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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K/A-1
(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, 1998
/ / Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For the Period From _________ to __________.
Commission File Number: 001-14593
THE MIIX GROUP, INCORPORATED
(Exact name of Registrant as specified in its charter)
DELAWARE 22-3586492
(State or other jurisdiction of incorporation or (I.R.S. employer
organization) identification number)
TWO PRINCESS ROAD, LAWRENCEVILLE, NEW JERSEY 08648
(Address of principal executive offices and zip code)
(609) 896-2404
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the
Act: Common Stock, par value $.01 per share
Securities registered pursuant to Section 12(g) of the Act: None
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 periods as the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
YES / / NO /X/
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. /X/
No securities are held by non-affiliates of the Registrant.
As of March 29, 1999, the number of outstanding shares of the
Registrant's Common Stock was 10.
DOCUMENTS INCORPORATED BY REFERENCE
No proxy statement, annual report to security holders or prospectus
filed pursuant to Rule 424(b) under the Securities Act of 1933 is incorporated
by reference into this Report on Form 10-K.
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The Private Securities Litigation Reform Act of 1995 provides a "safe harbor"
for forward-looking statements. This Form 10-K, the Company's Annual Report to
Stockholders, any Form 10-Q or any Form 8-K of the Company or any other written
or oral statements made by or on behalf of the Company may include
forward-looking statements which reflect the Company's current views with
respect to future events and financial performance. These forward-looking
statements are subject to uncertainties and other factors that could cause
actual results to differ materially from such statements. These uncertainties
and other factors (which are described in more detail elsewhere in this Form
10-K) include, but are not limited to: (i) the Company having sufficient
liquidity and working capital; (ii) the Company's strategy to seek consistent
profitable growth; (iii) the Company's ability to increase its market share;
(iv) the Company's ability to diversify its product lines; (v) the Company's
ability to expand into additional states; (vi) the Company's avoidance of any
material loss on collection of reinsurance recoverables; (vii) the continued
adequacy of the Company's loss and LAE reserves and (viii) the Company's ability
to consummate the underwritten Public Offering described herein. The words
"believe," "expect," "anticipate," "project," and similar expressions identify
forward-looking statements. Readers are cautioned not to place undue reliance on
these forward-looking statements, which speak only as of their dates. The
Company undertakes no obligation to publicly update or revise any
forward-looking statements, whether as a result of new information, future
events or otherwise.
PART I
ITEM 1. BUSINESS
OVERVIEW
The MIIX Group, Incorporated ("The MIIX Group") was organized as a Delaware
corporation in October 1997 and is currently a wholly owned subsidiary of the
Medical Inter-Insurance Exchange of New Jersey, a New Jersey reciprocal insurer
(the "Exchange"). The Exchange has adopted a plan of reorganization (the "Plan
of Reorganization," and together with the transactions contemplated thereby, the
"Reorganization"), pursuant to which the Exchange will reorganize as a stock
insurer and become a wholly owned subsidiary of The MIIX Group. In connection
with the Reorganization, up to 12,025,000 shares of Common Stock (the
"Reorganization Shares") of The MIIX Group will be distributed to eligible
current and former members of the Exchange ("Distributees").
As explained below, New Jersey State Medical Underwriters, Inc., a New Jersey
corporation (the "Attorney-in-Fact"), carries out all the Exchange's operations
pursuant to a management agreement. Upon the consummation of the Reorganization,
the assets and liabilities of the Exchange (except for the Common Stock and cash
to be distributed in the Reorganization) will be assumed by MIIX Insurance
Company, a newly formed New Jersey stock insurer ("MIIX Insurance"), MIIX
Insurance and the Attorney-in-Fact will become wholly-owned subsidiaries of The
MIIX Group, and the Exchange will be dissolved. Therefore, for purposes of
discussing business, strategies, risk factors, and other operational issues,
throughout this Report, the term "Company" refers (i) at all times prior to the
closing date of the Reorganization (the "Closing Date"), to the Exchange and its
subsidiaries and the Attorney-in-Fact and its subsidiaries, collectively, and
(ii) at all times after the Closing Date, to The MIIX Group and its
subsidiaries. However, the Exchange and the Attorney-in-Fact are currently
distinct entities. When discussing historical financial information, throughout
this Report, the term "Company" includes the Exchange and its subsidiaries but
excludes the Attorney-in-Fact and its subsidiaries. The historical financial
results of the Attorney-in-Fact are not significant in relation to the
historical financial results of the Exchange.
For purposes of this Report, the term "Insurance Subsidiaries" refers, at all
times prior to the Closing Date, to Lawrenceville Property and Casualty Co.,
Inc. ("LP&C"), MIIX Insurance Company of New York ("MIIX New York") and
Lawrenceville Re, Ltd. ("Lawrenceville Re") and, at all times on or after the
Closing Date, to MIIX Insurance, LP&C, Lawrenceville Re and MIIX New York.
Based on direct premiums written in 1998, the Company is the leading provider of
medical professional liability insurance in New Jersey and is ranked 8th among
medical professional liability insurers in the United States. The Company
currently insures approximately 16,500 physicians and other medical
professionals who practice alone, in medical groups, clinics or in other health
care organizations. The Company also insures more than 198 hospitals, extended
care facilities, HMOs and other managed care organizations. The Company's
business has historically been concentrated in New Jersey but has expanded to
other states in recent years. The Company currently writes policies in 20 states
and the District of Columbia. In 1998, approximately 50% of the Company's total
direct premiums written were generated outside of New Jersey. In addition to the
Company's medical malpractice insurance operations, the Company also offers a
broad range of complementary insurance products to its insureds and operates
several fee-based consulting and other businesses.
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Medical professional liability insurance, also known as medical malpractice
insurance, insures the physician, other medical professional or health care
institution against liabilities arising from the rendering of, or failure to
render, professional medical services. Under the typical medical professional
liability policy, the insurer also is obligated to defend the insured against
alleged claims.
In 1998, total medical professional liability direct premiums written in the
United States were approximately $6.0 billion, according to data compiled by
A.M. Best, an insurance rating agency and in New Jersey were approximately
$273.4 million, according to data compiled by OneSource Information Services,
Inc. ("OneSource"), an online data service. The Company's market share of such
direct premiums written was 3.8% in the United States according to data compiled
by A.M. Best and 41% in New Jersey according to data compiled by OneSource. In
1998, medical malpractice insurance accounted for approximately 97% of the
Company's direct premiums written.
The Company had total revenues and net income of $264.9 million and $29.7
million, respectively, for 1998 and $190.4 million and $29.1 million,
respectively, for 1997. As of December 31, 1998, the Company had total assets of
$1.7 billion and total equity of $322.8 million.
The Exchange was organized as a New Jersey reciprocal insurance exchange in
1977. A New Jersey reciprocal insurance exchange is an entity that may be formed
by persons seeking a particular type of insurance coverage. In the case of the
Exchange, medical and osteopathic physicians formed the Exchange to provide
medical malpractice insurance. Under New Jersey law, the business of a
reciprocal insurance exchange must be conducted by a separate entity acting as
the attorney-in-fact of such exchange.
The Attorney-in-Fact is a corporation that is wholly owned by the Medical
Society of New Jersey (the "Medical Society") and was originally formed to
fulfill the statutory role of the attorney-in-fact for the Exchange. In recent
years the Attorney-in-Fact has diversified its business, but its principal
activity continues to be managing the Exchange. The Attorney-in-Fact manages the
Exchange, subject to the supervision of the Board of Governors of the Exchange
(the "Board of Governors"), pursuant to a management contract that requires the
Exchange to reimburse the costs of the Attorney-in-Fact. In addition to the
power of attorney contained in such management contract, each member of the
Exchange is required to execute a power of attorney in favor of the
Attorney-in-Fact to affirm the Attorney-in-Fact's power to act on behalf of the
Exchange pursuant to the management contract.
The rights of a member of the Exchange are similar to the rights of a
policyholder of other types of insurance companies. Because members of the
Exchange are accorded certain voting rights, members' rights are more closely
analogous to the rights of a person insured by a mutual insurance company than
the rights of a person insured by a stock insurance company. Members' rights
include the right to elect the Board of Governors, which has supervisory
authority over the Attorney-in-Fact. Therefore, while the day-to-day affairs of
the Exchange are managed by the Attorney-in-Fact, the Exchange is ultimately
controlled by its members through their power to elect the Board of Governors.
The Exchange has been operated to generate profits. Such profits are part of the
Exchange's surplus account, and the application of such profits is in the
Exchange's discretion. Neither the Attorney-in-Fact nor the Medical Society owns
the Exchange or has any right to profits generated by the Exchange.
The Exchange is permitted by law to engage in any line of insurance permitted by
its rules and regulations, its certificate of authority, and applicable New
Jersey laws. All aspects of the Exchange's operations are regulated by state
regulatory authorities, particularly the regulatory authorities of New Jersey,
which is the state in which the Exchange is domiciled. State laws regulate the
process of soliciting insurance, the underwriting of insurance, the rates
charged, the nature of insurance products sold, the financial accounting methods
of the insurer, the amount of money required to be maintained by the insurer to
guard against insolvency, and many other aspects of the day-to-day operations of
the Exchange. See "Business -- Regulation."
The wholly owned subsidiaries of the Attorney-in-Fact offer a wide range of
reinsurance products, healthcare and financial consulting services to the
medical profession, healthcare institutions and other parties unrelated to the
Company.
Hamilton National Leasing is a middle-market leasing company for medical and
other equipment primarily to parties unrelated to the Company. Pegasus Advisors,
Inc. is a reinsurance consultant/broker specializing in the design and placement
of customized reinsurance programs for the Company and other unrelated insurance
and reinsurance companies. Medical Brokers, Inc., fully licensed in New Jersey,
provides insurance broker services and sells other insurance not underwritten by
the Exchange. MIIX Healthcare Group, Inc. provides comprehensive consulting
services designed to assist physicians, institutions and organizations in the
healthcare industry. Lawrenceville Re is a reinsurance company domiciled in
Bermuda designed to provide customized reinsurance solutions to large health
care institutions.
The Exchange was initially capitalized through the issuance of
non-interest-bearing subordinated loan certificates in an aggregate principal
amount of $22.9 million. These certificates were issued in varying principal
amounts to many of the physicians who were initial members. The loan
certificates have been redeemed, with the last such redemption occurring in
1995. As an insurer, the Exchange is required to maintain levels of capital and
surplus as determined by the insurance regulators of certain states. See
"Business -- Regulation -- Insurance Company Regulation."
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American Medical Mutual, Inc., a Vermont domiciled risk retention group ("AMM"),
is an underwriter of professional liability insurance for physicians. AMM is
managed by the Attorney-in-Fact through an insurance services agreement. All
medical professional liability coverage written by AMM is reinsured by the
Exchange under a quota share contract and two excess of loss contracts.
THE REORGANIZATION AND DISTRIBUTION
The Exchange is currently organized as a New Jersey reciprocal insurer, and
accordingly has no stockholders. Since the Exchange's inception, the business of
the Exchange has been managed by the Attorney-in Fact, which is a wholly owned
subsidiary of the Medical Society, under the supervision of the Board of
Governors. On October 15, 1997, the Board of Governors adopted the Plan of
Reorganization. A special meeting for members of the Exchange was held March 17,
1999 to vote on the Plan of Reorganization. The Plan of Reorganization was
approved by members of the Exchange at a special meeting held on March 17, 1999.
The key components of the Plan of Reorganization are set forth below.
- The Exchange has formed a new subsidiary, The MIIX Group. The
purpose of The MIIX Group is to act, when the Reorganization
is consummated, as a holding company for MIIX Insurance and
the Exchange's other subsidiaries, and the Attorney-in-Fact
and its subsidiaries. The MIIX Group is the entity that will
issue Common Stock in the Reorganization and in an anticipated
underwritten public offering (the "Public Offering") of Common
Stock. The Company expects to consummate the Public Offering,
if at all, simultaneously with the Reorganization.
- The MIIX Group has formed a new subsidiary, MIIX Insurance.
MIIX Insurance was formed to assume, when the Reorganization
is consummated, all of the Exchange's assets and liabilities
(except for the Common Stock and cash to be distributed
pursuant to the Reorganization), including insurance policies
written by the Exchange. After consummation of the
Reorganization, MIIX Insurance will continue the Exchange's
business of writing insurance policies and the Exchange will
be dissolved. In consideration of the foregoing assignments by
the Exchange to MIIX Insurance, The MIIX Group will issue
shares (the "Reorganization Shares") to the Exchange.
- The MIIX Group will acquire the Attorney-in-Fact from the
Medical Society for $11 million worth of Common Stock and
$100,000 in cash.
- When the Exchange is dissolved, the Reorganization Shares will
be distributed to the Distributees.
- Each Distributee will be allocated approximately
.0341 Reorganization Shares for each dollar of direct
premiums, less return premiums, paid by such
Distributee to the Exchange during the three years
prior to October 15, 1997.
- If a Distributee is allocated fewer than 100 shares
of Common Stock, or if such Distributee's address as
shown on the records of the Exchange is outside the
United States or is an address to which mail is
undeliverable, such Distributee will receive cash in
lieu of Common Stock. Distributees who receive cash
in lieu of Common Stock will receive an amount of
cash equal to the product of (i) the number of shares
of Common Stock which they would otherwise be
entitled to receive and (ii) the value of the Common
Stock when the reorganization is consummated
("Conversion Value"). The "Conversion Value" means
either (i) the price at which the Common Stock is
offered to the public in the event the Public
Offering is consummated simultaneously with the
Reorganization, or (ii) if the Public Offering is not
so consummated, then the economic value of the Common
Stock as determined in good faith by the Board of
Governors.
- To the extent that a Distributee receives cash in
lieu of Common Stock, the Common Stock otherwise
distributable to such Distributee will not be
distributed to other Distributees. Thus, fewer than
12,025,000 shares of Common Stock will be distributed
to the Distributees pursuant to the Reorganization.
The Company currently estimates that approximately
11,917,000 shares of Common Stock will be distributed
to the Distributees pursuant to the Reorganization.
Cash payments will be made from the Company's
existing cash reserves.
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Thus, when the Reorganization is consummated, (i) the Exchange will be
dissolved, (ii) the Distributees will receive Common Stock or cash, (iii) MIIX
Insurance will assume the assets and liabilities of the Exchange (except for the
Common Stock and cash to be distributed pursuant to the Reorganization), and
(iv) The MIIX Group will be the holding company for MIIX Insurance and the other
subsidiaries of the Exchange, and for the Attorney-in-Fact and its subsidiaries.
These steps will occur simultaneously.
REGULATORY APPROVALS
On March 5, 1998, the Commissioner (the "Commissioner") of the New Jersey
Department of Banking and Insurance (the "New Jersey Department") approved the
Plan of Reorganization, subject to two conditions. First, the Commissioner must
approve the formation of MIIX Insurance. This approval was obtained on August 3,
1998. Second, the Reorganization must be approved by the affirmative vote of not
less than two-thirds of those Members voting in person or by proxy. This
approval was obtained on March 17, 1999. On January 14, 1999, the New Jersey
Department approved an amendment to the Plan of Reorganization extending the
time for its consummation to September 5, 1999.
Pursuant to the Plan of Reorganization, MIIX Insurance is to assume all the
assets of the Exchange (except for the Common Stock and cash to be distributed
in the Reorganization). However, insurance licenses cannot be transferred.
Accordingly, MIIX Insurance must obtain regulatory approval to become an
admitted carrier in each of the eight states other than New Jersey in which the
Exchange is currently licensed. These states are Connecticut, Delaware,
Kentucky, Maryland, Michigan, Pennsylvania, Vermont and West Virginia. MIIX
Insurance has obtained such approval in Pennsylvania, Delaware, Vermont and
Michigan. These states must also approve MIIX Insurance's rates, rules and
policy forms, which the Company expects initially will be a continuation of
those currently used by the Exchange. Pennsylvania and Delaware have approved
MIIX Insurance's policy forms. In addition, Virginia, which is LP&C's state of
domicile, must approve the change in LP&C's ultimate parent from the Exchange to
The MIIX Group, and New York, which is MIIX New York's state of domicile, must
approve the change in the ultimate parent of MIIX New York from the Exchange to
The MIIX Group. Such approval has been obtained in Virginia. See "Business --
Regulation." Finally, Connecticut, Delaware and West Virginia approvals and the
consent of the reinsurers will be required in connection with the assignment to
MIIX Insurance of the various reinsurance agreements under which the Exchange
cedes risk. All necessary reinsurer consents have been obtained. Other
miscellaneous approvals may be required in a number of states.
BUSINESS STRATEGY
The Company has adopted a strategy which it believes will allow it to compete
effectively and create long-term growth. To maximize the strategy's
effectiveness, the Company has adopted the Plan of Reorganization to convert
from a reciprocal insurer to a stock insurer, which will provide the Company
with greater flexibility and access to capital. The Company's strategy is to:
- continue to expand geographically by increasing the number of
states in which the Company writes policies;
- enhance product offerings to facilitate "one-stop shopping"
for the Company's extensive customer base;
- expand distribution channels;
- maintain underwriting discipline to seek to assure that
profitability, rather than premium volume, is emphasized;
- take advantage of strategic acquisition opportunities; and
- maintain the Company's historically close relationship with
the medical community.
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This strategy is designed to capitalize on the Company's strengths that have
enabled it to achieve its current market position, including (i) its experience
with, commitment to and focus on medical professional liability insurance, (ii)
its history of providing a stable premium environment to its customers, (iii)
the high level of service it delivers to insureds, including the aggressive
defense of claims on their behalf, (iv) its "A (Excellent)" rating by A.M. Best,
(v) its capacity on a per insured basis, (vi) its ability to customize product
features and programs to fit the needs of different customers and (vii) its
close relationship with the medical community.
Expand Geographically. From its inception in 1977 through 1990, all of the
Company's business was written in New Jersey. In 1991, the Company began to
write business in Pennsylvania and in 1996 began its expansion to other states.
Since 1996, the Company has expanded its operations significantly and currently
writes policies in 20 states and the District of Columbia. As a result of this
expansion, the proportion of the Company's business written in states other than
New Jersey has grown from approximately 11% in 1996 to 50% in 1998. In order to
facilitate continued geographic expansion, the Company is in the process of
obtaining authority to write medical professional liability policies in 10 other
states. Over time, the Company intends to become licensed to write insurance in
all 50 states, although the Company may choose not to write insurance in certain
states based on market or regulatory conditions. In addition, the Company has
opened four regional sales and customer support offices to assist its marketing
efforts outside of New Jersey.
Enhance Product Offerings. In addition to its core medical professional
liability insurance products, the Company has developed other products and
services for health care institutions. Additional products currently offered
include comprehensive liability coverage for medical offices, directors and
officers, managed care errors and omissions, employment practices, fiduciary,
property and worker's compensation. Most of these coverages are underwritten by
the Company; several products are marketed by the Company and underwritten by
other insurance carriers with which the Company has developed strategic
alliances. The Company has also introduced the option for large health care
institutions to purchase excess insurance coverage on a multi-year basis for a
guaranteed prepaid premium. The Company intends to continue to increase the
number of products it offers to its customer base in order to be able to provide
them with a full range of coverages.
Expand Distribution Channels. The Company has traditionally written insurance on
a direct basis in New Jersey. In connection with the Company's expansion outside
New Jersey, the Company has increasingly utilized brokers and agents. In 1998,
63% of the Company's direct premiums written were generated through independent
brokers and agents. By increasing its use of this distribution channel, the
Company will be better positioned to achieve growth. In order to expand its
distribution channels further, the Company intends to develop additional
relationships with selected brokers and agents who have demonstrated expertise
in the medical malpractice insurance market.
Maintain Underwriting Discipline. The Company's experience with, commitment to
and focus on medical professional liability insurance for over 20 years has
allowed it to develop strong knowledge of the market and to build an extensive
database of medical malpractice claims experience. The Company takes advantage
of this specialized expertise in medical professional liability insurance to set
premiums that it believes are appropriate for exposures being insured. As the
Company expands its business, the Company intends to maintain underwriting
discipline and emphasize profitability over premium growth.
Take Advantage of Strategic Acquisition Opportunities. The Company believes that
the Reorganization will better position the Company to make strategic
acquisitions by providing greater access to capital as a source of financing and
creating an attractive stock acquisition currency. The Company believes that
consolidation will continue in the medical professional liability insurance
industry and that opportunities to make a strategic acquisition may arise, thus
providing an effective way to expand the Company's business, product offerings
and geographic scope.
Maintain Close Relationship with the Medical Community. Since its founding in
1977, the Company has maintained a close relationship with the medical
community. In addition to the active involvement of practicing physicians on
several of the Company's advisory committees, the Company and the medical
professional liability insurance that it offers have the endorsements of
different medical associations. The Company will continue to utilize practicing
physicians on advisory committees to provide management with input on medical
practice patterns, claims, customer needs and other relevant matters. In
addition, the Company will endeavor to maintain its endorsements.
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PRODUCT OFFERINGS
The Company has developed a variety of insurance products to cover the
professional liability exposure of individual and institutional health care
providers. The Company's core products include medical professional liability
insurance for individual providers, medical groups and health care institutions
on a claims made, "modified claims made" or occurrence basis.
In New Jersey, the Company offered physicians traditional occurrence coverage
from 1977 through 1986 and has offered a form of occurrence-like coverage,
"modified claims made," from 1987 to the present. The Company's modified claims
made policy is called the Permanent Protection Plan (the "PPP"). Under the PPP,
coverage is provided for claims reported to the Company during the policy period
arising from incidents since inception of the policy. The PPP includes "tail
coverage" for claims reported after the expiration of the policy for occurrences
during the policy period. The premium for tail coverage is included as part of
the annual premium, and the insured physician automatically receives tail
coverage when the policy is terminated for any reason. The automatic provision
for tail coverage in effect results in occurrence-like coverage provided under
the PPP.
Traditional claims made coverage is offered to institutions in New Jersey. In
Pennsylvania traditional occurrence coverage is primarily offered to physicians
and traditional claims made coverage is primarily offered to institutions. In
other states, the Company issues policies primarily on a claims made coverage
basis to physicians and institutions. Tail coverage may be offered as an
endorsement to those accounts written on a pure claims made basis to extend the
period when losses could be reported to the Company. Additional premium is
collected at the time such endorsement is purchased by the insured. In a number
of states, the Company offers policy limits up to $10,000,000 per incident and
$12,000,000 in the aggregate for individual physicians. Policy limits of up to
$75,000,000 per incident and in the aggregate are offered to institutions and
medical groups.
In addition to its core medical professional liability insurance products, the
Company has developed other products and services for health care institutions.
Expanded products offered include comprehensive liability coverage for medical
offices, directors and officers, managed care errors and omissions, employment
practices, fiduciary, property and worker's compensation.
For premises liability and property exposures of medical offices, the Company
offers the Medical Office Policy written on an occurrence basis. Commercial
general liability coverage is offered on an occurrence basis only.
Excess/umbrella liability covers excess of underlying policies or self-insured
retentions. Directors and officers coverage and errors and omissions coverage
are offered on a claims made basis. The Company has also introduced the option
for large health care institutions to purchase excess insurance coverage on a
multi-year basis for a guaranteed prepaid premium. Such coverages are also
available with reinstatement options, combined with the ability to pre-purchase
such options at the inception of the policy. The Company underwrites most of
these coverages, and the remaining coverages are marketed by the Company and
underwritten by other insurance carriers with which the Company has developed
strategic alliances.
Substantially all of the Company's policies are offered for periods of one year,
with renewal occurring on the anniversary date of the policy inception. Premiums
are recorded as earned over the life of the policy period. The PPP policy
provides occurrence-like coverage, and accordingly the premiums are earned in
the period the policy is written consistent with the recording of the expected
ultimate loss and LAE reserves on an occurrence basis. A profile of the
Company's direct premiums written is summarized in the table below.
<TABLE>
<CAPTION>
For the Year Ended December 31,
-------------------------------------------------------------------------------
1998 1997 1996
------------------------ ----------------------- -----------------------
(in thousands)
% of % of % of
$ total $ total $ total
------------ -------- ----------- -------- ----------- --------
<S> <C> <C> <C> <C> <C> <C>
Professional Liability Products
Occurrence/Occurrence-like $141,437 61% $127,610 79% $131,565 92%
Claims Made 82,543 36% 31,195 19% 9,660 7%
Other Products 6,334 3% 3,625 2% 1,993 1%
======== === ======== ===== ======== ===
Direct Premiums Written $230,314 100% $162,430 100% $143,218 100%
======== === ======== ===== ======== ===
</TABLE>
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As the Company expands its operations into additional states beyond New Jersey
and Pennsylvania, the Company expects that the majority of the policies issued
in such additional states will be on a claims made basis. As a result, the
Company expects the profile of its direct written premiums to be significantly
different in the future. When claims made coverage is more significant as a
percentage of the Company's business, loss reserves may develop more rapidly.
