<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON AUGUST 6, 1999
REGISTRATION NO. 333-78539
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
AMENDMENT NO. 1
TO
FORM S-4
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
-----------------
ISMIE HOLDINGS INC.
(Exact Name of registrant as specified in its charter)
<TABLE>
<S> <C> <C>
DELAWARE 6719 36-4293113
(State or other jurisdiction (Primary Standard Industrial (I.R.S. Employer
of incorporation or organization) Classification Code Number) Identification Number)
</TABLE>
20 North Michigan Avenue
Suite 700
Chicago, Illinois 60602
(312) 782-2749
(Address, including zip code, and telephone number, including area code, of
registrant's principal executive offices)
------------------
Alexander R. Lerner
President and Chief Executive Officer
20 North Michigan Avenue
Suite 700
Chicago, Illinois 60602
(312) 782-2749
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
------------------
copies to:
John S. Chapman, Esq.
Richard A. Hemmings, Esq.
Lord, Bissell & Brook
115 South LaSalle Street
Chicago, Illinois 60603
(312) 443-0700
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As
soon as practicable after this Registration Statement is declared effective.
If the securities being registered on this form are being offered in
connection with the formation of a holding company and there is compliance with
General Instruction G, check the following box: \ \
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. \ \
If this Form is a post-effective amendment filed pursuant to Rule
462(d) under the Securities Act, check the following box and list the Securities
Act registration statement number of the earlier effective registration
statement for the same offering. \ \
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH
DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE
REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS
REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH
SECTION 8(A) OF THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION
STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING
PURSUANT TO SAID SECTION 8(A), MAY DETERMINE.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
ILLINOIS STATE MEDICAL INTER-INSURANCE EXCHANGE
20 NORTH MICHIGAN AVENUE
SUITE 700
CHICAGO, ILLINOIS 60602
NOTICE OF SPECIAL MEETING
A special meeting of the members of Illinois State Medical
Inter-Insurance Exchange will take place at ____________, Chicago, Illinois at
_______ p.m., local time, on ________, 1999, for the following purpose:
To consider and vote on a proposal to approve a Plan and Agreement of
Merger, dated as of May 5, 1999, among Illinois State Medical
Inter-Insurance Exchange, ISMIE Indemnity Company and ISMIE Holdings
Inc., in which
- ISMIE will merge into Indemnity, with Indemnity surviving as a
subsidiary of Holdings; and
- members of ISMIE who were members on May 5, 1999 will receive
shares of common stock of Holdings in exchange for the rights
and interests they currently hold as members of ISMIE.
Under ISMIE's Rules and Regulations, no other business may be
transacted at the special meeting.
The purpose of the merger is to convert ISMIE into a company that is
owned by stockholders. The conversion will not affect your insurance coverage.
Only members of ISMIE at the close of business on May 5, 1999 are
entitled to notice of, and eligible to vote at, the special meeting or any
adjournment or postponement of the meeting. Please complete, date and sign the
enclosed proxy card and taxpayer identification card and return them promptly in
the enclosed pre-paid envelope whether or not you intend to attend the special
meeting. You may revoke your proxy in the way described in the accompanying
proxy statement/prospectus at any time before it is voted at the special
meeting.
YOUR BOARD OF GOVERNORS BELIEVES THAT THE CONVERSION IS IN THE BEST
INTERESTS OF ISMIE AND ITS MEMBERS. THE BOARD HAS APPROVED THE MERGER AGREEMENT
AND RECOMMENDS THAT YOU VOTE FOR ITS APPROVAL. YOU ARE ENCOURAGED TO READ THE
ACCOMPANYING PROXY STATEMENT/PROSPECTUS, WHICH PROVIDES DETAILED INFORMATION
ABOUT THE CONVERSION.
Approval of the merger agreement requires the favorable vote of
two-thirds of the eligible members voting in person or by proxy at the special
meeting. YOUR VOTE IS VERY IMPORTANT!
By Order of the Board of Governors of
Illinois State Medical Inter-Insurance Exchange
[LOGO]
Irwin A. Smith, M.D.
Secretary
Chicago, Illinois
, 1999
<PAGE>
[Intentionally blank]
<PAGE>
[ISMIE Logo]
CONVERSION PROPOSED - YOUR VOTE IS VERY IMPORTANT
The Board of Governors of the Illinois State Medical Inter-Insurance
Exchange, or ISMIE, has approved a merger agreement designed to convert ISMIE
into a company that is owned by stockholders. If we complete the merger, members
of ISMIE who were members on May 5, 1999 will receive shares of common stock of
ISMIE Holdings Inc., or Holdings, in exchange for their rights and interest in
ISMIE. Holdings will be the parent company of ISMIE Indemnity Company which will
be the successor to ISMIE in the merger. The conversion will not affect your
insurance coverage.
Only members of ISMIE who were members on May 5, 1999 are eligible to
vote on and receive stock in the conversion. In the conversion, approximately
10,000,000 shares of Holdings common stock will be issued to and allocated among
eligible members as follows:
- 9,000,000 shares of common stock will be allocated pro rata
among all eligible members based on the ratio of each eligible
member's earned premiums to the total earned premiums of all
eligible members from July 1, 1995 through May 5, 1999; and
- 1,000,000 shares of common stock will be allocated evenly
among all eligible members.
We cannot complete the conversion unless the eligible members approve
the merger agreement. We have scheduled a special meeting for our members to
vote on this important matter.
Whether or not you plan to attend the special meeting in person, please
take the time to vote by completing and mailing the enclosed proxy card. Voting
instructions are inside.
The date, time and place of the special meeting is:
___________, 1999
_______ __.m.
-----------------------
__________, Illinois
This document provides you detailed information about the conversion
and the special meeting. We urge you to read this entire document carefully. IN
PARTICULAR, YOU SHOULD READ THE "RISK FACTORS" SECTION BEGINNING ON PAGE __ FOR
A DESCRIPTION OF RISKS YOU SHOULD CONSIDER IN EVALUATING THE MERGER.
/s/ Harold L. Jensen
Harold L. Jensen
Chairman of the Board
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROXY STATEMENT PROSPECTUS. ANY REPRESENTATION TO
THE CONTRARY IS A CRIMINAL OFFENSE.
This proxy statement/prospectus is dated __________, 1999
and was first mailed to members on or about _______, 1999
<PAGE>
ORGANIZATIONAL STRUCTURE OF ISMIE BEFORE AND AFTER THE CONVERSION
FOR PURPOSES OF THIS PROXY STATEMENT/PROSPECTUS, THE TERMS "ISMIE,"
"WE," "OUR" AND "US" REFER, BEFORE THE MERGER IS COMPLETED, TO THE ILLINOIS
STATE MEDICAL INTER-INSURANCE EXCHANGE AND ITS SUBSIDIARIES, COLLECTIVELY, AND
AFTER THE MERGER IS COMPLETED, TO ISMIE INDEMNITY COMPANY AS THE SUCCESSOR TO
ISMIE IN THE MERGER; THE TERM "HOLDINGS" REFERS TO ISMIE HOLDINGS INC.
BEFORE THE CONVERSION AFTER THE CONVERSION
[GRAPHIC OMITTED]
After the conversion, Illinois Insurance laws and regulations will
prohibit any person from acquiring control of Holdings, and thus indirect
control of ISMIE, unless that person has obtained the approval of the
Illinois Director of Insurance in advance. Under Illinois law, any purchaser
of 10% or more of the voting stock of an insurance holding company is
presumed to have acquired control of affiliated or subsidiary insurers and
must obtain the approval of the Illinois Director of Insurance before
completing the purchase.
ii
<PAGE>
TABLE OF CONTENTS
<TABLE>
<S> <C>
ORGANIZATIONAL STRUCTURE OF ISMIE BEFORE AND AFTER THE CONVERSION.......................................................ii
QUESTIONS AND ANSWERS ABOUT THE CONVERSION...............................................................................1
SUMMARY ................................................................................................................3
Who We Are......................................................................................................3
Our Reasons for the Conversion..................................................................................3
Our Board's Recommendations to Members..........................................................................4
What Eligible Members will Receive in the Conversion............................................................4
The Special Meeting.............................................................................................4
Tax Consequences of the Merger..................................................................................5
Regulatory Approvals............................................................................................5
Dissenters' Rights..............................................................................................5
Interests of Certain Persons in the Conversion..................................................................5
Accounting Treatment............................................................................................5
Selected Financial and Operating Data...........................................................................6
RISK FACTORS.............................................................................................................9
If regulatory or competitive conditions in the medical malpractice insurance industry change,
our business could be hurt.............................................................................9
Since we operate only in Illinois, any negative change in conditions in Illinois will
disproportionately hurt our business ..................................................................9
Cyclical factors affecting our industry could reduce our profitability and our stock price......................9
The advent of "managed care" and proposed healthcare reforms could reduce the demand for
our products and our revenues and profits.............................................................10
Competition from other insurance companies could hurt our business.............................................10
A reduction in our ratings would make it difficult for us to compete...........................................10
If we increase our loss and loss adjustment expense reserves, our income will decrease in the
period in which the adjustment occurs.................................................................11
Fluctuations in interest rates could reduce our income and the value of our investment portfolio.
.....................................................................................................11
If our computer systems or those of our vendors and suppliers do not work properly after
December 31, 1999, our operations will be disrupted...................................................11
If we are unable to obtain adequate reinsurance coverage at reasonable rates in the future, it will
be difficult for us to manage our underwriting risks and operate our business profitably.
.....................................................................................................12
If our reinsurers do not fulfill their financial obligations to us, or if we do not have adequate
reinsurance coverage, we may not be profitable........................................................12
If we fail to comply with insurance regulatory requirements, or if those requirements become
burdensome to us, we may not be able to operate profitably............................................13
</TABLE>
iii
<PAGE>
<TABLE>
<S> <C>
Our ability to meet our obligations and pay dividends depends on the ability of ISMIE to pay
dividends to Holdings.................................................................................13
Antitakeover provisions could adversely affect the price of our common stock...................................13
An active or orderly trading market for the common stock may not develop; our stock price may
be volatile...........................................................................................13
WHERE YOU CAN FIND MORE INFORMATION.....................................................................................14
THE SPECIAL MEETING.....................................................................................................16
Time, Date and Place...........................................................................................16
Purpose ......................................................................................................16
Record Date, Quorum and Vote Required..........................................................................16
Recommendation of the Board of Governors.......................................................................16
Interests of the Board of Governors in the Conversion..........................................................16
Proxies ......................................................................................................16
Proxy Solicitation.............................................................................................17
Questions About the Conversion.................................................................................17
THE CONVERSION..........................................................................................................18
General ......................................................................................................18
Background of the Conversion...................................................................................18
Determination of Eligible Members..............................................................................20
Conversion of Membership Interests.............................................................................20
Consideration..................................................................................................20
Opinion of Salomon Smith Barney................................................................................22
Recommendation of the Board of Governors.......................................................................25
Description of the Merger Agreement............................................................................29
Dissenters' Rights.............................................................................................30
Additional Aspects of the Merger Agreement and the Conversion..................................................31
COMPARISON OF RIGHTS OF MEMBERS
BEFORE AND AFTER THE CONVERSION................................................................................32
MARKET FOR COMMON STOCK.................................................................................................46
DIVIDEND POLICY.........................................................................................................46
CAPITALIZATION..........................................................................................................47
CERTAIN FEDERAL INCOME TAX CONSEQUENCES OF THE CONVERSION...............................................................47
General ......................................................................................................48
Eligible Members...............................................................................................48
ISMIE and ISMIE Indemnity Company..............................................................................49
</TABLE>
iv
<PAGE>
<TABLE>
<S> <C>
Consequences of a Taxable Exchange ...........................................................................49
Issuance of Rules Dealing with Inversions......................................................................49
Possible Policyholder Dividend Treatment.......................................................................50
Taxpayer Identification Number.................................................................................50
SELECTED FINANCIAL AND OPERATING DATA...................................................................................51
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
..............................................................................................................54
Liquidity and Capital Resources................................................................................60
Effect of Inflation............................................................................................62
Year 2000 Issues......................................................................................63
Recent Accounting Pronouncement Not Yet Adopted................................................................64
BUSINESS ...............................................................................................................64
Overview ......................................................................................................64
History and Structure..........................................................................................64
Business Strategy..............................................................................................65
Products ......................................................................................................68
Marketing and Policyholder Services............................................................................71
Premium Rates and Discount Programs............................................................................72
Underwriting...................................................................................................73
Risk Management Services.......................................................................................74
Claims ......................................................................................................75
Loss Reserves..................................................................................................77
Reinsurance....................................................................................................81
Investment Portfolio...........................................................................................84
Market Risk....................................................................................................86
Competition....................................................................................................87
Relationship with the Medical Society..........................................................................87
Regulation.....................................................................................................88
Ratings ......................................................................................................91
Employees......................................................................................................92
Properties.....................................................................................................92
Litigation.....................................................................................................92
MANAGEMENT..............................................................................................................93
Directors and Executive Officers...............................................................................93
Committees of the Holdings Board...............................................................................95
Director Compensation..........................................................................................96
Executive Compensation.........................................................................................96
</TABLE>
v
<PAGE>
<TABLE>
<S> <C>
Employment Agreements..........................................................................................97
Compensation Plans.............................................................................................98
Related Party Transactions.....................................................................................99
OWNERSHIP OF COMMON STOCK..............................................................................................100
DESCRIPTION OF CAPITAL STOCK...........................................................................................102
General .....................................................................................................102
Common Stock..................................................................................................102
Preferred Stock...............................................................................................102
Statutory, Charter and Bylaw Provisions Which Could Have an Anti-Takeover Effect..............................103
Transfer Agent and Registrar..................................................................................105
LEGAL MATTERS..........................................................................................................105
EXPERTS ..............................................................................................................105
GLOSSARY OF SELECTED INSURANCE TERMS.....................................................................................1
INDEX TO FINANCIAL STATEMENTS..........................................................................................F-1
ANNEX I PLAN AND AGREEMENT OF MERGER
ANNEX II OPINION OF THE FINANCIAL ADVISOR
ANNEX III SECTION 168 OF THE ILLINOIS INSURANCE CODE
</TABLE>
vi
<PAGE>
QUESTIONS AND ANSWERS ABOUT THE CONVERSION
Q. WHAT DO I NEED TO DO NOW?
A. PLEASE CAREFULLY REVIEW ALL OF THE MATERIALS WE HAVE SENT TO YOU. AFTER
DOING SO, PLEASE:
- Complete, date and sign the enclosed BLUE PROXY CARD.
- Fill out and sign the enclosed YELLOW TAXPAYER IDENTIFICATION CARD
by including your taxpayer identification number (for most
individuals, your taxpayer identification number is your social
security number).
- Return the completed BLUE PROXY CARD AND YELLOW TAXPAYER
IDENTIFICATION CARD in the enclosed postage-paid envelope. WE MUST
RECEIVE THE PROXY CARD NO LATER THAN ______ P.M., LOCAL TIME, ON
____________, 1999 (TEN DAYS PRIOR TO THE DATE OF THE SPECIAL
MEETING). YOU HAVE THE RIGHT TO APPEAR AT THE SPECIAL MEETING AND
VOTE IN PERSON.
IF YOU HAVE ANY QUESTIONS OR NEED HELP IN COMPLETING THE PROXY CARD OR
THE TAXPAYER IDENTIFICATION CARD, PLEASE CALL OUR INFORMATION CENTER AT
1-888-__________ (TOLL FREE).
Q. CAN I CHANGE MY VOTE AFTER I HAVE MAILED MY SIGNED PROXY CARD?
A. Yes. You can change your vote at any time before your proxy card is voted
at the special meeting. You can do this in one of three ways. First, you
can send a written notice stating that you would like to revoke your
proxy. Second, you can complete and submit a new proxy card. Third, you
can attend the special meeting and vote in person. Your attendance alone
will not, however, revoke your proxy.
Q. WHEN DO YOU EXPECT THE CONVERSION TO BE COMPLETED?
A. We hope to complete the conversion in the third quarter of 1999. We are
working toward completing the conversion as quickly as possible.
Q. WHEN WILL I RECEIVE MY SHARES IF THE MERGER AGREEMENT IS APPROVED?
A. We will begin to mail the stock certificates to eligible members as soon
as we can after the 30th day following completion of the merger, unless a
dissenters' rights petition is filed with the Illinois Director of
Insurance in accordance with Illinois law. If a dissenters' rights
petition is filed, we will deliver the stock certificates only after the
Illinois Director of Insurance issues an order confirming the approval of
the merger.
1
<PAGE>
[intentionally blank-reverse side of Q&A]
2
<PAGE>
SUMMARY
THIS SUMMARY HIGHLIGHTS INFORMATION CONTAINED IN OTHER PLACES IN THIS
PROXY STATEMENT/PROSPECTUS. AS A RESULT, IT DOES NOT CONTAIN ALL OF THE
INFORMATION THAT YOU SHOULD CONSIDER BEFORE DECIDING HOW TO VOTE. YOU SHOULD
READ THE ENTIRE PROXY STATEMENT/PROSPECTUS CAREFULLY, INCLUDING THE "RISK
FACTORS" SECTION AND THE FINANCIAL STATEMENTS AND THE NOTES TO THOSE STATEMENTS.
ALL FINANCIAL DATA AND RATIOS PRESENTED IN THIS DOCUMENT HAVE BEEN PREPARED
USING GENERALLY ACCEPTED ACCOUNTING PRINCIPLES UNLESS OTHERWISE INDICATED.
WHO WE ARE (PAGE __)......... ISMIE is the largest provider of medical
malpractice insurance in Illinois and the
eleventh largest in the United States based
on direct premiums written. We currently
insure approximately 8,800 Illinois
physicians who practice alone or in medical
groups, clinics or other healthcare
organizations. In addition, we offer
insurance coverage to approximately 775
corporate and partnership entities and a
variety of other healthcare providers.
For the year ended December 31, 1998, our
total revenue was $182.4 million and our net
income was $12.7 million. For the three
months ended March 31, 1999, our total
revenue was $48.1 million and our net income
was $3.5 million. As of March 31, 1999, we
had $1.22 billion of total assets, no debt
outstanding and $237.8 million of total
equity. We believe that our leading market
share for medical malpractice insurance in
Illinois is due in large part to the loyalty
of our insured physicians.
Our principal executive and business offices
are located at 20 North Michigan Avenue,
Suite 700, Chicago, Illinois 60602-4890, and
our telephone number is (312) 782-2749.
3
<PAGE>
OUR REASONS FOR THE
CONVERSION (PAGE __)......... We believe that the growth in managed
healthcare and the emergence of multi-state
integrated healthcare providers and delivery
systems will lead to major changes in the
medical malpractice insurance industry. We
have adopted a strategy which we believe
will enable us to compete effectively,
improve profitability and create long-term
growth, while maintaining competitive rates
and market presence. We believe that the
conversion of ISMIE into a company owned by
stockholders will improve our ability to
achieve our strategic goals by providing us:
- greater operating flexibility
- access to the capital markets and
opportunities to use our stock for
acquisitions
- a form of organization that has a
higher degree of regulatory
certainty than we have as a
reciprocal insurance exchange
OUR BOARD'S
RECOMMENDATIONS TO
MEMBERS (PAGE __)............ Our Board of Governors has determined that
the conversion is in the best interests of
ISMIE and its members and has approved the
merger agreement on behalf of ISMIE. Our
board recommends that you vote FOR approval
of the merger agreement.
WHAT ELIGIBLE MEMBERS WILL
RECEIVE IN THE CONVERSION
(PAGE __).................... In the conversion, approximately 10,000,000
shares of the common stock of Holdings will
be issued to and allocated among eligible
members of ISMIE as follows:
- 9,000,000 shares of common stock
will be allocated pro rata among
eligible members based on the ratio
of each eligible member's earned
premiums to the total earned
premiums of all eligible members
from July 1, 1995 through May 5,
1999.
- 1,000,000 shares of common stock
will be allocated evenly among
eligible members.
You will receive shares of common stock of
Holdings in exchange for your membership
interest in ISMIE.
4
<PAGE>
THE SPECIAL MEETING (PAGE
__).......................... TIME, DATE AND PLACE. The special meeting
will be held at _______ p.m., local time, on
_____________, 1999 at __________________,
Chicago, Illinois. At the special meeting,
you will be asked to consider and vote on a
proposal to approve the conversion of ISMIE
into a company owned by stockholders.
RECORD DATE. The Board of Governors has set
the close of business on May 5, 1999 as the
record date for determining the members
eligible to vote at the special meeting.
QUORUM. The presence, either in person or by
proxy, of one- hundred eligible members
entitled to vote at the special meeting is
necessary to constitute a quorum.
VOTE REQUIRED. The favorable vote of
two-thirds of all eligible members present
in person or by proxy at the special meeting
is required to approve the merger agreement
on behalf of ISMIE. Each eligible member is
entitled to one vote at the special meeting.
TAX CONSEQUENCES OF THE
MERGER (PAGE __)............. Eligible members will not recognize gain or
loss for federal income tax purposes on
their exchange of membership interests for
Holdings common stock in the conversion. TAX
MATTERS ARE VERY COMPLICATED, AND THE TAX
CONSEQUENCES OF THE MERGER TO EACH ELIGIBLE
MEMBER WILL DEPEND ON THE FACTS OF THAT
MEMBER'S SITUATION. YOU ARE URGED TO CONSULT
YOUR TAX ADVISER FOR A FULL UNDERSTANDING OF
THE TAX CONSEQUENCES OF THE MERGER.
REGULATORY APPROVALS (PAGE
__).......................... If the members approve the merger agreement
at the special meeting, the merger agreement
will then have to be approved by the
Illinois Director of Insurance before we can
complete the conversion.
5
<PAGE>
DISSENTERS' RIGHTS
(PAGE __).................... Under the Illinois Insurance Code, if 5% or
more of the eligible members who do not vote
in favor of the merger agreement at the
special meeting file a petition with the
Illinois Director of Insurance for a hearing
on the merger agreement within 30 days after
the merger is completed, the Illinois
Director of Insurance is required to order a
hearing upon 15 days' written notice. if the
Illinois Director of Insurance finds that
the interests of the members are not
properly protected, or if he finds that any
reasonable objection exists to the merger
agreement, he will enter an order revoking
the approval already given. A copy of
Section 168 of the Illinois Insurance Code,
which sets forth the full text of the
dissenters' rights, is attached as Annex III
to this proxy statement/prospectus.
INTERESTS OF CERTAIN PERSONS
IN THE CONVERSION
(PAGE __).................... Except for the common stock allocated to
members of the Board of Governors in their
capacity as members of ISMIE, neither the
members of the Board nor the officers of
ISMIE will receive any compensation or other
benefits in connection with the completion
of the conversion.
ACCOUNTING TREATMENT
(PAGE __).................... The conversion involves a reorganization of
entities under common control, and the
assets and liabilities transferred to
accomplish the conversion will be accounted
for at historical cost in a manner similar
to that in pooling of interests accounting.
6
<PAGE>
SELECTED FINANCIAL AND OPERATING DATA
The following table shows selected financial and operating data for
ISMIE and subsidiary. the selected income statement data (other than direct and
assumed premiums written) set forth below for each of the years in the
three-year period ended December 31, 1998 and the selected balance sheet data as
of December 31, 1998 and 1997 are derived from the consolidated financial
statements audited by Ernst & Young LLP, independent auditors, included
elsewhere in this proxy statement/prospectus and should be read with, and are
qualified by those statements and the notes related to those statements. The
selected financial data for the three month periods ended March 31, 1999 and
1998 are derived from unaudited financial statements which management believes
incorporate all of the adjustments necessary for a fair presentation of the
financial condition and results of operations for those periods. The selected
income statement data (other than direct and assumed premiums written) for the
years ended December 31, 1995 and 1994 and the selected balance sheet data as of
December 31, 1996, 1995 and 1994 are derived from audited financial statements
of ISMIE and subsidiary. All summary income statement and balance sheet data are
presented in accordance with generally accepted accounting principles, or GAAP.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations."
