ratio of 60.7% for the
three months ended March 31, 1999, compared to 70.2% for the same period of
1998. The decrease in the personal liability insurance loss and loss adjustment
expense ratio was attributable to favorable development of prior years' loss
reserves and mild weather during the first quarter of 1999.
Policy acquisition and underwriting expenses were $8.4 million for the
three months ended March 31, 1999, a decrease of $0.2 million, or 2.2%, compared
to policy acquisition and underwriting expenses of $8.6 million for the same
period of 1998. As a percentage of premiums earned, the underwriting expense
ratio decreased to 21.7% for the three months ended March 31, 1999, from 22.7%
for the same period of 1998. Interest expense was $0.3 million and $0.4 million
during the three months ended March 31, 1999 and 1998, respectively. See
"Liquidity and Capital Resources."
The Company recorded $1.9 million in federal income tax expense for the
three months ended March 31, 1999, compared to $2.2 million during the same
period in 1998. The effective tax rate was 22.0% for the three months ended
March 31, 1999, compared to 25.9% for the three months ended March 31, 1998. The
Company's lower effective tax rate for the three months ended March 31, 1999 was
due primarily to increased holdings in tax-exempt municipal bonds compared to
the same period in 1998.
Net income for the three months ended March 31, 1999 was $6.7 million, or
$0.78 per share (assuming dilution) on revenues of $50.7 million. This compares
to net income of $6.3 million, or $0.76 per share (assuming dilution) on
revenues of $52.6 million, for the three months ended March
-14-
<PAGE> 15
31, 1998. The improvement in earnings was attributable to improvements in both
the loss and loss adjustment expense ratio and the underwriting expense ratio,
as described previously.
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. The Company did not borrow any funds in the three month
periods ended March 31, 1999 or 1998. As of March 31, 1999, 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.
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 (5.87% at March 31, 1999), and payable quarterly
(the "Credit Agreement"). The remaining principal payments are due on April 30,
as follows: 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.
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 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 by the Credit Agreement) of not less than
1.5:1 and 2.5:1, respectively. The Company was in compliance with, or had
received waivers of, all required covenants at March 31, 1999.
On April 14, 1999, Professionals Group's Board of Directors authorized
management to repurchase up to 400,000 shares of the Company's common stock in
open market transactions over the next twelve months. This repurchase plan
represents approximately 5% of the issued and outstanding common stock of the
Company. No shares have been repurchased under the program to date.
-15-
<PAGE> 16
On April 20, 1999, the Securities and Exchange Commission declared
effective the registration statement on Form S-1 filed by Michigan Educational
Employees Mutual Insurance Company ("MEEMIC"), through the newly formed MEEMIC
Holdings, Inc., for the purpose of registering shares of its common stock to be
issued in connection with the proposed demutualization of MEEMIC. Subject to the
approval of the policyholders of MEEMIC, at a policyholder meeting to be held on
May 25, 1999, MEEMIC would convert to a stock insurance company and become a
wholly owned subsidiary of MEEMIC Holdings, Inc., using a subscription rights
method of demutualization. MEEMIC's plan of demutualization contemplates the
conversion of the $21.5 million Surplus Note of MEEMIC owned by Professionals
Group into shares of MEEMIC Holdings, Inc. and the purchase by Professionals
Group, as the standby purchaser, of any unexercised subscription rights. After
the completion of MEEMIC's plan of demutualization, Professionals Group expects
to own at least 51% of the stock of MEEMIC Holdings, Inc. The registration
statement of MEEMIC Holdings, Inc. (registration statement no. 333-66671) should
be consulted for a description of the proposed demutualization of MEEMIC and the
expected role of Professionals Group.
Year 2000 Compliance:
The Company utilizes computerized information systems across its entire
operation. The inability of any of the Company's systems to recognize a date
using "00" as the year 2000 could result in information system errors or
failures. Accordingly, the Company has been working to resolve the potential
impact of the year 2000 on the ability of those systems to accurately process
information that may be date-sensitive. Subject to the discussion that follows,
and based on the information thus far available to the Company, the Company
currently believes that the costs expected to be incurred by it in connection
with its efforts to become Year 2000-compliant will not have a material adverse
impact on the Company's operating results or financial position.
The Company has developed and followed a plan to ensure all modifications
and conversions to its primary computerized information systems are implemented
and thoroughly tested on a timely basis. The Company estimates that 95% of such
modifications and conversions have been made to date. Management anticipates
that the remaining modifications and conversions will be completed by June 30,
1999 and that the Company's primary computerized information systems will be
Year 2000-compliant by that date.