See "Business-- Loss and LAE Reserves."
MARKETING AND POLICYHOLDER SERVICES
The Company employs various strategies for marketing its products and providing
policyholder services. In New Jersey, the Company markets its products to
physicians and physician groups principally through medical associations,
referrals by existing policyholders, advertisements in medical journals,
seminars on health care topics for physicians, and direct mail solicitation. The
Company's professional liability program has the endorsement of different
medical associations. In addition to these direct marketing channels, the
Company sells its products through independent brokers and agents who currently
produce approximately 27% of the Company's direct premiums written in New
Jersey. Health care institutions frequently prefer brokers over direct
solicitation when they purchase professional liability insurance, and the
Company believes that its broker relationships in New Jersey are important to
its ability to grow in that market segment. To provide localized marketing and
policyholder services in New Jersey and nationally, the Company has established
five regional offices. See "Business-- Business Strategy -- Maintain Close
Relationship with the Medical Community."
Outside New Jersey, the Company markets its products exclusively through
independent brokers and agents. In 1998, 107 independent brokers and agents
actively marketed the Company's products in 20 states and the District of
Columbia and produced approximately 63% of the Company's direct premiums written
on a national basis. No national broker or regional agency accounted for more
than 11% of the Company's year-end direct premiums written. The Company selects
brokers and agents that it believes have demonstrated growth and stability in
the medical malpractice insurance industry, strong sales and marketing
capabilities, and a focus on selling medical professional liability insurance.
Brokers and agents receive market rate commissions and other incentives based on
the business they produce. The Company strives to maintain relationships with
those brokers and agents who are committed to promoting the Company's products
and are successful in producing business for the Company. See "Business--
Business Strategy -- Expand Distribution Capabilities."
The Company also provides risk management services through its home office and
regional offices. In addition to supplementing the Company's marketing efforts,
these services are designed to reduce potential loss exposures by educating
policyholders on ways to improve medical practice and implement risk reduction
measures. The Company conducts surveys for hospitals and large medical groups to
review their practice procedures and to focus on specific areas in which
concerns arise. The Company prepares reports that identify areas of the
insured's medical practice that may need attention and provides recommendations
to the policyholder. The Company also presents periodic seminars for medical
societies and other groups to educate physicians on risk management techniques.
These educational programs are designed to increase risk awareness and to reduce
the risk of injury to patients and third parties.
UNDERWRITING
The Company maintains a dual underwriting function at its home office and at
each regional office. The home office Underwriting Department is responsible for
the underwriting and servicing of all institutional accounts and individual
providers that exceed the regional office underwriting authority. In addition,
the home office Underwriting Department is responsible for the issuance,
establishment and implementation of underwriting standards for all of the
coverages underwritten by the Company.
The Company's regional office underwriting staff have the authority to evaluate,
approve and issue medical professional liability coverage for individual
providers and medical groups with annual premiums up to a threshold amount.
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<PAGE> 9
The Company follows consistent and strict procedures with respect to the
issuance of all professional liability insurance policies. Individual providers
are required to submit an application for coverage along with supporting claims
history and proof of licensure. The individual provider applications provide
information regarding the medical training, current practice and claims history
of the applicant. Institutions are required to submit an application for
coverage, hard copy loss runs, proof of accreditation, financial statements,
copies of contracts with medical providers, information on employed
professionals and other information. An account analysis form is completed for
each submission and, if coverage is approved, the coverage recommendation and
the pricing methodology is added.
Risk management surveys may be performed prior to quoting a large account to
ascertain the insurability of the risk. All written accounts are referred to the
Risk Management Department to schedule risk management services. Representatives
from the Risk Management Department meet with the insured institution to develop
programs to control and reduce risk.
The Underwriting Department meets periodically with the Underwriting Committee
to review the guidelines for premium surcharges, cancellations and non-renewals
and any candidate for cancellation or non-renewal. The Underwriting Committee is
composed solely of physicians who are members of either the Board of Governors
or the Board of Directors of the Attorney-in-Fact and are insured by the
Company. Members of the Underwriting Committee are not employees of the Company.
The Company maintains quality control through periodic audits at the
underwriting and processing levels. Renewal accounts are underwritten as
thoroughly as new accounts. Insureds who no longer meet underwriting guidelines
are identified as non-renewal candidates. All non-renewal candidates are
referred to the home office Underwriting Department and discussed with the
Underwriting Committee to approve the Underwriting Department's recommendations.
PRICING
The Company establishes, through its own actuarial staff and independent
consulting actuaries, rates and rating classifications for its insureds based on
loss and LAE experience it has developed and on other relevant information. The
Company has various rating classifications based on practice location, medical
specialty and other factors. The Company applies various discounts, including
discounts for part-time practice, physicians just entering medical practice,
large medical groups and claims experience. The Company has established its
premium rates and ratings classifications for hospitals and managed care
organizations using actuarially significant data filed publicly by other
insurers.
CLAIMS
The Company's Claim Department is responsible for claims investigation,
establishment of appropriate case reserves for loss and ALAE, defense planning
and coordination, supervision of attorneys engaged by the Company to defend a
claim, and negotiation of the settlement or other disposition of a claim. All of
the Company's primary policies require it to defend its insureds. Medical
malpractice claims often involve the evaluation of highly technical medical
issues, severe injuries, and conflicting medical opinions. In almost all cases,
the person bringing the claim against the insured is already represented by
legal counsel when the claim is reported to the Company.
Litigation defense is provided almost exclusively by private law firms with
lawyers whose primary focus is defending malpractice cases. The Company also
maintains a staff counsel office located in New Jersey to defend malpractice
cases.
The claims representatives at the Company have on average 10 years of experience
handling medical professional liability cases. The Company limits the average
number of cases handled per claims representative to ensure personal attention
to each case.
The claims operation is assisted in its efforts by its technical unit, which is
responsible for training and educating the claims staff. The technical unit
manages the Company's relationship with defense counsel and helps control ALAE
associated with claims administration. The unit also is responsible for tracking
developments in case law and coordinating mass tort litigation.
A major resource for the Company's claims function is its database built over a
20-year period. The database provides comprehensive details on each claim, from
incident to resolution, coupled with a document file relating to each claim. The
database enables the Company's claims professionals to analyze trends in claims
by specialty, type of injury, precipitating causes, frequency and severity,
plaintiffs' counsel, expert witnesses, and other factors. The Company also uses
the data to identify and analyze trends and to develop seminars to educate
individual physicians, physician groups, hospital staff, and other insureds on
risk management to control and reduce their exposure to claims.
9
<PAGE> 10
LOSS AND LAE RESERVES
Loss reserves recorded by the Company include estimates of amounts owed for
losses and for LAE. LAE consists of two types of costs, allocated loss
adjustment expenses ("ALAE") and unallocated loss adjustment expenses ("ULAE").
ALAE are settlement costs that can be allocated to a specific claim such as
attorney fees and court costs. ULAE consists of costs that are general in nature
and cannot be allocated to any specific claim, primarily including salaries and
overhead associated with the Company's claim department. ULAE reserves recorded
by the Company represent management's best estimate of the internal costs
necessary to settle all incurred claims, including IBNR claims.
The determination of loss and LAE reserves involves the projection of ultimate
losses through an actuarial analysis of the claims history of the Company and
other professional liability insurers, subject to adjustments deemed appropriate
by the Company due to changing circumstances. Included in the Company's claims
history are losses and LAE paid by the Company in prior periods, and case
reserves for anticipated losses and ALAE developed by the Company's claim
department as claims are reported and investigated. Management relies primarily
on such historical loss experience in determining reserve levels on the
assumption that historical loss experience provides a good indication of future
loss experience despite the uncertainties in loss trends and the delays in
reporting and settling claims. As additional information becomes available, the
estimates reflected in earlier loss reserves may be revised. Any increase in the
amount of aggregate reserves reported in the financial statements, including
reserves for insured events of prior years, could have an adverse effect on the
Company's results of operations for the period in which the adjustments are
made.
There are significant inherent uncertainties in estimating ultimate losses in
the casualty insurance business and these uncertainties are increased in periods
when a company is expanding into new markets with new distribution channels. The
uncertainties are even greater for companies writing long-tail casualty
insurance, such as medical malpractice insurance, and in particular the
occurrence or occurrence-like coverages that substantially make up the Company's
current reserves. These additional uncertainties are due primarily to the longer
period of time during which an insured may seek coverage for a claim in respect
of an occurrence or occurrence-like policy as opposed to a claims made policy.
With the longer claim reporting and development period, reserves are more likely
to be impacted by, among other factors, changes in judicial liability standards
and interpretation of insurance contracts, changes in the rate of inflation and
changes in the propensities of individuals to file claims.
The Company offered traditional occurrence coverage from 1977 through 1986 and
has offered a form of occurrence-like coverage, "modified claims made," from
1987 to the present. The Company's modified claims made policy is the PPP. See
"Business-- Product Offerings." Under the PPP, coverage is provided for claims
reported to the Company during the policy period arising from incidents since
inception of the policy. The PPP includes "tail coverage" for claims reported
after expiration of the policy for occurrences during the policy period and thus
is reserved on an occurrence basis. Loss and LAE reserves carried for PPP
policies and traditional occurrence policies constitute approximately 87% of the
gross loss and LAE reserves at December 31, 1998.
The following table provides a summary of gross loss and LAE reserves by policy
type.
Gross Loss and Loss Adjustment Expense Reserves by Policy Type
(in thousands)
<TABLE>
<CAPTION>
Professional Liability
------------------------------------------------------
Occurrence/ % of Claims % of % of Total Gross
Occurrence-Like Total Made Total Other Total Reserves
---------------- -------- --------- -------- ---------- ------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Gross Reserves Held as of:
December 31, 1996 $759,324 95.4% $21,338 2.7% $14,787 1.9% $795,449
December 31, 1997 818,129 93.4% 42,423 4.8% 16,169 1.8% 876,721
December 31, 1998 825,636 86.8% 104,759 11.0% 21,264 2.2% 951,659
</TABLE>
As displayed in the above table, the proportion of the gross loss and LAE
reserves held on claims made professional liability policies has grown from 2.7%
of total gross loss and LAE reserves held at December 31, 1996 to 11.0% at
December 31, 1998. This is a result of the Company's expansion into new states
during 1997 and 1998. The majority of policies sold in these new states have
been claims made.
10
<PAGE> 11
Since a significant portion of the Company's reserves are recorded on an
occurrence basis, and given the long time that typically elapses between the
coverage incident and the resolution of the claim, IBNR reserves have
consistently represented a majority of the gross reserves recorded by the
Company. The following table summarizes the components of gross loss and LAE
reserves including ULAE reserves, and indicates that IBNR reserves constitute a
majority of gross reserves on a consistent basis:
Components of Gross Loss and Loss Adjustment Expense Reserves
(in thousands)
<TABLE>
<CAPTION>
Loss and Loss and Total
ALAE Case % of ALAE IBNR % of ULAE % of Gross
Reserves Total Reserves Total Reserves Total Reserves
------------- -------- ------------ -------- ---------- ------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Gross Reserves Held as of:
December 31, 1996 $272,570 34.2% $500,037 62.9% $22,842 2.9% $795,449
December 31, 1997 260,779 29.8% 591,158 67.4% 24,784 2.8% 876,721
December 31, 1998 299,178 31.4% 623,842 65.6% 28,639 3.0% 951,659
</TABLE>
The Company has issued occurrence policies since 1977 and occurrence-like
policies since 1987. There is a significant lag in reporting of incidents or
occurrences inherent in the medical malpractice insurance industry. As a result
the Company continues to experience reported claims that are alleged to have
occurred as far back as 1977. As of December 1998, 93 claims related to accident
years 1977-1981 are still outstanding, the majority of which have been reported
to the Company over the last five years.
The following table illustrates the amount and percentage of gross loss and LAE
reserves held by the Company at December 31, 1998 categorized by accident year.
Gross Loss and Loss Adjustment Expense Reserves By Accident Year
As of December 31, 1998
(in thousands)
<TABLE>
<CAPTION>
Accident Year Gross Reserves % of Total
- ---------------------------------------------- -------------- ------------
<S> <C> <C>
1977-81..................................... $ 3,188 .3%
1982........................................ 1,461 .2%
1983........................................ 1,580 .2%
1984........................................ 2,540 .3%
1985........................................ 2,285 .2%
1986........................................ 2,797 .3%
1987........................................ 4,450 .5%
1988........................................ 7,866 .8%
1989........................................ 10,404 1.1%
1990........................................ 13,146 1.4%
1991........................................ 29,913 3.1%
1992........................................ 27,840 2.9%
1993........................................ 61,828 6.5%
1994........................................ 97,569 10.3%
1995........................................ 139,319 14.6%
1996........................................ 155,229 16.3%
1997........................................ 177,174 18.6%
1998........................................ 213,070 22.4%
------------ ------
Total Gross Reserves held by the Company.... $ 951,659 100.0%
============ ======
</TABLE>
As shown in the above tables, at December 31, 1998: approximately 87% of gross
reserves are occurrence based; over 65% of gross reserves are IBNR reserves; and
over 82% of gross reserves relate to the most recent five accident years, which
are the most immature in terms of loss development.
11
<PAGE> 12
The Company uses a disciplined approach to setting and adjusting financial
statement loss and LAE reserves that begins with the claims adjudication
process. Claims examiners establish case reserves by a process that includes
extensive development and use of statistical information that allows for
comparison of individual claim characteristics against historical patterns and
emerging trends. This process also provides critical information for use in
pricing of products and establishing the IBNR component of the financial
statement reserves.
Initially, the Company establishes its best estimate of loss and LAE reserves
using pricing assumptions. The reserves are evaluated every quarter and annually
and are adjusted thereafter as circumstances warrant. These periodic evaluations
include a variety of loss development techniques that incorporate various data
accumulated in the claims settlement process including paid and incurred loss
data, accident year development statistics, and loss ratio analyses. Important
in these analyses are considerations of the amounts for which claims have
settled in comparison to case reserves held at settlement. Case reserves are
eliminated upon settlement of related claims. Actual settlement amounts above or
below case reserves are then regularly evaluated to determine whether estimated
ultimate losses by accident year, including IBNR reserves, should be adjusted.
Changes to aggregate reserves reported in the financial statements are made
based upon the extent and nature of these variances over the long claim
development period together with changes in estimates of the total number of
claims to be settled. As a final test of management's determination as to
whether it believes that aggregate reserves reported in the financial statements
are adequate and appropriate, management considers the detailed analysis
performed by the actuarial staff of its independent auditors in connection with
the audit of the Company's financial statements.
Recorded loss and LAE reserves represent management's best estimate of the
remaining costs of settling all incurred claims. While the Company believes that
its reserves for losses and LAE are adequate, there can be no assurance that the
Company's ultimate losses and LAE will not deviate, perhaps substantially, from
the estimates reflected in the Company's financial statements. If the Company's
reserves should prove inadequate, the Company will be required to increase
reserves, which could have a material adverse effect on the Company's financial
condition or results of operations.
Activity in the liability for unpaid losses and loss adjustment expenses gross
of reinsurance is summarized as follows:
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Balance as of January 1, gross of reinsurance
recoverable..................................... $876,721 $795,449 $748,660
Incurred related to:
Current year................................. 214,413 189,163 167,406
Prior years.................................. 3,822 205 --
-------- -------- --------
Total incurred.................................... 218,235 189,368 167,406
Paid related to: -------- -------- --------
Current year................................. 1,343 6,879 4,085
Prior years.................................. 141,954 101,217 116,532
-------- -------- --------
Total paid........................................ 143,297 108,096 120,617
-------- -------- --------
Balance at end of period, gross of reinsurance
recoverable..................................... 951,659 876,721 795,449
Reinsurance recoverable........................... 325,795 270,731 221,749
======== ======== ========
Balance at end of period, net of reinsurance...... $625,864 $605,990 $573,700
======== ======== ========
</TABLE>
12
<PAGE> 13
The aggregate reserves reported in the financial statements represent
management's best estimate of the remaining costs of settling all incurred
claims. The Company increased prior year gross reserves by $3.8 million and $0.2
million during 1998 and 1997, respectively. No adjustment to prior year
aggregate reserves was made in 1996. Notwithstanding management's analysis and
determination in setting its best estimate of aggregate reserves reported in the
financial statements, which may or may not require adjustments to aggregate
prior year reserves, management regularly evaluates, and adjusts when
appropriate, its estimates of accident year ultimate losses and LAE (i) as part
of its pricing analyses, (ii) as part of its evaluation of the effectiveness of
its reinsurance programs and (iii) for reporting to regulatory authorities such
as the Internal Revenue Service and the state insurance departments.
Accordingly, reserves established for losses and LAE on individual accident
years may experience greater volatility than aggregate reserves reported in the
Company's financial statements. Individual accident year reserves cover a
smaller amount of business over a shorter period of time than do the aggregate
reserves, which are an accumulation of reserves pertaining to all accident
years. Estimated ultimate losses and LAE associated with individual accident
years were adjusted in 1998, 1997 and 1996. The following table presents the
estimated ultimate losses and LAE gross of reinsurance (including changes in
such estimates) by accident year:
Accident Year Development
(in thousands)
<TABLE>
<CAPTION>
Changes in Estimated
Ultimate Losses and LAE
Estimated Ultimate for the Year Ended
Losses and LAE as of December 31, December 31,
---------------------------------------------------- --------------------------------------
Accident Year 1995 1996 1997 1998 1996 1997 1998
- ------------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
1988 and Prior $ 773,316 $ 766,100 $ 762,547 $ 766,847 $ (7,216) (3,553) $ 4,300
1989 105,775 105,766 102,249 99,315 (9) (3,517) (2,934)
1990 106,935 116,637 119,545 119,428 9,702 2,908 (117)
1991 114,598 119,310 121,531 121,454 4,712 2,221 (77)
1992 121,265 114,116 113,610 112,404 (7,149) (506) (1,206)
1993 137,316 137,279 140,304 121,990 (37) 3,025 (18,314)
1994 150,527 150,519 150,613 154,063 (8) 94 3,450
1995 161,296 161,301 156,099 165,973 5 (5,202) 9,874
1996 167,406 172,141 174,681 4,735 2,540
1997 189,163 195,469 6,306
1998 214,413
---------- ---------- ---------- ---------- ---------- -------- ----------
Total Estimated Ultimate Losses
and LAE $1,671,028 $1,838,434 $2,027,802 $2,246,037 -- $ 205 $ 3,822
---------- ---------- ---------- ---------- ========== ======== ==========
Less: Total Paid Loss and LAE $ 922,368 $1,042,985 $1,151,081 $1,294,378
---------- ---------- ---------- ----------
Gross Loss and LAE Reserves as
of December 31 $ 748,660 $ 795,449 $ 876,721 $ 951,659
========== ========== ========== ==========
</TABLE>
The accident year reserve development detailed in the above table is indicative
of the potential volatility of accident year reserve estimates. Management
believes that the level of volatility experienced and reflected therein, which
ranged up to plus or minus 15% of estimated accident year ultimate losses at
December 31, 1998, is not unreasonable for the medical malpractice line of
business.
Specific factors noted in management's actuarial analyses that gave rise to the
accident year development in 1998 included the following: reserves held on
accident years 1988 and prior were increased to reflect greater, but slower,
reserve development than had previously been projected. Reserves held on
accident years 1989 through 1992 were decreased to reflect lower than
anticipated loss severities somewhat offset by higher than anticipated LAE and
the longer expected development period. Reserves held on the 1993 accident year
were substantially reduced, reflecting lower than previously projected loss
frequency and severities on the occurrence-like PPP book. With six years of loss
experience with respect to the 1993 accident year, management believes there is
now sufficient actuarial confidence to adjust these very slowly developing
reserves. Reserves held on accident years 1994 through 1996 were increased,
primarily as a result of higher than anticipated losses on the hospital claims
made book of business. Reserves held on accident year 1997 were increased to
reflect higher than anticipated claim frequency on claims made business written
in certain expansion states, primarily Ohio and Texas. In addition, included in
the development for all accident years was $2.6 million of additional ULAE
reserves to reflect the anticipated longer development period in the PPP
occurrence-like book.
13
<PAGE> 14
Specific factors noted in management's actuarial analyses that gave rise to the
accident year development in 1996 and 1997 included: lower than expected claim
severity for accident years 1989 and prior, which management believes resulted
from the combined effects of tort reform in New Jersey and improvements made to
the internal claims settlement process; greater than expected claim frequency in
accident years 1990 and 1991, primarily resulting from increased claims filed
against physicians practicing in obstetrics and gynecology and internal medicine
specialties, frequency levels not seen in subsequent accident years; and less
than previously expected loss frequency and severity in accident year 1993.
Development in the 1995 and 1996 accident years largely pertained to adjustment
of reserves held on a specific medical professional liability program with a
large hospital group, and to development on other medical professional claims
made business once reported claims were known.
As previously discussed, approximately 87.0% of the Company's December 31, 1998
gross loss and LAE reserves are related to occurrence or occurrence-like
policies, which is down from 93.4% at December 31, 1997 and 95.4% at December
31, 1996. Management initially establishes its best estimate of reserves based
on the underlying pricing assumptions and adjusts those estimates over time as
significant developments in the legal environment or significant changes in
expected patterns of claim frequency and/or severity become apparent. However,
the Company is continuing to expand its operations into a number of states, and
the Company expects that the majority of the policies issued in such states will
be on a claims made basis. As a result, the Company believes that as claims made
reserves continue to comprise a greater percentage of aggregate reserves it is
likely that more frequent adjustments to aggregate reserves recorded in the
financial statements will become necessary because the reporting period for
claims made policies is shorter, which facilitates the ability of the Company to
more quickly determine ultimate losses.
On a net of reinsurance basis, the activity in the liability for unpaid losses
and LAE is summarized as follows:
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Balance as of January 1, net of
reinsurance recoverable ......................... $ 605,990 $ 573,700 $ 582,931
Incurred related to:
Current year ................................. 157,952 120,496 110,593
Prior years .................................. (2,084) -- --
--------- --------- ---------
Total incurred .................................... 155,868 120,496 110,593
--------- --------- ---------
Paid related to:
Current year ................................. 1,328 3,930 3,630
Prior years .................................. 134,666 84,276 116,194
--------- --------- ---------
Total paid ........................................ 135,994 88,206 119,824
--------- --------- ---------
Balance at end of period, net of
reinsurance recoverable ......................... 625,864 605,990 573,700
Reinsurance recoverable ........................... 325,795 270,731 221,749
--------- --------- ---------
Balance at end of period, gross of reinsurance $ 951,659 $ 876,721 $ 795,449
========= ========= =========
</TABLE>
Net loss and LAE reserves reported in accordance with statutory accounting
principles are lower than the net loss and LAE reserves displayed above. The
differences relate to a 1992 contract accounted for using deposit accounting for
GAAP reporting and amount to $103.3 million at December 31, 1998, $167.8 million
at December 31, 1997, and $173.4 million at December 31, 1996.
The following tables reflect the development of reserves for unpaid losses and
LAE, including reserves on assumed reinsurance, for the periods indicated at the
end of that year and each subsequent year. The first line shows the reserves as
originally reported at the end of the stated year. Reserves at each calendar
year-end include the estimated unpaid liabilities for that report or accident
year and for all prior report or accident years. The section under the caption
"Liability reestimated as of" shows the originally reported reserves as adjusted
as of the end of each subsequent year to reflect the cumulative amounts paid and
all other facts and circumstances discovered during each year. The line
"Cumulative redundancy" reflects the difference between the latest reestimated
reserves and the reserves as originally established. The section under the
caption "Cumulative amount of liability paid through" shows the cumulative
amounts paid through each subsequent year on those claims for which reserves
were carried as of each specific year end.
14
<PAGE> 15
The tables reflect the effect of all changes in amounts of prior periods. For
example, if a loss determined in 1995 to be $100,000 was first reserved in 1988
at $150,000, the $50,000 redundancy (original estimate minus actual loss) would
be included in the cumulative redundancy in each of the years 1988 through 1994
shown below. The tables present development data by calendar year and do not
relate the data to the year in which the claim was reported or the incident
actually occurred. Conditions and trends that have affected the development of
these reserves in the past will not necessarily recur in the future.