7
<PAGE>
<TABLE>
<CAPTION>
AS OF OR FOR THE THREE
MONTHS ENDED MARCH 31 AS OF OR FOR THE YEAR ENDED DECEMBER 31,
1999 1998 1998 1997 1996 1995 1994
---- ---- ---- ---- ---- ---- ----
INCOME STATEMENT DATA: (IN THOUSANDS, EXCEPT PER SHARE, RATIOS AND PERCENTAGE DATA)
PREMIUMS WRITTEN
<S> <C> <C> <C> <C> <C> <C> <C>
DIRECT AND ASSUMED PREMIUMS WRITTEN $ 39,588 $ 43,359 $ 179,668 $ 196,152 $ 207,578 $ 197,241 $ 203,756
---------- ---------- ---------- --------- --------- --------- ---------
---------- ---------- ---------- --------- --------- --------- ---------
NET PREMIUMS WRITTEN $ 33,024 $ 27,597 $ 134,215 $ 104,953 $ 85,532 $ 96,809 $ 140,504
---------- ---------- ---------- --------- --------- --------- ---------
---------- ---------- ---------- --------- --------- --------- ---------
DIRECT AND ASSUMED PREMIUMS EARNED $ 42,352 $ 44,242 $ 177,451 $ 188,866 $ 207,857 $ 221,491 $ 200,285
REINSURANCE PREMIUMS CEDED (6,564) (15,763) (45,453) (91,199) (122,040) (100,432) (63,252)
---------- ---------- ---------- --------- --------- --------- ---------
NET PREMIUMS EARNED 35,788 28,479 131,998 97,667 85,817 121,059 137,033
NET INVESTMENT INCOME 12,067 11,456 45,361 46,663 46,436 50,927 49,140
OTHER INCOME 0 0 5,095 0 0 0 0
REALIZED INVESTMENT GAINS (LOSSES) 283 13 (104) (401) 2,406 322 12,141
---------- ---------- ---------- --------- --------- --------- ---------
TOTAL REVENUES 48,138 39,948 182,350 143,929 134,659 172,308 198,314
---------- ---------- ---------- --------- --------- --------- ---------
LOSSES AND LOSS ADJUSTMENT EXPENSES 40,221 32,884 153,660 117,816 105,403 177,273 210,046
OTHER OPERATING EXPENSES 4,249 3,571 16,222 10,878 6,296 8,793 11,870
---------- ---------- ---------- --------- --------- --------- ---------
TOTAL EXPENSES 44,470 36,455 169,882 128,694 111,699 186,066 221,916
---------- ---------- ---------- --------- --------- --------- ---------
INCOME (LOSS) BEFORE INCOME TAXES 3,668 3,493 12,468 15,235 22,960 (13,758) (23,602)
INCOME TAXES (BENEFIT) 133 80 (257) (3,206) 19,541 6,007 (8,564)
---------- ---------- ---------- --------- --------- --------- ---------
NET INCOME (LOSS) $ 3,535 $ 3,413 $ 12,725 $ 18,441 $ 3,419 ($19,765) ($15,038)
---------- ---------- ---------- --------- --------- --------- ---------
---------- ---------- --------- --------- --------- ---------
BALANCE SHEET DATA:
TOTAL INVESTMENTS AND INVESTED CASH $ 893,563 $ 790,246 $ 887,661 $ 787,333 $ 780,209 $ 861,42 $ 780,362
TOTAL ASSETS 1,217,432 1,250,897 1,211,428 1,246,506 1,287,514 1,362,798 1,263,586
MEMBERS' EQUITY 237,776 223,615 242,690 220,169 193,336 200,969 175,200
ADDITIONAL DATA:
GROSS RATIOS (GAAP) (1):
LOSS & LAE 107.4% 108.8% 94.5% 95.1% 77.4% 128.6% 142.0%
EXPENSE 10.3% 9.4% 10.1% 8.8% 7.4% 6.4% 6.2%
COMBINED 117.7% 118.2% 104.6% 103.9% 84.8% 135.0% 148.2%
NET RATIOS (GAAP) (2):
LOSS & LAE 112.4% 115.5% 116.4% 120.6% 122.8% 146.4% 153.3%
EXPENSE 11.9% 12.5% 12.3% 11.1% 7.3% 7.3% 8.7%
COMBINED 124.3% 128.0% 128.7% 131.8% 130.2% 153.7% 161.9%
PRO FORMA EARNINGS PER SHARE (3) $ 0.35 $0.34 $1.27
PRO FORMA BOOK VALUE PER SHARE 23.78 22.36 24.27
PRO FORMA BOOK VALUE PER SHARE, NET OF FAS 115(4) 23.12 21.84 22.77
RETENTION RATE (5) 97.6% 97.6% 86.0% 90.1% 90.8% 92.4% 93.4%
INVESTMENT YIELD (6) 5.42% 5.82% 5.60% 6.07% 5.77% 6.10% 6.00%
STATUTORY COMBINED RATIO 125.3% 128.4% 128.5% 131.0% 130.2% 155.5% 161.9%
STATUTORY SURPLUS $ 190,196 $ 175,335 $ 187,224 $ 172,713 $ 158,622 $ 134,432 $ 135,339
</TABLE>
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(1) Direct ratios represent the ratios of losses and expenses, before
deducting reinsurance recoverables, to direct and assumed premiums
earned, before reinsurance premiums ceded.
(2) Net ratios represent the ratios of losses and expenses, after deducting
reinsurance recoverables, to net premiums earned, after reinsurance
premiums ceded.
(3) Gives effect in all periods to the issuance of approximately 10,000,000
shares of common stock to eligible members. The 100,000 shares of
common stock issued to ISMIE Indemnity Company are not considered
outstanding for purposes of determining the per share amounts.
(4) ISMIE has designated its entire fixed maturity and equity security
investment portfolio as "available for sale". Under FAS 115, members'
equity reflects unrealized market appreciation or depreciation on these
investments, net of deferred taxes thereon. For purposes of this
calculation, the unrealized market appreciation or depreciation, net of
deferred taxes, has been removed from members' equity.
(5) Represents the percentage of policyholders insured by ISMIE at the
beginning of the year that continued to be insured by ISMIE at the end
of the year.
(6) Represents the yield as determined for statutory reporting purposes
which, for any period, equals annualized investment income, excluding
realized capital gains or losses and net of expenses, divided by the
average of beginning and ending cash and investments at statement value
plus accrued investment income.
(7) Represents the sum of the statutory loss and expense ratios.
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RISK FACTORS
IN CONSIDERING THE MATTERS INCLUDED IN THIS PROXY STATEMENT/PROSPECTUS,
YOU SHOULD CAREFULLY CONSIDER, AMONG OTHER THINGS, THE SIGNIFICANT FACTORS
DESCRIBED BELOW AND UNDER "COMPARISON OF RIGHTS OF MEMBERS BEFORE AND AFTER THE
CONVERSION" THAT MAY ADVERSELY AFFECT YOU IF THE CONVERSION IS APPROVED OR THAT
MAY GENERALLY ADVERSELY AFFECT THE VALUE OF AN INVESTMENT IN COMMON STOCK.
SOME OF THE STATEMENTS IN THIS PROXY STATEMENT/PROSPECTUS THAT ARE NOT
HISTORICAL FACT ARE FORWARD-LOOKING STATEMENTS WHICH INVOLVE KNOWN AND UNKNOWN
RISKS, UNCERTAINTIES AND OTHER FACTORS THAT MAY CAUSE OUR ACTUAL RESULTS TO BE
MATERIALLY DIFFERENT FROM HISTORICAL RESULTS OR FROM ANY RESULTS EXPRESSED OR
IMPLIED BY THE FORWARD-LOOKING STATEMENTS. THESE STATEMENTS MAY BE IDENTIFIED BY
THE USE OF WORDS SUCH AS "BELIEVES," "EXPECTS," "MAY," "WILL," "SHOULD,"
"SEEKS," "PRO FORMA," OR "ANTICIPATES," AND SIMILAR EXPRESSIONS. THESE RISKS,
UNCERTAINTIES AND OTHER FACTORS INCLUDE, BUT ARE NOT LIMITED TO, THE FOLLOWING
RISKS:
IF REGULATORY OR COMPETITIVE CONDITIONS IN THE MEDICAL MALPRACTICE INSURANCE
INDUSTRY CHANGE, OUR BUSINESS COULD BE HURT.
We derive over 95% of our revenues from medical malpractice insurance
policies issued to physicians, medical groups and allied health professionals.
Our earnings could be hurt by negative developments in the economic, competitive
or regulatory conditions affecting the medical malpractice insurance industry,
particularly as those developments might affect medical malpractice insurance
for physicians, to a greater extent than if our business were diversified.
SINCE WE OPERATE ONLY IN ILLINOIS, ANY NEGATIVE CHANGE IN CONDITIONS IN ILLINOIS
WILL DISPROPORTIONATELY HURT OUR BUSINESS .
We currently are licensed to write insurance only in Illinois. Our
revenues and profitability are affected by prevailing regulatory, economic and
other conditions in Illinois to a greater extent than if we did business in
several states or regions. We believe that medical malpractice jury awards in
Illinois, particularly in the counties of Cook, Madison and St. Clair, are
significantly higher than those in a number of other states.
CYCLICAL FACTORS AFFECTING OUR INDUSTRY COULD REDUCE OUR PROFITABILITY AND OUR
STOCK PRICE.
The financial performance of medical malpractice insurers has tended to
fluctuate in cyclical patterns characterized by periods of greater competition
in pricing and underwriting terms and conditions followed by periods of capital
shortage and lesser competition. Our profitability and the profitability of the
industry as a whole can be affected significantly by:
- Changes in frequency and severity of claims
- Legal developments affecting insurer liability and the size of
jury awards
- Price competition
- Fluctuations in interest rates and other investment factors
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Profitability can also be affected significantly by other economic conditions
and trends, such as inflationary pressure that may affect the adequacy of
reserves.
THE ADVENT OF "MANAGED CARE" AND PROPOSED HEALTHCARE REFORMS COULD REDUCE THE
DEMAND FOR OUR PRODUCTS AND OUR REVENUES AND PROFITS.
In recent years, the emergence of managed care has caused many
physicians who are insured by us to affiliate with healthcare organizations that
obtain insurance for their physicians from other insurers. This consolidation
could reduce the number of our insureds and the amount of premium we earn.
Significant attention has recently been focused on reforming the
healthcare system at both the federal and state levels. A broad range of
healthcare reform measures has been suggested, and public discussion of these
measures will likely continue in the future. Proposals have included, among
other things, spending limits, price controls, limits on increases in insurance
premiums, limits on the liability of doctors and hospitals for tort claims and
changes in the healthcare insurance system. The adoption of any of these
proposals could have a negative effect on our profitability and the
profitability of the industry as a whole.
COMPETITION FROM OTHER INSURANCE COMPANIES COULD HURT OUR BUSINESS.
Our principal competitors for physicians and medical groups consist of
a number of commercial companies and, increasingly, programs of self-insurance
offered by hospitals that have acquired physician practices. Each competes for
the medical malpractice insurance business of larger medical groups, hospitals
and other healthcare providers. Several of these competitors have greater
financial resources and higher ratings than we do. In addition to pricing,
competitive factors include
- financial stability
- ratings
- breadth and flexibility of coverage
- the quality and level of services provided
- policyholder loyalty
The competitive environment in Illinois could also result in lower premium rates
and fees, reduced profitability and loss of market share. As we expand into new
product lines and new geographic markets, we will need to compete with
established companies in these markets, many of which will have existing
relationships with the doctors and medical groups that we will be seeking to
insure.
A REDUCTION IN OUR RATINGS WOULD MAKE IT DIFFICULT FOR US TO COMPETE.
Ratings are an important factor in establishing the competitive
position of insurance companies. ISMIE is rated "B++ (Very Good)" by A.M. Best
and "BBB (Good)" by Standard &
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Poor's Ratings Services, a division of The McGraw-Hill Companies, Inc. Other
insurance companies with which we compete currently have higher insurance
ratings. Our ability to maintain or improve our rating by A.M. Best or Standard
& Poor's may depend on our ability to implement successfully our business
strategy. See "Business -- Ratings." If our ratings are reduced from their
current level, it could weaken our competitive position and result in a loss of
business.
IF WE INCREASE OUR LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES, OUR INCOME WILL
DECREASE IN THE PERIOD IN WHICH THE ADJUSTMENT OCCURS.
We maintain loss and loss adjustment expense reserves to cover amounts
we estimate we will need to pay policyholders for insured losses and for the
expenses we expect to occur to settle policyholder claims. We make these
estimates based on assumptions related to the ultimate cost of settling the
claims based on facts and interpretation of circumstances then known,
predictions of trends in claims frequency and severity and judicial theories of
liability, legislative activity and other factors. However, establishing
appropriate reserves is an inherently uncertain process involving estimates of
future losses and we cannot be sure that currently established reserves will
prove adequate in light of subsequent actual experience. The inherent
uncertainty is greater for some types of insurance, such as medical malpractice,
where claims and expenses may be paid over a period of ten or more years which
is longer than most property and casualty claims. Trends in losses on
"long-tail" lines of business such as medical malpractice may be slow to appear
and, our reaction in terms of modifying underwriting practices and changing
premium rates may lag behind underlying loss trends. In addition, emerging
changes in the practice of medicine, such as new, larger medical groups that do
not have an established claims history and additional claims resulting from
restrictions on treatment by organizations, may require us to adjust our
underwriting and reserving practices.
If our reserves should prove inadequate, we would be required to
increase reserves and incur a charge to earnings in the period that these
reserves are increased, which would reduce income during that period and could
cause our stock price to fall.
FLUCTUATIONS IN INTEREST RATES COULD REDUCE OUR INCOME AND THE VALUE OF OUR
INVESTMENT PORTFOLIO.
Our investment portfolio consists substantially of fixed maturity
securities. We earn our investment income primarily from interest income on this
portfolio. Lower interest rates could reduce the return on our portfolio.
Reduced investment income could also reduce our cash flows. Higher interest
rates could reduce the market value of our fixed income investments.
IF OUR COMPUTER SYSTEMS OR THOSE OF OUR VENDORS AND SUPPLIERS DO NOT WORK
PROPERLY AFTER DECEMBER 31, 1999, OUR OPERATIONS WILL BE DISRUPTED.
We are highly dependent on our computer processing systems. Our
principal computer applications cover three broad areas of its operations: (1)
policy processing; (2) claims processing; and (3) our financial and accounting
systems. We have completed our assessment of
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all internal information technology systems that we believe could be
significantly affected by the Year 2000 issue. As a result of our assessment, we
identified some systems that needed to be reprogrammed or replaced in order to
bring them into Year 2000 compliance. We have substantially completed all the
software reprogramming and replacement that we believe will be necessary to
bring these systems into compliance.
We cannot be sure that this compliance schedule will be met or that any
software or systems of our vendors and suppliers, on which our business is
dependent, will be corrected in a timely manner. The inability of vendors or
suppliers to complete their Year 2000 resolution process in a timely fashion
could disrupt our business operations and materially and adversely impact our
results of operations, liquidity or capital resources.
Our failure to complete our Year 2000 compliance project successfully
could result in the disruption of our normal operations and in the inability or
unwillingness of our policyholders to utilize our services. In a worst case
scenario, any failure or disruption could hurt our business, financial condition
and results of operations and could result in litigation against us based upon
any disruption or failure. We also could be adversely affected if Year 2000
issues result in additional claims being made against our insureds.
We are in the process of developing contingency plans for our mission
critical business processes in the event of the failure of our own computer
systems or of a disruption of essential infrastructure services. We expect this
planning to be completed by October 1999.
IF WE ARE UNABLE TO OBTAIN ADEQUATE REINSURANCE COVERAGE AT REASONABLE
RATES IN THE FUTURE, IT WILL BE DIFFICULT FOR US TO MANAGE OUR UNDERWRITING
RISKS AND OPERATE OUR BUSINESS PROFITABLY.
Reinsurance involves transferring part of the liability and the premium
under an insurance policy to another insurance company. Like other insurance
companies, we use reinsurance arrangements to limit and manage the amount of
risk we retain, to stabilize our underwriting results and to increase our
underwriting capacity. The amount and cost of reinsurance available to companies
specializing in medical malpractice insurance are subject, in large part, to
prevailing market conditions beyond their control. Our ability to provide
professional liability insurance at competitive premium rates and coverage
limits on a continuing basis will depend in part upon our ability to secure
adequate reinsurance in amounts and at rates that are commercially reasonable.
If reinsurance is not available to us at reasonable rates, it will be difficult
for us to manage our underwriting risks and operate our business profitably.
IF OUR REINSURERS DO NOT FULFILL THEIR FINANCIAL OBLIGATIONS TO US, OR
IF WE DO NOT HAVE ADEQUATE REINSURANCE COVERAGE, WE MAY NOT BE PROFITABLE.
We depend on the credit-worthiness of our reinsurers because
reinsurance does not relieve us of liability to our insureds for the risks
transferred, or ceded, to reinsurers. Although we place our reinsurance with
reinsurers we believe are financially stable, the inability of a
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significant reinsurer to make payment under the terms of a reinsurance treaty
could cause our business to become unprofitable.
Due to the favorable trends in claims reported since mid-1995, we have
recently modified our reinsurance strategy to increase our retention and
decrease premiums and risk ceded to reinsurers. Though we believe these changes
to be prudent, we may suffer losses if it turns out that we do not have enough
reinsurance. See "Business -- Reinsurance."
IF WE FAIL TO COMPLY WITH INSURANCE REGULATORY REQUIREMENTS, OR IF THOSE
REQUIREMENTS BECOME BURDENSOME TO US, WE MAY NOT BE ABLE TO OPERATE PROFITABLY.
We are regulated by the Illinois Insurance Department in many aspects
of our business and financial condition. We are also affected by accounting and
financial requirements established by the National Association of Insurance
Commissioners. Our failure to comply with these requirements could result in
consequences ranging from a regulatory examination to a regulatory takeover of
ISMIE and would make our business less profitable. In addition, insurance laws
and regulations could change or additional restrictions could be imposed which
are more burdensome to us and which make our business less profitable. Because
these laws and regulations are for the protection of policyholders, changes may
not be in your best interest as a stockholder. See "Business -- Regulation."
OUR ABILITY TO MEET OUR OBLIGATIONS AND PAY DIVIDENDS DEPENDS ON THE ABILITY OF
ISMIE TO PAY DIVIDENDS TO HOLDINGS.
Any inability of ISMIE to pay dividends to Holdings in the future may
adversely affect our ability to meet our obligations and our ability to pay
dividends to you, and this may adversely affect the market value of the Holdings
common stock. ISMIE will be restricted by Illinois law in the amount of
dividends it can pay in relation to earnings or surplus, without consent of the
Illinois Insurance Department. ISMIE may pay dividends in any year, without
regulatory approval, to the extent of the greater of either 10% of its statutory
capital and surplus at the end of the preceding year or its net income for the
preceding year. If ISMIE had been a stock insurance company on December 31,
1998, the amount of dividends it would have been permitted to pay during 1999
without the approval from the Illinois Insurance Department would have been
approximately $18 million. We cannot be sure that ISMIE will be able to obtain
any approvals required from the Illinois Insurance Department in the future.
ANTITAKEOVER PROVISIONS COULD ADVERSELY AFFECT THE PRICE OF OUR COMMON STOCK.
Holdings' certificate of incorporation and bylaws include provisions
that may have anti-takeover effects and may delay, defer or prevent a takeover
attempt. Holdings is subject to provisions of the Delaware corporate law that
impose restrictions on a company's ability to enter into some transactions
unless the transaction is approved in a prescribed manner. In addition, Illinois
insurance laws restrict the acquisition of control of an insurance holding
company such as Holdings without the prior approval of the Illinois Director of
Insurance. These provisions may discourage a takeover attempt which you would
have considered to be in your best interests or in which you would have received
a substantial premium over the current market price. As a result,
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you may not have an opportunity to participate in this kind of a transaction.
The Illinois Insurance Department could withhold its approval even if the
transaction was in the stockholders' best interest if the Department determines
that the transaction would be detrimental to policyholders.
AN ACTIVE OR ORDERLY TRADING MARKET FOR THE COMMON STOCK MAY NOT DEVELOP; OUR
STOCK PRICE MAY BE VOLATILE.
Before the conversion is completed, there will be no public market for
the common stock and we cannot be sure that an active or orderly trading market
will develop or be sustained. We have applied to have the Holdings common stock
listed on the Nasdaq National Market once the conversion is completed. However,
we cannot be sure of the price at which the common stock will trade on the
Nasdaq National Market.
If an active and orderly trading market does not develop, the trading
price of the common stock may fluctuate widely and the bid and ask price of the
common stock might vary significantly. Factors such as variations in our
financial results or other developments affecting us also could cause the market
price of the common stock to fluctuate significantly. In addition, if a number
of stockholders attempt to sell their shares following completion of the
conversion, our share price may go down. See "Market for Common Stock."
We have considered, and may consider in the future, an initial public
offering of our common stock. However, we cannot be sure that an initial public
offering will occur. If an initial public offering does occur, sales of
substantial amounts of common stock in the public market or the perception that
sales might occur could adversely affect the market price of the common stock.
If an initial public offering does not occur, it is less likely that an active
or orderly trading market will develop for the common stock. If an active market
does not develop, you may not be able to sell your shares promptly or at the
desired price.
WHERE YOU CAN FIND MORE INFORMATION
After the conversion, we will file periodic reports and other
information with the Securities and Exchange Commission. We intend to furnish
our stockholders with annual reports containing audited financial information
and to make available a quarterly report containing unaudited financial
information for each of the first three quarters of each year.
We have filed a registration statement on Form S-4 with the Commission
to register the shares of common stock being issued in the conversion under the
Securities Act of 1933. As permitted by Commission rules, we have included some
of the information relating to the offering, such as the exhibits, in the
registration statement rather than this proxy statement/prospectus. The
registration statement can be read and copied at the Commission's Public
Reference Room at 450 Fifth Street, N. W., Washington, D. C. 20549. Information
about the operation of the Public Reference Room can be obtained by calling the
Commission at 1-800-SEC-0330. You may also obtain a copy of the registration
statement by accessing the Commission's website at http://www.sec.gov. We urge
you to review the exhibits which are
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attached to the registration statement, since our discussion of these documents
in the proxy statement/prospectus is often brief and may not include every
provision of the exhibit.
We have not authorized any person to give any information or to make
any representation with respect to the matters described in this proxy
statement/prospectus other than those contained in this proxy
statement/prospectus. Therefore, if anyone gives you information of this sort,
you should not rely on it. The information contained in this document speaks
only as of the date of this proxy statement/prospectus. This proxy
statement/prospectus is not an offer to sell, or a solicitation of an offer to
purchase, the securities offered by this proxy statement/prospectus, or make a
solicitation of a proxy, in any jurisdiction in which, or to or from any person
to or from whom, it is unlawful to make an offer or solicitation.
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THE SPECIAL MEETING
TIME, DATE AND PLACE
The special meeting will be held at _______ p.m., local time, on
__________, 1999 at __________________, Chicago, Illinois.
PURPOSE
At the special meeting, including any adjournment or postponement, all
eligible members will consider and vote upon a proposal to approve the merger
agreement. See "The Conversion - Description of the Merger Agreement."
RECORD DATE, QUORUM AND VOTE REQUIRED
All persons who were members of record of ISMIE on May 5, 1999 are
entitled to notice of, and are eligible to vote at, the special meeting. The
presence, either in person or by proxy, of one hundred eligible members at the
special meeting is necessary to are a quorum. There are approximately 9,667
eligible members of ISMIE. The favorable vote of two-thirds of eligible members
voting in person or by proxy at the special meeting is required to approve the
merger agreement on behalf of ISMIE. Each eligible member is entitled to one
vote at the special meeting.
RECOMMENDATION OF THE BOARD OF GOVERNORS
Your Board of Governors believes that the conversion is in the best
interests of ISMIE and its members and has approved the merger agreement on
behalf of ISMIE. THE BOARD RECOMMENDS THAT YOU VOTE FOR APPROVAL OF THE MERGER
AGREEMENT.
INTERESTS OF THE BOARD OF GOVERNORS IN THE CONVERSION
Under ISMIE's Rules and Regulations, only physician members of ISMIE
may serve on the Board of Governors. Each present member of the Board of
Governors is an eligible member of ISMIE who will be entitled to vote on the
merger agreement and to receive Holdings common stock in the conversion. The
number of shares of common stock to be allocated to members of the Board is set
forth under "Ownership of Common Stock." Common stock will be allocated to
members of the Board of Governors on the same basis as all other eligible
members. No additional shares of common stock will be allocated in the
conversion to members of the Board or to management. Upon completion of the
conversion, management and members of the Board of Governors who serve on the
Holdings Board will be eligible to participate in Holdings' equity incentive
plan. See "Management -- Compensation Plans."
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PROXIES
Eligible members may vote in person or by proxy. Duly signed
proxies, will, unless revoked, be voted as indicated on those proxies. If a
written proxy card is signed by a member and returned without instructions,
the proxy will be voted for approval of the merger agreement. An eligible
member who has submitted a proxy may revoke it at any time before its
exercise at the special meeting by delivering to us an instrument of
revocation or a duly signed proxy bearing a later date or by attending the
special meeting and voting in person. However, any later dated proxy must be
delivered to us at least ten days prior to the special meeting or it will not
be counted.