Although the Company has established a contingency plan for critical
computerized information systems to mitigate potential delays or other problems
associated with such modifications or conversions deemed necessary by
management, the Company continues to bear some risk related to the Year 2000
issue due to its voluntary interaction with other persons and entities not
affiliated with the Company (e.g., vendors and customers) who must address their
own Year 2000 issues. For this reason, the Company has been monitoring the Year
2000 issues of certain third parties with which it interacts. The Company has
asked such third parties to demonstrate, or give some indication as to their
ability to become Year 2000-compliant by June 30, 1999. With respect to any
third party who appears unlikely to remedy its Year 2000 issues, the Company
intends to take appropriate steps to mitigate the exposure to the risk posed by
such third party's failure to timely
-16-
<PAGE> 17
address its Year 2000 issues. However, due to the uncertainty inherent in both
the Year 2000 problem and the efforts of third parties to timely resolve their
own Year 2000 issues, there can be no assurances that the Company's mitigation
efforts will be successful or that the failure of any third party to timely
resolve its Year 2000 issues will not have a material adverse impact on the
Company's operations, operating results or financial position.
Both internal and external resources will be utilized in the Company's
efforts to become Year 2000-compliant. During 1998 and 1997, approximately
$160,000 and $150,000, respectively, of costs were incurred by the Company in
connection with its efforts to become Year 2000-compliant. During the three
months ended March 31, 1999, approximately $60,000 of costs were incurred by the
Company in connection with its efforts to become Year 2000-compliant. The total
costs of the Company's efforts to become Year 2000-compliant are not expected to
exceed $500,000. All such costs have been, and will continue to be, expensed as
incurred.
The costs expected to be incurred in connection with the Company's efforts
to become Year 2000-compliant, as well as the date by which the Company is
expected to be Year 2000-compliant, are based on management's best estimates.
Because such estimates were derived utilizing numerous assumptions of future
events (including the availability of certain resources, third party
modifications and other factors), there can be no assurance that these estimates
will be achieved and actual results could differ materially from those plans.
Specific factors that might cause material differences include, but are not
limited to, the availability and cost of personnel trained in this area, the
ability to locate and correct all relevant computer codes and similar
uncertainties.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
General:
The Company invests in fixed maturity, equity and short-term securities.
The Company's investment strategy recognizes the need to maintain capital
adequate to support its insurance operations. The Company evaluates the
risk/reward trade-off of investment opportunities, measuring their effects on
yield, stability, diversity, overall quality and liquidity of the investment
portfolio.
As of March 31, 1999, the majority of the Company's investment portfolio
was invested in fixed maturity securities and short-term investments. The fixed
maturity securities 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.
Qualitative Information About Market Risk:
Investments in the Company's portfolio have varying degrees of risk. The
primary market risk exposure to the fixed maturity portfolio is interest rate
risk, which is limited somewhat by managing duration to a defined range of 3.5
to 5.5 years. The distribution of maturities and sector concentrations are
monitored on a regular basis. Equity securities (common stocks), which generally
have greater risk and volatility of market value are not significant to the
Company's overall
-17-
<PAGE> 18
investment portfolio, therefore, exposure to equity price risk is not
significant. However, market values of equity securities are monitored
regularly.
The Company regularly examines the quality distribution of its investment
portfolio for evidence of impairment. In such cases, changes in market value are
evaluated to determine the extent to which such changes are attributable to: (i)
interest rates, (ii) market-related factors other than interest rates and (iii)
financial conditions, business prospects and other fundamental factors specific
to the issuer. Declines attributable to issuer fundamentals are reviewed in
further detail. Available evidence is considered to estimate the realizable
value of the investment. When a security in the Company's investment portfolio
has a decline in market value which is other than temporary, the Company is
required by GAAP to reduce the carrying value of such security to its net
realizable value. All declines in market values of the Company's investment
securities at March 31, 1999 were deemed to be temporary.
The Company currently has no market risk exposure to foreign currency
exchange rate risk or commodity price risk.
Quantitative Information About Market Risk:
Financial instruments subject to interest rate risk as of March 31, 1999 were as
follows:
<TABLE>
<CAPTION>
Market Value
---------------------------------------------------------------------------
-200 bps -100 bps +100 bps +200 bps
Change Change Actual Change Change
----------------------------------------------------------------------------
(in thousands)
<S> <C> <C> <C> <C> <C>
U.S. Treasury securities and obligations of
U.S. government corporations and agencies $ 45,916 $ 43,682 $41,895 $40,407 $39,080
Debt securities issued by states of the
United States and political subdivisions of the
states 344,261 325,546 307,845 290,999 275,063
Corporate debt securities 119,890 113,188 107,344 102,221 97,698
Mortgage-backed securities 135,529 133,556 130,027 125,061 119,804
Asset-backed securities 39,147 37,879 36,608 35,312 33,913
Redeemable preferred stocks 18,242 17,223 16,330 15,554 14,866
Short-term investments 56,873 56,873 56,873 56,873 56,873
-------- -------- -------- -------- --------
$759,858 $727,947 $696,922 $666,427 $637,297
======== ======== ======== ======== ========
</TABLE>
-18-
<PAGE> 19
The Company does not invest in fixed maturity securities for trading
purposes. Exposure to risk is represented in terms of changes in fair value due
to selected hypothetical movements in market rates. Bonds and preferred stocks
are individually priced to yield to the worst case scenario. Securities issued
by states of the United States and political subdivisions of the states are
assumed to hold their prepayment patterns. Mortgage-backed and asset-backed
securities are priced assuming deal specific prepayment scenarios, considering
the deal structure, prepayment penalties, yield maintenance agreements and the
underlying collateral. All of the preferred stocks have mechanisms that are
expected to provide an opportunity to liquidate at par.