TABLE I. LOSS AND LAE RESERVES DEVELOPMENT - GROSS
<TABLE>
<CAPTION>
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997
---- ---- ---- ---- ---- ---- ---- ---- ---- ----
(in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
LOSS AND LAE RESERVES $453,181 $502,928 $554,076 $593,828 $629,064 $667,200 $688,455 $748,660 $795,449 $876,721
LIABILITY REESTIMATED AS
OF:
One year later 448,413 516,113 541,778 583,133 616,042 623,988 688,455 748,660 795,654 880,543
Two years later 468,853 503,199 529,531 570,108 572,831 623,986 688,450 744,130 793,170
Three years later 455,076 495,663 516,501 532,877 572,831 623,989 689,122 739,106
Four years later 444,454 482,667 487,918 532,878 572,871 624,567 674,224
Five years later 432,338 463,784 487,921 540,067 570,424 606,219
Six years later 417,770 463,788 490,398 538,126 570,390
Seven years later 417,776 456,563 486,236 539,298
Eight years later 410,560 449,493 487,485
Nine years later 407,007 450,859
Ten years later 411,307
CUMULATIVE REDUNDANCY
(DEFICIENCY) 41,874 52,069 66,591 54,530 58,674 60,981 14,231 9,554 2,279 (3,822)
</TABLE>
<TABLE>
<CAPTION>
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997
---- ---- ---- ---- ---- ---- ---- ---- ---- ----
(in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
CUMULATIVE AMOUNT OF
LIABILITY PAID THROUGH:
One year later $58,060 $80,959 $67,483 $79,239 $83,837 $83,522 $98,053 $116,532 $101,217 $141,954
Two years later 137,271 146,137 144,987 161,532 165,737 179,714 212,284 214,484 231,755
Three years later 196,890 218,676 221,931 238,998 256,860 284,828 293,323 332,920
Four years later 254,428 286,181 288,463 318,934 348,868 343,563 407,357
Five years later 304,740 335,723 339,121 389,638 395,242 436,921
Six years later 339,140 370,225 390,991 413,413 462,920
Seven years later 356,697 391,596 401,626 459,668
Eight years later 370,850 396,442 437,768
Nine years later 372,361 414,288
Ten years later 385,140
</TABLE>
The Company experienced favorable development on gross financial statement
reserves held at each year-end in the table except 1997, largely in reserves
first recorded in 1992 and prior years. The Company believes that this favorable
development has resulted from (i) the disciplined approach to establishing
reserves for medical malpractice insurance losses and LAE; and (ii) the
improvements made to the internal claims settlement process. These internal
claims settlement process improvements resulted from: key staffing additions,
including a new Vice President of Claims, in 1990; the building of a detailed
claims database over a 20-year period, which enables the Company's claims
professionals to better evaluate and resolve claims; the addition of staff
counsel in 1993 to defend certain malpractice cases and to control legal costs;
and the expansion and enhancement of the risk management department in 1993 to
provide support to insureds in controlling and reducing their exposure to
claims. It is not possible to quantify the impact that these changes have had on
development of loss reserves. Most of the favorable reserve development
evidenced in the table was recognized during 1993 ($13.0 million) and 1994
($43.2 million). Favorable development was recognized at that time because major
trends in loss experience were first credibly apparent then. The loss experience
in the early 1990's, to some extent resulting from the then recently introduced
internal changes discussed above, suggested that the very conservative reserving
posture maintained by the Company since its inception during the medical
malpractice crisis of the late 1970's was no longer appropriate. Earlier
projections of loss frequencies and severities no longer appeared likely, and
financial statement loss and LAE reserves were adjusted accordingly. Financial
statement loss and LAE reserves established since 1994 have been set based upon
this new understanding. Development of reserves since 1994 has been modest,
primarily consisting of: favorable and adverse adjustments pertaining to
specific accident years on the occurrence-like PPP policy book; adverse
development on hospital claims made reserves; and adverse development on claims
made policies written in certain expansion states.
15
<PAGE> 16
TABLE II. LOSS AND LAE RESERVES DEVELOPMENT - NET
<TABLE>
<CAPTION>
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997
---- ---- ---- ---- ---- ---- ---- ---- ---- ----
(in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
LOSS AND LAE
RESERVES-GROSS $453,181 $502,928 $554,076 $593,828 $629,064 $667,200 $688,455 $748,660 $795,449 $876,721
REINSURANCE RECOVERABLE ON
UNPAID LOSSES 400 400 1,025 8,265 3,037 62,682 112,917 165,729 221,749 270,731
--- --- ----- ----- ----- ------ ------- ------- ------- -------
452,781 502,528 553,051 585,563 626,027 604,518 575,538 582,931 573,700 605,990
LIABILITY REESTIMATED AS
OF:
One year Later 446,101 513,096 534,087 581,453 600,655 559,518 575,538 582,931 573,700 603,906
Two year later 463,924 494,044 527,847 560,688 555,656 559,518 575,538 582,931 573,321
Three years later 444,537 491,987 512,867 521,671 555,656 559,518 575,538 580,883
Four years later 438,866 477,053 482,498 521,828 555,655 559,518 575,124
Five years later 425,224 456,696 482,658 529,008 555,656 559,133
Six years later 409,040 457,795 485,125 525,111 555,484
Seven year later 409,871 450,860 479,007 524,574
Eight years later 403,169 443,028 478,072
Nine years later 399,453 442,210
Ten years later 401,304
CUMULATIVE REDUNDANCY
(DEFICIENCY) 51,477 60,318 74,979 60,989 70,543 45,385 414 2,048 379 2,084
</TABLE>
<TABLE>
<CAPTION>
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997
---- ---- ---- ---- ---- ---- ---- ---- ---- ----
(in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
CUMULATIVE AMOUNT OF
LIABILITY PAID THROUGH:
One year later $56,148 $78,967 $67,479 $79,239 $83,212 $82,572 $97,496 $116,194 $84,276 $134,666
Two years later 133,367 144,141 144,983 161,532 164,469 178,357 211,426 197,370 214,404
Three years later 192,982 216,680 221,927 238,998 255,586 283,370 278,571 315,743
Four years later 250,520 284,185 288,459 318,928 347,493 328,836 392,522
Five years later 300,832 333,727 339,111 389,579 381,408 422,194
Six years later 335,232 368,223 390,928 401,000 449,086
Seven years later 352,783 389,541 394,999 447,255
Eight years later 366,883 390,579 431,141
Nine years later 365,144 408,425
Ten years later 377,923
</TABLE>
The aggregate excess reinsurance contracts, in place since 1993, provide
coverage above aggregate retentions for losses and ALAE occurring in 1993 and
after, other than losses and ALAE retained by LP&C and losses and ALAE reinsured
under other insignificant reinsurance contracts. LP&C's retention is $200,000
per loss. The aggregate reinsurance contracts, therefore, have the effect of
holding underwriting year net incurred losses and ALAE, other than losses and
ALAE retained by LP&C and losses and ALAE reinsured under other insignificant
reinsurance contracts, at a constant level as long as such losses and ALAE ceded
under the aggregate excess reinsurance contracts remain within the coverage
limits. Ceded losses and ALAE have remained within coverage limits in each year
since 1993. The adjustment to net reserves in 1998 relates to losses and LAE not
covered by the aggregate reinsurance contracts, including losses and ALAE for
accident years 1992 and prior, losses and ALAE for accident years 1997 and 1998
retained by LP&C, and ULAE.
General liability incurred losses have been less than 3.0% of medical
malpractice incurred losses in the last five years. The Company does not have
material reserves for pollution claims and the Company's claims experience for
pollution coverage has been negligible.
While the Company believes that its reserves for losses and LAE are adequate,
there can be no assurance that the Company's ultimate losses and LAE will not
deviate, perhaps substantially, from the estimates reflected in the Company's
financial statements. If the Company's reserves should prove inadequate, the
Company will be required to increase reserves, which could have a material
adverse effect on the Company's financial condition or results of operations.
16
<PAGE> 17
REINSURANCE
Reinsurance Ceded. The Company follows customary industry practice by reinsuring
some of its business. The Company typically cedes to reinsurers a portion of its
risks and pays a fee based upon premiums received on all policies so subject to
such reinsurance. Insurance is ceded principally to reduce net liability on
individual risks and to provide aggregate loss and LAE protection. Although
reinsurance does not legally discharge the ceding insurer from its primary
liability for the full extent of the policies reinsured, it does make the
reinsurer liable to the insurer to the extent of the reinsurance ceded. The
Company reviews its reinsurance needs annually and makes changes in its
reinsurance arrangements as necessary. The Company determines how much
reinsurance to purchase based upon its evaluation of the risks it has insured,
consultations with its reinsurance brokers, and market conditions, including the
availability and pricing of reinsurance. The Company's reinsurance arrangements
have generally been placed through Pegasus Advisors, Inc., a reinsurance broker
wholly owned by the Attorney-in-Fact and to be acquired by the Company as part
of the acquisition of the Attorney-in-Fact and its subsidiaries.
The Company reinsures its risks primarily under two reinsurance contracts, the
Specific Contract and the Aggregate Contract. Under the Specific Contract, the
Company's retention for casualty business is $10 million per loss. For medical
professional liability and commercial general liability business, coverage is
provided up to $65 million per loss above the retention. For other casualty
business, coverage is provided up to $15 million per loss above the retention.
Property coverage is also provided under the Specific Contract in the amount of
$14.5 million in excess of a Company retention of $500,000 per loss per policy.
The Company retains an 8% co-participation in covered losses. The Company has
maintained specific excess of loss reinsurance coverage generally similar to
that just described for several years.
The Aggregate Contract provides several coverages on an aggregate excess of
loss, specific excess of loss, and quota share basis. The primary coverage
afforded under the Aggregate Contract attaches above a Company retention
measured on an underwriting year basis as a 75% loss and ALAE ratio. Reinsurers
provide coverage for an additional 75% loss and ALAE ratio, with an aggregate
annual limit of $200 million. The Company has maintained aggregate excess of
loss coverage generally similar to that just described since 1993. See
"Business -- Loss and LAE Reserves -- Table II -- Loss and LAE Reserves
Development -- Net."
Each of the aggregate excess reinsurance contracts contains an adjustable
premium provision that may result in changes to ceded premium and related funds
held charges, based on loss experience under the contract. During 1998, combined
ceded losses under the aggregate excess reinsurance contracts were increased by
a net amount of $0.3 million, resulting in net additional premium charges of
$3.2 million and net reduction in funds held charges of $1.9 million. No
adjustments to ceded losses under the aggregate excess reinsurance contracts
were made during 1997 and 1996. Each of the aggregate excess reinsurance
contracts also contains a profit sharing provision whereby a significant portion
of any favorable gross loss and ALAE reserve development may ultimately be
returned to the Company once all subject losses and ALAE have been paid or the
contract has been commuted. Profit sharing would be recorded by the Company
after the funds withheld balance related to an aggregate excess reinsurance
contract exceeds the related ceded reserves, after any adjustments under the
adjustable premium provisions. Profit sharing would then be recorded as an
offset to funds held charges and to the funds withheld liability. There was no
accrual of profit sharing at December 31, 1998, 1997 or 1996.
The major elements of ceded reinsurance activity are summarized in the following
table:
<TABLE>
<CAPTION>
For the year ended December 31,
---------------------------------------------------------------------
1998 1997 1996
-------------------- --------------------- --------------------
(in thousands)
<S> <C> <C> <C>
Ceded premiums earned...................... $ 36,105 $ 42,337 $ 36,699
Ceded Losses and LAE....................... 62,367 68,872 56,813
Funds held charges......................... 13,420 13,361 10,273
</TABLE>
Credit risk from reinsurance is controlled by placing the reinsurance with
large, highly rated reinsurers and by collateralizing amounts recoverable from
reinsurers. The following table identifies the Company's most significant
reinsurers, the total amount recoverable from them for unpaid losses, prepaid
reinsurance premiums and other amounts as of December 31, 1998, and collateral
held by the Company primarily in the form of funds withheld and letters of
credit as of December 31, 1998. No other single reinsurer's percentage
participation in 1998 exceeded 5% of the total reinsurance recoverable at
December 31, 1998.
17
<PAGE> 18
<TABLE>
<CAPTION>
At December 31, 1998
-------------------------------------------------
Total Amounts Total Amount of
Reinsurer Recoverable Collateral Held
--------------------- ------------------------
(In Thousands)
<S> <C> <C>
Hannover Reinsurance (Ireland) Ltd............................. $150,156 $137,283
Eisen und Stahl Reinsurance (Ireland) Ltd...................... 37,080 34,469
Scandinavian Reinsurance Company Ltd........................... 46,267 48,793
London Life and Casualty Reinsurance Corporation............... 59,186 57,534
Underwriters Reinsurance Company (Barbados).................... 47,666 41,756
</TABLE>
The Company analyzes the credit quality of its reinsurers and relies on its
brokers and intermediaries to assist it in such analysis. To date, the Company
has not experienced any material difficulties in collecting reinsurance
recoverables. No assurance can be given, however, regarding the future ability
of any of the Company's reinsurers to meet their obligations.
Reinsurance Assumed. The Company assumed reinsurance under three programs, with
assumed premiums of $1.5 million, $4.6 million and $2.2 million in 1998, 1997
and 1996, respectively. The Company provides medical professional liability
reinsurance coverage to AMM under a quota share contract and two excess of loss
contracts. AMM is also managed by the Attorney-in-Fact and in 1998 had $1.3
million of premiums written. The Company participated in the IRM Services, Inc.
property pool the ("Pool") with a 5% share in 1996 and 1997. The Pool was
discontinued and placed into runoff on November 30, 1996. Only minimal further
activity beyond 1998 is expected under this arrangement. The Company was also a
participant in quota share reinsurance contracts in 1996 and 1997 with
Underwriters Reinsurance Company, whereby the Company reinsured up to $250,000
per risk on business identified by Underwriters Reinsurance Company as casualty
facultative business. The contract was discontinued on March 1, 1998.
In addition, in 1997 the Company assumed reinsurance under a novation agreement
pertaining to certain policies written for a large hospital group during 1989
through 1997. Premiums associated with this agreement amounted to $10.9 million
in 1997. Existing ceded reinsurance agreements with the hospital group's captive
insurer covering the novated business remain in effect following the novation.
The Company believes that as more managed care organizations and integrated
health care delivery systems retain a larger part of their exposure directly or
through captive arrangements, they will need to obtain excess insurance or
reinsurance for the potentially larger losses, and the Company believes that it
is prepared to meet this need through assumed reinsurance arrangements.
INVESTMENT PORTFOLIO
An important component of the operating results of the Company has been the
return on its invested assets. Such investments are made by investment managers
and internal management under policies established and supervised by the
Investment Advisory and Finance Committee of the Board of Governors and Board of
Directors of the Attorney-in-Fact (the "Investment Committee"). The Company's
current investment policy has placed primary emphasis on investment grade, fixed
maturity securities and maximization of after-tax yields while minimizing credit
risks of the portfolio. The Company currently uses three outside investment
managers for fixed maturity securities. At December 31, 1998 and 1997, the
average credit quality of the fixed income portfolio was AA- and AA+,
respectively. This change in average credit quality during 1998 resulted from
purchases of below-investment grade securities.
18
<PAGE> 19
The following table sets forth the composition of the investment portfolio of
the Company at the dates indicated. All of the fixed maturity investments are
held as available-for-sale.
<TABLE>
<CAPTION>
December 31, 1998 December 31, 1997
-------------------------- ----------------------------
Cost or Cost or
Amortized Fair Amortized Fair
Cost Value Cost Value
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Fixed Maturity Investments:
Bonds:
U.S. Government and Agencies ... $ 119,083 $ 123,264 $ 188,715 $ 193,007
States, municipalities and
political subdivisions ....... 176,798 185,216 202,386 209,605
Foreign securities - U.S. dollar
denominated .................. 15,694 15,128 -- --
Mortgage-backed securities and
other asset-backed securities 407,140 409,801 311,562 316,795
Corporate ...................... 322,477 324,330 130,159 133,339
---------- ---------- ---------- ----------
Total Fixed Maturity Investments . 1,041,192 1,057,739 832,822 852,746
---------- ---------- ---------- ----------
Equity Investments .................. 3,159 3,159 66,520 89,080
---------- ---------- ---------- ----------
Total ............................ $1,044,351 $1,060,898 $ 899,342 $ 941,826
========== ========== ========== ==========
</TABLE>
In July 1998, the Company liquidated its equity portfolio as part of a medium
term portfolio strategy that the Company believes will increase investment
yield. Following liquidation, the proceeds were reinvested in fixed maturity
securities.
The investment portfolio of fixed maturity investments consists primarily of
intermediate-term, investment-grade securities along with a modest allocation to
below investment-grade (i.e. high yield) fixed maturity investments not to
exceed 7.5% of invested assets. The Company's investment policy provides that
all security purchases be limited to rated securities or unrated securities
approved by the Investment Committee.
The table below contains additional information concerning the investment
ratings of the fixed maturity investments at December 31, 1998:
<TABLE>
<CAPTION>
Percentage of
S&P Rating of Investment (1) Amortized Cost Fair Value Fair Value
- -------------------------------------------- -------------- ----------- ----------
(in thousands)
<S> <C> <C> <C>
AAA (including U.S. Government and Agencies) $ 613,188 $ 628,516 59.3%
AA ......................................... 63,250 64,183 6.1%
A .......................................... 215,718 219,586 20.8%
BBB ........................................ 97,778 98,962 9.4%
Other Ratings (below investment grade) ..... 50,423 45,769 4.3%
Not Rated .................................. 835 723 0.1%
---------- ---------- -----
Total ................................... $1,041,192 $1,057,739 100.0%
========== ========== =====
</TABLE>
(1) The ratings set forth above are based on the ratings, if any, assigned
by Standard & Poor's Rating Services ("S&P"). If S&P's ratings were
unavailable, the equivalent ratings supplied by another nationally
recognized ratings agency were used.
19
<PAGE> 20
The following table sets forth certain information concerning the maturities of
fixed maturity investments in the investment portfolio as of December 31, 1998,
by contractual maturity:
<TABLE>
<CAPTION>
Percentage of
Maturity of Investment Amortized Cost Fair Value Fair Value
- ---------------------- -------------- ------------- -------------
(in thousands)
<S> <C> <C> <C>
Due one year or less .............................. $ 14,784 $ 14,810 1.4%
Due after one year through five years ............. 109,671 110,704 10.5%
Due after five years through ten years ............ 207,892 212,155 20.1%
Due after ten years ............................... 301,705 310,269 29.3%
Mortgage-backed and other asset-backed securities . 407,140 409,801 38.7%
---------- ---------- -----
Total .................................... $1,041,192 $1,057,739 100.0%
========== ========== =====
</TABLE>
The average effective maturity and the effective duration of the securities in
the fixed maturity portfolio (excluding short-term investments) as of December
31, 1998, was 9.75 years and 6.27 years, respectively.
The mortgage-backed portfolio represents approximately 27% of the total fixed
income portfolio, and is allocated equally across "standard" and "more complex"
securities, while the asset-backed portfolio represents approximately 12% of the
total fixed income portfolio.
Standard, mortgage-backed securities are issued on and collateralized by an
underlying pool of single-family home mortgages. Principal and interest payments
from the underlying pool are distributed pro rata to the security holders. More
complex mortgage-backed security structures prioritize the distribution of
interest and principal payments to different classes of securities which are
backed by the same underlying collateral mortgages.
MARKET RISK
Market risk represents the potential for loss due to adverse changes in the fair
value of financial instruments. The market risk associated with financial
instruments of the Company relates to the investment portfolio, which exposes
the Company to risks related to unforeseen changes in interest rates, credit
quality, prepayments and valuations. Analytical tools and monitoring systems are
in place to continually assess and react to each of these elements of market
risk.
Interest rate risk is considered by management to be the most significant market
risk element currently facing the Company. Interest rate risk is the price
sensitivity of a fixed income security to changes in interest rates. The Company
views these potential changes in price within the overall context of assets and
liability management. To reduce the Company's interest rate risk, duration
targets are set for the fixed income investment portfolios after consideration
of the duration of associated liabilities, primarily losses and LAE reserves,
and other factors.
The tables below provide, as of December 31, 1998 and December 31, 1997,
information about the Company's fixed maturity investments (which are sensitive
to changes in interest rates), showing principal amounts and the average yield
applicable thereto by expected maturity date and type of investment. The
expected maturities displayed have been compiled based upon the earlier of the
investment call date or the maturity date or, for mortgage-backed securities,
expected payment patterns based on statistical analysis and management's
judgment. Actual cash flows could differ, perhaps significantly, from the
expected amounts.
At December 31, 1998:
<TABLE>
<CAPTION>
Expected Maturity Date
--------------------------------------------------------------------------- Total
(in thousands) Principal
1999 2000 2001 2002 2003 Thereafter Amounts Fair Value
----------- --------- ---------- --------- --------- ---------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Government & Agency $ 430 $ 1,710 $ 2,651 $ 5,769 $ 415 $ 136,570 $ 147,545 $ 138,392
- - Average Yield ... 5.94% 6.12% 6.18% 4.51% 6.64% 5.65% 5.62%
Corporate ......... $ 14,300 $ 30,960 $ 23,450 $ 4,500 $ 28,745 $ 226,299 $ 328,254 $ 324,330
- - Average Yield ... 5.87% 6.22% 6.60% 6.47% 6.25% 7.12% 6.85%
Mortgage-Backed ... $ 10,313 $ 20,343 $ 9,780 $ 25,176 $ 32,072 $ 188,001 $ 285,685 $ 288,151
- - Average Yield ... 6.34% 7.03% 7.16% 6.68% 6.45% 6.52% 6.58%
Asset-Backed ...... $ 11,301 $ - $ 14,299 $ 13,500 $ 5,500 $ 75,336 $ 119,936 $ 121,650
Average Yield .... 5.78% 0.00% 6.69% 6.98% 7.47% 7.09% 6.93%
Municipal ......... $ - $ - $ 11,480 $ 2,225 $ 10,490 $ 147,165 $ 171,360 $ 185,216
- - Average Yield ... 0.00% 0.00% 5.07% 5.90% 5.21% 5.18% 5.18%
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
TOTALS ............ $ 36,344 $ 53,013 $ 61,660 $ 51,170 $ 77,222 $ 773,371 $1,052,780 $1,057,739
</TABLE>
At December 31, 1997:
<TABLE>
<CAPTION>
Expected Maturity Date
--------------------------------------------------------------------------- Total
(in thousands) Principal
1998 1999 2000 2001 2002 Thereafter Amounts Fair Value
------- ------- ------- ------- -------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Government & Agency..... $ -- $23,005 $ 9,770 $25,101 $38,800 $ 92,835 $189,511 $193,007
- Average Yield....... -- 6.21% 5.96% 6.44% 5.76% 6.35% 6.19%
Corporate............... $ 7,150 $10,563 $ -- $ 6,000 $ -- $111,000 $134,713 $133,339
- Average Yield ...... 6.36% 6.73% -- 8.00% -- 6.80% 6.83%
Mortgage-Backed ........ $11,652 $16,396 $42,835 $19,154 $13,638 $169,841 $273,516 $278,574
- Average Yield ...... 8.15% 7.37% 7.17% 6.92% 6.77% 7.09% 7.14%
Asset-Backed ........... $ -- $ -- $ 1,906 $ 9,500 $ 4,853 $ 21,601 $ 37,860 $ 38,221
- Average Yield ...... -- -- 6.98% 6.75% 7.30% 7.06% 7.01%
Municipal............... $ -- $ 500 $ -- $12,980 $ 8,045 $171,140 $192,665 $209,605
- Average Yield....... -- 3.89% -- 5.04% 5.14% 5.12% 5.11%
------- ------- ------- ------- ------- ---------- ---------- -----------
TOTALS $18,802 $50,464 $54,511 $72,735 $65,336 $566,417 $828,265 $852,746
</TABLE>
20
<PAGE> 21
In addition to interest rate risk, fixed income securities like those comprised
by the Company's investment portfolio involve other risks, such as default or
credit risk. For example, the corporate bonds that make up the largest portion
of the Company's investment portfolio, based on fair value at December 31, 1998,
are subject to non-payment if the issuer defaults and is unable to meet its
financial obligations as they become due. The Company manages this risk by
limiting the amount of higher risk corporate obligations (determined by credit
rating assigned by private rating agencies) in which it invests.
Regardless of structure, mortgage-backed securities involve the same risks
associated with all fixed income investments: interest rate risk, reinvestment
rate risk, and default or credit risk. In addition, mortgage-backed securities
also possess prepayment risk, which is the risk that a security's originally
scheduled interest and principal payments will differ considerably due to
changes in the level of interest rates. In a standard pass-through
mortgage-backed security, the inherent risks are identical across all security
holders, but as mortgage-backed security structures become more complex the risk
is spread unevenly across the different securities issued on the same underlying
pool of mortgages. This results in securities having dramatically different
credit and/or prepayment characteristics even though the securities are issued
from the same underlying collateral. The Company takes advantage of this
"structural" risk by purchasing those mortgage-backed securities which, due to
this uneven spread of risk, possess enhanced credit and/or stable prepayment
characteristics.