PROXY SOLICITATION
ISMIE will bear the cost of soliciting proxies from its eligible
members. In addition to solicitation by mail, proxies may be solicited by the
directors, staff and certain employees of ISMIE, who will not be specifically
compensated for those services, by personal interview, telephone or other
telecommunication. In addition, ISMIE has retained _______________ to assist in
soliciting proxies for the special meeting at a fee of approximately $_________
plus out-of-pocket expenses.
QUESTIONS ABOUT THE CONVERSION
If you have questions about the conversion or need help with any of the
accompanying materials you can call ISMIE's information center at
1-888-_________ (toll-free).
If you wish to comment to the Illinois Insurance Department regarding
the conversion, you may write to: Department of Insurance, 320 West Washington
Street, Fourth Floor, Springfield, Illinois 62767-0001 or may send comments to
the Illinois Insurance Department via facsimile at (217) 782-5020.
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THE CONVERSION
GENERAL
We are furnishing this proxy statement/prospectus to eligible members
of ISMIE in connection with the solicitation of proxies by the ISMIE Board for
use at the special meeting. At the special meeting which will be held on
________, 1999, we will ask you to vote to approve the merger agreement under
which ISMIE will become a wholly-owned subsidiary of Holdings and the eligible
members of ISMIE will receive shares of Holdings' common stock in exchange for
their membership interests. A copy of the merger agreement is attached to this
document as Annex I.
BACKGROUND OF THE CONVERSION
As a result of intense competition throughout the 1980's and 1990's,
premium rate increases in the medical malpractice industry generally have not
kept pace with increases in the severity of claims. Financially strong companies
with comparatively better financial strength ratings are benefitting from a
highly competitive market. We believe that these market conditions have created
a competitive environment that favors larger, well-capitalized companies with
multi-state operations and broad distribution systems that offer a variety of
products.
In light of this competitive environment, in the summer of 1998 we
engaged Salomon Smith Barney to serve as our financial advisor to investigate
the possible conversion of ISMIE from a reciprocal insurance exchange to a
stockholder-owned company or some other transaction involving the issuance of
debt or equity securities in order to secure and strengthen our market position
and prospects for growth in the future.
At a meeting of the Board of Governors on June 26, 1998, Salomon Smith
Barney reviewed in detail with the Board several capital raising alternatives
for ISMIE. The purpose of the review was to analyze the financial position and
operations of ISMIE and alternative sources for raising capital for a reciprocal
insurance exchange, including the feasibility of a public securities offering by
ISMIE in the event it were restructured and reorganized as a stock corporation.
Salomon Smith Barney discussed the following matters with the Board:
- trends in the insurance industry, including acquisitions of
malpractice insurance companies and the strategic environment
for medical malpractice insurers;
- projections of operating income for ISMIE;
- capital raising alternatives available to reciprocal insurance
companies, including financial reinsurance, the sale of
surplus note securities, the long-term utilization of a
downstream holding company and the conversion to a corporate
structure; and
- constraints inherent in a single state, single line of
business insurance company.
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Salomon Smith Barney emphasized the need for us to become financially
flexible in order to accomplish the strategic initiatives that our management
had identified. While additional capital was and is not an immediate need of
ISMIE, Salomon Smith Barney also presented an analysis of the feasibility of a
public stock offering if ISMIE converted to a corporate form. Salomon Smith
Barney concluded that it would be feasible for ISMIE to change its corporate
structure in order to gain access to the public markets and to proceed as a
publicly held company. Salomon Smith Barney also advised us that a holding
company structure, under which ISMIE would become a wholly owned subsidiary of a
publicly held holding company, would better serve us going forward.
At the June 26 meeting, the Board of Governors instructed management to
develop and prepare a plan of conversion, under which ISMIE would become a stock
corporation, for consideration at a future meeting.
On July 29, 1998, we met informally with the staff of the Illinois
Insurance Department to discuss in general terms ISMIE's reasons for the
proposed conversion and possible terms, including share allocation. Our legal
counsel then prepared a merger agreement incorporating the essential provisions
of the conversion, which was presented to the Board of Governors at its meeting
on September 2, 1998. At that meeting, which was also attended by our legal
counsel, our financial advisor and their counsel, the Board discussed in detail
the proposed terms of the conversion and approved in principle the merger
agreement as presented.
Following the September 2, 1998 meeting, we and our legal counsel
reviewed and revised the proposed merger agreement. The Board of Governors next
met on October 9, 1998, and further discussed the terms of the proposed
conversion and timing of implementation of the conversion. No action regarding
the proposed conversion was taken at that meeting. We and our advisors continued
to work on the terms of the merger agreement, including the method of allocating
common stock to be issued in the conversion. On January 29, 1999, we met again
with the staff of the Illinois Insurance Department to discuss the terms of the
proposed conversion.
At a regular meeting of the Board of Governors held on February 5,
1999, the Board met with management, Salomon Smith Barney and legal counsel to
consider the conversion and discuss the proposed merger agreement. No action
regarding the proposed conversion was taken at that meeting.
The Board of Governors met again at a special meeting on May 5, 1999.
All but one of the twenty one members of the Board of Governors were present at
the meeting. At this meeting, the Board again met with management, Salomon Smith
Barney and legal counsel to consider the conversion and the proposed merger
agreement. Salomon Smith Barney advised the Board that, based upon the current
structure of the conversion, they were of the opinion that the exchange of the
aggregate membership interests for shares of common stock under the merger
agreement was fair, from a financial point of view, to eligible members as a
group. See " -- Opinion of Salomon Smith Barney." After discussion and
consideration of various factors relating to the proposed conversion, the
members of the Board of Governors present at the meeting
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unanimously determined that the conversion was in the best interests of ISMIE
and its members and approved the merger agreement on behalf of ISMIE. See "-
Recommendations of the Board of Governors." The Board of Governors then directed
that the merger agreement be submitted to a vote of the members at a special
meeting of members called for that purpose. The Board set May 5, 1999 as the
record date for determining members eligible to vote at the special meeting and
to participate in the conversion. Salomon Smith Barney subsequently delivered to
the Board of Governors their written opinion, dated May 5, 1999, a copy of which
is attached to this proxy statement/prospectus as Annex II.
DETERMINATION OF ELIGIBLE MEMBERS
DETERMINATION OF ELIGIBILITY. Your right to vote on the proposal to
approve the merger agreement and to receive stock in the conversion is based on
whether you were a member on May 5, 1999, the date the Board of Governors
adopted the merger agreement. Whether or not you are an eligible member for
purposes of voting and receiving consideration is determined solely from ISMIE's
books and records.
DETERMINATION OF MEMBERSHIP. An ISMIE member is a person or
organization who is a "named insured" or "additional named insured" under a
policy. A "policy" is an insurance policy issued by ISMIE but does not include
either an agreement under which ISMIE has ceded or assumed reinsurance or a
reporting endorsement. "Named insured" or "additional named insured" means any
person who is specifically identified by name in the declarations page of a
policy as a "named insured" or as an "additional named insured" on any
endorsement other than a reporting endorsement. We will determine the identity
of the "named insured" or "additional named insured" in a policy without regard
to any interest of any other person in the policy, and our determination shall
be binding on all members. A "named insured" or "additional named insured"
ceases to be a member when the policy terminates.
CONVERSION OF MEMBERSHIP INTERESTS
Members have rights and interests in ISMIE which for purposes of the
conversion are called membership interests. Membership interests consist of the
rights arising under ISMIE's Subscription Agreements and Rules and Regulations,
the Illinois Insurance Code and otherwise, including the right to vote for the
election of members of the Board of Governors and on other matters, and to
participate in any distribution of surplus upon liquidation, but not including
claim obligations of ISMIE arising under policies. Upon completion of the
conversion, all membership interests in ISMIE will be canceled and extinguished,
and the membership interests of eligible members will be converted into the
right to receive consideration to be distributed in the conversion, as described
below.
CONSIDERATION
ALLOCATION OF SHARES. If the conversion is completed, eligible members
will receive consideration in the form of Holdings common stock. Each eligible
member will be allocated a number of shares of common stock equal to:
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(1) the product of x and y, where "x" equals 9,000,000
shares of common stock and "y" equals the ratio of
the earned premiums of that eligible member to the
total earned premiums of all eligible members during
the period beginning on July 1, 1995 and ending on
and including May 5, 1999, plus
(2) 1,000,000 shares of common stock divided by the total
number of eligible members.
The term "earned premiums" means earned premiums, exclusive of any
premium surcharges, on a policy covering an eligible member at any time during
the period beginning on July 1, 1995 and ending on and including May 5, 1999.
The term earned premiums refers to the gross premiums paid to ISMIE as earned
over the period of coverage provided under a policy and is, therefore, net of
return premiums due to cancellations or applications not accepted. Earned
premiums are not reduced by reinsurance premiums ceded or other reductions made
in calculating net premiums earned as presented in the financial statements
contained in this document.
The total amount of earned premiums of all eligible members for the
period July 1, 1995 through May 5, 1999 is approximately $575.7 million, or
$63.97 of earned premiums for each of the 9,000,000 shares of common stock to be
allocated based on earned premiums. There are approximately 9,667 eligible
members who will participate in the allocation of the 1,000,000 shares of common
stock distributed to those members.
As an example of how this would work, if you were a member on May 5,
1999, had joined ISMIE prior to July 1, 1995 and had paid average annual
premiums since that date of $15,480, you would be allocated approximately 1,006
shares of common stock. Of those shares, 903 shares would be allocated based on
your earned premiums and 103 would be allocated because you are an eligible
member. See "-- Recommendation of the Board of Governors -Determining the
Allocation Among Eligible Members."
For more information about the allocation of the common stock among
eligible members, see Section 2.3 of the merger agreement, a copy of which is
included in this proxy statement/prospectus as Annex I.
FRACTIONAL SHARES. No fractional shares of common stock will be issued
to any eligible member in the conversion. Fractional shares will be rounded up
or down to the nearest integral number of shares, with one-half being rounded
upward. Rounding may cause the aggregate number of shares of common stock issued
to eligible members in the conversion to be, in the aggregate, slightly less or
more than 10,000,000.
ESTIMATED ALLOCATION OF SHARES. Your GREEN RECORD CARD indicates the
estimated whole number of shares of common stock that you would be entitled to
receive under the merger agreement.
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DELIVERY OF SHARES. We will not send stock certificates for shares of
common stock to eligible members until at least 31 days after the conversion is
completed. See "-- Dissenters' Rights."
OPINION OF SALOMON SMITH BARNEY
We retained Salomon Smith Barney to assist us in evaluating the
possible conversion of ISMIE from an Illinois reciprocal insurance exchange to a
stockholder-owned company in order to secure and strengthen ISMIE's market
position and growth in the future. See "-- Background of the Conversion." As
part of the engagement, we instructed Salomon Smith Barney to evaluate the
fairness, from a financial point of view, to the eligible members, as a group,
of the exchange of the aggregate membership interests for shares of common stock
of Holdings under the merger agreement. We imposed no limitations on them
concerning the investigation to be made, or the procedures to be followed, by
them in rendering their opinion. We selected Salomon Smith Barney because of
their reputation and expertise as a nationally recognized investment banking
firm. Salomon Smith Barney, as part of their investment banking services,
regularly engages in the valuation of businesses and securities in connection
with stock repurchases, mergers, acquisitions, underwritings, sales and
distributions of listed and unlisted securities, private placements and
valuations for estate, corporate and other purposes.
Salomon Smith Barney delivered their written opinion, dated May 5,
1999, to the Board of Governors stating that, as of the date of their opinion,
and based upon the procedures, assumptions and qualifications described in their
opinion, the exchange of the aggregate membership interests for shares of common
stock of Holdings under the merger agreement is fair, from a financial point of
view, to the eligible members as a group.
THE FULL TEXT OF SALOMON SMITH BARNEY'S OPINION, DATED MAY 5, 1999,
WHICH SETS FORTH THE MATTERS REVIEWED, ASSUMPTIONS MADE, FACTORS CONSIDERED,
RELIANCE UPON OTHERS AND LIMITATIONS AS TO THE REVIEW UNDERTAKEN BY THEM, IS
ATTACHED AS ANNEX II TO THIS PROXY STATEMENT/PROSPECTUS. YOU ARE URGED TO READ
CAREFULLY THE OPINION OF SALOMON SMITH BARNEY IN ITS ENTIRETY. ANY DESCRIPTION
OF OR REFERENCE TO SALOMON SMITH BARNEY'S OPINION SHOULD BE VIEWED IN THE
CONTEXT OF THEIR ENTIRE OPINION. THE PREPARATION OF A FAIRNESS OPINION IS A
COMPLEX PROCESS AND DOES NOT LEND ITSELF TO PARTIAL ANALYSIS OR SUMMARY
DESCRIPTION. SALOMON SMITH BARNEY'S OPINION IS DIRECTED TO THE BOARD OF
GOVERNORS AND IS NOT A RECOMMENDATION TO YOU AS TO WHETHER YOU SHOULD VOTE TO
APPROVE THE CONVERSION.
We did not request Salomon Smith Barney to opine as to, and their
opinion does not address, the underlying business decision of the Board of
Governors to proceed with the conversion. In addition, Salomon Smith Barney's
opinion expressly excludes any opinion as to:
- which of ISMIE's policyholders are to be included among the
eligible members;
- the fairness of the proposed consideration to be paid to any
eligible member or to any class of eligible members in
connection with the conversion;
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- the fairness of any provisions of the merger agreement
relating to which members receive common stock of Holdings,
the allocation of common stock among eligible members and
other provisions of the merger agreement which distinguish
among eligible members;
- the fair market value of any shares of common stock of
Holdings to be issued under the merger agreement; or
- the price at which the common stock of Holdings could be sold
in an initial public offering or the price at which the common
stock of Holdings issued in the conversion or in an initial
public offering would trade.
Salomon Smith Barney noted that the price at which the common stock of
Holdings could be sold in an initial public offering, if an initial public
offering were conducted, would be a function of market conditions and the recent
performance of and outlook for ISMIE at that time. Further, Salomon Smith Barney
noted their belief that trading in the common stock of Holdings for a period
following the completion of a distribution of the common stock of Holdings,
including an initial public offering, would be characterized by a redistribution
of the common stock of Holdings among eligible members who received shares of
common stock and other investors. Salomon Smith Barney also noted that during
these periods of redistribution the common stock of Holdings could trade below
the prices at which it would trade on a fully distributed basis.
In arriving at their opinion, Salomon Smith Barney reviewed, analyzed
and relied upon material bearing upon the financial and operating condition and
prospects of ISMIE and material prepared in connection with the merger agreement
and the conversion. They considered such financial and other factors as they
considered appropriate under the circumstances, including, among other things,
the following:
- the statutory annual statements provided by ISMIE for the
years 1993 through 1998;
- GAAP financial data provided by ISMIE, including the audited
income statements for each year of the five year period ending
December 31, 1998 and the audited balance sheets for each year
of the five year period ending December 31, 1998;
- consolidated financial projections for Holdings and its
subsidiaries after the conversion provided to Salomon Smith
Barney by ISMIE;
- the draft registration statement on Form S-4 of Holdings,
dated April 28,1999;
- a copy of the merger agreement dated May 5, 1999;
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<PAGE>
- financial data of ISMIE which Salomon Smith Barney compared
with publicly available financial information and market data
of other companies which they believed to be comparable; and
- the financial terms of the transactions contemplated by the
merger agreement which they compared with the financial terms
of other transactions they considered relevant.
Salomon Smith Barney also conducted discussions with management and our
advisors relating to our business and the financial and other aspects of the
merger agreement and the conversion and other matters they believed to be
relevant to their inquiry. In addition, Salomon Smith Barney took into account
their assessment of general economic, market and financial conditions, their
experience in securities valuation and their knowledge of the insurance industry
generally.
In preparing their opinion, Salomon Smith Barney assumed, at our
instruction, that:
- the conversion will meet all applicable legal and regulatory
requirements and that all necessary action will have been
taken to comply with all applicable laws and requirements,
including the receipt of all required approvals by
policyholders, regulators and otherwise;
- the terms of an initial public offering, if undertaken, would
not affect the legal or tax treatment of the merger agreement
or the conversion;
- the conversion would be completed on the basis described in
the merger agreement;
- ISMIE will receive, prior to the effective date, a private
letter ruling from the Internal Revenue Service or an opinion
from our tax counsel as to certain matters as described in
Section 7.1(d) of the merger agreement; and
- the opinion of our tax counsel, if delivered, will be
confirmed as of the effective date of the merger with no
changes or exceptions whatsoever.
In preparing their opinion, Salomon Smith Barney considered a number of
factors including, but not limited to, the following (in no particular order):
- our belief that growth is extremely important to remain an
effective and competitive insurer in the future;
- our belief that it is of significant strategic importance that
we have broader access to external capital to finance this
growth;
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<PAGE>
- our financial strength ratings and the considerations on which
those ratings are based;
- in our present form as a reciprocal insurance exchange, we
have limited access to the capital markets for new capital;
- following the conversion, we will have a capital structure
potentially enabling us to access the capital markets for new
capital; and
- the non-transferability of membership interests.
In conducting their review and arriving at their opinion, Salomon Smith
Barney relied upon and assumed the accuracy and completeness of the financial
and other information that was provided to them or was publicly available and
have not attempted to independently verify that information. With respect to
financial forecasts, Salomon Smith Barney assumed that the forecasts have been
reasonably prepared on a basis reflecting our best currently available estimates
and judgments, and they expressed no opinion with respect to the forecasts or
the assumptions on which they are based. In addition, Salomon Smith Barney did
not make or obtain any evaluations or appraisals of our properties, assets,
liabilities, reserves or surplus. Salomon Smith Barney's opinion is limited to
the fairness, from a financial point of view, to the eligible members as a
group, of the exchange of the aggregate membership interests for shares of
common stock of Holdings, under the merger agreement. Salomon Smith Barney's
opinion is necessarily based upon conditions as they exist and could be
evaluated on the date of their opinion and the information made available to
them through the date of their opinion.
We engaged Salomon Smith Barney to serve as our financial advisor in
the summer of 1998. We agreed to pay Salomon Smith Barney an aggregate fee of up
to $500,000 and to reimburse them for reasonable out-of-pocket expenses up to
$70,000, including fees and expenses of counsel, for their services. These fees
and expenses were payable whether or not Salomon Smith Barney gave us a
favorable fairness opinion. We agreed to indemnify Salomon Smith Barney and
their affiliated entities, directors, officers, employees, legal counsel, agents
and controlling persons against certain costs, expenses and liabilities to which
they may become subject arising out of or in connection with their engagement.
We also agreed to retain Salomon Smith Barney to act as lead underwriter in
connection with an initial public offering, and Salomon Smith Barney will
receive fees in connection with that transaction when and if completed.
RECOMMENDATION OF THE BOARD OF GOVERNORS
The Board of Governors believes that the terms of the conversion are in
the best interests of ISMIE and its members and recommends that you vote FOR the
approval of the merger agreement at the special meeting.
The Board of Governors approved the terms of the merger agreement at a
meeting held on May 5,1999. At that meeting and at previous meetings of the
Board held on September 2,
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<PAGE>
1998 and February 5, 1999, members of our senior management, together with our
legal and financial advisors, reviewed with the Board the background of the
proposed conversion, the potential benefits of the conversion and the terms of
the proposed merger agreement. On May 5, 1999, Salomon Smith Barney rendered
their opinion as to the fairness, from a financial point of view, to eligible
members as a group, of the exchange of membership interests for shares of common
stock to be allocated in the conversion. A summary of the opinion and the
procedures followed in preparing the opinion is set forth in "-- Opinion of
Salomon Smith Barney."
DETERMINATION THAT THE CONVERSION IS IN THE BEST INTERESTS OF ISMIE AND
ITS MEMBERS. In reaching its determination at the May 5, 1999 meeting that the
conversion is in the best interests of ISMIE and its members, the Board of
Governors consulted with ISMIE's management and its legal and financial
advisors, and considered the following factors:
- The competitive forces affecting the medical malpractice
market in Illinois, which in the view of the Board require
ISMIE to grow and diversify its business in order to remain an
effective and competitive insurer in the future. The Board has
concluded that growth and diversification can best be
accomplished in a corporate form.
- The strategic importance of ISMIE having broader access to
external capital to achieve this growth, and the Board's
belief that in its present form as a reciprocal insurance
exchange, ISMIE has limited access to the capital markets for
new capital.
- Comments from A.M. Best and Standard & Poor's relating to
ISMIE's narrow product line and geographic concentration.
- The intense competition in the medical malpractice industry.
- The business, operations, earnings, assets, liabilities and
financial condition of ISMIE, on both an historical and
prospective basis, and the benefits to ISMIE that the Board
believes could be realized by pursuing its business strategy
of growth and diversification of which the conversion and
related transactions are a principal part.
- The conversion of other professional liability insurance
companies, including Southern California Physicians Insurance
Exchange and the pending conversion of the Medical
Inter-Insurance Exchange of New Jersey, to publicly held
companies, and the greater access to capital resources and
increased financial and structural flexibility available to
stock companies.
- The opinion of Salomon Smith Barney, based on the limitations
contained in their opinion, that the exchange of the aggregate
membership interests for shares of common stock under to the
merger agreement is fair, from a financial point of view, to
eligible members as a group.
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- That the merger of ISMIE and ISMIE Indemnity Company will be a
tax-free reorganization and that eligible members, ISMIE,
Holdings and ISMIE Indemnity Company will not recognize gain
or loss for federal income tax purposes in the merger.
- That membership interests in ISMIE are not transferable, and
that the Holdings common stock, in contrast, will be freely
tradable and will be listed on the Nasdaq Stock Market.
- That as a result of the conversion, eligible members will
become stockholders of Holdings, a Delaware corporation.
Delaware corporate law is widely regarded as the most
extensive and well defined body of corporate law in the United
States, and a substantial body of case law and public policies
have developed with respect to Delaware corporations.
DETERMINING THE ALLOCATION AMONG ELIGIBLE MEMBERS. In determining which
members would be eligible to participate in the conversion and receive shares of
Holdings common stock, and the apportionment of consideration among eligible
members, the Board of Governors further considered the following factors:
- the terms of other insurance company conversion transactions,
including the conversion of the Southern California Physicians
Insurance Exchange and the pending conversion of the Medical
Inter-Insurance Exchange of New Jersey;
- the provisions of applicable Illinois statutes;
- the nature and value of the membership interests being
exchanged;
- the financial results for recent years; and
- analyses prepared by management.
These factors are described in more detail below. The Board did not
find it practicable to, and did not, quantify or otherwise assign relative
weights to the individual factors considered in reaching its determinations.
As to the allocation of common stock among eligible members, there is
no Illinois statutory provision for the guidance of the Board of Governors. The
Board believed that two components of value should be given consideration when
allocating the common stock to be issued in the conversion:
- the relative contribution of members to the surplus of ISMIE,
and
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<PAGE>
- the "intangible" membership interest itself, meaning the right
to vote on significant transactions and for election of the
governing board, irrespective of the contribution to the
assets and surplus of ISMIE.
The Board of Governors considered the earned premiums from the eligible
members to be the predominant factor in determining contribution to surplus.
Earned premiums may contribute to the surplus of ISMIE in two ways. First,
pending the payment of expenses and claims, premiums are invested and generate
investment income to increase ISMIE's earnings. Second, to the extent the losses
and expenses are ultimately less than the aggregate premiums, some underwriting
profit is realized to further increase earnings and surplus. The Board did not
believe that an analysis of contributions to surplus on an individual policy
basis would be meaningful because ISMIE offers the same coverage forms to all of
its members and attempts to establish rates that are neither excessive nor
inadequate among any class of insureds. The Board intends that all classes of
insureds contribute to surplus in proportion to the premiums they pay. The Board
concluded that the earned premiums themselves were the predominant indicator of
contribution to ISMIE. This approach has been used by other property and
casualty companies in allocating interests in connection with conversion to
stock companies, including the Southern California Physicians Insurance Exchange
and the Medical Inter-Insurance Exchange of New Jersey.
The Board of Governors therefore determined to base the allocation
formula principally on the earned premiums paid by an eligible member in
proportion to the earned premiums paid by all eligible members during a
specified period. Consistent with this approach, the Board further concluded
that earned premiums should not include any discounts or surcharges or any
premiums paid for reporting endorsements.