Financial instruments subject to equity market risk as of March 31, 1999 were as
follows:
<TABLE>
<CAPTION>
Hypothetical Market
Actual Changes
Market ------------------------
Value +10% -10%
------ ------ ------
<S> <C> <C> <C>
Common stock (in thousands) $4,200 $4,620 $3,780
====== ====== ======
</TABLE>
The table above summarizes the Company's equity price risk as of March 31,
1999 and shows the effects of a hypothetical 10% increase and 10% decrease in
the market prices as of March 31, 1999. The selected hypothetical change does
not reflect what could be considered the best or worst case scenarios.
The Company generally does not invest in equity securities for trading
purposes. As of March 31, 1999, equity securities represented less than 1% of
the Company's total assets. The carrying values of publicly traded investments
subject to equity price risk are based on quoted market prices as of the balance
sheet date. Market prices are subject to fluctuation and, consequently, the
amount realized in the subsequent sale of the investment may significantly
differ from the reported market value. Fluctuation in the market price of a
security may result from perceived changes in the underlying economic
characteristics of the investee, the relative prices of alternative investments
and general market conditions. Furthermore, amounts realized in the sale of a
particular security may be affected by the relative quantity of the security
being sold. The carrying values of privately held investments are subject to
equity price risk which are based on the forgoing market price considerations
and also on the underlying value of the issuer and other buyer's perceptions of
such value, as well as lack of liquidity considerations.
-19-
<PAGE> 20
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a)Exhibits.
<TABLE>
<CAPTION>
Item 601
Regulation S-K
Exhibit Reference
Number Exhibit Description
------ -------------------
<S> <C>
(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.
(27) Financial Data Schedule of registrant.*
</TABLE>
- -----------------------------------
* Filed herewith.
(b)Reports on Form 8-K.
None.
-20-
<PAGE> 21
SIGNATURES
Pursuant to the requirements 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 GROUP, INC.
DATE: May 12, 1999 /s/ John F. Lang
---------------------------------------------
John F. Lang
Vice President, Treasurer and
Chief Accounting Officer (Principal Financial
Officer and Principal Accounting Officer)
-21-
<PAGE> 22
Exhibit Index
-------------
Exhibit No. Description
- ----------- -----------
27 Financial Data Schedule
-22-
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS OF PROFESSIONALS GROUP,
INC. AS OF MARCH 31, 1999 AND FOR THE THREE MONTH PERIOD THEN ENDED. (IN
THOUSANDS)
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<DEBT-HELD-FOR-SALE> 640,049
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 4,200
<MORTGAGE> 0
<REAL-ESTATE> 415
<TOTAL-INVEST> 701,537
<CASH> 2,963
<RECOVER-REINSURE> 565
<DEFERRED-ACQUISITION> 1,002
<TOTAL-ASSETS> 932,889
<POLICY-LOSSES> 556,110
<UNEARNED-PREMIUMS> 68,793
<POLICY-OTHER> 26,924
<POLICY-HOLDER-FUNDS> 10,094
<NOTES-PAYABLE> 20,000
0
0
<COMMON> 8,383
<OTHER-SE> 214,667
<TOTAL-LIABILITY-AND-EQUITY> 932,889
38,681
<INVESTMENT-INCOME> 9,217
<INVESTMENT-GAINS> 1,721
<OTHER-INCOME> 1,047
<BENEFITS> 32,866
<UNDERWRITING-AMORTIZATION> 0
<UNDERWRITING-OTHER> 8,379
<INCOME-PRETAX> 8,532
<INCOME-TAX> 1,877
<INCOME-CONTINUING> 6,655
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 6,655
<EPS-PRIMARY> 0.79
<EPS-DILUTED> 0.78
<RESERVE-OPEN> 540,583
<PROVISION-CURRENT> 33,513
<PROVISION-PRIOR> (897)
<PAYMENTS-CURRENT> 4,053
<PAYMENTS-PRIOR> 31,199
<RESERVE-CLOSE> 556,110
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