"Other asset backed securities" are classified similarly to mortgage-backed
securities as these types of securities also involve prepayment risk. Assets
other than traditional home mortgages are used to collateralize these types of
securities. Examples include securities backed by home equity loans, lease
receivables, high yield bonds, credit card receivables, and auto loan
receivables. The Company only purchases those securities structured to enhance
credit quality and/or provide prepayment stability. The Company continues to use
and adopt financial modeling techniques to monitor and manage the risks
associated with its fixed income portfolio holdings.
Short-term investments are composed of "AAA-rated" and "AA-rated" money market
instruments and money market mutual funds.
Asset and liability matching is an important part of the Company's portfolio
management process. The Company utilizes financial modeling and scenario
analysis to monitor closely the effective modified duration of both assets and
liabilities in order to minimize any "gapping" or "mismatching" issues with
respect to the balance sheet. Any adjustments to portfolio strategy indicated
from such analysis are made to reflect emerging liability pay-out trends,
significant changes in financial markets, and the Company's changing business.
Effective asset/liability management has resulted in the Company's ability to
consistently pay claims from operating funds without disrupting the Company's
long-term investment strategy.
COMPETITION
The physician professional liability insurance market in the United States is
highly competitive. According to A.M. Best, in 1997 there were 357 companies
nationally that wrote medical professional liability insurance. In New Jersey,
where approximately 50% of the Company's 1998 premiums were written for the year
ended December 31, 1998, the Company's principal competitor is Princeton
Insurance Companies. In New Jersey and other states, the Company's principal
competitors include CNA Insurance Group, Frontier Insurance Group, Inc., PHICO
Insurance Company and St. Paul Companies. Substantially all of these companies
rank among the top 20 medical malpractice insurers nationally and are actively
engaged in soliciting insureds in the states in which the Company writes
insurance. In addition, as the Company expands into new states, it may face
strong competition from local carriers that are closely focused on narrow
geographic markets. The Company expects to encounter such competition from
doctor-owned insurance companies and commercial companies in other states as it
carries out its expansion plans. Many of the Company's current and potential
competitors may have greater financial resources than the Company and may seek
to acquire market share by decreasing pricing for their products below
prevailing market rates, thereby reducing profitability. The Company believes
that several insurance companies that have greater financial resources than the
Company are writing medical malpractice insurance in New Jersey and Pennsylvania
that provides the same coverage as the Company's products at prices much lower
than the Company's prices. This price competition could have a material adverse
effect on the Company's financial condition and results of operations. The
Company believes that the principal competitive factors, in addition to pricing,
include financial stability and A.M. Best ratings, breadth and flexibility of
coverage, and the quality and level of services provided.
The hospital professional liability insurance market is also extremely
competitive. Most of the Company's principal insurance company competitors for
physicians and medical groups also now actively compete in the hospital
professional liability insurance market. Moreover, the Company's primary
competitor in New Jersey was founded to provide professional liability coverage
to hospitals, while the Company traditionally served the individual physician
market. The Company also believes that the number of health care entities that
insure their affiliated physicians through self-insurance may rise.
21
<PAGE> 22
The Company plans to compete by diversifying its products, expanding
geographically, extending its distribution channels, and differentiating itself
through superior claims, risk management, and customer services. All markets in
which the Company now writes insurance and in which it expects to enter have
certain competitors with substantially greater financial and operating resources
than the Company.
REGULATION
The Exchange, MIIX Insurance, LP&C and MIIX New York are each subject to
supervisory regulation by their respective states of incorporation, commonly
called the state of domicile. The Exchange and MIIX Insurance are domiciled in
New Jersey, LP&C is domiciled in Virginia and MIIX New York is domiciled in New
York. Therefore, the laws and regulations of these states, including the tort
liability laws and the laws relating to professional liability exposures and
reports, have the most significant impact on the operations of the combined
company.
Holding Company Regulation. As part of a holding company system, the Exchange,
MIIX Insurance, LP&C and MIIX New York are subject to the Insurance Holding
Company Systems Acts (the "Holding Company Act") of their domiciliary states.
The Holding Company Act requires the domestic company to file information
periodically with the state insurance department and other state regulatory
authorities, including information relating to its capital structure, ownership,
financial condition and general business operations. Certain transactions
between an insurance company and its affiliates, including sales, loans or
investments, are deemed "material" and require prior approval by New Jersey,
Virginia and/or New York insurance regulators. In New Jersey and Virginia,
transactions with affiliates involving loans, sales, purchases, exchanges,
extensions of credit, investments, guarantees, or other contingent obligations
which within any 12 month period aggregate at least 3% of the insurance
company's admitted assets or 25% of its capital and surplus, whichever is
lesser, require prior approval. In New York, such transactions which within any
12 month period aggregate to more than 1% of the insurance company's admitted
assets as of the end of such company's last fiscal year require the prior
approval of the New York Insurance Department. Prior approval is also required
for all management agreements, service contracts, and cost-sharing arrangements
between affiliates. Certain reinsurance agreements or modifications also require
prior approval.
Certain other material transactions, not involving affiliates, must be reported
to the domiciliary regulatory agency within 15 days after the end of the
calendar month in which the transaction occurred (in contrast to prior
approval). These transactions include acquisitions and dispositions of assets
that are nonrecurring, are not in the ordinary course of business, and exceed 5%
of the Company's admitted assets. Similarly, nonrenewals, cancellations, or
revisions of ceded reinsurance agreements, which affect statutorily established
percentages of the Company's business, are also subject to disclosure.
The Holding Company Act also provides that the acquisition or change of
"control" of a domestic insurance company or of any person or entity that
controls such an insurance company cannot be consummated without prior
regulatory approval. In general, a presumption of "control" arises from the
ownership of voting securities and securities that are convertible into voting
securities, which in the aggregate constitute 10% or more of the voting
securities of the insurance company or of a person or entity that controls the
insurance company, such as The MIIX Group. A person or entity seeking to acquire
"control," directly or indirectly, of the Company would generally be required to
file an application for change of control containing certain information
required by statute and published regulations and provide a copy of the
application to the Company. The Holding Company Act also effectively restricts
the Company from consummating certain reorganizations or mergers without prior
regulatory approval.
Regulation of Dividends from Insurance Subsidiaries. The Holding Company Act of
the State of New Jersey will limit the ability of MIIX Insurance to pay
dividends to The MIIX Group. Without prior notice to and approval of the
Commissioner, MIIX Insurance may not declare or pay an extraordinary dividend,
which is defined as any dividend or distribution of cash or other property whose
fair market value together with other dividends or distributions made within the
preceding 12 months exceeds the greater of such subsidiary's statutory net
income of the preceding calendar year or 10% of statutory surplus as of the
preceding December 31. The law further requires that an insurer's statutory
surplus following a dividend or other distribution be reasonable in relation to
its outstanding liabilities and adequate to meet its financial needs. New Jersey
permits the payment of dividends only out of statutory earned (unassigned)
surplus unless the payment out of other funds is approved by the Commissioner.
In addition, a New Jersey insurance company is required to give the New Jersey
Department notice of any dividend after declaration, but prior to payment.
22
<PAGE> 23
The other United States domiciled Insurance Subsidiaries will be subject to
similar provisions and restrictions under the Holding Company Acts of other
states.
Insurance Company Regulation. The Company is subject to the insurance laws and
regulations in each state in which it is licensed to do business. The Company is
licensed in 31 states and the District of Columbia. In three of such states, the
license currently does not include the authority to write medical malpractice
insurance. In addition, in seven of such states, the Company is in the process
of the rate, rule and form filings necessary in order to write medical
malpractice policies in such states. The extent of regulation varies by state,
but such regulation usually includes: (i) regulating premium rates and policy
forms; (ii) setting minimum capital and surplus requirements; (iii) regulating
guaranty fund assessments; (iv) licensing companies and agents; (v) approving
accounting methods and methods of setting statutory loss and expense reserves;
(vi) setting requirements for and limiting the types and amounts of investments;
(vii) establishing requirements for the filing of annual statements and other
financial reports; (viii) conducting periodic statutory examinations of the
affairs of insurance companies; (ix) approving proposed changes of control; and
(x) limiting the amounts of dividends that may be paid without prior regulatory
approval. Such regulation and supervision are primarily for the benefit and
protection of policyholders and not for the benefit of investors.
Insurance Guaranty Associations. Most states, including New Jersey, Virginia and
New York require admitted property and casualty insurers to become members of
insolvency funds or associations that 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 by state, and are
usually between 1% and 2% of annual premiums written by a member in that state
during the preceding year. New Jersey and Virginia, the states in which the
Exchange and LP&C are respectively domiciled, and Texas, Pennsylvania, Maryland
and Kentucky, states in which the Company has significant business, permit a
maximum assessment of 2%. Ohio permits a maximum assessment of 1.5%. New York
requires contributions of 1/2 of 1% of annual premiums written during the
preceding year until such time that the fund reaches a minimum amount set by New
York. Contributions can be increased if the fund falls below the minimum. New
York law does not establish a maximum assessment amount. New Jersey permits
recoupment of guaranty fund payments through future policy surcharges. Virginia
and Texas permit premium tax reductions as a means of recouping guaranty fund
payments. Most other states permit recoupment through future rate increases.
Examination of Insurance Companies. Every insurance company is subject to a
periodic financial 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 completed periodic financial
examination of the Exchange, based on December 31, 1993 financial statements,
was completed on March 5, 1995, and a report was issued on June 21, 1995. The
Exchange currently is undergoing another periodic examination that began on
November 24, 1997. The last periodic financial examination of LP&C, based on
December 31, 1996 financial statements, was completed on April 25, 1997, and a
report was issued on August 4, 1997. Various states also conduct "market conduct
examinations" which are unscheduled examinations designed to monitor the
compliance with state laws and regulations concerning the filing of rates and
forms and company operations in general. The Company has not undergone a market
conduct examination.
Risk-Based Capital. In addition to state-imposed insurance laws and regulations,
insurers are subject to the general statutory accounting practices and the
reporting format of the National Association of Insurance Commissioners (the
"NAIC"). The NAIC's methodology for assessing the adequacy of statutory surplus
of property and casualty insurers includes a risk-based capital ("RBC") formula
that attempts to measure statutory capital and surplus needs based on the risks
in a company's mix of products and investment portfolio. The formula is designed
to allow state insurance regulators to identify potentially under-capitalized
companies. Under the formula, a company determines its RBC by taking into
account certain risks related to the insurer's assets (including risks related
to its investment portfolio and ceded reinsurance) and the insurer's liabilities
(including underwriting risks related to the nature and experience of its
insurance business). The RBC rules provide for different levels of regulatory
attention depending on the ratio of an insurance company's total adjusted
capital to its "authorized control level" of RBC. At December 31, 1998, the
Exchange's RBC was 2.58 times greater than the threshold requiring the least
regulatory attention. At December 31, 1998, LP&C's RBC was 7.19 times greater
than the threshold requiring the least regulatory attention. MIIX Insurance and
MIIX New York did not write any premium during 1998, and therefore, RBC ratios
are not meaningful for that period.
23
<PAGE> 24
NAIC-IRIS Ratios. The NAIC Insurance Regulatory Information System ("IRIS") 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 insurance companies operating in their
respective states. IRIS identifies 12 ratios for the property and casualty
insurance industry and specifies a range of "usual values" for each ratio.
Departure from the "usual value" range on four or more ratios may lead to
increased regulatory oversight from individual state insurance commissioners. In
1998 the Exchange had one ratio (change in net writings) slightly outside the
usual range as a result of growth in business presented by opportunities in a
dynamic marketplace. In 1996 the Exchange had one ratio (investment yield ratio)
fall outside of the usual range, which resulted from the lower pre-tax yields
provided by the tax exempt securities in its investment portfolio. In 1997 LP&C
had two ratios (change in net writings and change in surplus), and in 1998 LP&C
had two ratios (change in net writings and two-year overall operating ratio),
outside the usual range. These ratios reflect the increase in premiums written
and the initial high cost of expanding LP&C's business, as LP&C was acquired in
1996 and had no business at that time. IRIS ratio results for MIIX Insurance and
MIIX New York are not applicable due to no business written in these companies
in 1998.
Regulation of Investments. The Insurance Subsidiaries are subject to state laws
and regulations that require diversification of their investment portfolios and
limit the amount of investments in certain investment categories such as below
investment grade fixed income securities, real estate and equity investments.
Failure to comply with these laws and regulations would cause investments
exceeding regulatory limitations to be treated as non-admitted assets for
purposes of measuring statutory surplus and, in some instances, would require
divestiture of such non-qualifying investments over specified time periods
unless otherwise permitted by the state insurance authority under certain
conditions. The Company did not have any non-qualifying investments in 1998.
Prior Approval of Rates and Policies. Pursuant to the New Jersey Insurance Code,
a domestic insurer must submit policies and endorsements to the Commissioner for
prior approval, but rating plans and rates are not subject to review until 30
days after use. Virginia law requires LP&C to submit rating plans, rates,
policies, and endorsements to regulators for prior approval. The possibility
exists that the Company may be unable to implement desired rates, policies,
endorsements, forms, or manuals if such items are not approved by the applicable
regulatory authorities. In the past, substantially all of the Company's rate
applications have been approved in the normal course of review. In most other
states, policy forms usually are subject to prior approval by the regulatory
agency while rates usually are "file and use." Unlike most other states, New
York's Insurance Department sets the rates for medical malpractice coverage on
an annual basis.
Medical Malpractice Tort Reform. Major revisions to New Jersey's statutory
scheme governing medical malpractice took effect in 1995. These revisions
included raising joint and several liability standards, requiring certificates
of merit, eliminating strict liability of health care providers due to defective
products used in their practices, and capping punitive damages at the greater of
five times compensatory damages or $350,000. The Company believes that these
changes are bringing stability to the medical malpractice insurance business in
New Jersey by making it more feasible for insurers to assess certain risks.
Legislation passed in 1996 in Pennsylvania provides, among other things, that
plaintiffs must prove causation in informed consent cases, that punitive damages
assessed against individual defendants be capped at twice the compensatory
damages, and that the Pennsylvania Medical Professional Liability Catastrophe
Loss Fund (the "Cat Fund") be responsible for delay damages and post-judgment
interest. Texas tort reform applicable to cases accruing on or after September
1, 1996, bars plaintiffs from recovery if their own negligence is more than 50%
responsible for their injuries, while defendants shall generally be jointly and
severally liable only if found to be more than 50% responsible. Exemplary
damages shall not exceed the greater of $200,000, or two times the economic
damage plus the non-economic damage, not to exceed $750,000.
Medical Malpractice Reports. The Company principally writes medical malpractice
insurance and additional requirements are placed upon them to report detailed
information with regard to settlements or judgments against their insureds. In
addition, the Company is required to report to state regulatory agencies and/or
the National Practitioners Data Bank payments, claims closed without payments,
and actions by the Company, such as terminations or surcharges, with respect to
its insureds. Penalties may attach if the Company fails to report to either the
state agency or the National Practitioners Data Bank.
Catastrophe Funds. In two states in which the Company write insurance, its
liability is capped at a level below the Company's typical policyholder limits
of coverage. Pennsylvania's Cat Fund provides coverage for medical malpractice
claims exceeding $400,000 per claim and $1.2 million aggregate per year. The Cat
Fund coverage is limited to $800,000 per claim and $2.4 million in the
aggregate. Similarly, effective July 1, 1999 physicians in Indiana are required
to purchase insurance limits of $250,000 per claim and $750,000 in the
aggregate. Effective July 1, 1999 the Indiana Patient Compensation Fund provides
an additional $1 million of coverage per claim for an insured. A plaintiff's
maximum total recovery for medical malpractice occurring after June 30, 1999
causing injury or death is $1.25 million in Indiana.
24
<PAGE> 25
A.M. BEST RATINGS
In 1997 A.M. Best, which rates insurance companies based on factors of concern
to policyholders, rated the Company "A (Excellent)" for the third consecutive
year and reaffirmed the rating in March of 1998. This is the third highest
rating of 16 ratings that A.M. Best assigns. The Company earned its first
rating, a "B+," in 1992 and achieved an "A" rating by 1995.
A.M. Best publications indicate that the "A" rating is assigned to those
companies that in A.M. Best's opinion have a strong ability to meet their
obligations to policyholders over a long period of time. In evaluating a
company's financial and operating performance, A.M. Best reviews the company's
profitability, leverage, and liquidity; its book of business; the adequacy and
soundness of its reinsurance; the quality and estimated market value of its
assets; the adequacy of its loss reserves and surplus; its capital structure;
the experience and competence of its management; and its market presence.
EMPLOYEES
The Company employs approximately 220 persons. None of the Company's employees
are covered by a collective bargaining agreement. The Company believes that its
relations with its employees are good.
25
<PAGE> 26
ITEM 6. SELECTED FINANCIAL DATA
SUMMARY FINANCIAL AND OPERATING DATA
The following table sets forth selected consolidated financial and operating
data for the Company. The income statement data set forth below for each of the
four years in the period ended December 31, 1998 and the balance sheet data as
of December 31, 1998, 1997, and 1996 are derived from the consolidated financial
statements of the Company audited by Ernst & Young LLP, independent auditors.
The income statement data for the year ended 1994 and the balance sheet data as
of December 31, 1994 and 1995 are derived from unaudited consolidated financial
statements of the Company which management believes incorporate all of the
adjustments necessary for the fair presentation of the financial condition and
results of operations for such periods. All selected financial data are
presented in accordance with GAAP, except for the item entitled "statutory
surplus," which is presented in accordance with Statutory Accounting Principles
("SAP"). The statutory surplus amounts are derived from the audited statutory
financial statements of the Company and, in the opinion of management, fairly
reflect the specified data for the periods presented. The information set forth
below should be read in conjunction with, and is qualified by reference to, the
Company's financial statements and related notes thereto included elsewhere
herein.
26
<PAGE> 27
<TABLE>
<CAPTION>
(in thousands, except per share amounts)
For the Year Ended December 31,
-------------------------------------------------------------------------------
1998 1997 1996 1995 1994
----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Direct premiums written ........... $ 230,314 $ 162,430 $ 143,218 $ 137,291 $ 127,647
=========== =========== =========== =========== ===========
Net premiums earned ............... $ 162,501 $ 123,330 $ 107,887 $ 105,256 $ 85,992
Net investment income ............. 65,107 53,892 49,135 51,896 47,765
Realized investment gains (losses) 36,390 10,296 5,832 13,149 (11,030)
Other revenue ..................... 891 2,884 3,164 2,807 2,385
----------- ----------- ----------- ----------- -----------
Total revenues ................ 264,889 190,402 166,018 173,108 125,112
----------- ----------- ----------- ----------- -----------
Losses and loss adjustment expenses .. 155,868 120,496 110,593 107,889 55,687
Underwriting expenses ................ 42,063 25,415 17,553 14,743 12,777
Funds held charges ................... 13,420 13,361 10,273 6,996 4,669
Impairment of capitalized system
development costs .................. 12,656 -- -- -- --
----------- ----------- ----------- ----------- -----------
Total expenses ................ 224,007 159,272 138,419 129,628 73,133
----------- ----------- ----------- ----------- -----------
Income before income taxes ........... 40,882 31,130 27,599 43,480 51,979
Income tax expense ................... 11,154 2,006 10,004 11,402 16,327
----------- ----------- ----------- ----------- -----------
Net income .................... $ 29,728 $ 29,124 $ 17,595 $ 32,078 $ 35,652
=========== =========== =========== =========== ===========
BALANCE SHEET DATA (AT END OF PERIOD):
Total investments ................. $ 1,165,698 $ 1,026,971 $ 916,330 $ 895,146 $ 788,465
Total assets ...................... 1,674,262 1,446,559 1,295,441 1,173,681 1,014,664
Total liabilities ................. 1,351,419 1,136,585 1,033,129 919,050 827,659
Total equity ...................... 322,843 309,974 262,312 254,631 187,005
ADDITIONAL DATA:
GAAP ratios:
Loss ratio ........................ 95.9% 97.7% 102.5% 102.5% 64.8%
Expense ratio ..................... 25.9% 20.6% 16.3% 14.0% 14.9%
----------- ----------- ----------- ----------- -----------
Combined ratio .................... 121.8% 118.3% 118.8% 116.5% 79.7%
=========== =========== =========== =========== ===========
Statutory surplus .................... $ 253,166 $ 242,395 $ 208,478 $ 184,651 $ 156,246
=========== =========== =========== =========== ===========
Earnings per share (pro forma) (1) ... $ 2.47
===========
Book value per share (pro forma) (1) . $ 26.85
===========
</TABLE>
(1) Gives effect to the assumed aggregate issuance of approximately
12,025,000 shares of Common Stock to Distributees. Does not give effect
to the sale of Common Stock in the anticipated Public Offering, to the
issuance of Common Stock to the Medical Society in connection with the
acquisition of the Attorney-in-Fact, or to the sale of Common Stock to
certain officers of the Company pursuant to the Stock Purchase and Loan
Agreements between such officers and The MIIX Group. See "Executive
Compensation -- Stock Purchase and Loan Agreements."
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the financial
statements and the related notes thereto appearing elsewhere in this Form 10-K.
GENERAL
The Exchange was organized as a New Jersey reciprocal insurance exchange
in 1977. A New Jersey reciprocal insurance exchange is an entity that may be
formed by persons seeking a particular type of insurance coverage. In the case
of the Exchange, medical and osteopathic physicians formed the Exchange to
provide medical malpractice insurance. Under New Jersey law, the business of a
reciprocal insurance exchange must be conducted by a separate entity acting as
the attorney-in-fact of such exchange.
The medical malpractice insurance industry is cyclical in nature. Many factors
influence the financial results of the medical malpractice insurance industry,
several of which are beyond the control of the Company. These factors include,
among other things, changes in severity and frequency of claims; changes in
applicable law; regulatory reform; and changes in inflation, interest rates and
general economic conditions.
27
<PAGE> 28
The availability 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.
Management periodically reviews the Company's guidelines for premiums, premium
surcharges, discounts, cancellations and non-renewals and other related matters.
As part of this review, rates and rating classifications for its physicians,
medical groups and other insureds are evaluated based on current and historical
loss, LAE and other actuarially significant data. This process may result in
changes in rates for certain exposure classes.
Currently, a substantial portion of the Company's policies have January 1
effective dates. Premium is recognized as written in the quarter the policy is
effective, yet the premiums are earned ratably throughout the year. As the
Company expands geographically, new policies are being written with effective
dates other than January 1.
Reinsurance. The Company reinsures its risks primarily under two reinsurance
contracts, a specific excess of loss treaty ("Specific Contract") and an
aggregate excess of loss treaty ("Aggregate Contract"). Under the Specific
Contract, the Company's retention for casualty business is $10 million per loss.
For medical professional liability and commercial general liability business,
coverage is provided up to $65 million per loss above the retention. For other
casualty business, coverage is provided up to $15 million per loss above the
retention. Property coverage is also provided under the Specific Contract in the
amount of $14.5 million in excess of a Company retention of $500,000 per loss
per policy. The Company retains an 8% co-participation in covered losses. The
Company has maintained specific excess of loss reinsurance coverage generally
similar to that just described for several years.
The Aggregate Contract provides several coverages on an aggregate excess of
loss, specific excess of loss, and quota share basis. The primary coverage
afforded under the Aggregate Contract attaches above a Company retention
measured as a 75% loss and allocated loss adjustment expense ratio ("loss and
ALAE ratio"). Reinsurers provide coverage for an additional 75% loss and ALAE
ratio, with an aggregate annual limit of $200 million. The Company has
maintained aggregate excess of loss coverage substantially similar to that just
described since 1993.
The Company's aggregate reinsurance contracts are maintained on a funds withheld
basis whereby the Company holds the ceded premiums in a funds withheld account
for purposes of paying losses and related loss adjustment expenses. Interest
charges are credited on funds withheld at predetermined contractual rates.
Loss and LAE Reserves. The determination of loss and LAE reserves involves the
projection of ultimate losses through an actuarial analysis of the claims
history of the Company and other professional liability insurers, subject to
adjustments deemed appropriate by the Company due to changing circumstances.
Included in the Company's claims history are losses and LAE paid by the Company
in prior periods, and case reserves for anticipated losses and ALAE developed by
the Company's Claim Department as claims are reported and investigated.