ISMIE considered various measurement periods for determining the amount
of premiums to be included in the allocation formula, including measurement
periods used by other companies in similar conversions. ISMIE concluded that
periods of three to five years were the most common measurement periods in
similar conversions and in the demutualization laws of other states that address
allocation procedures. ISMIE selected a measurement period for earned premiums
beginning on July 1, 1995 and continuing through the May 5, 1999, a measurement
period of approximately 3 7/8 years. ISMIE also determined that a period of
approximately 3 7/8 years provided an appropriate weighing of the interests of
both long-time and newer members.
The Board also considered the "intangible" membership interest itself
and what value should be attributed to this interest independent of premiums
paid by eligible members. This intangible value, independent of premiums,
includes the right to vote and any right to share in the assets of ISMIE in the
event of ISMIE's liquidation. The Rules and Regulations of ISMIE give one vote
to each member regardless of longevity with or premiums paid to ISMIE. See
"Comparison of Rights of Members Before and After the Conversion -- Description
of Rights of Members of ISMIE -- Voting." Since the conversion could not be
effected under Illinois law and under the Rules and Regulations of ISMIE without
the vote of eligible members, ISMIE concluded that there is value to the
intangible membership interests that should be recognized in the allocation
formula.
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In considering a value for the membership interest, the Board concluded
that no value should be attributable to the membership interest for those
members who joined after the Board approved the conversion, as this could
encourage healthcare providers to seek a windfall by joining ISMIE primarily for
the purpose of obtaining stock ownership attributable to the membership
interest. ISMIE therefore set the date of adoption of the merger agreement as
the record date for receiving any stock distribution attributable to the
membership interest itself.
The Board of Governors considered what portion of the stock
distribution should be attributed to the intangible membership interest. ISMIE
reviewed other transactions and considered the measurement periods used for the
earned premium component of the distribution and the independent value, if any,
attributed to the membership interest in those transactions. Because the Board
concluded that there is value to the intangible membership interests, the Board
determined that it would be appropriate to allocate some value represented by
the common stock to be issued in the conversion to the membership interests.
ISMIE analyzed various allocations based upon the membership interests and
considered the effect that those allocations would have on the distribution of
consideration to eligible members. The Board concluded that the allocation
formula should provide those persons who were members of ISMIE at the time the
conversion was approved by the Board with a meaningful ownership interest in
ISMIE. Accordingly, the Board determined that an allocation of 10% of the common
stock to be issued in the conversion was an appropriate measure of value to be
attributed to the intangible membership interests.
Based on all of the factors described above, the Board of Governors
believes that the conversion is in the best interests of ISMIE and its members.
Accordingly, the Board has approved the merger agreement and recommends that
eligible members vote FOR the proposal to approve the merger agreement.
DESCRIPTION OF THE MERGER AGREEMENT
The following is a summary of the significant provisions of the merger
agreement, a copy of which is attached as Annex I to the proxy
statement/prospectus. We encourage you to read the merger agreement because it
is the legal document that governs the merger.
EFFECT OF THE MERGER. After the conditions to the merger have been
satisfied or waived, ISMIE will be merged with ISMIE Indemnity Company, and
ISMIE Indemnity Company will continue as a subsidiary of Holdings. The
conversion will be completed and become effective at the time that the Illinois
Director of Insurance issues a certificate of merger, unless the Illinois
Director later revokes his approval of the merger after the exercise of
dissenters' rights as provided in the Illinois Insurance Code. See "-
Dissenters' Rights." After the merger, the separate existence of ISMIE will
cease, and ISMIE Indemnity Company will continue as the surviving corporation.
CONVERSION OF MEMBERSHIP INTERESTS. Subject to applicable dissenters'
rights discussed below, at the effective time of the merger:
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- the membership interests of all members will end;
- each eligible member will be allocated his or her pro rata
share of 10,000,000 shares of common stock as provided in
Section 2.3 of the merger agreement; and
- ISMIE Indemnity Company will receive 100,000 shares of common
stock or another number as provided in Section 2.3 of the
merger agreement. These shares will be issued to ISMIE
Indemnity Company so that the conversion will have the tax
consequences discussed in "Material Tax Consequences of the
Conversion."
CONDITIONS TO THE MERGER. In order for the merger to become effective,
and for the conversion to occur, the following conditions must be satisfied:
- The merger agreement must be approved by the favorable vote of
two-thirds of eligible members present in person or by proxy
at the special meeting.
- The merger agreement must be approved by the Illinois Director
of Insurance after approval by eligible members at the special
meeting.
- An opinion of tax counsel regarding material federal income
tax consequences of the merger is required to be received in
order for the merger to become effective. As more fully
discussed in "Certain Federal Income Tax Consequences of the
Conversion," an opinion of tax counsel has been received
regarding these matters and must be reconfirmed before the
merger can be completed.
ISSUANCE AND DELIVERY OF COMMON STOCK TO ELIGIBLE MEMBERS. The Holdings
common stock allocated to eligible members and ISMIE Indemnity Company will be
treated as having been issued at the time that the merger is completed.
Certificates representing the common stock will be delivered on the thirty-first
day after the effective date of the merger, or as soon as reasonably practicable
after that date, unless a petition has been filed with the Illinois Director of
Insurance in accordance with Section 168 of the Illinois Insurance Code. If a
petition has been filed, the common stock will be delivered only upon the
issuance of an order of the Illinois Director of Insurance in accordance with
Section 168 of the Illinois Insurance Code.
AMENDMENT. The merger agreement may not be amended except by an
instrument in writing signed by each of the parties to it. However, after
approval of the merger agreement by eligible members at the special meeting, no
amendment may be made without the further approval of eligible members which
under applicable law requires their further approval.
TERMINATION. The merger agreement may be terminated and the merger may
be abandoned, at any time before the completion of the merger, whether prior to
or after approval of the merger agreement by eligible members at the special
meeting:
- by mutual written consent of the parties;
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- if any party breaches in any material respect any of its
covenants or agreements contained in the merger agreement;
- if the merger has not been consummated prior to December 31,
1999; or
- if any court of competent jurisdiction or any other
governmental body has taken any action restraining, enjoining
or otherwise prohibiting the merger and the order, decree,
ruling or other action, has become final and non-appealable.
DISSENTERS' RIGHTS
Under Section 168 of the Illinois Insurance Code, if five percent or
more of all eligible members who do not vote in favor of the merger agreement at
the special meeting file a petition with the Illinois Director of Insurance
within thirty days after the merger has been completed for a hearing upon the
merger agreement, the Illinois Director of Insurance is required to order a
hearing upon at least fifteen days' notice. Any petitioning eligible member may
appear before the Illinois Director of Insurance at the hearing. If the Illinois
Director of Insurance finds that the interests of the members of ISMIE are not
properly protected, or if he finds that any reasonable objection exists to the
merger agreement, he will enter an order revoking the approval already given.
The merger of ISMIE and ISMIE Indemnity Company would then become null and void,
the conversion would not occur, and no eligible member would receive common
stock as proposed or have any further rights under the merger agreement. The
Illinois Director of Insurance also has the power to revoke any approval of the
merger if any officer, director or employee of any party to the merger agreement
fails or refuses without reasonable cause to attend and testify at the hearing,
or to produce any books or papers called for by the Illinois Director of
Insurance.
ADDITIONAL ASPECTS OF THE MERGER AGREEMENT AND THE CONVERSION
INSURANCE COVERAGE. The conversion will not affect any member's policy
coverage. In the conversion, each member will become a policyholder of ISMIE
Indemnity Company and ISMIE Indemnity Company will assume all policy and other
obligations of ISMIE.
EXPENSES OF THE CONVERSION. All expenses related to the conversion will
be borne by ISMIE.
REGULATORY APPROVALS. Except for approval by the Illinois Director of
Insurance, and compliance with federal and state securities laws, we are not
aware of any material federal or state regulatory requirement necessary to be
complied with or approval that must be obtained in connection with the
conversion.
ISSUANCE OF SHARES TO ISMIE INDEMNITY COMPANY. The merger agreement
provides that Holdings will issue to ISMIE Indemnity Company 100,000 shares of
common stock in consideration of the cancellation of the outstanding shares of
common stock of Holdings
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currently held by ISMIE. The Board of Governors and the Holdings Board may
adjust the number of shares of common stock issuable to ISMIE Indemnity Company
in the merger in order to ensure that the common stock issued to ISMIE Indemnity
Company has a fair market value equivalent to the fair market value of the
common stock currently held by ISMIE which is to be canceled in the merger.
The shares of common stock will be issued to ISMIE Indemnity Company so
that the merger will have the tax consequences set forth in "Significant Federal
Income Tax Consequences of the Conversion -- ISMIE and ISMIE Indemnity Company."
Under the Delaware General Corporation Law, or DGCL, ISMIE Indemnity Company
will not be entitled to vote the shares of common stock issued to it in the
conversion, but those shares will be entitled to receive dividends. Under GAAP
those shares will be treated as issued but not outstanding. See
"Capitalization."
ACCOUNTING TREATMENT. The conversion and related transactions involve a
reorganization of entities under common control, and the assets and liabilities
transferred to effect the conversion and related transactions will be accounted
for at historical cost in a manner similar to that in pooling of interests
accounting.
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COMPARISON OF RIGHTS OF MEMBERS
BEFORE AND AFTER THE CONVERSION
Upon completion of the conversion and expiration or termination of
dissenters' rights, your membership interests will be canceled and extinguished
and converted into the right to receive common stock, and you will become a
stockholder of Holdings. The following is a comparison of rights of eligible
members of ISMIE and holders of Holdings common stock. This comparison is
intended to highlight the material rights of members before and after the
conversion and should be read in conjunction with ISMIE's Rules and Regulations
and Holdings' certificate of incorporation and bylaws, copies of which are
available for inspection at the executive offices of ISMIE and will be sent to
you upon request.
<TABLE>
<CAPTION>
DESCRIPTION OF RIGHTS OF MEMBERS OF ISMIE DESCRIPTION OF RIGHTS OF HOLDERS OF ISMIE
HOLDING STOCK AFTER THE CONVERSION
<S> <C>
GENERAL. Membership in ISMIE is limited GENERAL. The authorized capital stock of
to and composed of those persons who are Holdings consists of (i) 40,000,000 shares of
"named insureds" or "additional named common stock, par value $0.01 per share, and
insureds" in ISMIE. "Named insured" or (ii) 5,000,000 shares of preferred stock, par
"additional named insured" means any person value $0.01 per share. Immediately after the
who is specifically identified by name in the consummation of the conversion, it is expected
declarations page of a policy as a "named that there will be approximately 10,000,000
insured" or as an "additional named insured" on shares of common stock outstanding and no
any endorsement attached to the policy other shares of preferred stock outstanding.
than a reporting endorsement. Each "named
insured" or "additional named insured" under a Shares of common stock have no
policy of insurance issued by ISMIE becomes a preemptive rights, conversion rights, or
member when the policy is issued and the redemption rights. No shares of preferred
period of coverage commences under the stock will be issued or outstanding
policy. immediately following the conversion. When
and if issued, the preferred stock will have the
Membership interests in ISMIE have no rights, powers and preferences as may be
preemptive or conversion rights, redemption established by the Holdings Board. See
rights, or sinking fund provisions. "Description of Capital Stock -- Preferred
Stock."
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<CAPTION>
DESCRIPTION OF RIGHTS OF MEMBERS OF ISMIE DESCRIPTION OF RIGHTS OF HOLDERS OF HOLDINGS
STOCK AFTER THE CONVERSION
<S> <C>
LIQUIDITY/MARKETABILITY. A membership LIQUIDITY/MARKETABILITY. Holdings has
interest is not transferable and ceases when the applied for listing of the shares of common
coverage period or certificate period of the stock on the Nasdaq National Market. As a
member under the policy issued by ISMIE result, Holdings anticipates that there will be a
terminates. public market for the shares of common stock,
although we cannot be sure of the price at
DISTRIBUTIONS. The Board of Governors may which the common stock will trade. See "Risk
declare dividends to qualifying members of Factors-- An active or orderly trading market
ISMIE. The qualifications of members to for the common stock may not develop; our
receive dividends declared may be determined stock price may be volatile."
by the Board of Governors, except that a
dividend may only be paid to a member who has DISTRIBUTIONS. Subject to the rights of
been insured during four (4) continuous policy holders of preferred stock, if any, holders of
periods. common stock will be entitled to participate
equally in dividends if, as and when declared
If ISMIE is liquidated, any assets by the Holdings Board, and in the distribution
remaining after payment of all liabilities would of assets in the event of dissolution. See
be distributed to members in accordance with "Dividend Policy."
the provisions of Article 13 of the Illinois
Insurance Code. ISMIE has not made any determination as
to whether it will pay dividends on the
common stock in the foreseeable future. There
can be no assurance that dividends will be paid
or, if paid initially, that they would continue to
be paid in the future. See "Dividend Policy."
INCOME TAXATION. Holdings is a taxable
entity. A holder of common stock or preferred
stock will not be taxed with respect to
Holdings' income, but will realize taxable
INCOME TAXATION. ISMIE, as a reciprocal income to the extent that Holdings pays
insurance exchange, is taxable under the dividends to the holder out of current or
Internal Revenue Code as a "mutual insurance accumulated earnings and profits. As a stock
company." A holder of a membership interest is corporation, Holdings will not receive a
not taxed with respect to ISMIE's income, but deduction for dividends. Accordingly, to the
may realize taxable income to the extent that extent distributed, earnings and profits of
ISMIE makes actual distributions (in the form Holdings generally will face two levels of
of premium credits or other dividends) to the federal income tax.
holder out of current or accumulated earnings
and profits of ISMIE. As a "mutual insurance
company" for federal income tax purposes, ISMIE
will receive adeduction in the amount of the
distributions when accrued.
35
<PAGE>
<CAPTION>
DESCRIPTION OF RIGHTS OF MEMBERS OF ISMIE DESCRIPTION OF RIGHTS OF HOLDERS OF HOLDINGS
STOCK AFTER THE CONVERSION
<S> <C>
ASSESSMENTS. Members may not be ASSESSMENTS. Shares of common stock and
assessed on policies issued or renewed by preferred stock will not be callable or
ISMIE. assessable by Holdings.
MEETINGS AND ACTIONS. Action required to MEETINGS AND ACTIONS. Any action
be taken by the members may be taken at a duly required or permitted to be taken by the
called annual or special meeting of members of stockholders of Holdings must be taken by
ISMIE. Annual meetings are held during, and vote of the stockholders at a duly called annual
at the same place as, the annual meeting of the or special meeting of stockholders and not by
Illinois State Medical Society. Special meetings written consent. Special meetings of
of the members may be called only by (i) the stockholders may be called only by (i) the
Chairman of the Board of Governors or (ii) one- President or Secretary at the request of a
third of the total number of Governors and majority of the Holdings Board or (ii) the
twenty (20) members of ISMIE. Chairman of the Holdings Board.
The business transacted at any special The business transacted at any special
meeting of the members is confined to matters meeting of stockholders is confined to matters
specified in the notice of meeting. specified in the notice of meeting.
The Rules and Regulations of ISMIE The certificate of incorporation establishes
provide for an advance notice procedure with an advance notice procedure with regard to the
respect to the nomination by members of nomination by stockholders of candidates for
candidates for election as members of the Board election as directors and with regard to
of Governors. Nominations by members proposals of business to be brought before an
require a nominee to be nominated by an ISMIE annual meeting of stockholders of Holdings.
policyholder and seconded by two other Notice as to any stockholder nomination or
members of ISMIE. other proper proposal must be received by
Holdings not less than 60 days nor more than
The Rules and Regulations of ISMIE may 90 days prior to the anniversary date of the
be amended by the Board of Governors at any immediately preceding annual meeting. In the
regular or special meeting by a vote of two- event that the date of the annual meeting is
thirds of the total Governors holding office or at more than 30 days before or more than 60 days
a meeting of members of ISMIE upon the after the anniversary date, however, the
favorable vote of two-thirds of the members Certificate of incorporation provides additional
represented at the meeting either in person or by time for notice. In addition, the notice must
proxy. contain certain specified information
concerning the person to be nominated or the
matters to be brought before the meeting as
well as the name and address of the
stockholder and the class and number of
shares beneficially owned by the stockholder
submitting the proposal.
DOMICILIARY STATE. Illinois STATE OF INCORPORATION. Delaware
36
<PAGE>
<CAPTION>
DESCRIPTION OF RIGHTS OF MEMBERS OF ISMIE DESCRIPTION OF RIGHTS OF HOLDERS OF HOLDINGS
STOCK AFTER THE CONVERSION
<S> <C>
VOTING. Each member entitled to vote is VOTING. Holders of common stock are
entitled to one vote at all meetings of members entitled to one vote per share on all matters
on all matters submitted to the members for with respect to which the holders of common
action. The Rules and Regulations of ISMIE stock are entitled to vote (including the
generally require the favorable vote of a election of directors) and, except as otherwise
majority of members voting to approve matters required by law or by the terms of any series of
submitted to the members. There is no preferred stock then outstanding, the holders of
cumulative voting, and, therefore, a majority of common stock will exclusively possess all
the members voting at the meeting will be voting power. Under the DGCL, in the
entitled to elect all of the members of the Board absence of specific requirements in a
of Governors to be elected at the meeting. corporation's certificate of incorporation or
bylaws, all matters submitted to
stockholders for approval must be approved
at a meeting at which a quorum is present by
the favorable vote of the holders of a
majority of the outstanding shares present
in person or by proxy and entitled to vote,
except for election of directors, which
requires a plurality vote, and certain
matters governed by Section 203 of the DGCL,
which requires the approval of the Board of
Directors and of two-thirds (66-2/3%) vote
of disinterested stockholders to approve
certain types of business combinations. See
"Description of Capital Stock -- Statutory,
Charter and Bylaw Provisions Which Could
Have an Anti-Takeover Effect." Pursuant to
the certificate of incorporation, directors
may be removed only for cause and only by
the favorable vote of two-thirds (66-2/3% of
the outstanding voting securities. In the
election of members of the board of
directors, there is no cumulative voting,
and therefore, except as otherwise required
by the terms of any series of preferred
stock then outstanding, the holders of a
majority of the shares of common stock
entitled to vote and voting at the meeting
will be entitled to elect all of the members
of the Board of directors to be elected at
the meeting if they choose to do so.
37
<PAGE>
<CAPTION>
DESCRIPTION OF RIGHTS OF MEMBERS OF ISMIE DESCRIPTION OF RIGHTS OF HOLDERS OF HOLDINGS
STOCK AFTER THE CONVERSION
<S> <C>
QUORUM. One hundred (100) members QUORUM. The holders of a majority of the
represented in person or by proxy constitutes a stock issued and outstanding and entitled to
quorum for the transaction of business at any vote, represented in person or by proxy, will
meeting of the members. constitute a quorum for the transaction of
business at all meetings of stockholders.
PREFERRED STOCK. Not applicable. PREFERRED STOCK. The Holdings Board is
authorized, subject to any limitations
prescribed by law, without further action by
stockholders, to issue up to 5,000,000 shares of
preferred stock, from time to time, in one or
more series and, with respect to each series, to
determine its terms, including the number of
shares, dividend rates, redemption rights,
conversion rights, voting rights and rights on
liquidation. Because the Holdings Board has
the power to establish the preferences, powers
and rights of each series, it may confer upon
the holders of any particular series of preferred
stock preferences, powers and rights (including
dividend rights, voting powers and liquidation
preferences) senior to the rights of the holders
of common stock. No shares of preferred stock
will be outstanding immediately following the
conversion, and Holdings has no immediate
plans to issue any series of preferred stock.
The issuance of a series of preferred stock
could, depending on the terms of the series,
have the effect of discouraging, delaying or
preventing a third party from acquiring or
proposing to acquire a majority of the
outstanding voting stock of Holdings. See
"Description of Capital Stock-- Preferred
Stock."
LIMITED LIABILITY. The liability of a member LIMITED LIABILITY. The liability of holders
generally is limited to the premiums accrued of common stock is generally limited to the
under the current policies of insurance issued by price paid for the common stock by the holder.
ISMIE to the member. Members of ISMIE are
not assessable by ISMIE.
38
<PAGE>
<CAPTION>
DESCRIPTION OF RIGHTS OF MEMBERS OF ISMIE DESCRIPTION OF RIGHTS OF HOLDERS OF HOLDINGS
STOCK AFTER THE CONVERSIO
<S> <C>
MANAGEMENT. ISMIE is a reciprocal MANAGEMENT. The Holdings Board has the
insurance exchange and management power and duty to manage the business and
responsibility is divided between the Board of affairs of Holdings and, indirectly, all its
Governors and the attorney-in-fact, Illinois State subsidiaries. The Holdings Board may
Medical Insurance Services, Inc. The attorney- designate committees, each committee to
in-fact is designated as the attorney-in-fact for consist of one or more directors, and has
each subscriber under an agreement which each established an audit committee, a
subscriber signs when making application for compensation committee, an executive
insurance. The power of attorney agreement committee, a stock option committee, a
between the attorney-in-fact and ISMIE, nominating committee and an investor
describes the allocation of powers and duties relations committee. Directors are elected by
between the attorney-in-fact and the Board of the stockholders of Holdings. See "--Voting"
Governors. and "--Election of Directors."
The attorney-in-fact is under the control The officers of Holdings serve
and supervision of the Board of Governors, is at the discretion of the Holdings Board.
authorized to operate the business of ISMIE, accepts
or rejects, underwrites and issues policies for
ISMIE, collects and accounts for all premiums paid,
handles and disposes of claims, and performs all
related functions.
39
<PAGE>
<CAPTION>
DESCRIPTION OF RIGHTS OF MEMBERS OF ISMIE DESCRIPTION OF RIGHTS OF HOLDERS OF HOLDINGS
STOCK AFTER THE CONVERSION
<S> <C>
BOARD OF GOVERNORS. The Rules and BOARD OF DIRECTORS. The Holdings Board
Regulations of ISMIE provide that the Board of consists of not less than three
Governors shall consist of twenty-one and more than fifteen directors, the exact
members, each of whom must be a physician number to be fixed from time to time
member. The Board of Governors is divided by the favorable vote of a majority of
into three classes who serve for staggered terms. the Holdings Board.
Each class is composed of seven governors,
who serve for a term of three years, with one Immediately following the consummation
class being elected at each annual meeting. of the conversion, the Holdings Board will
consist of ten members. The Board of
directors is divided into three classes who
serve staggered terms (not including
directors who may be selected from time to
time by holders of preferred stock). Each
class consists, as nearly as possible, of
one-third of the total number of directors,
who serve for a term of three years, with
one class being elected at each annual
meeting. See "Management -Directors and
Executive Officers."
In the future, the Board's ability
to determine the number of directors could
delay any stockholder from obtaining
majority representation on the Holdings
Board and filling the new vacancies with its
own nominees until the next stockholder
election.
ELECTION OF GOVERNORS. ISMIE's Rules and ELECTION OF DIRECTORS. The Certificate of
Regulations provide that nominations for incorporation provides that nominations for
election of members of the Board of Governors election of directors may be made only by or at
must be made by members who comply with the direction of the Holdings Board or by any
specified notice procedures. A Nominating stockholder of Holdings entitled to vote on the
Committee composed of at least three but no election of directors who complies with
more than five members of the Board of specified notice procedures and who was a
Governors reviews the nominees and presents stockholder of record at the time of giving
its recommendations to the Executive notice. See "--Meetings and Actions."
Committee of the Board of Governors which Directors are elected at the annual meeting of
ultimately approves a slate of recommended stockholders except when filling vacancies or
nominees for consideration by the members. newly-created vacancies. See "--Vacancies."
The Rules and Regulations also provide that A plurality of votes present in person or by
members who comply with specified procedures proxy and entitled to vote on the election of
may run without being recommended by the directors is required for election.
Nominating Committee. See "--Meetings and
Actions."
40
<PAGE>
<CAPTION>
DESCRIPTION OF RIGHTS OF MEMBERS OF ISMIE DESCRIPTION OF RIGHTS OF HOLDERS OF HOLDINGS
STOCK AFTER THE CONVERSION
<S> <C>
REMOVAL OF GOVERNORS. ISMIE's Rules and REMOVAL OF DIRECTORS. The Certificate of
Regulations do not contain any provisions incorporation provides that directors can be
relating to the removal of a member of the removed from office only for cause and only
Board of Governors. with the vote of two-thirds of the voting power
of the then outstanding shares of voting
stock of Holdings, voting together as a
single class.
VACANCIES. The Certificate of
VACANCIES. Vacancies in the Board of incorporation provides that vacancies on the
Governors are filled by a vote of the majority of Holdings Board and any newly-created
the remaining Governors (1) for the remaining directorships resulting from an increase in the
term if the remaining term is less than 18 authorized number of directors may be filled
months, or (2) only until the next annual for the remainder of a term only by an
meeting of members if the remaining term is favorable vote of a majority of the remaining
more than 18 months. directors (even though less than a quorum).