Management relies primarily on such historical loss experience in determining
reserve levels on the assumption that historical loss experience provides a good
indication of future loss experience despite the uncertainties in loss trends
and the delays in reporting and settling claims. As additional information
becomes available, the estimates reflected in earlier loss reserves may be
revised. Any increase in the amount of aggregate reserves reported in the
financial statements, including reserves for insured events of prior years,
could have a material adverse effect on the Company's results of operations for
the period in which the adjustments are made.
There are significant inherent uncertainties in estimating ultimate losses in
the casualty insurance business and these uncertainties are increased in periods
when a company is expanding into new markets with new distribution channels. The
uncertainties are even greater for companies writing long-tail casualty
insurance, such as medical malpractice insurance, and in particular the
occurrence or occurrence-like coverages that substantially make up the Company's
current reserves. These additional uncertainties are due primarily to the longer
period of time during which an insured may seek coverage for a claim in respect
of an occurrence or occurrence-like policy as opposed to a claims made policy.
With the longer claim reporting and development period, reserves are more likely
to be impacted by, among other factors, changes in judicial liability standards
and interpretation of insurance contracts, changes in the rate of inflation and
changes in the propensities of individuals to file claims.
28
<PAGE> 29
The Company offered traditional occurrence coverage from 1977 through 1986 and
has offered a form of occurrence-like coverage, "modified claims made," from
1987 to the present. The Company's modified claims made policy is the PPP. Under
the PPP, coverage is provided for claims reported to the Company during the
policy period arising from incidents since inception of the policy. The PPP
includes "tail coverage" for claims reported after expiration of the policy for
occurrences during the policy period and thus is reserved on an occurrence
basis. Loss and LAE reserves carried for this policy and traditional occurrence
policies constitute approximately 87% of the gross loss and LAE reserves at
December 31, 1998.
With the additional uncertainties associated with occurrence business, as
discussed above, incurred but not reported ("IBNR") reserves have consistently
represented a majority of the gross reserves recorded by the Company.
The Company uses a disciplined approach to setting and adjusting financial
statement loss and LAE reserves that begins with the claims adjudication
process. Claims examiners establish case reserves by a process that includes
extensive development and use of statistical information that allows for
comparison of individual claim characteristics against historical patterns and
emerging trends. This process also provides critical information for use in
pricing of products and establishing the IBNR component of the financial
statement reserves.
Initially, the Company establishes its best estimate of loss and LAE reserves
using pricing assumptions. The reserves are evaluated every quarter and annually
and are adjusted thereafter as circumstances warrant. These periodic evaluations
include a variety of loss development techniques that incorporate various data
accumulated in the claims settlement process including paid and incurred loss
data, accident year development statistics, and loss ratio analyses. Important
in these analyses are considerations of the amounts for which claims have
settled in comparison to the case reserves held at settlement. Case reserves are
eliminated upon settlement of related claims. Actual settlement amounts above or
below case reserves are then regularly evaluated to determine whether estimated
ultimate losses by accident year, including IBNR reserves, should be adjusted.
Changes to aggregate reserves reported in the financial statements are made
based upon the extent and nature of these variances over the long claim
development period together with changes in estimates of the total number of
claims to be settled. As a final test of management's determination as to
whether it believes that aggregate reserves reported in the financial statements
are adequate and appropriate, management considers the detailed analysis
performed by the actuarial staff of its independent auditors in connection with
the audit of the Company's financial statements.
The aggregate reserves reported in the financial statements represent
management's best estimate of the remaining costs of settling all incurred
claims. The Company increased prior year gross reserves by $0.2 million and
$3.8 million during 1997 and 1998, respectively. No adjustment to prior year
aggregate reserves was made in 1996.
The Company is currently expanding its operations into a number of states, and
the Company expects that the majority of the policies issued in such states will
be on a claims made basis. See "Business -- Product Offerings." As a result, the
Company believes that as claims made reserves begin to comprise a greater
percentage of aggregate reserves it is likely that more frequent adjustments to
aggregate reserves recorded in the financial statements will become necessary
because the reporting period for claims made policies is shorter, which
facilitates the ability of the Company to more quickly determine ultimate
losses.
Underwriting Expenses. The Company's continued expansion into other states and
markets will most likely increase underwriting expenses. The Company believes
that its plan of expansion through broker and agent distribution channels will
increase its marketing expenses, but it also believes that this relationship
will reduce the need to make other significant expenditures in order to expand
into other states. Commissions for policies sold on a brokerage basis typically
range from 2.0% to 12.5% of premiums, whereas the Company does not incur
commissions on products it sells directly. To the extent that brokered business
represents an increased percentage of the Company's business in the future,
expense ratios will continue to increase.
29
<PAGE> 30
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1998 COMPARED TO THE YEAR ENDED DECEMBER 31, 1997
Direct premiums written. Direct premiums written were $230.3 million for the
year ended December 31, 1998, a $67.9 million or 41.8% increase over the $162.4
million written during 1997. Of this $67.9 million increase, approximately $16
million is attributable to policies effective toward the end of 1997 that were
issued in 1998. An increase of $29.9 million of premiums written in Connecticut
and Pennsylvania was primarily a result of successful marketing efforts directed
at large medical institutions in these states during the third quarter of 1998.
Individual physician and surgeon premiums written in Ohio and Kentucky increased
by $19.4 million primarily due to successful marketing efforts directed at
former policyholders of PIE Mutual Insurance Company ("PIE Mutual"), an insurer
which ceased writing business in these states during 1997. Additional premium
written increases of $21.5 million primarily occurred in Maryland, Texas,
Massachusetts, Michigan and Illinois as a result of successful marketing efforts
to physicians, surgeons and institutions in these targeted expansion states.
This increase in business written outside of New Jersey more than offset a net
$2.9 million decrease in New Jersey direct premiums written for the year ended
December 31, 1998, as compared to the year ended December 31, 1997. The net
decrease in New Jersey business during 1998 was composed of an increase of $1.6
million in 1998 policy year premiums and a decrease of $4.5 million relating to
policies that normally would have renewed January 1, 1998, but which were
accelerated to November, 1997 as part of the Company's competitive strategy. The
Company's decision to accelerate the renewal of such policies reduced the
concentration of premium renewals, which substantially exposed the Company's
book of business to market competition in one time period. Additional direct
premiums written were therefore recognized in 1997 which would have otherwise
been recognized in 1998 but for this change. The acceleration of premiums
written had no impact on net premiums earned in 1997 or 1998. The Company's
geographic expansion is continuing to reduce the concentration of business in
New Jersey which comprised 50% of direct premiums written for the year ended
December 31, 1998, as compared to approximately 73% in 1997 and 89% in 1996.
Net premiums earned. Net premiums earned increased approximately $39.2 million,
or 31.8% to $162.5 million, for the year ended December 31, 1998 from $123.3
million for the same period in 1997. This increase is generally consistent with
the increase in direct premiums written.
Net investment income. Net investment income increased approximately $11.2
million or 20.8% to $65.1 million for the year ended December 31, 1998 from
$53.9 million for the same period in 1997. Average invested assets increased to
approximately $1.1 billion during the year ended December 31, 1998 compared to
approximately $1.0 billion for the same period last year. The average annualized
pre-tax yield on the investment portfolio increased to 5.88% for the year ended
December 31, 1998 from 5.61% for the same period in 1997, primarily as a result
of changes in asset allocation with an increased concentration in higher pre-tax
yielding securities and a corresponding decrease in government and tax exempt
security holdings.
Realized investment gains. Net realized investment gains increased approximately
$26.1 million to $36.4 million for the year ended December 31, 1998 compared to
$10.3 million for the same period in 1997. In 1998, the Company implemented an
"equity collar" around its equity securities of $85 million. An "equity collar"
is an option position created with the simultaneous purchase and sale of an
equal number of put and call options. This resulting option position
establishes, for a specified time period, both a ceiling and a floor with
respect to the financial performance of the underlying asset upon which the
equity collar is established. The purpose of the collar was to reduce equity
market volatility and to stabilize unassigned surplus. The collar was
constructed using European-style S&P 500 options. A "European-style" option is
an option contract that may be exercised only upon expiration of the contract
whereas an "American-style" option may be exercised at any time prior to the
expiration of the contract. The reference to "S&P 500" refers to the underlying
asset upon which the option contract's value will be based. To minimize loss
exposure due to credit risk, the Company utilized intermediaries with a Standard
and Poor's rating of "AA" or better. Approximately $24.4 million of the net
gains realized during 1998 resulted from the liquidation of the Company's equity
portfolio during the third quarter of 1998. This net gain was comprised of a
gain of approximately $38.4 million on the disposition of the equities, which
was partially offset by a $14.0 million loss realized (since gains were capped
at 5% by the equity collar and any gains above the equity collar are treated as
a realized loss to be offset against the gross realized gains) on the expiration
of the Company's equity collar position on July 13, 1998.
In July 1998, the Company liquidated its equity portfolio as part of a medium
term portfolio strategy which the Company believes will increase investment
yield. Following liquidation, the proceeds were reinvested in fixed income
securities. The remaining $12.0 million of gains recognized during 1998 pertain
to the sale of government and tax exempt bonds in a generally falling interest
rate environment.
30
<PAGE> 31
Other revenue. Other revenue decreased approximately $2.0 million or 69.1% to
$0.9 million for the year ended December 31, 1998 from $2.9 million for the same
period last year and is composed primarily of finance charge income associated
with the Company's financing of policyholder premiums, which declined as the
Company outsourced its installment payment plans in the second quarter of 1998.
Losses and loss adjustment expenses (LAE). The provision for losses and LAE
increased $35.4 million or 29.4% to $155.9 million for the year ended December
31, 1998 from $120.5 million for the same period in 1997. As a percentage of
earned premiums, however, incurred losses and LAE decreased to 95.9% for the
year ended December 31, 1998 from 97.7% for the same period in 1997. The
decrease in the loss ratio is principally attributable to an increasing portion
of the Company's business being written on a claims made basis which resulted
from the Company's geographic expansion. The provision for losses and LAE for
the year ended December 31, 1998 included favorable reserve development of $2.1
million relating to prior years, the net result of adverse gross reserve
development of $3.8 million offset by favorable development of ceded reserves of
$5.9 million. The provision for losses and LAE for the year ended December 31,
1997 included no development relating to prior years. At December 31, 1998 and
1997, reserves for gross losses and allocated loss adjustment expenses on
incurred but not reported claims amounted to $623.8 million and $591.2 million
respectively, of which $436.3 million and $430.3 million related to prior years.
While certain individual cases were settled during the years ended 1998 and 1997
at values more or less than specific case reserve amounts established in prior
years, there were no overall indications that prior established aggregate
reserves, including the significant portion of reserves for incurred but not
reported claims, should be adjusted beyond the amounts recorded. Medical
malpractice business, particularly occurrence or occurrence-like coverage, has a
very long development period. Cases may take years to be reported, and as a
rule, take several years to adjust, settle or litigate. The provision for losses
and LAE is net of $62.4 million and $68.9 million for the years ended December
31, 1998 and 1997, respectively, of incurred losses and LAE ceded to reinsurers,
primarily on a funds withheld basis.
Additionally, the aggregate excess reinsurance contracts, in place since 1993,
provide coverage for losses and allocated loss adjustment expenses above
aggregate retentions. The aggregate excess reinsurance contracts, therefore,
have the effect of holding net incurred losses and allocated loss adjustment
expenses at a constant level as long as losses and allocated loss adjustment
expenses remain within the coverage limits, which was the case for the years
ended December 31, 1998 and 1997.
Underwriting expenses. Underwriting expenses increased $16.6 million or 65.5% to
$42.1 million for the year ended December 31, 1998, from $25.4 million for the
year ended December 31, 1997. The expense ratio was 25.9% for the year ended
December 31, 1998 compared to 20.6% for the same period in 1997. Approximately
$5.5 million of this increase was attributable to the cost of acquiring new
business, primarily through a broker distribution network, and an additional
$10.1 million related to the expansion of both facilities and staff necessary to
service the increased volume of business activity in 1998. Also in 1998, the
Company recognized approximately $1.0 million in connection with guaranty fund
assessments associated with insurance company insolvencies, primarily in
Pennsylvania and Ohio which are not offset against premium taxes.
Funds held charges. Funds held charges of $13.4 million remained unchanged from
1997 and relate primarily to the interest credited on amounts held under ceded
aggregate reinsurance contracts in effect since 1993. This result is the net
effect of an increase of $1.9 million in interest expense accrued on funds held
under the aggregate reinsurance agreements, consistent with the increase in the
related funds held balances, reduced by an adjustment to funds held interest of
$1.9 million associated with adjustments to losses and premium ceded under those
reinsurance contracts.
Impairment of capitalized system development costs. Statement of Financial
Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed of" ("SFAS No. 121") requires
recognition of impairment losses for long-lived assets whenever events or
changes in circumstances result in the carrying amount of an asset to exceed the
sum of the expected future cash flow associated with the asset. During 1998
management replaced its policy administration system and accordingly recognized
a $12.7 million pre-tax charge which represents the net book value of
capitalized costs associated with the old computer system, which is no longer
being used for the Company's operations.
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<PAGE> 32
Income taxes. Income taxes increased approximately $9.2 million to $11.2 million
for the year ended December 31, 1998, resulting in an effective tax rate of
27.3%, compared to $2.0 million and an effective tax rate of 6.4% for the year
ended December 31, 1997. This increase was primarily attributable to three
factors: an increase in pre-tax income in 1998 of $9.8 million resulting in
additional tax of $3.4 million at a 35% rate; an increase in taxes of $0.8
million associated with a reduction in tax exempt interest in 1998; and release
of a provision of $4.2 million for tax contingencies in 1997.
Net income. Net income was $29.7 million for the year ended December 31, 1998, a
2.1% increase from the $29.1 million for the year ended December 31, 1997. This
increase was the net result of a number of factors, but is primarily due to
higher realized gains and net investment income, partially offset by higher
underwriting costs and income taxes and the one time charge of $12.7 million for
the impairment of capitalized system development costs.
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
Direct premiums written. Direct premiums written were $162.4 million for the
year ended December 31, 1997, a $19.2 million or 13.4% increase over the $143.2
million for the year ended December 31, 1996, as the Company significantly
accelerated its geographic expansion. An almost three-fold increase (to $44.1
million) in premiums written outside of New Jersey more than offset a 7.3%
decrease (to $118.3 million) in New Jersey business, which was primarily
attributable to policies that were not renewed due to rate increases for certain
exposure classes that resulted from the Company's annual underwriting process.
Net premiums earned. Net premiums earned were $123.3 million for the year ended
December 31, 1997, an increase of 14.3% over the $107.9 million for the year
ended December 31, 1996. This increase is generally consistent with the increase
in direct premiums written.
Net investment income. Net investment income was $53.9 million for the year
ended December 31, 1997, an increase of 9.7% over the $49.1 million for the year
ended December 31, 1996. Cash flow from operations of $64.0 million for the year
ended December 31, 1997 provided the majority of the increase in the Company's
invested asset base which totaled approximately $1 billion at December 31, 1997.
Although the invested asset base increased, the pre-tax book yield on invested
assets remained comparable at approximately 5.6%.
Realized investment gains. Net realized investment gains were approximately
$10.3 million for the year ended December 31, 1997 compared to $5.8 million for
the year ended December 31, 1996. Substantially all of these gains resulted from
the sale of equity securities during 1997 and from the sale of bonds in 1996.
Other revenue. Other revenue was $2.9 million for the year ended December 31,
1997, a decrease of 8.8% from the $3.2 million for the year ended December 31,
1996 and is composed primarily of finance charge income associated with the
Company's financing of policyholder premiums.
Losses and loss adjustment expenses (LAE). The provision for losses and LAE was
$120.5 million for the year ended December 31, 1997, an increase of 9.0% over
the $110.6 million for the year ended December 31, 1996. The loss and LAE ratio
was 97.7% for the year ended December 31, 1997 compared to 102.5% for 1996. The
decrease in the loss and LAE ratio is primarily attributed to changes in the
Company's business mix with an increasing amount of policies being issued on a
claims made basis. The provision for net losses and LAE for the years ended
December 31, 1997 and 1996 included no development relating to prior years.
Gross loss and loss adjustment expenses incurred related to prior years
increased by $0.2 million for the year ended December 31, 1997 and did not
change for the year ended December 31, 1996. Reviews of gross losses and loss
adjustment expenses conducted as of December 31, 1996 and 1997 did not indicate
a basis to further revise prior estimates at December 31, 1997 or December 31,
1996. At December 31, 1996 and 1997, reserves for gross losses and allocated
loss adjustment expenses on incurred but not reported claims amounted to $500.0
million and $591.2 million, respectively, of which $350.9 million and $430.3
million related to prior years. While certain individual cases were settled
during 1996 and 1997 at values more or less than specific case reserve amounts
established in prior years, there were no overall indications that prior
established financial reserves, including the significant portion of reserves
for incurred but not reported claims, should be adjusted. Medical malpractice
business, particularly occurrence or occurrence-like coverage, has a very long
development period. Cases may take years to be reported, and as a rule, take
several years to adjust, settle or litigate. The provision for losses and LAE is
net of $68.9 million for the year ended December 31, 1997 and $56.8 million for
the year ended December 31, 1996 of incurred losses and LAE ceded to reinsurers.
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<PAGE> 33
Additionally, the aggregate excess reinsurance contracts, in place since 1993,
provide coverage for losses and allocated loss adjustment expenses above
aggregate retentions. The aggregate excess reinsurance contracts, therefore,
have the effect of holding net incurred losses and allocated loss adjustment
expenses at a constant level as long as losses and allocated loss adjustment
expenses remain within the coverage limits, which occurred for the years ended
December 31, 1996 and 1997.
Underwriting expenses. Underwriting expenses were $25.4 million for the year
ended December 31, 1997, an increase of 44.8% over the $17.6 million for the
year ended December 31, 1996. The expense ratio was 20.6% for the year ended
December 31, 1997 compared to 16.3% for the year ended December 31, 1996.
Approximately $5.0 million of the increase is attributable to staffing,
commissions, premium taxes and facilities costs related to the Company's
geographic expansion and increases in direct premiums earned. Additional
increases of approximately $1.6 million are related to various consulting
projects geared towards business process enhancements and approximately $0.6
million relates to an increase in the reserve for uncollectible accounts
receivable with the remaining increases attributable to the Company's geographic
expansion.
Funds held charges. Funds held charges of $13.4 million for the year ended
December 31, 1997 increased by $3.1 million or 30.1% over the $10.3 million for
the year ended December 31, 1996 and relate to the interest credited on amounts
held under certain ceded aggregate excess reinsurance contracts. This increase
is the result of the net effect of the increase in interest expense accrued on
funds held under these contracts, consistent with the increase in the related
funds held balances.
Income taxes. Income taxes were $2.0 million for the year ended December 31,
1997, a decrease of 79.9% from the $10.0 million for the year ended December 31,
1996. The effective tax rate was 6.4% for the year ended December 31, 1997
compared to 36.2% for 1996, primarily due to the reversal of reserves for
potential tax contingencies, the majority of which were provided for in 1996 and
which were resolved in the Company's favor in 1997.
Net income. Net income was $29.1 million for the year ended December 31, 1997, a
65.5% increase from the $17.6 million for the year ended December 31, 1996,
principally as a result of higher investment income and realized investment
gains and lower income taxes.
FINANCIAL CONDITION
Cash and invested assets. Aggregate invested assets, including cash and short
term investments, were $1,167.1 million and $1,031.8 million at December 31,
1998 and 1997, respectively. The increase in invested assets between December
31, 1997 and December 31, 1998 resulted primarily from cash flow from operations
generated during the period and net realized and unrealized investment gains.
Fixed maturities available for sale, including short-term investments,
aggregated approximately $1.2 billion, or 99.7% of the investment portfolio of
the Company as of December 31, 1998. At that date, the average credit quality of
the fixed income portfolio was "AA-," as defined by Standard & Poor's, while the
total portfolio effective duration (including short-term investments) was 4.45
years.
In 1997, the Company implemented an "equity collar" around its equity securities
of $81.6 million. An "equity collar" is an option position created with the
simultaneous purchase and sale of an equal number of put and call options. This
resulting option position establishes, for a specified time period, both a
ceiling and a floor with respect to the financial performance of the underlying
asset upon which the equity collar is established. The collar transaction was
executed on July 8, 1997 and expired on January 2, 1998. The purpose of the
collar was to reduce equity market volatility and to stabilize unassigned
surplus. The collar was constructed using European-style S&P 500 options, and as
of December 31, 1997, the collar had no unrealized gain or loss. A
"European-style" option is an option contract that may be exercised only upon
expiration of the contract whereas an "American-style" option may be exercised
at any time prior to the expiration of the contract. The reference to "S&P 500"
refers to the underlying asset upon which the option contract's value will be
based. To minimize loss exposure due to credit risk, the Company utilized
intermediaries with a Standard and Poor's rating of "AA" or better.
In 1998, another equity collar was implemented with a notional value of $85
million around the equity portfolio. Again, the purpose of the collar was to
reduce equity market volatility and to stabilize unassigned surplus. The collar
was constructed using European style S&P 500 options. The collar transaction was
executed on January 13, 1998 and expired on July 13, 1998.
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<PAGE> 34
Since the expiration of the equity collar mentioned above, the Company has not
held any derivative investments.
In July, 1998 the Company liquidated its equity portfolio as part of a medium
term portfolio strategy that the Company believes will increase investment
yield. Following liquidation, the proceeds were reinvested in fixed maturity
securities.
Unpaid losses and LAE, reinsurance recoverable on unpaid losses and LAE and
funds held under reinsurance treaties. Gross unpaid losses and LAE were $951.7
million and 876.7 million at December 31, 1998 and 1997, respectively.
Reinsurance recoverable on unpaid losses and LAE was $325.8 million and 270.7
million at December 31, 1998 and 1997, respectively. Funds held under
reinsurance treaties, which are unrestricted, collateralize a significant
portion of reinsurance recoverable on unpaid losses and LAE and were $228.1
million and $182.6 million at December 31, 1998 and 1997, respectively. The
increases in these amounts were consistent with the continued growth in the
Company's book of business.
Equity. Total equity was $322.8 million and $310.0 million at December 31, 1998
and 1997, respectively. The increases were attributable to net income and
changes in unrealized net appreciation of investments.
LIQUIDITY AND CAPITAL RESOURCES
The MIIX Group, Incorporated. The MIIX Group is a holding company whose only
material assets immediately after the Reorganization will be the capital stock
of MIIX Insurance and the Attorney-in-Fact. The net proceeds of the anticipated
Public Offering will be used for general corporate purposes, which may include,
without limitation, capitalizing The MIIX Group's subsidiaries in order to
support their continued growth and for financing potential acquisitions. The
MIIX Group's ongoing cash flow will consist primarily of dividends and other
permissible payments from its subsidiaries. The MIIX Group will depend upon such
payments for funds for general corporate purposes and for the payment of
dividends on the Common Stock.
The payment of dividends to The MIIX Group by MIIX Insurance will be subject to
limitations imposed by the New Jersey Holding Company Act. Based upon these
limitations, the maximum amount that will be available for payment of dividends
to The MIIX Group by MIIX Insurance in any year without the prior approval of
regulatory authorities is subject to restrictions related to surplus and net
income. MIIX Insurance's future cash flow available to The MIIX Group may be
influenced by a variety of factors, including cyclical changes in the medical
malpractice insurance market, MIIX Insurance's financial results, insurance
regulatory changes, including changes in the limitations imposed by the New
Jersey Holding Company Act on the payment of dividends by MIIX Insurance, and
changes in general economic conditions. The MIIX Group expects that the current
limitations that will be imposed on MIIX Insurance should not affect its ability
to declare and pay dividends sufficient to support The MIIX Group's initial
dividend policy. See "Business -- Regulation -- Regulation of Dividends from
Insurance Subsidiaries."
MIIX Insurance. The primary sources of MIIX Insurance's liquidity, on both a
short- and long-term basis, will be funds provided by insurance premiums
collected, net investment income, recoveries from reinsurance and proceeds from
the maturity or sale of invested assets. Funds are generally used to pay claims,
LAE, operating expenses, reinsurance premiums and taxes. The Company's net cash
flow from operating activities was approximately $90.1 million for the year
ended December 31, 1998 and $64.0 million and $43.2 million for the years ended
1997 and 1996, respectively. The higher amount of cash flow from operations in
1998 compared to 1997 was principally due to an increase in collected premiums
in 1998 somewhat offset by increases in paid losses and loss adjustment expenses
and in paid underwriting expenses during 1998. Because of the inherent
unpredictability related to the timing of the payment of claims, it is not
unusual for cash flow from operations for a medical malpractice insurance
company to vary, perhaps substantially, from year to year.
The Company held collateral of $228.1 million and $182.6 million at December 31,
1998 and 1997 respectively, in the form of funds withheld, for recoverable
amounts on ceded unpaid losses and loss adjustment expenses under certain
reinsurance agreements. Under the contracts, reinsurers may require that a trust
fund be established to hold the collateral should one or more triggering events
occur, such as a downgrade in the Company's A.M. Best rating to B+ or lower, or
a reduction in statutory capital and surplus to less than $60 million.
Otherwise, no restrictions are placed on investments held in support of the
funds withheld. In accordance with the provisions of the reinsurance contracts,
the funds withheld are credited with interest at contractual rates ranging from
7.5% to 8.6%, which is recorded as an expense in the year incurred.
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<PAGE> 35
The Company invests its positive cash flow from operations in fixed maturity
securities. The current investment strategy, which will be continued by MIIX
Insurance immediately after the Reorganization, seeks to maximize after-tax
income through a high quality, diversified, duration sensitive, taxable bond and
tax-preferenced municipal bond portfolio, while maintaining an adequate level of
liquidity.
Based on historical trends, market conditions and its business plans, the
Company believes that its sources of funds will be sufficient to meet its
liquidity needs over the next 18 months and beyond. However, because economic,
market, and regulatory conditions may change, there can be no assurance that the
Company's funds will be sufficient to meet these liquidity needs.
The Attorney-in-Fact currently leases the Company's headquarters in
Lawrenceville, New Jersey from the Medical Society, a related party. The Company
is considering purchasing this building. An independent appraisal firm has been
retained by the Company to determine the fair market value of the property to
assist both parties in negotiating the transaction.
YEAR 2000
Because certain computer software programs have historically been designed to
use a two-digit code to identify the year for date-sensitive material, such
programs may not properly recognize post twentieth century dates. This could
result in system failures and improper information processing that could disrupt
the Company's business operations.
The Company began evaluating this issue in 1996 in connection with an overall
evaluation of the Company's systems and during 1997 assigned a project manager
to study the Company's information systems and computers to determine whether
they will appropriately handle post-1999 date codes. The identification of
compliance issues included the Company's internal systems and processes, as well
as exposure from service providers, brokers and other external business
partners. Software applications, hardware and information technology ("I/T")
infrastructure and non I/T systems such as the Company's telephone, security and
heating and ventilating systems have been reviewed to identify those requiring
upgrading or replacement to improve current computing capabilities and to ensure
that they are Year 2000 compliant. In the course of evaluating the Year 2000
readiness of its internal systems, the Company determined that its claims
administration system is not Year 2000 compliant. The Company has purchased a
replacement system that the vendor has represented to be Year 2000 compliant and
is expected to be operational in 1999. The Company has determined that its
telephone equipment is not Year 2000 compliant. The Company is currently
choosing among different methods of making its telephone equipment Year 2000
compliant. The new telephone equipment is expected to be operational in 1999.
During 1997 and 1998 the Company upgraded all its I/T systems to improve their
performance and efficiency. As part of this process, the Company obtained
certifications from the vendors of such new systems that such systems would be
Year 2000 compliant. The Company has conducted internal tests of its new systems
to ensure that they are Year 2000 compliant and continues to conduct such tests.
To date, such tests have not revealed any Year 2000 issues other than in
connection with the claims administration system discussed above. However, the
Company has retained an outside expert to independently evaluate the Year 2000
readiness of the Company's internal systems. The Company may also be adversely
affected if Year 2000 issues result in additional claims being made against the
Company's insureds. The Company's liability for such claims, if any, is not
clearly established. A number of companies who underwrite liability coverage in
the healthcare industry have submitted applications to various state regulators
requesting that policy exclusions for such liability, if any, be approved. Other
carriers have advised their clients of their intent to deny coverage in certain
circumstances. The Company has not yet taken a formal position and is still
conducting research on the matter.
The Company is in the process of sending inquiries to its service providers,
brokers and other external business partners to determine whether they may
experience Year 2000 problems that could affect the Company. Management is
currently evaluating alternative contingency plans that could become necessary
if its own or its significant external business partners' Year 2000 remediation
efforts fail. Such alternatives will most likely involve the assignment of
internal and external resources to process business manually during the duration
of any non-compliance. All contingency planning and testing efforts are
scheduled for completion in the third quarter of 1999. It is not possible at
this time to estimate the cost, if any, of such contingency plans or system
failures.
Remediation costs to date (including expenditures associated with replacement
systems) have been approximately $390,000 and are estimated to be less than $1
million through the completion of remediation, which is expected in 1999. These
costs have been considered in preparing the Company's capital and operating
budgets. There can be no assurance, however, that remediation efforts will be
completed within these estimated costs and time periods.
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ITEM 11. EXECUTIVE COMPENSATION
DIRECTOR COMPENSATION
Following the Reorganization, directors will receive the following fees. The
Chairman will receive an annual stipend of $35,000, the Vice-Chairman will
receive an annual stipend of $20,000, the Secretary will receive an annual
stipend of $20,000, the Chairman of the Audit Committee will receive an annual
stipend of $25,000, the Chairman of any other committee will receive an annual
stipend of $16,000, and other members of the Board will receive an annual
stipend of $14,000. Board members will not receive travel expense reimbursement
for meetings held in New Jersey.
In 1991, the Company invested in a number of corporate owned life insurance
policies insuring the lives of members of the Board of Governors, the Board of
Directors of the Attorney-in-Fact and committee members of such Boards. The
proceeds of such policies were payable to the Company. Under a separate Board
Members Plan the beneficiaries of such members were entitled to death benefit
payments from the Company over a ten-year period. On July 15, 1998, the Company
terminated such Board Members Plan.
EXECUTIVE COMPENSATION
Since its organization in 1997, The MIIX Group has not paid any cash
compensation to its executive officers. The following Summary Compensation Table
sets forth information concerning the compensation by the Company of (i) the
Company's President and Chief Executive Officer and (ii) the five other most
highly compensated executive officers of the Company (collectively, the "Named
Executive Officers"), for the years ended December 31, 1997 and 1998.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
All Other
Name and Principal Positions(s) Year Salary Bonus Compensation(1)
----------- -------------- ------------- --------------------
<S> <C> <C> <C> <C>
Daniel Goldberg 1998 $479,583(2) $475,000 $123,331(3)
President and Chief Executive Officer 1997 421,335(2) 76,000 113,132(3)
Joseph J. Hudson 1998 232,500 215,000 14,542(4)
Executive Vice President, Marketing 1997 200,000 33,000 13,117(4)
And Business Development
Kenneth Koreyva 1998 258,667 320,000 30,997(5)
Executive Vice President, 1997 225,000 49,500 34,421(5)
Chief Financial Office and Treasurer
Richard J. Gergasko(6) 1998 83,846 37,600 2,068(7)
Vice President, Underwriting and
Actuarial Services 1997 -- -- --
Lisa Kramer 1998 225,000 33,750 20,562(8)
Vice President, Claims 1997 225,000 24,000 25,604(8)
Ronald Wade(9) 1998 188,370 18,900 14,751(10)
Vice President, Western Region 1997 172,500 26,000 7,750(10)
</TABLE>
(1) The value of certain perquisites or personal benefits is not included
in the amounts disclosed because it did not exceed for any Named
Executive Officer the lesser of either $50,000 or 10% of the total
annual salary and bonus reported for the Named Executive Officer.
(2) Includes $78,750 of deferred compensation paid in each of 1997 and
1998.
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<PAGE> 37
(3) Represents 401(k) contributions of $4,750 and $5,000 in 1997 and 1998,
respectively; $10,429 and $3,840 in supplemental health and disability
insurance premiums in 1997 and 1998, respectively; $87,000 in premiums
paid by the Company in each of 1997 and 1998 in respect of a
supplemental executive retirement program; $16,538 in lieu of vacation
days not taken in 1998; and $10,953 in respect of a Split Dollar Life
Insurance Agreement in each of 1997 and 1998. Under this Agreement, the
Company did not pay any amount attributable to term life insurance
coverage in 1997 or 1998, and the dollar value to Mr. Goldberg of the
remainder of the premiums paid by the Company during each of 1997 and
1998 is $10,953. See "Employment Agreements."
(4) Represents 401(k) contributions of $4,750 and $5,000 in 1997 and 1998,
respectively; $4,967 and $6,142 in supplemental health and disability
insurance premiums in 1997 and 1998, respectively; and $3,400 in
respect of Split Dollar Life Insurance Agreement in each of 1997 and
1998. Under such Agreement, the Company did not pay any amount
attributable to term life insurance coverage in 1997 or 1998, and the
dollar value to Mr. Hudson of the remainder of the premiums paid by the
Company during each of 1997 and 1998 is $3,400. See "Employment
Agreements."
(5) Represents 401(k) contributions of $4,750 and $5,000 in 1997 and 1998,
respectively; $7,113 and $5,411 in supplemental health and disability
insurance premiums in 1997 and 1998, respectively; $17,308 and $15,336
in lieu of vacation days not taken in 1997 and 1998, respectively; and
$5,250 in respect of a Split Dollar Life Insurance Agreement in each of
1997 and 1998. Under such Agreement, the Company did not pay any amount
attributable to term life insurance coverage in 1997 or 1998, and the
dollar value to Mr. Koreyva of the remainder of the premiums paid by
the Company during each of 1997 and 1998 is $5,250. See "Employment
Agreements."
(6) Mr. Gergasko was not employed by the Company in 1997.
(7) Consists of supplemental health and disability insurance premiums.
(8) Represents 401(k) contributions of $4,750 and $5,000 in 1997 and 1998,
respectively; $5,000 and $4,035 in supplemental health and disability
insurance premiums in 1997 and 1998, respectively; $8,654 and $4,327 in
lieu of vacation days not taken in 1997 and 1998 respectively; and
$7,200 in respect of a Split Dollar Life Insurance Agreement in each of
1997 and 1998. Under such Agreement, the Company did not pay any amount
attributable to term life insurance coverage in 1997 or 1998, and the
dollar value to Ms. Kramer of the remainder of the premiums paid by the
Company during each of 1997 and 1998 is $7,200. See "Employment
Agreements."
(9) Reported pursuant to Item 402(a)(3)(iii) of Regulation S-K.
(10) Represents 401(k) contributions of $4,750 and $5,000 in 1997 and 1998,
respectively; $3,000 and $6,128 in supplemental health insurance
premiums in 1997 and 1998, respectively; and $3,623 in lieu of vacation
days not taken in 1998.
EMPLOYMENT AGREEMENTS
Each of Messrs. Goldberg, Koreyva and Hudson is party to a separate employment
agreement dated October 9, 1998 (each an "Employment Agreement") with The MIIX
Group and the Attorney-in-Fact. Each Employment Agreement is for an initial
three year term. Mr. Goldberg's Employment Agreement provides for an initial
base salary of $430,000 per annum, Mr. Koreyva's Employment Agreement provides
for an initial base salary of $275,000 per annum and Mr. Hudson's Employment
Agreement provides for an initial base salary of $250,000 per annum. Bonuses are
payable at the discretion of the Board of Directors of The MIIX Group. In the
event of a termination of employment, severance pay including up to three years'
salary (in the case of Mr. Goldberg) or two years' salary (in the case of
Messrs. Koreyva and Hudson) is payable under certain circumstances. Under the
terms of their respective Employment Agreements each of Messrs. Goldberg,
Koreyva, and Hudson is entitled to the grant of stock options. Such stock
options will be granted under The MIIX Group's Long Term Incentive Equity Plan
(as described in more detail below) on or by the date of consummation of the
anticipated Public Offering at an exercise price equal to the fair market value
of the Common Stock as of the date of grant. Mr. Goldberg will be granted
175,000 options, Mr. Hudson will be granted 60,000 options and Mr. Koreyva will
be granted 80,000 options. Twenty-five percent of these options will vest upon
grant and an additional twenty-five percent will vest upon the first, second and
third anniversaries of the date of grant. Under the terms of each Employment
Agreement, Messrs. Goldberg, Koreyva and Hudson are permitted to participate in
the stock purchase and loan agreements and the compensation plans described
below.
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The Attorney-in-Fact is party to an employment agreement dated as of August 1,
1990, with Ms. Kramer. This is currently a year-to-year agreement. Ms. Kramer's
current compensation under such agreement is $225,000 per annum. If Ms. Kramer's
employment is terminated without cause, the Attorney-in-Fact is required to pay
Ms. Kramer's salary and benefits through the end of the term of the Agreement,
reduced by the amount of any compensation received by Ms. Kramer from other
employment.
The Attorney-in-Fact is party to an employment agreement dated as of November 1,
1997 with Mr. Wade. This agreement is for a two year term. Mr. Wade's base
salary per annum under this agreement is $179,400. Additional compensation and
bonuses are payable at the discretion of the Board of Directors of the
Attorney-in-Fact. If Mr. Wade's employment is terminated without cause, the
Attorney-in-Fact is required to pay Mr. Wade's salary and benefits for 12 months
or, if earlier, until Mr. Wade obtains full-time employment with another
employer. If Mr. Wade's employment is terminated prior to November 1, 1999, he
is entitled to receive the greater of (i) the amount determined in accordance
with the preceding sentence and (ii) his salary and benefits payable through
November 1, 1999.
The Attorney-in-Fact provides Mr. Goldberg with a supplemental executive
retirement program through a Restricted Split Dollar Life Insurance Agreement
and a related Collateral Assignment of Split-Dollar Policy dated September 12,
1996. Under the terms of these agreements, the Attorney-in-Fact is responsible
for the payment of all premiums due under a life insurance policy on the life of
Mr. Goldberg with a total face value of $1.4 million. The annual premium under
such policy is $87,000. Mr. Goldberg owns such policy, but upon Mr. Goldberg's
death, the Attorney-in-Fact is entitled to receive (i) if the Attorney-in-Fact
or the Exchange has been declared insolvent, an amount equal to the lesser of
the cash surrender value of the policy or the sum of the premiums paid by the
Attorney-in-Fact, net of previous withdrawals or policy loans made to the
Attorney-in-Fact, and if the Attorney-in-Fact and the Exchange have not been
declared insolvent, zero (the "Insolvency Payment") and (ii) an amount equal to
the proceeds of the policy less the sum of $900,000 and the Insolvency Payment.
If the policy is paid under circumstances other than Mr. Goldberg's death, the
Attorney-in-Fact is entitled to receive the Insolvency Payment. Mr. Goldberg's
Employment Agreement requires The MIIX Group to maintain this or an equally
favorable arrangement on behalf of Mr. Goldberg.
The Attorney-in-Fact is party to Split Dollar Life Insurance Agreements and
related Collateral Assignments of Split-Dollar Policy with each of Mr. Goldberg,
Mr. Hudson, Mr. Koreyva and Ms. Kramer. Under the terms of such agreements, the
Named Executive Officer owns a life insurance policy, and the Attorney-in-Fact
and the applicable Named Executive Officer share the cost of such policy's
premiums. Upon payment of the proceeds or cash value of each such policy, the
Attorney-in-Fact is entitled to receive the excess of such proceeds or cash
value over the greater of (i) the excess of the proceeds or cash value of the
policy over the sum of total premiums paid by the Attorney-in-Fact, or (ii) the
sum of the applicable Named Executive Officer's premium payments, plus interest
at 5% per annum, compounded annually on the anniversary date of the applicable
policy.
STOCK PURCHASE AND LOAN AGREEMENTS
The MIIX Group is party to separate Stock Purchase and Loan Agreements with each
of Messrs. Goldberg, Koreyva and Hudson (the "Stock Purchase and Loan
Agreements"). The purpose of the Stock Purchase and Loan Agreements is to align
more closely the interests of such officers with the interests of The MIIX
Group's stockholders. Pursuant to such agreements, upon the closing of the
anticipated Public Offering, The MIIX Group will loan $1,290,000 to Mr.
Goldberg, $550,000 to Mr. Koreyva and $500,000 to Mr. Hudson. The proceeds of
such loans will be used to purchase unregistered shares of Common Stock from The
MIIX Group at the price at which the Common Stock is sold to the public in the
Public Offering (the "Public Offering Price"), and the interest rate charged
therefor will be the minimum rate necessary to avoid income imputation under the
Code as of the date of the closing of the Reorganization. Although the purchased
shares will be pledged to The MIIX Group to secure the applicable loan, each
loan will be made with full recourse against the applicable executive. Each loan
has a five-year term. If the anticipated Public Offering is not consummated then
no loans will be made and no shares will be purchased pursuant to the Stock
Purchase and Loan Agreements.
DEFERRED COMPENSATION PLANS
Effective as of December 31, 1998, the Attorney-in-Fact entered into Deferred
Compensation Agreements with each of Mr. Goldberg, Mr. Hudson and Mr. Koreyva.
Pursuant to each such Agreement, the officers may elect to defer payment of
certain compensation. Interest shall be credited monthly to the deferred amounts
equal to the aggregate investment portfolio total rate of return for the
Exchange, or the return associated with other investments as agreed by the
parties. Distributions of benefits shall commence no earlier than January 15,
2004, but shall be accelerated upon the applicable officer ceasing to be
employed by the Attorney-in-Fact, or upon such officer's death. In the event of
a Change in Control, as defined in the applicable officer's Employment Agreement
with the Attorney-in-Fact and The MIIX Group, a change in the officer's title or
responsibilities, a reduction in the officer's base salary, or a failure by the
Attorney-in-Fact to increase the officer's compensation at a rate commensurate
with that of other key executives of the Attorney-in-Fact, the Attorney-in-Fact
must establish a trust and fund such trust with an amount equal to the
Attorney-in-Fact's obligation to the officer under the Deferred Compensation
Plan.
38
<PAGE> 39
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Attorney-in-Fact leases 49,000 square feet for its home office and
Mid-Atlantic Region office from the Medical Society pursuant to a lease
agreement dated June 29, 1981 and extended on June 26, 1998. Annual lease
payments are approximately $770,000. The Company held a note receivable of $2.8
million and $3.0 million, included in other assets, at December 31, 1998 and
1997, respectively, from the Medical Society, collateralized by the building in
which the Company maintains its home office. The note provides for monthly
payments of $40,000, which includes interest at 9.05% until September 1, 2004
and reduced payments thereafter until June 1, 2009. Vincent A. Maressa, a
director of the Medical Society, is a director of The MIIX Group.
In addition to the lease mentioned above, the Attorney-in-Fact leases space
pursuant to a lease guaranteed by the Exchange. Such lease expires in May 2001,
with total minimum lease payments remaining of $1.3 million as of December 31,
1998. The Exchange has extended a line of credit to an Attorney-in-Fact
subsidiary in an amount up to $5.0 million, none of which was outstanding as of
December 31, 1998. The Exchange guarantees a bank loan on behalf of the
Attorney-in-Fact, which had an outstanding balance of $0.8 million at December
31, 1998. Mr. Goldberg, the Chief Executive Officer and a director of The MIIX
Group, is a director, the Chief Executive Officer and the President of the
Attorney-in-Fact.
A majority of the members of The MIIX Group Board are also policyholders and
Distributees. Such directors may experience claims requiring coverage under
their respective policies with the Company.
Mr. Goldberg is the Chief Executive Officer of AMM. The Attorney-in-Fact manages
the business of AMM. In 1998, AMM paid the Attorney-in-Fact $234,078 for such
management services.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a)(1) and (2) and (d)
The required schedules as identified on the Index to
Financial Statements on page F-1 of the 10-K are incorporated herein by
reference. All other schedules for which provision is made in the applicable
accounting regulation of the Securities and Exchange Commission are not
required under the related instructions or are inapplicable and therefore
have been omitted.
(a) (3) and (c) The following exhibits are filed herewith unless
otherwise indicated:
Exhibit
Number Description
2.1 Plan of Reorganization of Medical Inter-Insurance Exchange.(1)
2.2 Stock Purchase Agreement between The Medical Society of New Jersey and
the MIIX Group, Incorporated (incorporated by reference to Exhibit 2.1
filed with the registrant's registration statement on Form S-1 (Reg.
No. 333-59371)).
2.3 Amendment No. 1 to Stock Purchase Agreement between The Medical Society
of New Jersey and the MIIX Group, Incorporated, dated as of September
20, 1998 (1).
2.4 Amendment No. 2 to Stock Purchase Agreement between The Medical Society
of New Jersey and The MIIX Group, Incorporated, dated as of December
21, 1998 (1).
2.5 Resolution of the Medical Inter-Insurance Exchange of New Jersey Board
of Governors amending the Plan of Reorganization (1).
3.1 Restated Certificate of Incorporation of the MIIX Group,
Incorporated.(1)
3.2 Bylaws of The MIIX Group, Incorporated.(1)
10.1 Lease Between the Medical Society of New Jersey and New Jersey State
Medical Underwriters, Inc. dated June 29, 1981.(1)
10.2 Extension of Lease between the Medical Society of New Jersey and New
Jersey State Medical Underwriters, dated June 26, 1998.(1)
10.3 Lease Between Princeton Pike Corporate Center Associates IV and
Physician Healthcare Plan of New Jersey Inc. dated May 24, 1991 and
assigned to New Jersey State Medical Underwriters, Inc. on February 11,
1997.(1)
10.4 Specific Excess Reinsurance Contract, effective January 1, 1997, among
Medical Inter-Insurance Exchange of New Jersey and Swiss Reinsurance
Company; Hannover Ruckversicherungs; Underwriters Reinsurance Company;
Kemper Reinsurance Company; and London Life and Casualty Reinsurance
Corporation.(1)
39
<PAGE> 40
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
The MIIX GROUP, INCORPORATED
By: /s/ DANIEL GOLDBERG
---------------------------------------
Daniel Goldberg
President and Chief Executive Officer
July 26, 1999
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>
Name Title Date
---- ----- ----
<S> <C> <C>
/s/ DANIEL GOLDBERG President, Chief Executive Officer and
- ------------------------------------- and Director (principal executive officer) July 26, 1999
Daniel Goldberg
/s/ KENNETH KOREYVA Executive Vice President and Chief Financial Officer
- ------------------------------------- (principal financial and accounting officer) July 26, 1999
Kenneth Koreyva
* Director
- -------------------------------------
Angelo S. Agro, M.D. July 26, 1999
* Director
- -------------------------------------
Harry M. Carnes, M.D. July 26, 1999
* Director
- -------------------------------------
Paul Hirsch, M.D. July 26, 1999
* Director
- -------------------------------------
Arganey Lucas, Jr., M.D. July 26, 1999
* Director
- -------------------------------------
Vincent A. Maressa, Esq. July 26, 1999
</TABLE>
40
<PAGE> 41
<TABLE>
<S> <C> <C>
* Director
- -------------------------------------
Gabriel F. Sciallis, M.D. July 26, 1999
* Director
- -------------------------------------
Bessie M. Sullivan, M.D. July 26, 1999
*By: /s/ Daniel Goldberg
- -------------------------------------
Daniel Goldberg
Attorney-in-Fact
</TABLE>
41
<PAGE> 42
INDEX TO FINANCIAL STATEMENTS AND SCHEDULE
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Auditors........................................... F-2
Consolidated Balance Sheets as of December 31, 1998 and
1997................................................................... F-3
Consolidated Statements of Income for the years ended
December 31, 1998, 1997 and 1996....................................... F-4
Consolidated Statements of Equity for the three years ended
December 31, 1998...................................................... F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 1998, 1997, and 1996...................................... F-6
Notes to Consolidated Financial Statements............................... F-7
Schedule I -- Summary of Investments -- Other than
Investments in Related Parties......................................... F-21
</TABLE>
(ALL OTHER SCHEDULES FOR WHICH PROVISION IS MADE IN THE APPLICABLE ACCOUNTING
REGULATION OF THE SECURITIES AND EXCHANGE COMMISSION ARE OMITTED FOR THE REASON
THAT THEY ARE NOT APPLICABLE OR THE INFORMATION IS OTHERWISE CONTAINED IN THE
FINANCIAL STATEMENTS).
F-1
<PAGE> 43
REPORT OF INDEPENDENT AUDITORS
Board of Governors
Medical Inter-Insurance Exchange
We have audited the accompanying consolidated balance sheets as of December
31, 1998 and 1997, of Medical Inter-Insurance Exchange and subsidiaries and the
related consolidated statements of income, equity, and cash flows for each of
the three years in the period ended December 31, 1998. Our audits also included
the financial statement schedule listed in the Index at Item 14a. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit 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 financial position of the Medical
Inter-Insurance Exchange and subsidiaries at December 31, 1998 and 1997, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1998, in conformity with generally accepted
accounting principles. Also, in our opinion, the related financial statement
schedule when considered in relation to the basic financial statements taken as
a whole, presents fairly, in all material respects, the information set forth
therein.