The provisions of the Certificate of
incorporation governing removal of directors
and the filling of vacancies would preclude
a third party from removing incumbent
directors and simultaneously gaining control
of the Holdings Board by filling vacancies
created by the removal with its own nominees
unless, among other things, the third party
controls at least two-thirds of the combined
voting power of Holdings' voting stock.
41
<PAGE>
<CAPTION>
DESCRIPTION OF RIGHTS OF MEMBERS OF ISMIE DESCRIPTION OF RIGHTS OF HOLDERS OF HOLDINGS
STOCK AFTER THE CONVERSION
<S> <C>
INDEMNIFICATION. ISMIE's Rules and INDEMNIFICATION. The Certificate of
Regulations provide that ISMIE shall indemnify incorporation provides that Holdings shall
the members of the Board of Governors, the indemnify its directors, officers and any person
officers of ISMIE, the employees of ISMIE and serving at the request of the corporation as a
any person serving as a director, trustee, officer, director, officer employee or agent of another
or employee of another enterprise at the request corporation, and may indemnify its employees
of ISMIE, from and against expenses (including and agents, who are parties or threatened to be
attorneys' fees), judgments, decrees, fines, made parties to any action, suit or proceeding
penalties, and amounts paid in settlement by reason of the person's capacity as a director,
actually and reasonably incurred in connection officer, employee or agent of Holdings, from
with any actions, suits or proceedings relating to and against expenses (including attorneys'
claims or liabilities asserted against the fees), judgments, fines and settlements arising
management or operations of ISMIE, including from the action, suit or proceeding to the
any derivative actions brought in the name of or fullest extent authorized by the DGCL. Section
on behalf of ISMIE. However, indemnification 145(a) of the DGCL provides that a
may be made only if the person acted in good corporation may indemnify a director, officer,
faith and in a manner reasonably believed to be employee or agent if the person acted in good
in, or not opposed to, the best interests of ISMIE faith and in a manner reasonably believed to be
and, with respect to any criminal proceeding, in, or not opposed to, the best interests of the
had no reasonable cause to believe the conduct corporation and, with respect to any criminal
was unlawful. In a derivative action, no proceeding, had no reasonable cause to believe
indemnification will be made if the person shall the conduct was unlawful. As permitted by the
have been finally adjudged to be liable for DGCL, the Certificate of incorporation
negligence or misconduct unless the court in eliminates in specified circumstances the
which the action was brought shall determine monetary liability of the directors of Holdings
that the person is fairly and reasonably entitled for a breach of their fiduciary duties as
to indemnity for the expenses. directors.
AMENDMENTS TO GOVERNING DOCUMENTS.
AMENDMENTS TO GOVERNING DOCUMENTS. Stockholders of Holdings are entitled to adopt,
Members of ISMIE may adopt, alter, amend or alter, amend, rescind or repeal provisions of
repeal provisions of ISMIE's Rules and the Holdings Bylaws by the favorable vote of a
Regulations by the vote of two-thirds of the majority of the stockholders present in person
members voting at an annual or special meeting or by proxy at a duly called meeting of
or by the vote of two-thirds of the number of stockholders at which a quorum is present.
Governors holding office at any regular or The Holdings Board is also entitled to alter,
special meeting of the Board. amend, change or repeal provisions of the
Holdings Bylaws by majority vote. Generally,
under Section 242 of the DGCL, an
amendment to
42
<PAGE>
<CAPTION>
DESCRIPTION OF RIGHTS OF MEMBERS OF ISMIE DESCRIPTION OF RIGHTS OF HOLDERS OF HOLDINGS
STOCK AFTER THE CONVESION
<S> <C>
the Certificate of incorporation requires
adoption by the Holdings Board of a resolution
setting forth the proposed amendment and the
approval of the resolution by a majority vote of
the common stock issued, outstanding and
entitled to vote.
FINANCIAL REPORTING. ISMIE is not required FINANCIAL REPORTING. Holdings will file
to provide the members with any annual or annual and quarterly reports with the Securities
quarterly income and expense statements or and Exchange Commission and with the
balance sheets. ISMIE is required to file annual Nasdaq National Market. Holdings will also
and quarterly financial statements prepared in provide to the holders of common stock annual
accordance with statutory accounting practices and quarterly reports of its financial condition
(SAP) with the Illinois Insurance Department, and results of operations, prepared in
which are open to public inspection. ISMIE accordance with GAAP and, with respect to
provides to members an annual report of its the annual reports, audited by independent
financial condition and results of operations, auditors. Following the conversion, ISMIE will
prepared in accordance with GAAP and audited file annual and quarterly financial statements
by independent auditors. under SAP with the Illinois Insurance
Department.
BUSINESS COMBINATIONS. The DGCL
BUSINESS COMBINATIONS. The Rules and generally requires that a majority of the
Regulations of ISMIE do not contain any stockholders approve a merger, consolidation
provisions relating to business combinations. or the sale, lease or exchange of all or
The Illinois Insurance Code generally requires a substantially all of a corporation's property and
vote of two-thirds of the members voting in assets. The DGCL contains additional
person or by proxy to approve a merger, restrictions where the action or transaction is
consolidation or plan of exchange. with, or proposed by or on behalf of, an
"interested stockholder" (defined generally as a
person owning 15% or more of Holdings'
outstanding voting stock). See "--
Anti-takeover Provisions" and "Description of
Capital Stock -- Statutory, Charter and Bylaw
Provisions Which Could Have an Anti-
Takeover Effect."
43
<PAGE>
<CAPTION>
DESCRIPTION OF RIGHTS OF MEMBERS OF ISMIE DESCRIPTION OF RIGHTS OF HOLDERS OF HOLDINGS
STOCK AFTER THE CONVERSION
<S> <C>
ANTI-TAKEOVER PROVISIONS. As a reciprocal ANTI-TAKEOVER PROVISIONS. Holdings is a
insurance exchange, ISMIE has no capital stock Delaware corporation and is subject to the
or other transferable ownership interests and provisions of Section 203 of the DGCL. In
therefore could not be acquired by a hostile general, Section 203 prevents an "interested
bidder. The Board of Governors is divided into stockholder" (defined generally as a person
three classes of directors, serving staggered owning 15% or more of Holdings' outstanding
three-year terms. As a result, one third of the voting stock) from engaging in a "business
Board of Governors is elected each year. This combination" (as defined in Section 203) with
classified board provision could delay a Holdings for three years following the time
majority of members who do not favor the that person became an interested stockholder
policies of the Board of Governors from unless:
removing a majority of the Board of Governors
for two years. - before that person became an
interested stockholder, the Holdings Board
approved the transaction in which the
interested stockholder became an interested
stockholder or approved the business
combination;
- upon completion of the transaction
that resulted in the interested stockholder
becoming an interested stockholder, the
interested stockholder owned at least 85% of
the voting stock of Holdings outstanding at
the time the transaction commenced
(excluding stock held by directors who are
also officers of Holdings and by employee
stock plans that do not provide employees
with the right to determine confidentially
whether shares held by the plan will be
tendered in a tender or exchange offer); or
- at or following the time on which
that person became an interested
stockholder, the business combination is
approved by the Holdings Board and
authorized at a meeting of stockholders by
the favorable vote of the holders of at
least two-thirds of the outstanding voting
stock of Holdings not owned by the
interested stockholder.
Under Section 203, these restrictions
also do not apply to certain business
combinations proposed by an interested
stockholder following the announcement or
notification of one of certain extraordinary
transactions involving Holdings and a person
who was not an interested stockholder during
the previous three years or who became an
44
<PAGE>
<CAPTION>
DESCRIPTION OF RIGHTS OF MEMBERS OF ISMIE DESCRIPTION OF RIGHTS OF HOLDERS OF HOLDINGS
STOCK AFTER THE CONVERSION
<S> <C>
interested stockholder with the approval of a
majority of Holdings' directors or during a time
when the restrictions in Section 203 did not
apply, if that extraordinary transaction is
approved or not opposed by a majority of the
directors (but not less than one) who were
directors before any person became an
interested stockholder in the previous three
years or who were recommended for election
or elected to succeed the directors by a
majority of the directors then in office.
The Holdings Board of directors is
divided into three classes of directors,
serving staggered three-year terms. The
classified board provisions could have the
effect of discouraging a third party from
making a tender offer or otherwise
attempting to gain control of Holdings. The
Certificate of incorporation of Holdings and
its Bylaws also contain certain provisions
that may delay, defer or prevent a change of
control of Holdings and make removal of
management more difficult. These provisions
are intended to
- improve the likelihood of continuity
and stability in the composition of the
Holdings Board and in the policies formulated
by the Holdings Board;
- discourage certain types of
transactions which may involve an actual or
threatened change of control of Holdings;
- reduce the vulnerability of Holdings
to an unsolicited proposal for a takeover of
we that does not contemplate the acquisition
of all its outstanding shares or an
unsolicited proposal for the restructuring
or sale of all or part of Holdings; and
- discourage certain tactics that may
be used in proxy fights.
45
<PAGE>
<CAPTION>
DESCRIPTION OF RIGHTS OF MEMBERS OF ISMIE DESCRIPTION OF RIGHTS OF HOLDERS OF HOLDINGS
STOCK AFTER THE CONVERSION
<S> <C>
Moreover, the issuance of shares of
preferred stock by Holdings (or the issuance
of rights to purchase shares) could be used
to discourage an unsolicited acquisition
proposal. For instance, the issuance of a
series of preferred stock might (i) impede a
business combination by including class
voting rights that would enable the holders
to block a transaction or (ii) facilitate a
business combination by including voting
rights that would provide a required
percentage vote of the stockholders. Also,
under certain circumstances, the issuance of
preferred stock could adversely affect the
voting power of the holders of common stock.
46
<PAGE>
DESCRIPTION OF RIGHTS OF MEMBERS OF ISMIE DESCRIPTION OF RIGHTS OF HOLDERS OF HOLDINGS
STOCK AFTER THE CONVERSION
<S> <C>
The provisions described in "-- Meetings
and Actions," "-- Board of directors," "Election
of Directors," "-- Removal of Directors,"
"-Vacancies," and "-- Amendments to
Governing Documents," together with the
ability of the Holdings Board to authorize
the issuance of preferred stock without
further stockholder action, could delay or
frustrate the removal of incumbent directors
or the assumption of control of Holdings by
the holder of a large block of common stock.
These provisions could also discourage or
make more difficult a merger, tender offer
or proxy contest even if a majority of the
stockholders might consider the event to be
in their best interest. See "Description of
Capital Stock -- Statutory, Charter and
Bylaw Provisions Which Could Have an
Anti-Takeover Effect."
</TABLE>
47
<PAGE>
MARKET FOR COMMON STOCK
ISMIE, as a reciprocal insurance exchange, does not have any capital
stock. Holdings has been organized for the purpose of becoming the parent
company of ISMIE upon completion of the conversion. We have applied to have the
Holdings' common stock approved for listing, after completion of the conversion,
on the Nasdaq National Market under the symbol "ISME." We cannot be sure that an
active or orderly market for the common stock will develop after listing or, if
developed, will continue. Regardless of whether a public market for the common
stock develops, if a substantial number of shares of common stock are sold by
eligible members or any other stockholders following the completion of the
conversion, the market price of the common stock could fall.
Although we have considered, and may consider in the future, an initial
public offering of Holdings' common stock, we cannot be sure that an initial
public offering will occur. If an initial public offering does not occur, it is
less likely that an active or orderly trading market will develop for Holdings'
common stock. The absence of an active and orderly trading market could
adversely effect the market price of the common stock after the conversion. See
"Risk Factors -- An active or orderly trading market for the common stock may
not develop; our stock price may be volatile."
DIVIDEND POLICY
The declaration and payment of dividends to holders of common stock
will be at the discretion of the Holdings Board and will be dependent upon our
financial condition, results of operations, cash requirements, future prospects,
regulatory restrictions on the payment of dividends to Holdings by ISMIE and
other factors considered relevant by the Holdings Board. We have not made any
determination whether we will pay dividends on the common stock in the
foreseeable future. We cannot be sure whether dividends will be paid or, if paid
initially, that they would continue to be paid in the future. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Liquidity and Capital Resources." See "Comparison of Rights of Members Before
and After the Conversion -- Distributions."
Following completion of the conversion, Holdings will be an insurance
holding company whose assets will consist primarily of the outstanding shares of
the common stock of ISMIE. Holdings' ability to pay dividends to its
stockholders and meet its other obligations, including operating expenses and
any debt service, will depend primarily upon the receipt of sufficient funds
from ISMIE. The payment of dividends by ISMIE to Holdings will be restricted by
applicable insurance law. See "Risk Factors -- If we fail to comply with
insurance regulatory requirements, or if those requirements become burdensome to
us, we may not be able to operate profitably," "Business -- Regulation --
Regulation of Dividends from Insurance Subsidiaries".
48
<PAGE>
CAPITALIZATION
The information set forth in the table presented below is derived from
the consolidated financial statements and the related notes included in this
proxy statement/prospectus. The table presents the capitalization of: (1) ISMIE
and subsidiary at March 31, 1999; and (2) Holdings, adjusted to reflect, on a
pro forma basis as if the conversion had occurred as of March 31, 1999, the
effect of the conversion and the issuance of 10,000,000 shares of common stock
in the conversion to eligible members and 100,000 shares of common stock to
ISMIE Indemnity Company. The table should be read in conjunction with the
historical consolidated financial statements and related notes included in this
proxy statement/prospectus.
<TABLE>
<CAPTION>
At March 31, 1999
------------------------------------------------
ACTUAL AS ADJUSTED
------ -----------
(Dollars in Thousands)
<S> <C> <C>
Total debt................................................. $ - $
Equity:
Preferred stock, $0.01 par value, 5,000,000
shares authorized; no shares issued and
outstanding................................................ - -
Common stock, $0.01 par value,
40,000,000 shares authorized; 10,100,000 issued and
10,000,000 outstanding, as adjusted (1).................... - 100
Additional paid-in capital................................. - 231,142
Policyholders' surplus/retained earnings................... 231,242 -
Accumulated other comprehensive income..................... 6,534 6,534
------- -------
Total Equity.......................................... $237,776 $237,776
------- -------
Total capitalization....................................... $237,776 $237,776
------- -------
------- -------
</TABLE>
(1) The 100,000 shares issued to ISMIE Indemnity Company in the conversion
are treated as issued but not outstanding under GAAP. See "The
Conversion -- Additional Aspects of the Merger Agreement and the
Conversion -- Issuance of Shares to ISMIE Indemnity Company."
49
<PAGE>
CERTAIN FEDERAL INCOME TAX CONSEQUENCES OF THE CONVERSION
The following discussion is a summary of some of the federal income tax
consequences which are expected to result from the conversion and the related
transactions, and is based on the opinion of our tax counsel, Lord, Bissell &
Brook. This summary is based on the current provisions of the Internal Revenue
Code of 1986, existing Treasury Regulations and administrative rulings and court
decisions, all of which could change with retroactive effect. The discussion is
limited to those persons who are citizens or residents of the U.S., corporations
or partnerships organized in or under the laws of the U.S., and an estate or
trust, the income of which is taxable by the federal government regardless of
its source.
Lord, Bissell & Brook's opinion is based on current law, assumptions
set forth in the opinion, representations from ISMIE, Holdings and ISMIE
Indemnity Company and other information, data, documentation and materials they
relied on. An opinion of counsel is not binding on the Internal Revenue Service,
and therefore we cannot be sure that this opinion would not be challenged by the
Internal Revenue Service or would be sustained by a court if it were challenged.
It is impractical to comment on all aspects of federal, state, local
and foreign laws that may affect the tax consequences of the conversion as they
relate to each eligible member. This discussion does not address any aspect of
foreign, state or local law or federal estate or gift tax considerations. In
addition, the discussion does not address how the federal income tax rules
affect all of the possible types of eligible members, some of whom (E.G.,
tax-exempt entities) may be taxable under special rules not discussed in this
document.
THE DISCUSSION SET FORTH BELOW ADDRESSES ONLY THE SIGNIFICANT FEDERAL
INCOME TAX CONSEQUENCES OF GENERAL APPLICATION WHICH ARE EXPECTED TO RESULT FROM
THE CONVERSION. ELIGIBLE MEMBERS SHOULD CONSULT THEIR TAX ADVISORS TO DETERMINE
THE TAX CONSEQUENCES OF THE CONVERSION, AND HOLDING AND DISPOSITION OF COMMON
STOCK TO BE RECEIVED IN CONNECTION WITH THE CONVERSION, INCLUDING THE
APPLICABILITY AND EFFECT OF FEDERAL, STATE, LOCAL AND FOREIGN INCOME AND OTHER
TAX LAWS WITH RESPECT TO THEIR OWN PARTICULAR CIRCUMSTANCES.
GENERAL
Assuming that the conversion and the related transactions will take
place as described in this proxy statement/prospectus and that the factual
matters represented by ISMIE are true and correct, it is the opinion of Lord,
Bissell & Brook that (1) the conversion will constitute a reorganization within
the meaning of Section 368(a) of the Code, (2) eligible members will recognize
no gain or loss for federal income tax purposes by reason of the exchange of
their membership interests for the common stock, and (3) no gain or loss will be
recognized by ISMIE, Holdings or ISMIE Indemnity Company, as further discussed
below.
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ELIGIBLE MEMBERS
Eligible members will not recognize gain or loss for federal income tax
purposes on their exchange of membership interests for common stock in the
conversion. The tax basis in their common stock will be equal to their tax basis
in their exchanged membership interests, which is deemed to be zero for federal
income tax purposes. The holding period for the common stock received by an
eligible member will include the holding period for the exchanged membership
interest.
On a sale or other taxable disposition of common stock issued in the
conversion, eligible members will recognize gain in an amount equal to the
amount of cash and fair market value of any property received upon the sale or
other taxable disposition minus their tax basis in that common stock. Since
their tax basis in the common stock would be zero, as discussed above, the
entire amount of cash and fair market value of any property received would be
the amount of taxable gain. This gain will be long-term capital gain if the
holding period of the common stock, which includes the holding period of the
exchanged membership interest, is more than one year.
Policies issued by ISMIE before the conversion will not be treated as
reissued or newly issued in exchange for existing policies as a result of the
conversion. Accordingly, the federal income tax rules that currently apply to
each policy will generally continue to apply after the conversion.
ISMIE AND ISMIE INDEMNITY COMPANY
Subject to the discussion below under "-- Issuance of Rules Dealing
with Inversions," no gain or loss will be recognized by ISMIE or ISMIE Indemnity
Company as a result of the conversion. ISMIE Indemnity Company's tax basis in
the assets of ISMIE acquired in the merger will be equal to the tax basis of
those assets in the hands of ISMIE immediately prior to the merger.
CONSEQUENCES OF A TAXABLE EXCHANGE
If the conversion were not to qualify as a tax-free reorganization
under Section 368(a) of the Code, eligible members would recognize gain equal to
the fair market value of the common stock received in the conversion minus their
tax basis in their exchanged membership interests (which, as discussed above,
would be zero). The gain would generally be capital gain, and would be long-term
capital gain if the eligible member has held the membership interest for more
than one year. The tax basis of the common stock received under the merger
agreement would generally be equal to the fair market value of that stock at the
effective time of the merger, and the holding period of the exchanged membership
interest would not be included in the holding period of the common stock
received.
In addition, if the conversion were not to qualify as a tax-free
reorganization, ISMIE would recognize gain equal to the excess of the fair
market value of the common stock
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distributed to eligible members in the conversion over ISMIE's aggregate tax
basis in its assets transferred to ISMIE Indemnity Company in the conversion.
ISSUANCE OF RULES DEALING WITH INVERSIONS
There is a pending project at the Internal Revenue Service dealing with
the tax consequences of a transaction involving an "inversion" of members of an
affiliated group (I.E., the positions of the members are inverted or otherwise
reversed). The Service has announced in Notice 94-93 that any Treasury
Regulations addressing inversion transactions will apply to transactions
occurring on or after September 22, 1994. Notice 94-93 provides that future
Treasury Regulations may require, where appropriate, "recognition of income or
gain at the time of an inversion transaction" or "reductions to the basis (or
increases in gain on the sale or other disposition) of the stock of one or more
corporations that are involved in inversion transactions." While the potential
scope of any future Treasury Regulations or other Service positions applicable
to inversion transactions is unclear, Lord, Bissell & Brook does not believe
that income or gain recognition should be required in connection with the
conversion and the related transactions.
POSSIBLE POLICYHOLDER DIVIDEND TREATMENT
You should be aware that a federal court of appeals recently affirmed a
federal district court decision which rejected a claim by a life insurance
company that its distribution to its policyholders of stock and cash under its
plan of demutualization should be treated as a policyholder dividend
distribution, rather than as part of an exchange. UNUM CORP. V. UNITED STATES,
929 F. Supp. 15 (D. Me. 1996), AFF'D, 130 F.3d 501 (1st Cir. 1997), CERT.
DENIED, 119 S. Ct. 42 (1998). If the distribution were treated for federal
income tax purposes as a dividend distribution, ISMIE would be entitled to a
policyholder dividend deduction equal to the amount of cash and the fair market
value of any stock distributed, and each policyholder receiving stock or cash
would likely be treated for federal income tax purposes as if the policyholder
had received a policyholder dividend equal to the amount of cash or the fair
market value of the stock received. Consistent with the holding in UNUM CORP.,
ISMIE plans to treat the common stock distributed in the conversion as issued in
exchange for the membership interests in a tax-free reorganization and not as a
policyholder dividend.
In the unlikely event that any portion of the consideration received by
an eligible member in the conversion were treated as a policyholder dividend,
the normal tax consequences of the receipt of a policyholder dividend would
apply rather than the rules summarized above. The tax basis of the common stock
received in the conversion would be equal to the fair market value of that stock
at the effective time of the merger, and the holding period of the exchanged
membership interest would not be included in the holding period of the common
stock received.
TAXPAYER IDENTIFICATION NUMBER
It is important that you complete, sign and return the taxpayer
identification card accompanying your proxy card. For most individuals, your
taxpayer identification number is
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your Social Security number. ANY ELIGIBLE MEMBER WHO FAILS TO COMPLETE, SIGN AND
RETURN THIS CARD MAY FACE A $50 PENALTY AND WE MAY BE REQUIRED TO WITHHOLD FOR
FEDERAL INCOME TAXES 31% OF ANY CASH PAYMENT, INCLUDING ANY FUTURE DIVIDENDS ON
COMMON STOCK, YOU WOULD OTHERWISE RECEIVE. This 31% withholding is not an
additional tax and any amount withheld may be claimed on the your federal income
tax return as a credit against the your federal income tax liability.
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SELECTED FINANCIAL AND OPERATING DATA
The following table sets forth selected financial and operating data
for ISMIE and subsidiary. The selected income statement data (other than direct
and assumed premiums written) set forth below for each of the three years in the
three-year period ended December 31, 1998 and the selected balance sheet data as
of December 31, 1998 and 1997 are derived from the consolidated financial
statements audited by Ernst & Young LLP, independent auditors, included
elsewhere in this proxy statement/prospectus and should be read in conjunction
with, and are qualified by reference to those statements and the related notes.
The selected financial data for the three month periods ended March 31, 1999 and
1998 are derived from unaudited financial statements which management believes
incorporate all of the adjustments necessary for a fair presentation of the
financial condition and results of operations for those periods. The selected
income statement data (other than direct and assumed premiums written) for the
years ended December 31, 1995 and 1994 and the selected balance sheet data as of
December 31, 1996, 1995 and 1994 are derived from audited financial statements
of ISMIE and subsidiary. All selected income statement and balance sheet data
are presented in accordance with GAAP. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations."
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<TABLE>
<CAPTION>
As of or for the Three
Months Ended March 31 As of or for the Year Ended December 31,
1999 1998 1998 1997 1996 1995 1994
Income Statement Data: (in thousands, except per share, ratios and percentage data)
Premiums written
<S> <C> <C> <C> <C> <C> <C> <C>
Direct and assumed premiums written $ 39,588 $ 43,359 $ 179,668 $ 196,152 $ 207,578 $ 197,241 $ 203,756
--------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- ---------
Net premiums written $ 33,024 $ 27,597 $ 134,215 $ 104,953 $ 85,532 $ 96,809 $ 140,504
--------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- ---------
Direct and assumed premiums earned $ 42,352 $ 44,242 $ 177,451 $ 188,866 $ 207,857 $ 221,491 $ 200,285
Reinsurance premiums ceded (6,564) (15,763) (45,453) (91,199) (122,040) (100,432) (63,252)
--------- --------- --------- --------- --------- --------- ---------
Net premiums earned 35,788 28,479 131,998 97,667 85,817 121,059 137,033
Net investment income 12,067 11,456 45,361 46,663 46,436 50,927 49,140
Other income 0 0 5,095 0 0 0 0
Realized investment gains (losses) 283 13 (104) (401) 2,406 322 12,141
--------- --------- --------- --------- --------- --------- ---------
Total revenues 48,138 39,948 182,350 143,929 134,659 172,308 198,314
--------- --------- --------- --------- --------- --------- ---------
Losses and loss adjustment expenses 40,221 32,884 153,660 117,816 105,403 177,273 210,046
Other operating expenses 4,249 3,571 16,222 10,878 6,296 8,793 11,870
--------- --------- --------- --------- --------- --------- ---------
Total expenses 44,470 36,455 169,882 128,694 111,699 186,066 221,916
--------- --------- --------- --------- --------- --------- ---------
Income (loss) before income taxes 3,668 3,493 12,468 15,235 22,960 (13,758) (23,602)
Income taxes (benefit) 133 80 (257) (3,206) 19,541 6,007 (8,564)
--------- --------- --------- --------- --------- --------- ---------
Net income (loss) $ 3,535 $ 3,413 $ 12,725 $ 18,441 $ 3,419 ($ 19,765)($ 15,038)
--------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- ---------
Balance Sheet Data:
Total investments and invested cash $ 893,563 $ 790,246 $ 887,661 $ 787,333 $ 780,209 $ 861,428 $ 780,362
Total assets 1,217,432 1,250,897 1,211,428 1,246,506 1,287,514 1,362,798 1,263,586
Members' Equity 237,776 223,615 242,690 220,169 193,336 200,969 175,200
Additional Data:
Gross ratios (GAAP) (1):
Loss & LAE 107.4% 108.8% 94.5% 95.1% 77.4% 128.6% 142.0%
Expense 10.3% 9.4% 10.1% 8.8% 7.4% 6.4% 6.2%
Combined 117.7% 118.2% 104.6% 103.9% 84.8% 135.0% 148.2%
Net ratios (GAAP) (2):
Loss & LAE 112.4% 115.5% 116.4% 120.6% 122.8% 146.4% 153.3%
Expense 11.9% 12.5% 12.3% 11.1% 7.3% 7.3% 8.7%
Combined 124.3% 128.0% 128.7% 131.8% 130.2% 153.7% 161.9%
Pro forma earnings per share (3) $ 0.35 $ 0.34 $ 1.27
Pro forma book value per share 23.78 22.36 24.27
Pro forma book value per share, net of FAS 115(4) 23.12 21.84 22.77
Retention rate (5) 97.6% 97.6% 86.0% 90.1% 90.8% 92.4% 93.4%
Investment yield (6) 5.42% 5.82% 5.60% 6.07% 5.77% 6.10% 6.00%
Statutory combined ratio 125.3% 128.4% 128.5% 131.0% 130.2% 155.5% 161.9%
Statutory surplus $ 190,196 $ 175,335 $ 187,224 $172,713 $158,622 $ 134,432 $ 135,339
</TABLE>
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<PAGE>
(1) Direct ratios represent the ratios of losses and expenses, before
deducting reinsurance recoverables, to direct and assumed premiums
earned, before reinsurance premiums ceded.
(2) Net ratios represent the ratios of losses and expenses, after deducting
reinsurance recoverables, to net premiums earned, after reinsurance
premiums ceded.
(3) Gives effect in all periods to the issuance of approximately 10,000,000
shares of common stock to eligible members. The 100,000 shares of
common stock issued to ISMIE Indemnity Company are not considered
outstanding for purposes of determining the per share amounts.
(4) ISMIE has designated its entire fixed maturity and equity security
investment portfolio as "available for sale". Under FAS 115, members'
equity reflects unrealized market appreciation or depreciation on these
investments, net of deferred taxes thereon. For purposes of this
calculation, the unrealized market appreciation or depreciation, net of
deferred taxes, has been removed from members' equity.
(5) Represents the percentage of policyholders insured by ISMIE at the
beginning of the year that continued to be insured by ISMIE at the end
of the year.
(6) Represents the yield as determined for statutory reporting purposes
which, for any period, equals annualized investment income, excluding
realized capital gains or losses and net of expenses, divided by the
average of beginning and ending cash and investments at statement value
plus accrued investment income.
(7) Represents the sum of the statutory loss and expense ratios.
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<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the
consolidated financial statements and the related notes appearing elsewhere in
this proxy statement/prospectus.
GENERAL
The financial results for medical malpractice insurers are influenced
by a number of factors, many of which are beyond ISMIE's control. These factors
include, among other things, changes in frequency and severity of claims,
changes in tort laws (tort reform), judicial decisions and changes in general
economic conditions. The availability of medical malpractice insurance, or the
industry's underwriting capability, is determined primarily by historical
underwriting results, investment returns, available capital and the perception
of adequate pricing.
Historically, the financial performance of medical malpractice insurers
has tended to fluctuate in cyclical patterns characterized by periods of greater
competition in pricing and underwriting terms and conditions followed by periods
of capital shortage and lesser competition. In a soft market, competitive
conditions can result in premium rates and underwriting terms and conditions
which may be below profitable levels. For a number of years, medical malpractice
insurers in Illinois and elsewhere have faced a soft insurance market. We cannot
be sure whether or when these conditions will improve.
Our financial results in recent years have been influenced by a number
of factors, including:
- the need to institute premium discounts to compete effectively
for business from physician groups;
- reductions in the number of insureds as a result of stricter
underwriting and increased competition;
- claims trends and the timing of reported claims as a result of
earlier tort reform efforts;
- changes in reinsurance strategies designed to stabilize
operating results and protect our surplus position;
- changes in our deferred income tax account; and
- recent increases in the use of independent brokers to sell our
coverages.
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PREMIUM TRENDS. The growth of managed healthcare and the consolidation
of healthcare providers have led to major changes in the medical malpractice
insurance industry, which we believe will continue in the future. Practice
management organizations, hospitals, administrators of large group practices and
other organizations increasingly influence the purchasing decision for the
medical malpractice insurance coverages of their affiliated physicians. At the
same time, the medical malpractice insurance market in Illinois has become even
more competitive. In response to these challenges, ISMIE has designed and is
marketing its Clinic Option program, which provides premium discount
opportunities and risk management programs to physician groups with favorable
loss experience. This has resulted in reductions in direct premiums written over
the past three years. ISMIE expects that it will continue to offer experienced
based discount programs in the future. We implemented a general rate increase of
12% in mid year 1998, targeted at those insureds with less favorable loss
experience, which partly offset the impact of premium discounts. Earlier, we had
increased our rates 9% in 1995, 15% in 1994 and 5% in 1993. Over the past three
years, premium decreases also reflect reductions ranging from 2% to 6% in the
number of insureds per year as a result of ISMIE's application of stricter
underwriting criteria as well as increased competition.
CLAIMS TRENDS. Our claims cost trends have improved in recent years
following high claims costs in the early 1990's. Claims frequency increased
significantly in 1995 just before passage of tort reform legislation in
Illinois. We believe this earlier than expected surge of claims resulted in a
corresponding reduction in reported claims for the next two years, particularly
in 1996 when losses and loss adjustment expenses dropped to $105.4 million from
$177.3 million in 1995 and our gross GAAP loss and LAE ratio dropped to 77.4%
from 128.6%. Even though the Illinois legislation was subsequently reversed, we
have continued to experience lower claims frequency as compared to historical
patterns. It is uncertain whether this reduction in claims frequency will
continue.
REINSURANCE. Consistent with industry practice, we have traditionally
reinsured a portion of our risks, ceding to reinsurers an agreed portion of the
risk and paying to the reinsurers a premium based on the direct premiums
received on the reinsured policies. We determine the nature and amount of our
reinsurance based on our evaluation of the risks we have insured, consultation
with our reinsurance brokers and consulting actuaries and market conditions. Our
strategy is to obtain reinsurance to protect against unexpected increases in
severity and frequency in any given year. From 1995 to 1997, as a result of
improved operating results, we steadily increased our retention under our excess
of loss reinsurance program from a retention level of $500,000 to $1 million per
medical incident. For the policy year July 1, 1995 to June 30, 1996, we
purchased reinsurance from Cologne Re (Dublin), which provided a combination of
quota share and stop loss protection. We entered into the Cologne Re treaty
after consulting with our internal and external actuaries. This treaty was
designed to provide us additional protection against higher than expected claims
frequency for the periods covered, such as that experienced in the first half of
1995, and reduce the impact of increased claims exposure as we increased our net
retention levels under our excess reinsurance programs. We entered into similar
treaties with Cologne Re for both the 1996/1997 and 1997/1978 policy years.
During the period the treaties
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were in effect, we substantially increased our statutory surplus from $110.1
million to $178.4 million and our claims frequency improved significantly.
Accordingly, we commuted the first two treaties and recovered cash of $81.1
million in 1997 and $79.1 million in 1998. There was no premium ceded to Cologne
Re after June 30, 1998.
DEFERRED TAX AMOUNTS. Our deferred tax assets and liabilities arise
because of differences between the requirements of the tax laws and the
recognition and measurement requirements of financial accounting standards.
Deferred tax assets and liabilities are determined based on the differences
between the tax and financial reporting bases of the assets and liabilities and
are measured using the applicable tax rates in effect. The principal component
of our total deferred tax asset relates to tax basis loss reserve discounting.
Note 4 of Notes to the Consolidated Financial Statements provides a summary of
all the components of our deferred tax assets and liabilities. Under financial
accounting standards, we are required to assess the need for a valuation
allowance related to the deferred tax assets. A valuation allowance must be
established if it is "more likely than not" that the deferred tax assets will
not be realized. Future realization of deferred tax assets ultimately depends on
sufficient taxable income over certain time periods.
We established a valuation allowance of $14.4 million in 1995 based on
our analysis of the future realization of the deferred tax assets at December
31, 1995. The valuation allowance was then reviewed and changed as follows for
the years ended December 31, 1996, 1997 and 1998, respectively:
<TABLE>
<CAPTION>
Increase (Decrease)
In Valuation Allowance
----------------------
<S> <C>
1996 $8,914,000
1997 ($8,597,000)
1998 ($4,901,000)
</TABLE>
The establishment of the valuation allowance and subsequent changes to the
balance had a significant impact on our income tax provision and net income for
the years 1995 through 1998.
Our analysis to determine the amount of the valuation allowance
considered a number of sources of taxable income that, if available, provide
evidence that supports the realization of the deferred tax assets. These sources
were generally consistent each year and can be summarized as follows:
- Taxable income in prior carryback years.
- Taxable income from reversals of existing taxable temporary
differences.
- Expected future taxable income.
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In each of the years 1995 through 1998, the principal factor we
considered when determining the balance of the valuation allowance was expected
future taxable income. When we established the initial valuation allowance in
1995, we had experienced three consecutive years of pre-tax financial reporting
basis losses and also net operating losses for tax purposes. Although these
losses were caused by one-time events (principally reserve strengthening in 1993
and 1994 and the front loading of claims due to the passage of tort reform in
Illinois in 1995), we believed at that time that there was uncertainty over the
future realization of the deferred tax assets at December 31, 1995. In 1996, we
reported significant improvement in our pre-tax financial reporting basis
results, but continued to have a loss for income tax return purposes. The
continuing income tax return loss was the principal negative evidence that
contributed to the increase in the valuation allowance in 1996. For 1997 and
1998, we experienced positive pre-tax financial reporting basis results and also
reported taxable income. These factors were considered in our analysis of our
ability to produce future taxable income. This positive evidence was the
principal reason we were able to reduce the valuation allowance in 1997 and
1998. For further information about our deferred tax assets and liabilities, see
Note 4 of Notes to the Consolidated Financial Statements.
INCREASED USE OF BROKERS. The growth of managed healthcare and
consolidation of healthcare providers have led to changes in how we market our
insurance coverages. Historically, because of our relationship with the Medical
Society, we did not rely on brokers to sell policies. Insurance sold to
physicians insured through larger organizations is increasingly sold through
brokers and our strategy is and will continue to be to strengthen our broker
relationships to expand our business through programs such as the Clinic Option
program. Independent brokers produce approximately 32% of our premiums written.
Increased use of brokers will continue to increase marketing expense, but we
will continue to utilize our rigorous expense controls which we believe have
been successful to date.
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 1999 COMPARED TO THREE MONTHS ENDED MARCH 31, 1998
PREMIUMS. Direct premiums written decreased $3.8 million to $39.6
million for the three months ended March 31, 1999 from $43.4 million for the
same period in 1998, due primarily to premium discounts associated with the
conversion of group practices to the Clinic Option program plus a small decrease
in the number of insured physicians. Net premiums earned increased $7.3 million
to $35.8 million for the three months ended March 31, 1999 from $28.5 million
for the same period in 1998. This increase was due to the reduction in ceded
premiums associated with the termination of the quota share reinsurance program.
NET INVESTMENT INCOME. Net investment income increased $0.6 million to
$12.1 million for the three months ended March 31, 1999 from $11.5 million for
the same period in 1998. Average invested assets for three months ended March
31, 1999 were 13.1% higher than the same period in 1998, due primarily to funds
received from commuting a portion of the quota
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share reinsurance program. The overall pre-tax investment yield was 5.42% for
the three months ended March 31, 1999, a decrease from a yield of 5.82% for the
same period in 1998.
LOSSES AND LAE. Losses and loss adjustment expenses, net of
reinsurance, increased $7.3 million to $40.2 million for the three months ended
March 31, 1999 from $32.9 million for the same period in 1998. The increase was
due primarily to the reduction in losses ceded associated with the termination
of the quota share reinsurance program in 1998. The net loss ratio decreased to
112.4% for the three months ended March 31, 1999 from 115.5% for the same period
in 1998. The reduction in the net loss ratio was attributable primarily to a
decrease in reported claims between these periods. Because of the reinsurance in
place during this period, management believes it is also meaningful to examine
the losses on our book of business by analyzing the direct loss ratio. The
direct loss ratio for the three months ended March 31, 1999 and 1998 was 107.4%
and 108.8%, respectively, attributable primarily to a general decrease in
frequency of claims.
OTHER OPERATING EXPENSES. Other operating expenses increased $0.7
million to $4.3 million for the three months ended March 31, 1999 from $3.6
million for the same period in 1998. This was due primarily to a $0.5 million
decrease in the commission ceding allowance associated with the quota share
reinsurance program. Commissions paid to brokers as a result of increased
brokerage transactions increased somewhat for the first quarter in 1999 over the
same period in 1998. We believe another meaningful way to compare our operating
expenses is by looking at our direct expense ratio, before reinsurance
transactions. On this basis, direct expenses were 10.3% for the three months
ended March 31, 1999, up 0.9 percent from the 9.4% for the three months ended
March 31, 1998.
FEDERAL INCOME TAXES. Our income tax expense was approximately $0.1
million for the three months ended March 31, 1999 compared to a similar amount
for the same period in 1998. The difference between the effective tax rate and
the statutory rate relates principally to changes in the valuation allowance
established for deferred tax assets. The valuation allowance represents that
portion of the deferred tax assets for which it is more likely than not that a
tax benefit will not be realized. For more information, please see "- General -
Deferred Tax Amounts" above and Note 4 of Notes to the Consolidated Financial
Statements.
NET INCOME. Net income increased $0.1 million to $3.5 million for the
three months ended March 31, 1999 from $3.4 million for the same period in 1998.
The increase in net income primarily reflects an increase in net investment
income, enhanced by an improvement in the combined ratio.
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
PREMIUMS. Direct premiums written decreased $16.5 million to $179.7
million for the year ended December 31, 1998 from $196.2 million for the same
period in 1997. This decrease was due primarily to premium discounts associated
with the conversion of group practices to the
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Clinic Option program. In addition, there was a small decrease in the number of
insured physicians for the year. Net premiums earned increased $34.3 million to
$132.0 million for the year ended December 31, 1998 from $97.7 million for the
same period in 1997. This increase was due to the reduction in ceded premiums
associated with our quota share reinsurance program.
NET INVESTMENT INCOME. Net investment income decreased $1.3 million to
$45.4 million for the year ended December 31, 1998 from $46.7 million for the
same period in 1997. The overall pretax investment yield was 5.60% for the year
ended December 31, 1998, a decrease from the yield of 6.07% for the same period
in 1997.
LOSSES AND LAE. Losses and loss adjustment expenses, net of
reinsurance, increased $35.9 million to $153.7 million for the year ended
December 31, 1998 from $117.8 million for the same period in 1997. The increase
was due primarily to a reduction in losses ceded under the quota share
reinsurance program in 1998. The net loss ratio decreased to 116.4% for the year
ended December 31, 1998 from 120.6% for the same period in 1997. The reduction
in the net loss ratio was attributable primarily to a decrease in reported
claims between these periods. The direct loss ratio for the years ended December
31, 1998 and 1997 was 94.5% and 95.1%, respectively, attributable primarily to a
general decrease in frequency of claims.
OTHER OPERATING EXPENSES. Other operating expenses increased $5.3
million to $16.2 million for the year ended December 31, 1998 from $10.9 million
for the same period in 1997. This was due primarily to a $0.5 million increase
in commissions paid to brokers as a result of increased broker transactions, a
$4.0 million decrease in the commission ceding allowance associated with the
quota share reinsurance program and expenses of $0.7 million related to the
proposed conversion of ISMIE to a stock company. These factors resulted in a 1.2
percentage point increase in the net expense ratio to 12.3% for the year ended
December 31, 1998 from 11.1% for the same period in 1997. Our direct expense
ratio, before reinsurance transactions, was 10.1% for the year ended December
31, 1998, up from 8.8% for the year ended December 31, 1997.
FEDERAL INCOME TAXES. Our income tax benefit decreased approximately
$2.9 million to $0.3 million for the year ended December 31, 1998 compared to
$3.2 million for the same period in 1997. The difference between the effective
tax rate and the statutory rate relates principally to changes in the valuation
allowance established for deferred tax assets. The valuation allowance
represents that portion of the deferred tax assets for which it is more likely
than not that a tax benefit will not be realized. For more information, please
see "- General - Deferred Tax Amounts" above and Note 4 of Notes to the
Consolidated Financial Statements.
NET INCOME. Net income decreased $5.7 million to $12.7 million for the
year ended December 31, 1998 from $18.4 million for the same period in 1997. The
decrease in net income primarily reflects an increase in net premiums earned, at
a combined ratio greater than 100%, as
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a result of a reduction in ceded premiums under our quota share reinsurance
program; a slight increase in the net expense ratio; and the decrease in our
income tax benefit.
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
PREMIUMS. Direct premiums written decreased $11.4 million to $196.2
million for the year ended December 31, 1997 from $207.6 million for 1996, due
primarily to premium discounts related to the conversion of group practices to
the Clinic Option program plus a small decrease in the number of insured
physicians. Net premiums earned increased $11.9 million to $97.7 million for the
year ended December 31, 1997 from $85.8 million for 1996, due to the reduction
in ceded premiums associated with our quota share reinsurance program.
NET INVESTMENT INCOME. Net investment income increased $0.3 million to
$46.7 million for the year ended December 31, 1997 from $46.4 million for 1996.
A decrease of approximately 4% in average invested assets between periods was
offset by an increase in the overall pre-tax yield on investments to 6.07% for
the year ended December 31, 1997 from 5.77% for 1996. The increase in yield
resulted from a change in the portfolio composition that added relatively more
investment grade corporate bonds in lieu of lower yielding U.S. treasury
securities.
LOSSES AND LAE. Losses and LAE, net of reinsurance, increased $12.4
million to $117.8 million for the year ended December 31, 1997 from $105.4
million for 1996. The increase resulted primarily from an increase in retention
levels under our excess of loss reinsurance program, but was offset by a 4.5%
decrease in reported claims. The net loss and LAE ratio decreased 2.2 percentage
points to 120.6% for the year ended December 31, 1997 from 122.8% for 1996. The
direct loss and LAE ratio for the year ended December 31, 1997 and 1996 were
95.1% and 77.5% respectively. The direct loss and LAE ratio in 1996 was 17.6%
lower than in 1995 due to a one-time favorable effect of a reduction in claims
reported during 1996 after a "frontloading" of claims experienced during 1995
immediately prior to the passage of tort reform legislation in Illinois.
OTHER OPERATING EXPENSES. Other operating expenses increased $4.6
million to $10.9 million for the year ended December 31, 1997 from $6.3 million
for 1996. This was due primarily to a $0.9 million increase in commissions paid
to brokers as a result of increased broker transactions and a $3.3 million
decrease in the commission ceding allowance associated with the quota share
reinsurance program. These factors resulted in a 3.8 percentage points increase
in the net expense ratio to 11.1% for the year ended December 31, 1997 from 7.3%
for 1996. The direct expense ratio increased to 8.8% for the year ended December
31, 1997 from 7.4% for 1996.
FEDERAL INCOME TAXES. The income tax benefit was $3.2 million for the
year ended December 31, 1997 compared to income tax expense of $19.5 million for
1996. The difference between the effective tax rate and the statutory rate
relates principally to changes in the valuation allowance established for
deferred tax assets. The valuation allowance represents that portion of
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the deferred tax assets for which it is more likely than not that a tax benefit
will not be realized. For more information, please see "- General - Deferred Tax
Amounts" above and Note 4 of Notes to the Consolidated Financial Statements.
NET INCOME. Net income increased $15.0 million to $18.4 million for the
year ended December 31, 1997 from $3.4 million for 1996. The increase in 1997
resulted primarily from an increase in our income tax benefit to $3.2 million
for 1997 in contrast to an income tax expense of $19.5 million in 1996. Items
offsetting this increase were a realized investment loss of $0.4 million for the
year ended December 31, 1997 as compared to a gain of $2.4 million for 1996 and
a $4.6 million increase in other operating expenses.
LIQUIDITY AND CAPITAL RESOURCES
Our primary sources of cash are from insurance premiums, net investment
income, recoveries from reinsurers and proceeds from the maturity or sale of
invested assets. Funds are used to pay claims, LAE, operating expenses,
reinsurance premiums and taxes, and to purchase additional invested assets.
Historically, we have been successful in timing the maturities of our fixed
income investments to permit us to manage our cash flow and liquidity in order
to meet anticipated short-term and long-term payment of obligations. We seek to
maximize opportunities to earn interest on those funds that are not immediately
required to meet our obligations.
Prior to 1998, ISMIE's cash flow fluctuated due to reinsurance
transactions. The largest cash outflow came from premiums paid for the purpose
of quota share reinsurance program. Also, ISMIE made scheduled premium payments
in each year, reflecting the additional premiums due above the deposits paid
three years prior. Excluding these reinsurance transactions, ISMIE would have
shown net cash provided by operating activities of $12.9 million, $14.6 million
and $39.6 million for the years 1998, 1997 and 1996, respectively.
In addition, effective July 1, 1998 ISMIE discontinued a reinsurance
program with Cologne Re (Dublin) which provided a combination of quota share and
stop loss protection. This program began July 1, 1995. ISMIE's improved surplus
position, along with recent favorable trends in claims frequency, also enabled
it to commute the first two years of this reinsurance program, thereby
recovering cash of $81.1 million in 1997 and $79.1 million in 1998. The
1997/1998 treaty with Cologne Re remains in force.
ISMIE invests primarily in government-backed securities, and
securities that are A-rated or higher based on Standard & Poor's and Moody's
rating systems. The average overall effective maturity of ISMIE's portfolio
has consistently been slightly under five years, which approximates the
anticipated turnover rate of its loss reserves. To further improve liquidity,
ISMIE has maintained about 25% of its invested assets in U.S. treasury notes
and short-term investments. See "Business--Investment Portfolio."
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Approximately 35% of our fixed maturity portfolio consists of
mortgage-backed and other asset-backed securities. These securities are subject
to prepayment risk and credit risk. During periods of declining interest rates,
mortgage-backed securities may be prepaid and as a result we generally will be
unable to reinvest the proceeds of any prepayment at comparable yields.
Conversely, during periods of rising interest rates, prepayments are generally
slow and mortgage-backed securities that have an amortized value that is less
than par may incur a decrease in yield or a loss as a result of slower
prepayments. Credit risk is the risk that the securities may suffer a default.
We manage the prepayment risk of our mortgage-backed and asset-backed securities
by concentrating those securities in fifteen year U.S. agency pass through
securities which are inherently less volatile and have more stable average life
and cash flow characteristics. We manage credit risk by investing only in
mortgage-backed and asset-backed securities that are in U.S. agency securities
or are AAA rated securities where we believe the risk of loss of principal due
to borrower defaults is minimal. We do not own high risk mortgage-backed or
other asset-backed securities. Since all of our holdings are AAA rated, and
short to intermediate duration securities, we believe our mortgage-backed and
other asset-backed securities are readily marketable.