ERNST & YOUNG LLP
New York, New York
March 24, 1999
F-2
<PAGE> 44
MEDICAL INTER-INSURANCE EXCHANGE
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1998 1997
---------- ----------
<S> <C> <C>
ASSETS
Securities available-for-sale:
Fixed-maturity investments, at fair value (amortized cost:
1998 -- $1,041,192; 1997 -- $832,822).................. $1,057,739 $ 852,746
Equity investments, at fair value (cost: 1998 -- $3,159;
1997 -- $66,520)....................................... 3,159 89,080
Short-term investments, at cost which approximates fair
value.................................................. 104,800 85,145
---------- ----------
Total investments................................. 1,165,698 1,026,971
Cash........................................................ 1,408 4,877
Accrued investment income................................... 13,563 10,324
Premium receivable, net..................................... 23,876 4,817
Reinsurance recoverable on unpaid losses.................... 325,795 270,731
Prepaid reinsurance premiums................................ 26,921 19,814
Reinsurance recoverable on paid losses, net................. 724 2,692
Deferred policy acquisition costs........................... 2,810 100
Due from Attorney-in-Fact................................... 3,949 13,347
Deferred income taxes....................................... 34,731 17,696
Other assets................................................ 74,787 75,190
---------- ----------
Total assets...................................... $1,674,262 $1,446,559
========== ==========
LIABILITIES AND EQUITY
LIABILITIES
Unpaid losses and loss adjustment expenses.................. $ 951,659 $ 876,721
Unearned premiums........................................... 54,139 20,886
Premium deposits............................................ 28,392 21,024
Funds held under reinsurance treaties....................... 228,148 182,590
Payable for securities...................................... 34,115 229
Other liabilities........................................... 54,966 35,135
---------- ----------
Total liabilities................................. $1,351,419 $1,136,585
---------- ----------
Commitments and contingencies (Notes 5 and 8)
EQUITY
Surplus..................................................... 312,087 282,359
Accumulated other comprehensive income...................... 10,756 27,615
---------- ----------
Total equity...................................... 322,843 309,974
---------- ----------
Total liabilities and equity...................... $1,674,262 $1,446,559
========== ==========
</TABLE>
See accompanying notes
F-3
<PAGE> 45
MEDICAL INTER-INSURANCE EXCHANGE
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
REVENUES
Net premiums earned........................................ $162,501 $123,330 $107,887
Net investment income...................................... 65,107 53,892 49,135
Realized investment gains, net............................. 36,390 10,296 5,832
Other revenue.............................................. 891 2,884 3,164
-------- -------- --------
Total revenues................................... 264,889 190,402 166,018
EXPENSES
Losses and loss adjustment expenses........................ 155,868 120,496 110,593
Underwriting expenses...................................... 42,063 25,415 17,553
Funds held charges......................................... 13,420 13,361 10,273
Impairment of capitalized system development costs......... 12,656 -- --
-------- -------- --------
Total expenses................................... 224,007 159,272 138,419
Income before income taxes................................. 40,882 31,130 27,599
Provision for income taxes................................. 11,154 2,006 10,004
-------- -------- --------
Net income................................................. $ 29,728 $ 29,124 $ 17,595
======== ======== ========
Earnings per share (pro forma)............................. $ 2.47
========
</TABLE>
See accompanying notes
F-4
<PAGE> 46
MEDICAL INTER-INSURANCE EXCHANGE
CONSOLIDATED STATEMENTS OF EQUITY
FOR THE THREE YEARS ENDED DECEMBER 31, 1998
(IN THOUSANDS)
<TABLE>
<CAPTION>
ACCUMULATED
OTHER
COMPREHENSIVE
SURPLUS INCOME TOTAL EQUITY
-------- ------------- ------------
<S> <C> <C> <C>
Balance at January 1, 1996............................. $235,640 $ 18,991 $254,631
Net income........................................... 17,595 17,595
Other comprehensive income, net of tax:
Unrealized depreciation on securities available-for-
sale, net of deferred taxes....................... (9,914) (9,914)
-------- -------- --------
Balance at December 31, 1996........................... 253,235 9,077 262,312
Net income........................................... 29,124 29,124
Other comprehensive income, net of tax:
Unrealized appreciation of securities available-for-
sale, net of deferred tax......................... 18,538 18,538
-------- -------- --------
Balance at December 31, 1997........................... 282,359 27,615 309,974
Net income........................................... 29,728 29,728
Other comprehensive income, net of tax:
Unrealized depreciation on securities available-for-
sale, net of deferred tax......................... (16,859) (16,859)
-------- -------- --------
Balance at December 31, 1998........................... $312,087 $ 10,756 $322,843
======== ======== ========
</TABLE>
See accompanying notes
F-5
<PAGE> 47
MEDICAL INTER-INSURANCE EXCHANGE
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income............................................ $ 29,728 $ 29,124 $ 17,595
Adjustments to reconcile net income to net cash
provided by operating activities:
Unpaid losses and loss adjustment expenses......... 74,938 81,272 46,789
Unearned premiums.................................. 33,253 12,588 1,883
Premium deposits................................... 7,368 (16,224) (3,873)
Premium receivable, net............................ (19,059) (271) (751)
Reinsurance balances, net.......................... (14,645) (14,649) (20,326)
Deferred policy acquisition costs.................. (2,710) 351 (451)
Realized gains..................................... (36,390) (10,296) (5,832)
Depreciation, accretion and amortization........... (980) (1,029) 976
Deferred income tax provision...................... (7,957) (1,417) 776
Due from Attorney-in-Fact.......................... (3,258) (3,687) (2,307)
Impairment of capitalized system development
costs............................................ 12,656 -- --
Accrued investment income.......................... (3,239) (142) 2,159
Other assets....................................... 578 (9,185) (2,101)
Other liabilities.................................. 19,831 (2,461) 8,667
--------- --------- ---------
Net cash provided by operating activities............. 90,114 63,974 43,204
========= ========= =========
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from fixed-maturity investment sales......... 664,988 228,005 606,172
Proceeds from fixed-maturity investments matured,
called, or prepaid................................. 112,473 120,034 97,325
Proceeds from equity investment sales, net of equity
collar expiration.................................. 91,789 24,249 3,386
Cost of investments acquired.......................... (976,889) (444,168) (704,486)
Change in short-term investments, net................. (19,655) 1,085 (33,979)
Payable for securities................................ 33,886 229 --
Acquisition of goodwill............................... (175) -- (1,700)
--------- --------- ---------
Net cash used in investing activities................. (93,583) (70,566) (33,282)
CASH FLOWS FROM FINANCING ACTIVITIES
Subordinated loan certificates redeemed............... -- -- (248)
--------- --------- ---------
Net cash used in financing activities................. -- -- (248)
Net change in cash.................................... (3,469) (6,592) 9,674
Cash at beginning of year............................. 4,877 11,469 1,795
--------- --------- ---------
Cash at end of year................................... $ 1,408 $ 4,877 $ 11,469
========= ========= =========
</TABLE>
See accompanying notes
F-6
<PAGE> 48
MEDICAL INTER-INSURANCE EXCHANGE
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND RELATED MATTERS
The Medical Inter-Insurance Exchange ("The Exchange") was organized as a
New Jersey reciprocal insurance exchange in 1977. A New Jersey reciprocal
insurance exchange is an entity that may be formed by persons seeking a
particular type of insurance coverage. In the case of the Exchange, medical and
osteopathic physicians formed the Exchange to provide medical malpractice
insurance. Under New Jersey law, the business of a reciprocal insurance exchange
must be conducted by a separate entity acting as the attorney-in-fact of such
exchange.
The Attorney-in-Fact is a corporation that is wholly owned by the Medical
Society of New Jersey (the "Medical Society") and was originally formed to
fulfill the statutory role of attorney-in-fact for the Exchange. In recent years
the Attorney-in-Fact has diversified its business, but its principal activity
continues to be managing the Exchange. The Attorney-in-Fact manages the
Exchange, subject to the oversight of the Board of Governors of the Exchange,
pursuant to a management contract that requires the Exchange to reimburse the
costs of the Attorney-in-Fact. In addition to the power of attorney contained in
such management contract, each member of the Exchange is required to execute a
power of attorney in favor of the Attorney-in-Fact to affirm the
Attorney-in-Fact's power to act on behalf of the Exchange pursuant to the
management contract.
The rights of a member of the Exchange are similar to the rights of a
policyholder of other types of insurance companies. Because members of the
Exchange are accorded certain voting rights, members' rights are more closely
analogous to the rights of a person insured by a mutual insurance company than
the rights of a person insured by a stock insurance company. Members' rights
include the right to elect the Board of Governors, which has oversight authority
over the Attorney-in-Fact. Therefore, while the day-to-day affairs of the
Exchange are managed by the Attorney-in-Fact, the Exchange is ultimately
controlled by its members through their power to elect the Board of Governors.
The Exchange has been operated to generate profits. Such profits are part
of the Exchange's surplus account, and the application of such profits is in the
Exchange's discretion. Neither the Attorney-in-Fact nor the Medical Society owns
the Exchange or has any right to profits generated by the Exchange.
The Exchange is permitted by law to engage in any line of insurance
permitted by its rules and regulations, its certificate of authority, and the
applicable New Jersey laws, its state of domicile, and other states where it is
authorized to do business. All aspects of the Exchange's operations are
regulated by state regulatory authorities, particularly the regulatory
authorities of New Jersey, which is the state in which the Exchange is
domiciled. State laws regulate the process of soliciting insurance, the
underwriting of insurance, the rates charged, the nature of insurance products
sold, the financial accounting methods of the insurer utilized for regulatory
matters, the amount of money required to be maintained by the insurer to guard
against insolvency, and many other aspects of the day-to-day operations of the
Exchange. See Note 9.
In 1996, the Exchange formed a down-stream holding company, Lawrenceville
Holdings, Inc. ("LHI"). On April 16, 1996, LHI acquired all of the common stock
of a property and casualty insurance company, Lawrenceville Property and
Casualty Co., Inc. ("LP&C"), which is domiciled in Virginia, and is licensed in
twenty-five states and the District of Columbia. On July 14, 1998, LHI acquired
all of the common stock of a property and casualty insurance company, MIIX
Insurance Company of New York ("MIIX New York"), which is domiciled in New York.
The Exchange owns all of the common stock of The MIIX Group, Incorporated, ("The
MIIX Group") a Delaware holding company formed in 1997. The MIIX Group owns all
of the common stock of MIIX Insurance Company ("MIIX Insurance"), a New
Jersey-domiciled property and casualty insurance company incorporated on May 14,
1998.
The Exchange, LHI, LP&C, MIIX New York and MIIX Insurance (collectively,
"the Company") provide a wide range of insurance products to the medical
profession and health care institutions primarily in the states of New Jersey
and Pennsylvania. The primary business of the Company is medical professional
liability and it
F-7
<PAGE> 49
MEDICAL INTER-INSURANCE EXCHANGE
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
issues claims-made, modified claims made with prepaid extended reporting
endorsements and occurrence policies. The Company currently maintains licenses
in 31 states and the District of Columbia.
2. SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying consolidated financial statements have been prepared in
conformity with generally accepted accounting principles ("GAAP") which differs
from statutory accounting practices prescribed or permitted by regulatory
authorities (see Note 9). The significant accounting policies followed by the
Company that materially affect financial reporting are summarized below:
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of
the Exchange, LHI, LP&C (from the date of acquisition, April 16, 1996), MIIX New
York (from the date of acquisition, July 14, 1998) and MIIX Insurance (from the
date of incorporation, May 14, 1998). During 1996, no business was written by
LP&C subsequent to its acquisition. No business was written by MIIX New York or
MIIX Insurance during 1998. All significant intercompany transactions and
balances have been eliminated in the consolidation.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the amounts reported in
the financial statements and accompanying notes. Such estimates and assumptions
could change in the future as more information becomes known which could impact
the amounts reported and disclosed herein.
Investments
The Company has designated its entire investment portfolio as
available-for-sale. The Company designates its investment portfolio as
available-for-sale to provide the Company flexibility to respond to changes in
market conditions and tax planning considerations. As such, all investments are
carried at their fair values. The Company has no securities classified as
"trading" or "held-to-maturity." Transfers to these categories are restricted.
Investments are recorded at the Trade date.
Changes in fair values of available-for-sale securities, after adjustment
of deferred income taxes, are reported as unrealized appreciation or
depreciation directly in equity as a component of other comprehensive income
and, accordingly, have no effect on net income.
For the loan-backed bonds, the Company recognizes income using a constant
effective yield based on anticipated prepayments and the estimated economic life
of securities. Prepayment assumptions are obtained from both proprietary and
broker/dealer estimates and are consistent with the current interest rate and
economic environment. When actual prepayments differ significantly from
anticipated prepayments, which are assessed periodically, the effective yield is
recalculated to reflect actual payments to date and anticipated future payments.
The net investment in the security is adjusted to the amount that would have
existed had the new effective yield been applied since the acquisition of the
security. That adjustment is included in net investment income.
Derivative financial instruments are held as part of a hedging strategy and
are classified as other than trading. As such, all derivatives are carried at
their fair values. Changes in fair values, net of deferred taxes, are reported
as unrealized appreciation or depreciation directly in equity as a component of
other comprehensive income and, accordingly, have no effect on net income.
F-8
<PAGE> 50
MEDICAL INTER-INSURANCE EXCHANGE
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Premiums and discounts on investments (other than loan-backed bonds) are
amortized/accreted to investment income using the interest method over the
contractual lives of the investments. Realized investment gains and losses are
included as a component of revenues based on a specific identification of the
investment sold.
Short-term investments include investments maturing within one-year and
other cash and cash equivalent balances earning interest.
Losses and Loss Adjustment Expenses
Estimates for unpaid losses and loss adjustment expenses are based on the
Company's evaluation of reported claims and actuarial analyses of the Company's
operations since its inception, including assumptions regarding expected
ultimate losses and reporting patterns, and estimates of future trends in claim
severity and frequency. The Company's philosophy is to have a disciplined
process consistently applied in setting and adjusting loss and LAE reserves.
Although variability is inherent in such estimates, recorded loss and LAE
reserves represent management's best estimate of the remaining costs of settling
all incurred claims. Changes in the Company's best estimate of ultimate claim
costs are recognized in the period in which the Company's estimate of those
ultimate costs is changed. These estimates are reviewed regularly and any
adjustments to prior year reserves are reflected in current year operating
results.
The Company offered pure occurrence coverage from 1977 through 1986 and a
form of occurrence coverage, "modified claims made" from 1987 to the present
through its Permanent Protection Plan ("PPP") policy. The PPP policy provides
coverage for claims reported during the policy period as well as, under the
extended reporting endorsement, claims reported after the termination of the
policy (for any reason), and thus is reserved on an occurrence basis.
Traditional claims-made and occurrence coverages are reserved on a claims-made
or occurrence basis, as appropriate.
Premiums
Premiums are recorded as earned over the period the policies to which they
apply are in force. Premium deposits represent amounts received prior to the
effective date of the new or renewal policy period. The reserve for unearned
premiums is determined on a monthly pro-rata basis. Gross premiums include both
direct and assumed premiums earned.
Reinsurance
Reinsurance premiums, losses, and loss adjustment expenses are accounted
for on a basis consistent with the accounting for the original policies issued
and the terms of the reinsurance contracts. Premium deposits, unearned premiums,
and unpaid losses and loss adjustment expenses are reported gross of reinsurance
amounts.
All reinsurance contracts are accounted for in accordance with the
provisions of SFAS No. 113, "Accounting and Reporting for Reinsurance of
Short-Duration and Long-Duration Contracts", which provides the criteria for
determining whether the contracts should be accounted for utilizing reinsurance
accounting or deposit accounting. Reinsurance contracts that do not satisfy
certain requirements of SFAS No. 113 are accounted for by the deposit method.
Recorded deposits are initially established based on the consideration paid less
any fees which are expensed in accordance with the contract terms. Subsequent
adjustments to the deposit are measured based on the present value of the
expected future cash flows arising from the contract.
F-9
<PAGE> 51
MEDICAL INTER-INSURANCE EXCHANGE
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Premium Receivable
Premium receivable is net of an allowance for doubtful accounts as of
December 31, 1998 and 1997 of $455,000 and $627,000, respectively. Amounts
charged to expense in 1998, 1997 and 1996 were ($172,000), $627,000 and $0.
Reinsurance Recoverable on Paid Losses
Reinsurance recoverable on paid losses at December 31, 1998 is net of an
allowance of $1,300,000. A corresponding amount was reflected in 1998
operations.
Deferred Policy Acquisition Costs
Policy acquisition costs, (primarily commissions, premium taxes and other
selling expenses) which vary with and are directly related to the production of
business, are capitalized and amortized over the effective period of the related
policies. Anticipated investment income is considered in determining if premium
deficiencies exist.
Software Development Costs
Costs incurred in the development of software used for Company operations
are capitalized and amortized over a useful life ranging from three to five
years.
Income Taxes
The Company utilizes the liability method of accounting for income taxes.
Under the liability method, deferred income taxes arise as a result of applying
enacted statutory tax rates to the temporary differences between the financial
statement carrying value and the tax basis of assets and liabilities. A
valuation allowance is established for any portion of a deferred tax asset that
management believes will not be realized.
Reclassification
Certain amounts have been reclassified for the prior years to be comparable
to the 1998 presentation.
Cash Flow Reporting
For purposes of reporting cash-flows, cash consists of amounts held at
banks, cash in money market accounts and time deposits with original maturities
of generally three months or less.
Pro forma Earnings per Share
The earnings per share reflected on the consolidated statements of income
is calculated on a pro forma basis and gives effect in 1998 to the assumed
aggregate issuance of approximately 12,025,000 shares of Common Stock to
eligible MIIX Members upon consummation of the Plan of Reorganization (see Note
15). The calculation does not give effect to the issuance of shares of Common
Stock in the anticipated underwritten Public Offering, the issuance of shares of
Common Stock to certain officers of the Company on the anticipated underwritten
Public Offering date pursuant to Stock Purchase and Loan Agreements between such
officers and the Company, or to the issuance of shares of Common Stock to the
Medical Society of New Jersey in connection with the purchase of New Jersey
State Medical Underwriters Inc.
Recent Accounting Pronouncements
In December 1997, the American Institute of Certified Public Accountants
issued Statement of Position (SOP) 97-3 "Accounting by Insurance and Other
Enterprises for Insurance-Related Assessments." The SOP provides guidance for
determining when a liability for guaranty fund and other insurance-related
assessments should be recognized and how such liability should be measured. The
SOP is effective for financial statements
F-10
<PAGE> 52
MEDICAL INTER-INSURANCE EXCHANGE
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
for fiscal years beginning after December 15, 1998. The adoption of this
statement will not have a significant impact on the Company's financial position
or results of operations.
Effective January 1, 1998, the Company adopted the Financial Accounting
Standards Board's Statement of Financial Accounting Standards No. 131,
Disclosures about Segments of an Enterprise and Related Information (SFAS No.
131). SFAS No. 131 superseded FASB Statement No. 14, Financial Reporting for
Segments of a Business Enterprise. SFAS No. 131 establishes standards for the
way that public business enterprises report information about operating segments
in annual financial statements and requires that those enterprises report
selected information about operating segments in interim financial reports. SFAS
No. 131 also establishes standards for related disclosures about products and
services, geographic areas, and major customers. The Company's operations are
classified into one reportable segment: providing professional liability and
related insurance coverages to the healthcare industry. In connection therewith
the company generally offers three products, occurrence policies, claims made
policies with prepaid tail coverage and claims made policies in each of its
markets. The Company distributes its products both directly to the insureds and
through intermediaries. The Company does not currently prepare discrete
financial information for any individual component of the Company's operations
that are regularly reviewed by the chief operating decision maker and utilized
to allocate resources and assess performance.
In June 1998, the Financial Accounting Standards Board (FASB) issued SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities" which is
effective for fiscal years beginning after June 15, 1999. Adoption of this
statement is not expected to have a significant impact on the Company's
financial position or results of operations.
3. LIABILITY FOR UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES
Activity in the liability for unpaid losses and loss adjustment expenses is
summarized as follows:
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Balance as of January 1, net of reinsurance recoverable of
$270.7 million, $221.7 million and $165.7 million,
respectively............................................. $605,990 $573,700 $582,931
Incurred related to:
Current year............................................. 157,952 120,496 110,593
Prior years.............................................. (2,084) -- --
-------- -------- --------
Total incurred............................................. 155,868 120,496 110,593
Paid related to:
Current year............................................. 1,328 3,930 3,630
Prior years.............................................. 134,666 84,276 116,194
-------- -------- --------
Total paid................................................. 135,994 88,206 119,824
-------- -------- --------
Balance as of December 31, net of reinsurance
recoverable.............................................. 625,864 605,990 573,700
Reinsurance recoverable.................................... 325,795 270,731 221,749
-------- -------- --------
Balance, gross of reinsurance.............................. $951,659 $876,721 $795,449
======== ======== ========
</TABLE>
The Company increased prior year gross reserves in the amounts of $3.8
million and $0.2 million during 1998 and 1997, respectively. No adjustment to
prior year gross reserves was made in 1996. At December 31, 1998, 1997 and 1996,
reserves for gross losses and loss adjustment expenses on incurred but not
reported claims amounted to $623.8 million, $591.2 million and $500.0 million,
respectively, of which $436.3 million, $430.3 million and $350.9 million related
to prior years.
F-11
<PAGE> 53
MEDICAL INTER-INSURANCE EXCHANGE
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Loss and loss adjustment expense reserve estimates have been reviewed
regularly and adjusted where judged prudent to do so. Medical malpractice
business, particularly occurrence or occurrence-like coverage, has a very long
development period. Cases may take years to be reported, and, as a rule, take
several years to adjust, settle or litigate. In addition, general long term
trends impacting ultimate reserve values such as changes in liability standards
and expanding views of contract interpretation increase the uncertainty. While
certain individual cases were settled during 1998, 1997 and 1996 at values more
or less than specific case reserve amounts established in prior years, there
were no overall indications that prior established best estimates, including the
significant portion of reserves for incurred but not reported claims, should be
adjusted beyond the amounts recorded.
The Company maintains aggregate excess reinsurance contracts that provide
coverage, above aggregate retentions for most losses and allocated loss
adjustment expenses. The aggregate excess reinsurance contracts, therefore, have
the effect of holding net incurred losses and allocated loss adjustment expenses
at a constant level as long as losses and allocated loss adjustment expenses
remain within the coverage limits, which occurred for the years ended December
31, 1998, 1997 and 1996. The adjustment to net reserves in 1998 relates to loss
and loss adjustment expenses not covered by the aggregate excess reinsurance
contracts.
4. MANAGEMENT SERVICES AGREEMENT
Management services agreements between the Exchange and the
Attorney-in-Fact and LP&C and the Attorney-in-Fact provide, among other things,
that the Attorney-in-Fact is responsible for the administration and management
of the Exchange and LP&C. These agreements have been filed with the insurance
departments of the Exchange's and LP&C's respective domiciliary states. The
agreement between the Exchange and the Attorney-in-Fact empowers the
Attorney-in-Fact to issue, modify, reinsure, or cancel contracts; to adjust and
settle claims; to accept service of process; to collect and have charge of all
funds coming into the Exchange; to keep the books and accounts of the Exchange;
and to do any and all things necessary to comply with any laws, subject to the
control, oversight and direction of the Board of Governors of the Exchange. This
agreement is automatically renewable each year unless notice of termination by
either party has been provided by December 1 of the preceding year. No such
notice has been given.
The agreement between LP&C and the Attorney-in-Fact provides for similar
services to be performed by the Attorney-in-Fact for LP&C, subject to the
general supervision of the Board of Directors of LP&C. This agreement is
automatically renewable for three-year terms unless notice of termination by
either party has been provided by April 16 of the year preceding the expiration
of the agreement.
In exchange for services provided, fees are paid to the Attorney-in-Fact by
the Exchange and LP&C equal to actual direct expenses of the Attorney-in-Fact
incurred in performing services on behalf of the Exchange and LP&C, plus in the
case of the LP&C agreement, 3 percent of LP&C's revenues of the preceding
calendar year. Expenses of the Attorney-in-Fact reimbursed by the Exchange and
LP&C amounted to $30.6 million in 1998, $22.7 in 1997 and $18.6 in 1996. LP&C
was acquired by the Exchange in 1996 and generated no revenue during such year.
Therefore, 1997 payments to the Attorney-in-Fact under the LP&C agreement were
only in respect of actual direct expenses of the Attorney-in-Fact. 1998 payments
to the Attorney-in-Fact included $0.2 million related to the percentage of
revenue feature of the LP&C agreement.