As a holding company, Holdings' assets will consist primarily of the
stock of ISMIE. The principal source of funds for Holdings will be dividends
from ISMIE and proceeds, if any, from the issuance of debt and equity
securities. ISMIE is and will be restricted by Illinois law in the amount of
dividends it can pay in relation to earnings or surplus, without consent of the
Illinois Insurance Department. ISMIE may pay dividends in any year, without
regulatory approval, to the extent of the greater of (1) 10% of its statutory
capital and surplus at the end of the preceding year or (2) its net income for
the preceding year. If ISMIE had been a stock insurance company on December 31,
1998, the amount of dividends it would have been permitted to pay during 1999
without approval from the Illinois Insurance Department would have been
approximately $18 million.
Based on historical trends, market conditions and its business plan, we
believe that our sources of funds will be sufficient to meet our liquidity needs
in the foreseeable future. However, because economic, market and regulatory
conditions may change, we cannot be sure that our sources of funds will be
sufficient to meet these liquidity needs. Also, our short-term and long-term
liquidity needs may vary because of the uncertainties regarding the timing of
claims settlement.
EFFECT OF INFLATION
The primary effect of inflation on us relates to pricing and estimating
reserves for unpaid losses and LAE for claims in which there is a long period
between reporting and settlement, such as medical malpractice claims. The actual
effect of inflation on our results cannot be accurately known until claims are
ultimately settled. Based on actual results to date, we believe that loss and
LAE reserve levels and our rate making process adequately incorporate the
effects of inflation.
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YEAR 2000 ISSUES
We have completed our assessment of all internal information technology
systems that we believe could be significantly affected by the Year 2000 issue.
In February 1998, we completed the installation of new systems to handle our
policy processing requirements. We believe that these systems are Year 2000
compliant because these systems are currently processing new business and policy
renewals with an effective date in 1999 and expiration date in the year 2000. We
installed our claims processing system in 1989 and designed it with a four digit
year code field. Testing of the claims processing system is ongoing to verify
the system's overall Year 2000 compliance. We purchased our financial and
accounting systems from third party vendors. We have received vendor
certification that the financial and accounting systems are Year 2000 compliant.
Completion of the user testing phase for all significant systems is expected by
mid-September, with all remediated systems fully tested and implemented by the
end of September. We expect to complete all phases of our Year 2000 efforts by
October 31, 1999.
We are gathering information about the Year 2000 compliance status of
its significant vendors and suppliers. We have received written certification
from approximately 95% of our vendors, service providers, brokers and other
business partners certifying as to the status of their Year 2000 compliance
readiness. We are not aware of any vendor or supplier with a Year 2000
compliance problem that would materially impact our results of operations,
liquidity, or capital resources. However, we have no means of ensuring that
those vendors or suppliers will be Year 2000 compliant. The inability of vendors
or suppliers to complete their Year 2000 resolution process in a timely fashion
could materially and adversely impact our operations, liquidity or capital
resources.
We are utilizing internal and external resources to reprogram or
replace, test, and implement the software modifications for Year 2000
compliance. We have incurred costs to date of approximately $80,000 and costs
are estimated to be less than $175,000 through the end of the project, which is
targeted for October 1999. These costs do not include expenditures associated
with installing new or upgraded systems as part of our ongoing efforts to
maintain and upgrade our information technology. We have considered these costs
in preparing our capital and operating budgets. Year 2000 compliance costs are
being expensed as they are incurred. We cannot be sure, however, that efforts
will be completed within these estimated costs and time periods. See "Risk
Factors -- If our computer systems or those of our vendors and suppliers do not
work properly after December 31, 1999, our operations will be disrupted."
We may also be adversely affected if Year 2000 issues result in
additional claims being made against our insureds. While we believe that our
risk of loss from Year 2000 issues is not extensive because of the relatively
small number of exposures that likely would be impacted by the Year 2000, we
cannot be sure about the degree of liability we might face because of those
claims.
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RECENT ACCOUNTING PRONOUNCEMENT NOT YET ADOPTED
In June 1998, the Financial Accounting Standards Board (FASB) issued
SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities"
which was to be effective for fiscal years beginning after June 15, 1999. In
June 1999, the FASB issued SFAS No. 137 which deferred the effective date of
this statement to fiscal years beginning after June 15, 2000. Adoption of this
statement is not expected to have a significant impact on our financial position
or results of operations because we do not engage in any significant derivative
or hedging activities.
BUSINESS
OVERVIEW
Founded by the Illinois State Medical Society in 1976, ISMIE is the
largest provider of medical malpractice insurance in Illinois and is the
eleventh largest provider of medical malpractice insurance in the United States
based on direct premiums written. We currently insure approximately 8,800
Illinois physicians who practice alone or in medical groups, clinics or other
healthcare organizations. In addition, we offer insurance coverage to
approximately 775 corporate and partnership entities as well as a variety of
other healthcare providers.
For the three months ended March 31, 1999 our total revenue was $48.1
million and our net income was $3.5 million. As of March 31, 1999, we had $1.22
billion of total assets, no debt outstanding and $237.8 million of total equity.
In 1998, A.M. Best upgraded our insurer financial strength rating to "B++ (Very
Good)."
Medical malpractice insurance, or medical professional liability
insurance, insures the physician or other healthcare provider against
liabilities arising from the rendering of, or failure to render, professional
medical services. Under the typical medical malpractice insurance policy, the
insurer also defends the insured against potentially covered claims. Based on
data compiled by A.M. Best, total medical malpractice premiums in the United
States in 1997 exceeded $5.7 billion. In Illinois, the fourth largest market for
medical malpractice insurance based on premiums written, approximately $393.0
million of medical malpractice premiums were written in 1997 by licensed
insurance companies. Our share of the medical malpractice premiums written in
Illinois in 1997 by licensed insurance companies was approximately 50%. For the
last five years, on average, we have had a policyholder retention rate in excess
of 90%.
HISTORY AND STRUCTURE
ISMIE is an Illinois reciprocal insurance exchange organized in 1976 by
the Medical Society to provide medical malpractice insurance to its physician
and other healthcare provider members. A reciprocal insurer is an insurance
company similar to a mutual insurance company but without corporate form. Like a
mutual company, a reciprocal is organized and operated for
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the benefit of its members. Members of a reciprocal insure one another through a
commonly appointed attorney-in-fact, and the company generally is not operated
for profit. Earnings that ISMIE has generated through its history have been used
to increase its surplus, thereby increasing its capacity to write more business
and absorb losses. ISMIE was organized with capital contributed by members in
the form of guaranty fund certificates. These certificates were redeemed before
1989.
The business of ISMIE is managed by its Board of Governors and by its
attorney-in-fact, Illinois State Medical Insurance Services, Inc., or ISMIS.
ISMIS was formed in July 1998 and is owned by ISMIE. Before July 1998, the
attorney-in-fact for ISMIE was a company owned by the Medical Society. ISMIE
plans to contribute the stock of ISMIS to Holdings just before the conversion.
After the conversion, ISMIS will continue to perform service functions for ISMIE
as a subsidiary of Holdings.
Holdings is a new Delaware corporation formed to be the publicly held
holding company for ISMIE after the conversion. Holdings was organized in April,
1999 and has no operating history. Our principal executive and business offices
are located at 20 North Michigan Avenue, Suite 700, Chicago, Illinois
60602-4890, and our telephone number is (312) 782-2749.
Since its organization in 1976 by the Medical Society, ISMIE and the
Medical Society have enjoyed a mutually beneficial relationship which has
cultivated the loyalty of Illinois physicians to ISMIE. We believe that our
leading market share for medical malpractice insurance in Illinois is due in
large part to the loyalty of our insured physicians. Over the past five years,
on average, we have had a policyholder retention rate in excess of 90%. We
attribute this loyalty to:
- the high quality, personalized "Physician-First Service" we
provide;
- our traditional focus on the physician marketplace;
- our commitment to protecting the reputation of our insureds
and our aggressive defense of claims;
- our financial stability;
- our ability to customize product features and programs to fit
the needs of different customers; and
- our close relationship with the medical community, including
our longstanding relationship with the Medical Society.
BUSINESS STRATEGY
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We believe that the growth in managed healthcare and the emergence of
multi-state integrated healthcare providers and delivery systems will lead to
major changes in the medical malpractice insurance industry. We have adopted a
strategy which we believe will enable us to compete effectively, improve
profitability and create long-term growth, while maintaining consistent coverage
and market presence. Our strategy is to:
- maintain our strong relationship with our policyholders and
continue to provide superior service;
- expand geographically by increasing the number of states in
which we write policies;
- improve product offerings to include hospital coverage, our
"Physician Business Practice Liability (E&O/D&O)" insurance,
workers compensation insurance and employment practices
liability insurance;
- respond to market changes, including strengthening our
relationships with independent brokers and agents in order to
expand our Clinic Option program, while continuing to expand
our direct relationships with individual policyholders;
- maintain underwriting discipline in order to emphasize
profitability rather than premium volume;
- maintain operating expense below the industry average;
- continue to improve our financial ratings; and
- pursue acquisition and consolidation opportunities relating to
our core insurance business.
As part of this strategy, we have undertaken the conversion. We believe
that the conversion will improve our ability to achieve our strategic goals by
providing us:
- greater operating flexibility;
- access to the capital markets and opportunities to use our
stock for acquisitions; and
- a form of organization that has a higher degree of regulatory
certainty than we have as a reciprocal insurance exchange.
To implement our strategy, we have taken the following steps:
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MAINTAIN RELATIONSHIPS. To help assure a continued close relationship
with our policyholders and with the Medical Society, we intend to continue to
provide the superior service which we believe has fostered those relationships.
See "--Relationship with the Medical Society" and "Management -- Related Party
Transactions."
GEOGRAPHIC EXPANSION. To initiate our geographic expansion beyond
Illinois, we have entered into a fronting relationship to write business in
other states. "Fronting" is a reinsurance arrangement where one insurance
company issues policies to specified insureds and then reinsures all or
substantially all of the risks on the insurance to another insurance company for
a fee or a portion of the profits on the business. This is a first step toward
our goal of expanding into the neighboring states of Wisconsin, Iowa, Missouri,
Kentucky, Indiana and Michigan. Eventually, we intend to become a fully admitted
carrier in these and possibly other states.
IMPROVED PRODUCT OFFERINGS. We are in the process of expanding our
product offerings to include employment practices liability, hospital affiliated
staff medical malpractice liability and workers compensation insurance. We
intend to market these products aggressively.
In 1998, we began a one year pilot program in conjunction with the
Illinois Provider Trust, an organization managed by a subsidiary of the Illinois
Hospital and Healthsystems Association, or the IHHA, which provides hospital
malpractice coverage for its members. Under this program, we offer a combined
hospital and affiliated professional staff medical malpractice liability
insurance program at three Illinois hospitals. We believe that programs like
this represent an increasing share of the market for malpractice insurance and
provide us with a significant area for future growth. See "Business -- Products
- -- IPT Pilot Program."
Additionally, we recently began a relationship with the IHHA where the
Illinois Compensation Trust, another organization managed by a subsidiary of the
IHHA, acts as the managing general agent to administer a workers compensation
product marketed to physicians and physician organizations. ISMIE acts as both a
direct insurer and a reinsurer in this program.
See "Business -- Reinsurance -- Reinsurance Assumed."
EXPANSION OF OUR CLINIC OPTION PROGRAM AND STRENGTHENING BROKER
RELATIONSHIPS. We believe that the growth in managed healthcare and the
emergence of multi-state integrated healthcare providers and delivery systems
will lead to major changes in the medical malpractice insurance industry.
Practice management organizations, hospitals, administrators of large group
practices and other organizations increasingly influence the purchasing decision
for the medical malpractice insurance coverages of their affiliated physicians.
As the consolidation of healthcare providers continues, the number of physicians
insured through these organizations will increase. We believe that these
organizations increasingly will seek well-capitalized medical malpractice
insurers that can provide a full range of products and a high level of service.
In response to these challenges, we have designed and are marketing
our Clinic Option program, which provides discount opportunities and risk
management programs to physicians
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groups. We began our Clinic Option program in 1992. It has expanded steadily
since then and now covers approximately 34% of all policyholders. Historically,
because of our relationship with the Medical Society, we have not relied on
brokers to sell policies. However, we believe that insurance sold to physicians
insured through larger organizations increasingly will be sold through
independent brokers An important part of expanding business through programs
such as the Clinic Option program is strengthening our relationships with
independent brokers. As part of our effort to foster relationships with brokers,
we are now beginning to align our broker commissions with market levels.
MAINTAINING UNDERWRITING DISCIPLINE. Our experience with, commitment to
and focus on medical malpractice insurance for over 20 years has allowed us to
develop a strong knowledge of the market and to build an extensive data base of
medical malpractice claims experience. We take advantage of this specialized
expertise in medical malpractice insurance to set premiums that we believe are
appropriate for exposures being insured. We have also adopted more prospective
underwriting guidelines that apply to insureds with evolving adverse loss
experience. This enables us to provide lower premiums or pricing for those
insureds who have the best loss experience, and minimize the propensity for
adverse selection within the insured base. As we expand our business, we intend
to maintain underwriting discipline and emphasize profitability over premium
growth.
CONTROL OF OPERATING EXPENSES. ISMIE's net expense ratio, defined as
other operating expenses as a percent of net premiums earned, has ranged from 7%
to 12% over the last five years, remaining consistently below the industry
average for medical malpractice insurers, which management estimates ranged from
15% - 18% for the same period. Although increased use of brokers in writing
group business has led to an increase in operating expenses, we will continue to
utilize the rigorous controls which have proved successful to date. We believe
we will be able to improve operating efficiencies if we achieve our business
strategy through the conversion.
IMPROVE STRONG FINANCIAL RATINGS. Our traditional goal has been to
continually improve our strong financial ratings through steady performance. We
believe that the conversion will provide us with increased corporate flexibility
and greater access to capital, and as a result will help us to improve our
financial ratings.
PURSUE STRATEGIC ACQUISITION OPPORTUNITIES. We believe that the
conversion will better position us to make strategic acquisitions by providing
greater access to capital as a source of financing and creating a stock
acquisition currency. We believe that consolidation will continue in the medical
professional liability insurance industry and that opportunities to make
strategic acquisitions may arise which could provide an effective way to expand
our business, product offerings and geographic scope.
PRODUCTS
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ISMIE underwrites professional and related liability policy coverages
for physicians, physician medical groups and clinics, associated healthcare
professionals and other providers in the healthcare industry. Our principal
products are discussed below.
PHYSICIAN AND MEDICAL GROUP LIABILITY. ISMIE offers coverage for both
physicians who are sole practitioners and those who are part of a medical group
or clinic. The policy issued to physicians and medical groups or clinics
includes:
- coverage for professional liability which arises out of
medical practice;
- a limited defendant reimbursement benefit which is payable for
attendance at certain depositions and trial; and
- a limited legal expense reimbursement benefit for proceedings
brought by a governmental disciplinary board.
Professional liability insurance provides protection against the liability of
physicians and their employees arising from an error in the diagnosis or
treatment of a patient's condition.
We issue our professional liability coverages primarily on a "claims
made" basis. We provide coverage for claims reported to us during the policy
period arising from incidents that occurred on or after the retroactive date
contained in the policy. We also offer "tail coverage" for claims reported after
the expiration of the policy for occurrences during the coverage period. The
price of the tail coverage is based on the length of time the insured has been
covered under ISMIE's claims made form. We provide tail coverage without
additional charge for insured physicians who die or become totally disabled
during the coverage period of the policy and those who retire from the practice
of medicine after having been insured by ISMIE for at least sixty consecutive
months and who are also at least 55 years old. As of July 1, 1999, free
retirement tail coverage will be granted at any age, as long as the insured
physician has been insured with ISMIE for 10 years.
For individual physicians, we offer limits of insurance up to $2.0
million per person, with an aggregate policy limit of up to a $4.0 million per
person for all claims reported for each calendar year or other 12-month policy
period. The most common limit is $1.0 million per claim or occurrence, with a
$3.0 million aggregate policy limit. The defense reimbursement benefit for
governmental disciplinary proceedings is $25,000.
Our Clinic Option program provides various discount opportunities and
effective risk management programs to groups of physicians. Tail coverage is
available to physicians under the Clinic Option on the same basis as it is to
all of our insureds. Under the Clinic Option program, practice groups are
underwritten on a group basis instead of on a per physician basis. This allows
for experience rating. The Clinic Option program provides economies of scale for
both the physicians and for ISMIE by permitting underwriting and pricing
considerations to be
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made on a collective basis. Through the Clinic Option program, ISMIE is able to
offer competitive pricing while striving to maintain underwriting discipline.
Additionally, development of the Clinic Option program has allowed us to
maintain our relationship with physicians regardless of changes in the way they
organize their practice.
The Clinic Option limits are $1.0 million or $2.0 million per person
with a shared annual aggregate limit based on the number of physicians in the
group. The shared annual aggregate limit under the Clinic Option program is
generally less than the accumulated aggregate limit would be for a group of
doctors insured individually. At $1.0 million per person limits, the ratio of
the shared annual aggregate limit to the number of physicians in a group ranges
from 2.50 for a group of two physicians to .86 for a group of ninety-nine
physicians. At $2.0 million per person limits, the ratio ranges from 3.00 for a
group of two to .91 for a group of ninety-nine. These ratios decrease as the
number of physicians in a group increases beyond ninety-nine.
To date, substantially all of our premiums have been generated by
physician and medical group liability insurance.
OTHER COVERAGES. Other coverages, some of which we believe offer the
opportunity for significant growth, include the following:
- IPT PILOT PROGRAM. We recently began a one year pilot program
in conjunction with the Illinois Provider Trust, an
organization composed of 38 Illinois hospitals which is
managed by a subsidiary of the IHHA, to offer a combined
hospital and affiliated professional staff medical malpractice
liability insurance program at one Illinois hospital. Due to
the success of this venture, we have expanded this pilot
program to other hospitals within Illinois.
- ICT PROGRAM. Earlier this year, we entered into a reinsurance
treaty with the Illinois Compensation Trust, another
organization managed by a subsidiary of the IHHA, under which
the Illinois Compensation Trust would act as the managing
general agent to market a workers compensation product to
physicians and physician organizations. ISMIE would act as
both a direct insurer and a reinsurer under this proposed
program. See "Business -- Reinsurance -- Reinsurance Assumed."
- HEALTHCARE PROVIDER LIABILITY. We offer our professional
liability insurance to a variety of specialty provider
organizations, including outpatient surgery centers,
hemodialysis laboratories and associated healthcare
professionals. These policies include the standard
professional liability coverage provided to physicians and
medical groups. The policies generally are issued on a claims
made basis with the limits of liability up to those offered to
larger medical groups. The limits of coverage under our
healthcare provider policies are between $1.0 million and $2.0
million each person, with a $3.0 million to $4.0 million
aggregate policy limits.
- PHYSICIAN BUSINESS PRACTICE LIABILITY (E&O/D&O). In 1995, we
introduced a policy that provides coverage for liability
arising out of the conduct of an insured's business
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operations and for liability of directors and officers of an
organization. We designed the Physician Business Practice
Liability (E&O/D&O) product to address the need for coverage
in activities such as utilization review, credentialing, peer
review, quality assurance and other aspects of delivering
health care services in a managed care environment. In
addition, the product includes coverage for the liability of
directors and officers. We generally issue these policies on a
claims made basis. The limits of coverage under these policies
issued by ISMIE are between $1.0 million and $2.0 million.
- EMPLOYMENT PRACTICES LIABILITY INSURANCE. Together with NAS
Insurance Services, an underwriting manager for Lloyds of
London in the United States, we provide employment practices
liability insurance to physicians and physician organizations
and hospitals. Employment practices liability insures the
employer for suits brought by employees for wrongful
termination, harassment, and discrimination claims. The limits
of coverage range from $100,000 to $1.0 million per
occurrence.
- JOINT HOSPITAL RISK MANAGEMENT PROGRAMS. In 1990, we entered
into a joint program with a Chicago hospital on a pilot basis
under which ISMIE insureds who were members of the medical
staff were eligible for premium discounts. These premium
discounts were based on mandatory participation in risk
management, as well as participation in a joint defense
program.
Based upon the success of this initial joint program, other
hospital medical staffs requested participation in a joint
program with ISMIE. In 1995, we began joint programs with two
other Chicago-area hospitals. In 1996, we added two downstate
hospitals and a physician-hospital organization. We now have
10 similar programs in operation, affecting over 600 physician
policyholders.
Each of these joint programs has varying discount levels,
depending on whether they require risk management
participation of members and their participation in a joint
defense program. Although not all programs have agreed to
joint defense, all of the joint programs have mandatory risk
management participation as an element of the program.
MARKETING AND POLICYHOLDER SERVICES
We employ several strategies for marketing our products and providing
policyholder services. We market our products to physicians, physician groups,
group managers and other key decision-makers within a group principally through
recommendations from our large existing policyholder base, advertisements in
medical journals and other publications, seminars on healthcare and risk
management topics for physicians, and direct mail solicitation.
As part of our marketing and service efforts, we also maintain the
ISMIE network of physician policyholders at most hospitals in Illinois. We
developed the ISMIE network in the mid-1980's to promote personal physician
representation of ISMIE at the hospital level and to
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foster advocacy and communication between ISMIE and its policyholders.
Currently, the ISMIE network has approximately 180 physician representatives.
These ISMIE representatives are physicians at each hospital who have volunteered
to be a local informational liaison between their colleagues and ISMIE. They
maintain an awareness of new and existing ISMIE products and programs and assist
in keeping their local physician colleagues up-to-date regarding them. In
addition, they are asked to report back to ISMIE any questions or concerns that
policyholders have. ISMIE uses this information to identify and address
policyholder concerns.
In addition to these direct marketing channels, we sell our products
through independent brokers who currently produce approximately 32% of our
direct premiums written. Larger physician groups and clinics frequently prefer
brokers over direct solicitation when they purchase professional liability
insurance, and we believe that our broker relationships are important to our
ability to grow in that market segment.
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<PAGE>
The following pie chart summarizes our physician and medical group
professional liability direct premiums written for the year ended December 31,
1998:
[Pie Chart]
[Sole Practitioner Physicians 41.6%
Groups with less than 10 43.6%
Groups with more than 10 14.8%]
Over the past five years, direct premiums written attributable to sole
practitioner physician members decreased slightly from 44.9% at December 31,
1993 to 41.6% at December 31, 1998. Group coverage increased proportionately.
Over this period, direct premiums written under our Clinic Option program
increased steadily from 3% at year end 1993 to over 28% at year end 1998.
We regularly provide account information to all insureds and maintain
relationships with all policyholders insured by ISMIE. Each insured has a
designated client service representative who can answer most inquiries and, in
other instances, can provide the insured with immediate access to the person
with expertise in a particular department. For larger physician group and
clinics, we have a service team composed of underwriting, risk management and
claims management representatives, each of whom the policyholder may contact
directly for prompt response.
In addition, through a formal outreach program, we present seminars and
communication forums at the local level. Through this program, our
representatives present workshops and exhibits during various specialty and
other healthcare related organization meetings. This provides an effective
communication vehicle for information about our products and services.
PREMIUM RATES AND DISCOUNT PROGRAMS
Through our own actuarial staff and independent actuaries, we establish
rates and rating classifications for our insured physicians and clinics. Rates
are based on loss and LAE experience that ISMIE has developed since 1976. Based
on our large policyholder base and the length of time we have been in business,
we believe we have established the largest database of
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<PAGE>
experience of any professional liability insurer in Illinois. ISMIE has various
rating classifications based on medical specialty, practice location, years in
practice and limits of coverage. We also offer various discount programs,
including discounts for part-time practice, newly practicing physicians, loss
free physicians based on number of years without losses, and group practice.
Approximately 70% of all of our active policyholders currently qualify for the
loss free discount. Additional discounts are available to qualifying groups
based on favorable loss experience through the Clinic Option program. Risk
management discounts are awarded to qualified insureds who attend risk
management programs. Surcharges and debit charges may also be given to insureds
based on unfavorable loss experience.
We set rates annually and file them with the Illinois Insurance
Department. We implemented general rate increases of 12% in 1998, 9% in 1995,
15% in 1994 and 5% in 1993. Where warranted by favorable loss experience,
changes were made to discount programs to offset a portion of the rate increase.
These rate actions did not have a material effect on policyholder retention.