5. RELATED PARTY TRANSACTIONS
As of December 31, 1998 and 1997, the Exchange is guarantor for space
leased by the Attorney-in-Fact. The lease expires in May 2001, with total
minimum lease payments remaining of $1.3 million. Additionally, the Exchange has
extended a line of credit to an Attorney-in-Fact subsidiary in an amount up to
$5.0 million, none of which was outstanding at December 31, 1998 or 1997. The
Exchange guarantees a bank loan on behalf of the Attorney-in-Fact, which had an
outstanding balance of $0.8 million and $1.6 million at December 31, 1998 and
1997, respectively. Lawrenceville Re, Ltd., a subsidiary of the Attorney-in-Fact
assumes premiums,
F-12
<PAGE> 54
MEDICAL INTER-INSURANCE EXCHANGE
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
losses, commissions and other insurance balances pursuant to reinsurance
contracts with the Exchange, principally a one percent participation on the
Exchange's aggregate excess of loss programs. In addition, other subsidiaries of
the Attorney-in-Fact received commissions related to the placement of the
Company's reinsurance programs. During 1998, 1997 and 1996, the Company assumed
premiums from a risk retention group managed by the Attorney-in-Fact. In
addition, the Company made contributions to the Medical Society in 1998, 1997
and 1996.
The Company held a note receivable of $2.8 million and $3.0 million,
included in other assets, at December 31, 1998 and 1997, respectively, from the
Medical Society of New Jersey, collateralized by the building in which the
Company maintains its home office. The note provides for monthly payments of
$40,000, which includes interest at 9.05% until September 1, 2004 and reduced
payments thereafter until June 1, 2009.
6. INVESTMENTS
The Company's investment strategy focuses primarily on the purchase of
intermediate-term, investment-grade securities along with a modest allocation to
below investment-grade (i.e., high yield) fixed maturity investments not to
exceed 7.5% of invested assets. At December 31, 1998 and 1997, the average
credit quality of the fixed income portfolio was AA- and AA+, respectively. The
portfolio does not include any investments in real estate.
The actual or amortized cost and estimated market value of the Company's
available-for-sale securities as of December 31, 1998 and 1997 were as follows:
<TABLE>
<CAPTION>
GROSS UNREALIZED ESTIMATED
AMORTIZED ----------------- MARKET
COST GAINS LOSSES VALUE
---------- ------- ------ ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
1998
U.S. Treasury securities and obligations of U.S.
government corporations and agencies.......... $ 119,083 $ 4,451 $ 270 $ 123,264
Obligations of states and political
subdivisions.................................. 176,798 8,420 2 185,216
Foreign securities -- U.S. dollar denominated... 15,694 352 918 15,128
Corporate securities............................ 322,477 6,874 5,021 324,330
Mortgage-backed and other asset-backed
securities.................................... 407,140 4,415 1,754 409,801
---------- ------- ------ ----------
Total fixed maturity investments................ 1,041,192 24,512 7,965 1,057,739
Equity investments.............................. 3,159 -- -- 3,159
---------- ------- ------ ----------
Total investments..................... $1,044,351 $24,512 $7,965 $1,060,898
========== ======= ====== ==========
1997
U.S. Treasury securities and obligations of U.S.
government corporations and agencies.......... $ 188,715 $ 4,348 $ 56 $ 193,007
Obligations of states and political
subdivisions.................................. 202,386 7,224 5 209,605
Corporate securities............................ 130,159 3,747 567 133,339
Mortgage-backed and other asset-backed
securities.................................... 311,562 5,702 469 316,795
---------- ------- ------ ----------
Total fixed maturity investments................ 832,822 21,021 1,097 852,746
Equity investments.............................. 66,520 23,154 594 89,080
---------- ------- ------ ----------
Total investments..................... $ 899,342 $44,175 $1,691 $ 941,826
========== ======= ====== ==========
</TABLE>
The fair values for fixed maturity investments are based on quoted marked
prices, where available. For fixed maturity investments not actively traded,
fair values are estimated using values obtained from
F-13
<PAGE> 55
MEDICAL INTER-INSURANCE EXCHANGE
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
independent pricing services. The fair values for equity securities are based on
quoted market prices and quantitative estimates of management for non-traded
securities.
The amortized cost and estimated fair value of fixed maturity investments
at December 31, 1998, by contractual maturity, are shown below. Actual
maturities will 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..................................... $ 14,784 $ 14,810
Due after one year through five years....................... 109,671 110,704
Due after five years through ten years...................... 207,892 212,155
Due after ten years......................................... 301,705 310,269
Mortgage-backed and other asset-backed securities........... 407,140 409,801
---------- ----------
Total............................................. $1,041,192 $1,057,739
========== ==========
</TABLE>
Major categories of the Company's net investment income are summarized as
follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------
1998 1997 1996
------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C>
Fixed maturity investments............................ $59,037 $49,241 $44,914
Equity investments.................................... 878 1,678 2,096
Short-term investments................................ 7,376 4,925 3,774
Other................................................. 361 775 588
------- ------- -------
Subtotal.................................... 67,652 56,619 51,372
Investment expenses................................... 2,545 2,727 2,237
------- ------- -------
Net investment income................................. $65,107 $53,892 $49,135
======= ======= =======
</TABLE>
Realized gains and losses from sales of investments are summarized as
follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------
1998 1997 1996
------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C>
Fixed maturity investments
Gross realized gains................................ $13,084 $ 2,803 $11,522
Gross realized losses............................... 1,052 1,158 3,279
------- ------- -------
Net realized gains on fixed maturity investments...... 12,032 1,645 8,243
Equity investments
Gross realized gains................................ 38,823 8,719 474
Gross realized losses............................... 465 68 2,885
------- ------- -------
Net realized gains (losses) on equity investments..... 38,358 8,651 (2,411)
------- ------- -------
Net realized losses on equity collar investments...... 14,000 -- --
------- ------- -------
Net realized gains on investments..................... $36,390 $10,296 $ 5,832
======= ======= =======
</TABLE>
The net realized gains on equity investments for the year ended December
31, 1998 resulted from the Company's decision to liquidate substantially all of
its equity investments during the third quarter of 1998.
F-14
<PAGE> 56
MEDICAL INTER-INSURANCE EXCHANGE
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The change in the Company's unrealized appreciation (depreciation) on fixed
maturity investments was $(3,377), $17,856 and ($24,896) for the years ended
December 31, 1998, 1997 and 1996, respectively. The corresponding amounts for
equity investments were $(22,560), $10,664, and $9,643.
At December 31, 1998 and 1997, investments in fixed maturity investments
with a carrying amount of approximately $10.1 million and $6.8 million,
respectively, were on deposit with state insurance departments to satisfy
regulatory requirements.
7. REINSURANCE
Certain premiums, losses and loss adjustment expenses are ceded to other
insurance companies under various reinsurance agreements in-force during 1998,
1997 and 1996. These reinsurance agreements protect the underwriting and
operating results from unexpected increases in frequency, severity, and
acceleration of the payments of losses and loss adjustment expenses, and contain
the following significant terms:
<TABLE>
<CAPTION>
CONTRACT COVERAGE TYPE RETENTION COVERAGE LIMIT OTHER
-------- ------------- --------- -------------- -----
<S> <C> <C> <C> <C>
1998 Specific Excess Per loss $2-$3 million $48 million Aggregate deductible
Aggregate limits
1998 Aggregate Excess Aggregate 75% loss and ALAE ratio 75% loss and ALAE ratio Aggregate limit
1997 Specific Excess Per loss $2-$3 million $38 million Aggregate deductible
Aggregate limits
1997 Aggregate Excess Aggregate 75% loss and ALAE ratio 75% loss and ALAE ratio Aggregate limit
1996 Specific Excess Per loss $2-$3 million $28 million Aggregate deductible
Aggregate limits
1996 Aggregate Excess Aggregate 75% loss and ALAE ratio 75% loss and ALAE ratio Aggregate limit
</TABLE>
In addition, in 1992, the Company entered into a combined aggregate and
specific excess of loss contract to protect statutory underwriting and operating
results from adverse development on those losses and ALAE which occurred on or
before December 31, 1992. This contract is being accounted for using deposit
accounting on a GAAP basis. The net deposit carried related to this contract is
$0 as the initial consideration under this contract was retained by the Company
as an unrestricted funds held liability. The deposit has not been adjusted since
initially recorded in 1992.
The effect of assumed and ceded reinsurance on premiums is summarized in
the following table (dollars in thousands):
<TABLE>
<CAPTION>
1998 1997 1996
-------------------- -------------------- --------------------
WRITTEN EARNED WRITTEN EARNED WRITTEN EARNED
-------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Direct............... $230,314 $195,591 $162,430 $150,099 $143,218 $142,399
Assumed.............. 1,543 3,015 15,478 15,568 3,550 2,187
Ceded................ (37,685) (36,105) (44,522) (42,337) (34,890) (36,699)
-------- -------- -------- -------- -------- --------
Net premiums......... $194,172 $162,501 $133,386 $123,330 $111,878 $107,887
======== ======== ======== ======== ======== ========
</TABLE>
During 1998, 1997 and 1996, approximately $62.4 million, $68.9 million and
$56.8 million, respectively, of losses and loss adjustment expenses were ceded
to reinsurers.
The Company remains liable in the event that amounts recoverable from
reinsurers are uncollectible. To minimize its exposure to losses from reinsurer
insolvencies, the Company enters into reinsurance arrangements with carriers
rated "A" or better by A.M. Best. At December 31, 1998 and 1997, the Company
held collateral under related reinsurance agreements for all unpaid losses and
loss adjustment expenses ceded in the form of funds withheld of $228.1 million
and $182.6 million and letters of credit of $143.0 million and $126.7 million,
respectively. The Company also held collateral at December 31, 1998 and 1997 of
$126 million and $192 million, respectively, under the deposit contract referred
to above. However, the corresponding funds held
F-15
<PAGE> 57
MEDICAL INTER-INSURANCE EXCHANGE
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
liability was offset by a receivable of the same amount representing the minimum
amount due to the Company if that arrangement was terminated at December 31,
1998.
In accordance with the provisions of the reinsurance contracts, the funds
withheld are credited with interest at contractual rates ranging from 7.5% to
8.6%, which is recorded as a period expense in the year incurred. There are no
restrictions on investments held in support of funds withheld.
8. COMMITMENTS, CONTINGENCIES AND OFF BALANCE SHEET RISK
The Company's securities lending program was terminated during 1998.
Investment securities with an aggregate market value of $92.1 million were
loaned to various brokers in connection with a securities lending program at
December 31, 1997. The Company received lending fees and earned interest on the
loaned securities.
In 1997, the Company implemented an "equity collar" (collar) around the
Company's equity securities of $81.6 million. An "equity collar" is an option
position created with the simultaneous purchase and sale of an equal number of
put and call options which serves as a hedge transaction, the purpose of which
is to reduce equity market volatility and to protect surplus from significant
declines in the market value of the Company's equity securities. This resulting
option position establishes both a ceiling and a floor with respect to the
financial performance of the underlying asset, upon which the "equity collar" is
established, for a specified time period. The collar transaction was executed on
July 8, 1997 and expired on January 2, 1998. The collar was constructed using
European-style S&P 500 options and as of December 31, 1997, the collar had no
unrealized gain or loss. A "European-style" option is an option contract that
may be exercised only upon expiration of the contract. To minimize loss exposure
due to credit risk, the Company utilizes intermediaries with a Standard and
Poor's rating of "AA" or better.
In 1998, another equity collar was implemented with a notional value of $85
million around the equity portfolio. Again, the purpose of the collar was to
reduce equity market volatility and to stabilize unassigned surplus. The collar
was constructed using European-style S&P 500 options. The collar transaction was
executed on January 13, 1998 and expired on July 13, 1998, and resulted in a net
realized loss to the Company of $14 million. This loss offset gains on the
related hedged equity securities liquidated in the third quarter of 1998.
Since the expiration of the equity collar mentioned above, the Company has
not held any other derivative investments.
The Company currently purchases annuities without recourse on a competitive
basis to fund settlements of indemnity losses. The nature and terms of the
annuities vary according to settlements. The current value of annuities
purchased in prior years from other insurance companies, but with recourse to
the Company, and reflected as an other asset and an other liability in the
consolidated balance sheets, totaled $19.3 million and $18.8 million as of
December 31, 1998 and 1997, respectively. The Company becomes liable only in the
event that an insurance company cannot meet its obligations under existing
agreements and state guarantee funds are not available. To minimize its exposure
to such losses, the Company only utilizes insurance companies with an A.M. Best
rating of "A+" or better.
There were no pending legal proceedings beyond the ordinary course of
business at December 31, 1998, except that three individual insured physicians
filed an appeal of the order issued by the Commissioner of the New Jersey
Department of Banking and Insurance approving the Company's Plan of
Reorganization. The plaintiffs are seeking a remand of the matter to the
Department for reconsideration. The court has denied plaintiffs' request for a
stay of the order; the appeal remains pending. Additional court challenges to
the reorganization were filed in 1999. (See Note 15)
F-16
<PAGE> 58
MEDICAL INTER-INSURANCE EXCHANGE
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
9. STATUTORY ACCOUNTING PRACTICES
The Exchange and MIIX Insurance, domiciled in New Jersey, LP&C, domiciled
in Virginia, and MIIX New York, domiciled in New York, prepare statutory-basis
financial statements in accordance with accounting practices prescribed or
permitted by the New Jersey Department of Banking and Insurance, the Virginia
Department of Insurance, and the New York State Insurance Department,
respectively. "Prescribed" statutory accounting practices include state laws,
regulations, and general administrative rules, as well as a variety of
publications of the National Association of Insurance Commissioners (the
"NAIC"). "Permitted" statutory accounting practices encompass all accounting
practices that are not prescribed; such practices may differ from state to
state, may differ from company to company within a state, and may change in the
future. The NAIC currently is in the process of codifying statutory accounting
practices, the result of which is expected to constitute the only source of
"prescribed" statutory accounting practices. Combined policyholders' surplus and
net income, as reported to the domiciliary state insurance departments in
accordance with its prescribed or permitted statutory accounting practices for
these four companies, are summarized as follows:
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Statutory net income for the year.................. $ 29,631 $ 30,302 $ 20,078
Statutory surplus at year-end...................... $253,166 $242,395 $208,478
</TABLE>
The maximum amount of dividends that domestic insurance companies in New
Jersey, Virginia and New York can pay to their policyholders without prior
approval of the respective insurance commissioners of those states is subject to
restrictions relating to statutory surplus and statutory net income. No
dividends were paid or declared in 1998, 1997 or 1996. In 1998, the Exchange,
MIIX Insurance, LP&C, and MIIX New York could have paid maximum dividends
totaling approximately $30.9 million without the prior approval of the
respective insurance commissioners.
10. INCOME TAXES
For federal income tax purposes, the Exchange files a consolidated return
with its subsidiaries.
The components of the income tax provision in the accompanying statements
of income are summarized as follows:
<TABLE>
<CAPTION>
1998 1997 1996
------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C>
Current income tax expense............................ $19,111 $ 3,423 $ 9,228
Deferred income tax expense........................... (7,957) (1,417) 776
------- ------- -------
Total income tax expense.............................. $11,154 $ 2,006 $10,004
======= ======= =======
</TABLE>
A reconciliation of income tax computed at the federal statutory tax rate
to total income tax expense is as follows:
<TABLE>
<CAPTION>
1998 1997 1996
------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C>
Federal income tax at 35%............................. $14,309 $10,896 $ 9,660
Increase (decrease) in taxes resulting from:
Tax-exempt interest................................. (2,810) (3,583) (4,490)
Provision for (reversal of) tax contingencies and
other tax matters................................ -- (4,217) 5,224
Other............................................... (345) (1,090) (390)
------- ------- -------
Total income taxes.......................... $11,154 $ 2,006 $10,004
======= ======= =======
</TABLE>
F-17
<PAGE> 59
MEDICAL INTER-INSURANCE EXCHANGE
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Significant components of the Company's deferred tax assets and liabilities
are summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1998 1997
------- -------
(IN THOUSANDS)
<S> <C> <C>
Deferred tax assets:
Discounting of loss reserves.............................. $37,181 $30,820
Other..................................................... 5,255 2,186
------- -------
Total deferred tax assets......................... 42,436 33,006
------- -------
Deferred tax liabilities:
Unrealized gains on fixed maturity investments............ 5,791 6,973
Unrealized gains on equity investments.................... -- 7,896
Other..................................................... 1,914 441
------- -------
Total deferred tax liabilities.................... 7,705 15,310
------- -------
Net deferred tax assets........................... $34,731 $17,696
======= =======
</TABLE>
Deferred tax assets are presently considered by management to be realizable
based on the level of anticipated future taxable income. Net deferred tax assets
and income tax expense in future years can be significantly affected by changes
in enacted tax rates or by unexpected adverse events that would impact
management's conclusions as to the ultimate realizability of deferred tax
assets.
At December 31, 1998 and 1997, the Company had income taxes payable
included in other liabilities of $4.5 million and $2.2 million, respectively.
The amount of income taxes paid in 1998, 1997 and 1996 was $17.4 million,
$6.0 million and $3.6 million, respectively.
As a result of developments during 1996 related to Internal Revenue Service
examinations, the Company established a provision for tax contingencies of $5.2
million. During 1997, the Company reached favorable resolutions and was able to
release $4.2 million of that amount. The federal income tax returns of the
Company have been examined by the Internal Revenue Service through the years
1994. Management believes the Company has adequately provided for any remaining
tax contingencies.
11. IMPAIRMENT OF CAPITALIZED SYSTEM DEVELOPMENT COSTS
Statement of Financial Accounting Standards No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed of "
("SFAS No. 121") requires recognition of impairment losses for long-lived assets
whenever events or changes in circumstances result in the carrying amount of an
asset to exceed the sum of the expected future cash flow associated with the
asset. During 1998, management replaced its policy administration system, and
accordingly, recognized a $12.7 million pre-tax charge which represented the net
book value of capitalized system development costs associated with the old
computer system at the time of disposal.
F-18
<PAGE> 60
MEDICAL INTER-INSURANCE EXCHANGE
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
12. DEFERRED POLICY ACQUISITION COSTS
The following represents the components of deferred policy acquisition
costs and the amounts that were charged to expense for the year ended December
31, 1998, 1997 and 1996.
<TABLE>
<CAPTION>
1998 1997 1996
-------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C>
Balance at beginning of period....................... $ 100 $ 451 $ 0
Cost deferred during the period...................... 14,648 4,379 1,917
Amortization expense................................. (11,938) (4,730) (1,466)
-------- ------- -------
Balance at end of period............................. $ 2,810 $ 100 $ 451
======== ======= =======
</TABLE>
13. COMPREHENSIVE INCOME
Statement of Financial Accounting Standard No. 130 -- Reporting
Comprehensive Income, ("SFAS 130") became effective for years beginning after
December 15, 1997. For purposes of comparison, all previous financial statements
presented include the SFAS 130 disclosures. The Company considers its investment
portfolio as available-for-sale and had unrealized gains at each balance sheet
date that are reflected as comprehensive income in the Consolidated Statements
of Equity.
F-19
<PAGE> 61
MEDICAL INTER-INSURANCE EXCHANGE
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The components of comprehensive income, net of related tax, for the years
ended December 31, 1998, 1997 and 1996 were as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------
1998 1997 1996
-------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C>
Net income.................................................. $ 29,728 $29,124 $17,595
Other comprehensive income:
Unrealized holding gains (losses) arising during period
(net of tax of $3,659, $13,586, and $3,297,
respectively).......................................... 6,795 25,230 (6,124)
Reclassification adjustment for (gains) losses realized in
net income (net of tax of $12,736, $3,604, and $2,042,
respectively).......................................... (23,654) (6,692) (3,790)
-------- ------- -------
Net unrealized gains (losses) at December 31, (net of tax
of $9,078, $9,982, and $5,339, respectively)........... $(16,859) $18,538 $(9,914)
-------- ------- -------
Comprehensive income........................................ $ 12,869 $47,662 $ 7,681
======== ======= =======
</TABLE>
14. UNAUDITED QUARTERLY FINANCIAL DATA
The following is a summary of unaudited quarterly results of operations for
1998 and 1997:
<TABLE>
<CAPTION>
1998
-----------------------------------------
1ST 2ND 3RD 4TH
-------- ------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Direct written premiums............................ $143,521 $15,129 $40,184 $31,480
Net premiums earned................................ 35,817 38,563 40,286 47,835
Net investment income.............................. 14,803 16,051 16,769 17,484
Realized investment gains.......................... 1,441 2,805 29,317 2,827
Losses and loss adjustment expenses................ 36,050 36,902 40,098 42,818
Underwriting expenses.............................. 8,194 9,125 10,419 14,325
Impairment of capitalized system development
costs............................................ -- 12,656 -- --
Net income......................................... $ 3,461 $(1,530) $21,497 $ 6,300
Earnings per share (pro forma)..................... $ 0.29 $ (0.13) $ 1.79 $ 0.52
</TABLE>
<TABLE>
<CAPTION>
1997
-----------------------------------------
1ST 2ND 3RD 4TH
-------- ------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Direct written premiums............................ $126,689 $ 8,114 $19,904 $ 7,723
Net premiums earned................................ 27,035 30,724 34,411 31,160
Net investment income.............................. 13,163 12,875 14,628 13,226
Realized investment gains (losses)................. 195 (491) 1,169 9,423
Losses and loss adjustment expenses................ 27,708 30,842 34,159 27,787
Underwriting expenses.............................. 5,330 5,641 8,748 5,696
Net income......................................... $ 4,233 $ 3,928 $ 3,305 $17,658
</TABLE>
15. PLAN OF REORGANIZATION
In 1997, the Exchange's Board of Governors unanimously approved a plan to
convert from a reciprocal insurance exchange to a New Jersey domestic stock
insurer (Plan of Reorganization). On March 5, 1998, the Commissioner of the
Department of Banking and Insurance of the State of New Jersey approved the Plan
of Reorganization. On February 3, 1999, the Securities and Exchange Commission
declared the Plan of Reorganization prospectus effective. The Plan of
Reorganization was ratified by members of the Exchange at a special meeting held
on March 17, 1999.
Under the Plan of Reorganization: The MIIX Group will issue shares (the
"Reorganization Shares") to the Exchange solely in consideration of the
contemplated asset and liability transfers between the Exchange and MIIX
Insurance; MIIX Insurance will assume the assets and liabilities of the Exchange
(except for the Reorganization Shares and certain cash amounts to be distributed
pursuant to the Reorganization), The MIIX Group will acquire the
Attorney-in-Fact from the Medical Society for $11 million worth of Common Stock
and $100,000 in cash; the Reorganization Shares and certain cash amounts will be
distributed to the distributees by the Exchange and the Exchange dissolved; and,
thereby, The MIIX Group will be the holding company for MIIX Insurance, the
other subsidiaries of the Exchange and the Attorney-in-Fact.
The earnings per share reflected on the consolidated statements of income
is calculated on a pro forma basis and gives effect in 1998 to the assumed
aggregate issuance of approximately 12,025,000 shares of Common stock to
eligible MIIX members upon consummation of the Plan of Reorganization, and does
not give effect to the sale of Common Stock in the anticipated Public Offering
or to the issuance of Common Stock to the Medical Society in connection with the
purchase of the Attorneys-in-Fact.
F-20
<PAGE> 62
SCHEDULE I
SUMMARY OF INVESTMENTS -- OTHER THAN INVESTMENTS IN RELATED PARTIES
DECEMBER 31, 1998
(IN THOUSANDS)
<TABLE>
<CAPTION>
AMOUNT ON
COST FAIR VALUE BALANCE SHEET
---------- ---------- -------------
<S> <C> <C> <C>
Fixed maturities:
Bonds:
United States government and government agencies
and authorities.................................. $ 330,759 $ 337,245 $ 337,245
States, municipalities and political subdivisions... 176,798 185,216 185,216
Public utilities.................................... 48,668 49,264 49,264
Foreign securities--U.S. dollar denominated......... 15,694 15,128 15,128
All other corporate bonds........................... 468,473 470,086 470,086
Certificates of deposit............................. 800 800 800
---------- ---------- ----------
Total fixed maturities........................... 1,041,192 1,057,739 1,057,739
---------- ---------- ----------
Equity securities:
Common stock:
Banks, trust and insurance companies............. 3,159 3,159 3,159
---------- ---------- ----------
Total equity securities.......................... 3,159 3,159 3,159
---------- ---------- ----------
Short-term investments................................ 104,800 104,800 104,800
---------- ---------- ----------
Total investments..................................... $1,149,151 $1,165,698 $1,165,698
========== ========== ==========
</TABLE>
F-21