ISMIE has not paid dividends to its policyholders since 1991. We
believe that policyholders prefer receiving premium credits through discounts
rather than receiving dividends. We also believe that discounts are a better way
to provide rewards for favorable loss experience of an insured.
UNDERWRITING
Our underwriting division is responsible for the evaluation of
applicants for professional liability and other coverages, the issuance of
policies and the establishment and implementation of underwriting standards for
all of our coverages. In addition, the division provides extensive support for
our marketing activities, including sales presentations to both existing and
prospective policyholders, outreach activities and policyholder services. See
"-- Marketing and Policyholder Services."
Our underwriting division consists of thirty professional and support
staff. All of the professional staff is involved in underwriting professional
liability coverage for physicians and their employees. However, a select number
specialize in underwriting employment practices liability insurance and the
Physician Business Practice Liability (E&O/D&O) product.
We follow strict procedures for the issuance of all professional
liability policies. We require each applicant or member of an applicant medical
group to provide proof of medical licensing and complete a detailed application
that provides a personal and professional history, the type and nature of the
applicant's professional practice, information relating to specific practice
procedures, hospital and professional affiliations and a complete history of any
prior claims and incidents.
We perform a continuous process of re-underwriting our insureds. We
develop information concerning physicians with large losses, a high frequency of
claims or unusual practice characteristics is developed through online claims
and risk management reports.
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<PAGE>
Beginning in 1999, we plan to send current practice questionnaires to
approximately one-third of our insureds each year. Each insured should receive a
current practice questionnaire approximately every three years. These
questionnaires will request information similar to that submitted in connection
with the original application for insurance. We designed the questionnaires to
detect any changes in the specialty or practice characteristics of the physician
that may require a higher or lower premium rate or possible removal from the
program.
The underwriting division is assisted by the Physician Review and
Evaluation Panel (PREP) which is composed of nine practicing physicians who are
insured by ISMIE. Members of PREP are not employed by us, but receive
compensation for their services on the panel. PREP provides medical expertise to
the underwriting process. The panel meets monthly and reviews underwriting
profiles which include information regarding practice patterns and
relationships, overall loss experience, details of significant claims, loss
ratios and frequency ratios. A review by PREP may result in mandatory risk
management, continuing medical education, coverage restrictions, surcharges or
non-renewal. Physicians have the right to seek reconsideration of some actions
by PREP. We have found that physician input in the underwriting process is often
helpful in fairly judging exposure to malpractice risk and improving the
practice characteristics of the insured.
RISK MANAGEMENT SERVICES
The risk management department provides a variety of educational
activities for all policyholders in an effort to minimize and prevent losses and
supplement our marketing efforts. Activities are directed in three general
areas: those that are of general interest to all policyholders, those issues
that are specialty-specific, and activities designed as remedial education for
identified policyholders.
Among the general interest activities are:
- risk management seminars for both physicians and their office
staffs that we conduct throughout Illinois;
- self-study programs designed to educate physicians in risk
management principles;
- audio and videotapes on risk management topics and litigation
support; and
- written pamphlets and brochures that address general and
specific risk management topics.
Specialty-specific activities are identified and designed by designated
subcommittees composed of physicians in the designated specialty areas. By
reviewing specialty-specific claims, these subcommittees develop educational
materials, including seminars, pamphlets and advisories to help each
policyholder evaluate and implement risk management activities that are designed
to address their specific practice needs.
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<PAGE>
We also make available educational activities to policyholders who
require assistance in specifically identified areas. Among these activities are:
- on-site office assessments, with specific recommended
improvement strategies;
- small group workshops designed to address general, as well as
specific problem areas; and
- access to other general interest materials that are designated
to be helpful to the individual policyholder.
Many of our educational programs have been approved for continuing
medical education credit, which is required for renewal of medical licenses in
Illinois.
CLAIMS
Our claims department is responsible for:
- selecting and assigning defense counsel;
- establishing injury estimates which we use in developing
reserves for loss and LAE, directing the defense of each claim
while weighing objective and subjective issues to establish
settlement values; and
- negotiating settlements while directing the claim in
preparation for trial.
Under most of our policies, except Physician Business Practice Liability
(E&O/D&O) policies, we are obligated to defend our insureds. In almost all
cases, the person bringing the claim against the physician is already
represented by legal counsel when the claim is reported to us.
Our claims department consists of approximately 50 technical and
management personnel, plus support staff. These personnel are responsible for
all aspects of claims handling and coverage analysis from initial reporting
through appeals of verdicts. We have an experienced claims staff which is able
to handle all claims without using independent adjusters. Experience shows that
the longer a claim goes unsettled, the more likely a loss will be paid.
Therefore, ISMIE places a priority on resolving claims as early as possible.
One distinct feature of our claims department is our "Physician-First
Service" program through which we strive to develop a high degree of involvement
and interaction with our policyholders. We encourage insured physicians to
remain actively involved in their claims throughout the legal discovery process
in addition to the trial. We believe that a physician's close involvement not
only benefits the physician during the claims process but also leads to a more
efficient and successful disposition of the claim. To further encourage this
involvement, we provide a "defendant reimbursement" stipend for each day of
attendance at depositions or other discovery and at trial.
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<PAGE>
Medical malpractice claims often involve highly complex medical and
legal issues which take a significant amount of time to resolve and often carry
severe damages. The sensitive nature of these claims requires an open-minded
professional approach to claims disposition. We believe that we have developed a
reputation for aggressively defending our insureds against nonmeritorious
claims. Over the past five years, ISMIE has taken more than 10% of claims to
verdict and has won 80% of these claims. During this period, nearly 80% of all
the claims against ISMIE insureds have been resolved with no payment made. Each
claim, when received, is viewed as neutral. The claims department works to
develop facts to move the claim into a "defend" or "settle" category as soon as
possible. Our desire is to settle cases that should be settled as early in the
claims process as possible. A system of ascending authority levels ensures that
the more serious claims receive multiple reviews. We also maintain a special
unit of claims personnel to work with insured physicians to help resolve patient
conflicts early to avoid litigation where possible.
A special Physician Review Committee or PRC, encompasses a large
variety of specialties and is composed of nine voting members and approximately
twenty consulting members. The PRC makes each decision to defend or settle a
claim. Each member of the PRC must have previously been through the professional
liability litigation process. The PRC is appointed by the ISMIE Board of
directors based upon recommendations submitted by the claims department. A
significant number of the PRC members have developed several years of experience
reviewing claims. All claims involving settlement and all claims taken to
verdict are reviewed by the PRC. As soon as sufficient information is developed
to establish a "defend" or "settle" posture, the claim handler submits the case
to the PRC with detailed information about the claim which specifically includes
the claim handler's recommendation, the defense attorney's recommendation and
the insured physician's recommendation. If the insured disagrees with the PRC's
decision, the insured physician may meet with the PRC to discuss the case and
the PRC's decision. This doctor to doctor interaction has helped us develop a
strong loyalty among our policyholders.
Litigation defense is provided almost exclusively by private law firms
with lawyers whose primary focus is defending malpractice cases. ISMIE maintains
a database to track and analyze trends in our claims experience and to assess
the rates, cost and other performance data of our defense counsel. Our ongoing,
high volume relationships allow us to work more closely and efficiently with
defense counsel and insureds to provide the best defense possible while
maintaining consistency in results at a reasonable cost.
We monitor the ongoing satisfaction of our insureds through a series of
claims monitoring surveys. These surveys allow us to promptly address developing
problems on specific cases and also to ensure that our policies and procedures
continue to address our customer's concerns. To ensure that we maintain our
strong market presence and customer satisfaction, every claim that is filed
receives three monitoring surveys during the pendency of the claim. These
surveys are generally conducted 45 days after the claim is filed, after the
decision to "defend" or "settle" has been reached, and after a claim is closed.
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<PAGE>
LOSS RESERVES
We establish our loss and loss adjustment expense reserves based on
known facts and our interpretation of circumstances, including our experience
with similar cases and historical trends involving claim payment patterns, loss
payments, pending levels of unpaid claims, as well as court decisions and
economic conditions. For claims-made policies, reserves apply only to claims
that have been reported during the period that coverage has been granted. We
establish reserves for claims under claims-made policies at the time the claim
is reported to us. For "tail coverage," which is available under an extended
reporting endorsement feature of the policy, an estimate of possible future
claims needs to be made as well. In addition, we establish reserves on an
ongoing basis to fund the issuance of free tail coverage. While historical
experience is helpful in determining loss trends, each case is unique and the
outcomes can vary substantially from any pattern derived. Therefore, ISMIE
attempts to record reserves based on its best estimate of future losses and
expenses from claims. Nevertheless, we cannot be sure whether the reserves
recorded will ultimately be adequate to cover the losses from claims.
Adding to the uncertainty in establishing loss reserves is the fact
that medical malpractice claims can typically take several years to close. In
fact, more than 45% of ISMIE's direct loss reserves as of December 31, 1998 were
related to losses incurred in 1995 or earlier. The majority of unfavorable loss
development prior to 1995 related to underestimated exposure under occurrence
policies, which we wrote until 1986. As of December 31, 1998, there remained $46
million, or about 5% of total reserves, in estimated unpaid losses and LAE
applicable to occurrence policies written prior to 1986.
The setting of loss reserves involves a projection of ultimate losses,
developed through an actuarial study of ISMIE's claims history and an assessment
of economic trends. We also consider the injury estimates established by the
claims analysts and the liability assessment of the PRC. Actuaries rely heavily
on historical trends, but also consider any changes in economic and legal
conditions. As additional information becomes available, we may revise estimates
reflected in earlier reserve projections. Any increase to previously set
reserves could reduce our earnings for the period in which the increase is made.
External factors, such as judicial precedents, social temperament and
economic conditions increase the uncertainties associated with estimating
ultimate losses. The inherent uncertainty of estimating reserves is relatively
greater for companies like ours writing long-tail casualty insurance, due
primarily to the greater length of time before ultimate claims resolution.
ISMIE uses both its internal actuarial staff and independent actuaries
to establish its reserves. ISMIE's independent actuaries review reserves for
losses and LAE at the end of each policy year and prepare a report that includes
a recommended level for reserves. ISMIE considers their recommendations, along
with other factors, when determining reserve levels. Between reserve studies,
ISMIE continues to monitor trends in frequency and severity, settlements,
judicial and legislative decisions, etc. in order to refine estimates and keep
them current.
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<PAGE>
The following table shows our loss reserve experience and sets forth a
reconciliation of beginning and ending reserves for unpaid losses and LAE for
the periods indicated:
<TABLE>
<CAPTION>
Three Months Ended
MARCH 31, 1999 YEAR ENDED DECEMBER 31
-------------- ----------------------
(in thousands) 1999 1998 1998 1997 1996
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Reserves for losses and LAE at beginning of $895,275 $946,082 $946,082 $980,217 $1,021,647
period
Less reinsurance recoverables 221,759 331,857 331,857 395,104 362,978
------- ------- ------- --------- ---------
Net reserves for losses and LAE at beginning of 673,516 614,225 614,225 585,113 658,669
period ------- ------- ------- --------- ---------
Provision for losses and LAE for claims, net of
reinsurance, occurring in:
Current period 40,221 32,884 163,962 121,912 99,373
Prior periods 0 0 (10,302) (4,096) 6,030
-------- -------- -------- ----------- --------
Total incurred losses and LAE 40,221 32,884 153,660 117,816 105,403
------ ------ ------- --------- --------
Effect of commutation 0 0 79,130 81,080 0
Less loss and LAE payments for claims, net of
reinsurance, occurring in:
Current period 16 10 4,379 6,436 3,449
Prior periods 35,542 43,533 169,120 163,348 175,510
------ ------ ------- ------- -------
Total payments 35,558 43,543 173,499 169,784 178,959
------ ------ ------- ------- -------
Net reserves for losses and LAE at end of period 678,179 603,566 673,516 614,225 585,113
Add reinsurance recoverables 217,656 340,818 221,759 331,857 395,104
------- ------- ------- ------- -------
Reserves for losses and LAE at end of period $895,835 $944,384 $895,275 $946,082 $980,217
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
</TABLE>
The following tables reflect the development of loss and LAE reserves, on a net
basis and then on a gross basis, for the periods indicated at the end of that
year and each subsequent year. The first line shows the reserves as originally
reported at the end of the stated year. Each calendar year end reserve includes
the estimated unpaid liabilities for that report or accident year and for all
prior report or accident years. The section under the caption "liability
reestimated as of" shows the original recorded reserve as adjusted as of the end
of each subsequent year to reflect the cumulative amounts paid and all other
facts and circumstances discovered during each year.
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<PAGE>
The line "cumulative redundancy (deficiency)" reflects the difference between
the latest reestimated reserve amount and the reserve amount as originally
established. The section under the caption "cumulative amount of liability paid
through" shows the cumulative amounts paid related to the reserves as of the end
of each subsequent year. In evaluating the information in the tables below, you
should note that each amount includes the effects of all changes in amounts of
prior periods. The tables present development data by calendar year and do not
relate the data to the year in which the claim was reported or the accident
actually occurred. Conditions and trends that have affected the development of
these reserves in the past will not necessarily recur in the future.
ISMIE RESERVE REDUNDANCY (DEFICIENCY) -- NET BASIS
<TABLE>
<CAPTION>
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998
---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ----
($ in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Loss & LAE 496,674 583,442 643,309 644,913 643,285 622,108 648,158 658,669 585,113 614,225 673,516
Reserves
Liability
Reestimated as
of:
1 Years Later 511,249 582,554 628,553 647,011 654,407 631,924 631,502 666,835 581,015 603,923
2 Years Later 513,671 595,474 649,320 669,605 656,932 622,002 635,237 675,466 568,237
3 Years Later 548,577 619,696 669,300 668,413 644,392 616,055 649,167 668,652
4 Years Later 583,511 654,292 661,326 668,057 634,752 630,760 628,315
5 Years Later 606,915 650,864 657,991 652,131 646,342 621,108
6 Years Later 599,366 659,804 638,725 667,934 635,901
7 Years Later 604,378 642,734 648,967 665,281
8 Years Later 588,554 655,741 648,506
9 Years Later 602,245 655,000
10 Years Later 601,090
Cumulative
Redundancy
(Deficiency) (104,416) (71,558) (5,197) (20,368) 7,384 1,000 19,843 (9,983) 16,876 10,302
</TABLE>
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<PAGE>
<TABLE>
<CAPTION>
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998
---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ----
Cumulative
Amount of
Liability Paid
Through:
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1 Years Later 87,923 105,137 158,356 182,397 215,785 178,197 157,706 177,647 82,266 89,989
2 Years Later 179,720 247,834 311,117 366,149 362,097 306,971 305,116 281,713 187,373
3 Years Later 301,243 372,263 455,001 479,100 446,811 411,334 400,236 403,451
4 Years Later 387,839 496,965 533,566 542,517 513,741 478,766 467,690
5 Years Later 481,754 556,359 565,489 578,261 551,223 527,175
6 Years Later 517,881 582,684 584,351 601,749 571,624
7 Years Later 536,849 597,253 595,936 616,044
8 Years Later 549,884 607,304 608,311
9 Years Later 558,609 618,387
10 Years Later 567,117
Net Reserves -
December 31, 614,225 673,516
Reinsurance
Recoverables 331,857 221,759
------- -------
Gross Reserves 946,082 895,275
------- --------
------- --------
</TABLE>
ISMIE RESERVE REDUNDANCY (DEFICIENCY) - GROSS BASIS
<TABLE>
<CAPTION>
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998
---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ----
($ in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Loss & LAE 621,979 779,907 798,029 809,477 883,428 895,401 942,680 1,021,647 980,216 946,082 895,275
Reserves
Liability
Reestimated
as of:
1 Years Later 687,594 740,996 920,247 874,846 921,458 901,168 921,056 988,686 942,868 920,082
2 Years Later 670,255 884,888 995,332 928,603 922,253 889,572 917,112 955,765 928,940
3 Years Later 832,919 963,057 1,046,736 927,095 906,562 874,327 862,439 927,020
4 Years Later 919,492 1,029,169 1,040,873 922,085 888,383 826,722 833,221
5 Years Later 973,990 1,028,149 1,034,152 896,722 851,312 810,232
6 Years Later 968,461 1,029,244 1,006,606 872,998 841,288
7 Years Later 965,633 1,004,791 981,457 873,238
8 Years Later 941,648 984,897 987,319
9 Years Later 924,447 991,535
</TABLE>
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<PAGE>
<TABLE>
<CAPTION>
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998
---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
10 Years 929,668
Later
Cumulative
Redundancy
(Deficiency) (307,689) (211,628) (189,290) (63,761) 42,140 85,169 109,459 94,627 51,276 26,000
Cumulative
Amount of
Liability Paid
Through:
1 Years Later 104,407 136,269 322,908 226,377 268,996 222,547 197,010 200,949 192,288 214,041
2 Years Later 226,791 443,517 519,649 460,672 459,126 389,062 366,765 373,981 386,142
3 Years Later 512,699 611,926 710,312 610,706 580,201 513,446 484,033 525,216
4 Years Later 643,275 776,665 818,862 704,188 665,697 596,114 580,016
5 Years Later 769,847 859,669 873,334 755,841 709,270 659,555
6 Years Later 824,992 896,773 903,293 777,372 740,442
7 Years Later 849,479 919,602 908,241 797,770
8 Years Later 869,249 919,374 925,986
9 Years Later 865,970 935,084
10 Years 878,603
Later
Gross
Reserves -
December 31 946,082 895,275
Reinsurance
Recoverables 331,857 221,759
------- -------
Net Reserves 614,225 673,516
------- -------
------- -------
</TABLE>
While we believe our reserves for losses and LAE are adequate, we
cannot be sure that our ultimate losses and LAE will not deviate, perhaps
substantially, from the estimates reflected in our financial statements. If our
reserves should prove inadequate, we will have to increase reserves, which could
have a material adverse effect on our financial condition or results of
operation.
REINSURANCE
REINSURANCE CEDED. ISMIE follows customary industry practice by
reinsuring a portion of its risks. We cede to reinsurers a portion of our risk
and pay a premium to reinsurers based upon direct premiums received on all
policies that we reinsure. Insurance is ceded principally to reduce net
liability on individual risks and to provide protection against large losses.
Although reinsurance does not legally discharge the ceding insurer from its
primary liability for the full amount of policies reinsured, it does make the
reinsurer liable to the insurer to the extent of the reinsurance ceded. We
determine how much reinsurance to purchase based upon the evaluation of the
risks we have insured, consultation with our reinsurance brokers and market
conditions, including the availability and
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pricing of reinsurance. During the ten years between 1989 and 1998, through
excess reinsurance we have reduced our average loss by 31%, from $360,000 per
claim average on a gross basis to $247,000 per claim average on a net of
reinsurance basis.
ISMIE's reinsurance strategy is to obtain reinsurance to protect
against unexpected increases in severity and frequency in any given year. From
1995 to 1997, ISMIE steadily increased its retention under its excess of loss
reinsurance program from a retention level of $500,000 per medical incident to
$1,000,000 per medical incident. With increased retentions, ISMIE bears more of
the potential losses and cedes only losses excess of specified retention levels
to reinsurers. In 1998, ISMIE ceded $45.5 million of its earned premiums to
reinsurers.
ISMIE has two layers of excess reinsurance: a per incident treaty
(ISMIE often has more than one insured named in a lawsuit or claim arising from
the same incident, and therefore multiple policies and limits may be involved),
and a per claim treaty applicable to insureds with $2 million/$4 million limits.
The per incident treaty is applicable to all medical malpractice policies and
applies to the first $1.0 million in limits per insured per incident. Currently,
ISMIE retains the first $1.0 million per incident and the per incident treaty
covers losses up to $5.0 million per incident. The per claim treaty covers $1.0
million excess of $1.0 million per insured per claim for insurance with $2.0
million/$4.0 million policy limits.
For the three-year period from July 1, 1995 to July 1, 1998, ISMIE
purchased reinsurance from Cologne Re (Dublin), which provided a combination of
quota share and stop loss protection. This reinsurance provided ISMIE additional
protection against higher than expected claims frequency and severity. During
the period that this treaty was in effect, we substantially improved our surplus
position on a statutory basis, from $110.1 million to $178.4 million. ISMIE has
discontinued this reinsurance program effective July 1, 1998. Our improved
surplus position, along with recent favorable trends in claims frequency,
permitted us to commute the first two years of this reinsurance program and
recover cash of $81.1 million in 1997 and $79.1 million in 1998.
ISMIE also has a treaty which is applicable to $5.0 million per claim
limits issued to entities under our Clinic Option program and our corporate
policy. This treaty cedes 100% of $3.0 million excess of $2.0 million per claim
to reinsurers.
In addition, ISMIE has a quota share treaty applicable to all Physician
Business Practice Liability (E&O/D&O) policies. ISMIE retains 10% of all losses
on these policies and 90% is ceded to reinsurers.
We place reinsurance under reinsurance treaties and agreements with a
number of individual companies and with syndicates at Lloyd's to avoid
concentrations of credit risk. The following table identifies the most
significant reinsurers, their percentage participation in the aggregate
reinsured risk based upon premiums paid and their rating as of December 31,
1998. No other reinsurer's percentage participation in 1998 exceeded 3% of total
reinsurance premiums.
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<PAGE>
<TABLE>
<CAPTION>
PREMIUMS CEDED PERCENTAGE OF TOTAL
FOR YEAR ENDED REINSURANCE
REINSURER DECEMBER 31, 1998 RATING (1) PREMIUMS
- --------- ----------------- ---------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Cologne Re (Dublin) $15,986 AAA 35.2%
Transatlantic Reinsurance Co. $6,052 A ++ 13.3%
Lloyd's Syndicates $4,376 A 9.6%
Union America Insurance Co. $4,252 A - 9.4%
CNA Reinsurance Co. (U.K.) $3,385 A 7.4%
NAC Reinsurance Corp. $2,697 A + 5.9%
Everest Reinsurance Re $1,930 A 4.2%
Kemper Reinsurance Co. $1,908 A 4.2%
Chartwell Reinsurance Co. $1,526 A 3.4%
Other reinsurers (2) $3,341 7.4%
------ ----
Total $45,453 100.00%
======= =======
</TABLE>
(1) All ratings are assigned by A.M. Best, except for Cologne Re
(Dublin) which is rated by Standard & Poor's. Our minimum requirement for
ratings of our reinsurers is "B+" or better from A.M. Best or "A" or better from
Standard & Poor's.
(2) None of the "other reinsurers" percentage of total reinsurance
premiums exceeded 3% of total reinsurance premiums in 1998.
We analyze the credit quality of our reinsurers and rely on our brokers
and intermediaries to assist in the analysis. To date we have not experienced
any material difficulties in collecting reinsurance recoverables. However, we
cannot be certain of the future ability of any of our reinsurers to meet their
obligations. The largest percentage of reinsurance ceded to any one company is
ceded to Cologne Reinsurance Co. (Dublin) which is a non-admitted carrier in the
U.S. Recoverables from this reinsurer are secured by an irrevocable and
unconditional letter of credit issued by Citibank N.A. and a trust account at
AmalgaTrust (Chicago). ISMIE is the sole beneficiary of both the letter of
credit and trust account.
REINSURANCE ASSUMED. Earlier this year, we entered into a reinsurance
treaty with the Illinois Compensation Trust to reinsure the Trust's workers'
compensation risks. The Trust is organized under the Illinois Religious and
Charitable Organization Risk Pooling Act and insures the workers' compensation
risks of various Illinois hospitals. The risk assumed by ISMIE is the layer of
$375,000 excess of $25,000 per claim. The Trust retains the first $25,000 of
loss. The estimated aggregate amount of losses assumed under this treaty are
approximately $2.6 million.
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INVESTMENT PORTFOLIO
Return on invested assets is an important component of our operating
results. Our investment managers make our investments for us in accordance with
the prescribed investment objectives and guidelines. ISMIE's guidelines
emphasize high-quality, fixed-maturity investments. ISMIE has used Scudder
Insurance Assets Management (SIAM) since 1985 to manage its portfolio, which has
primarily been fixed-income securities. ISMIE also uses an investment advisor,
Gofen & Glossberg, to review the performance of its portfolio relative to the
market and economic conditions.
ISMIE recently hired two equity investment managers, Dearborn Partners
and Trees Front Associates, to institute an equity securities portfolio. We
began this investment program in July, 1998 in order to provide more
diversification in our overall portfolio. We currently restrict this portfolio
to no more than 5% of ISMIE's total invested assets.
The following table sets forth the composition of ISMIE's investment
portfolio at the dates indicated. All of the fixed maturity securities are held
as available-for-sale.
<TABLE>
<CAPTION>
MARCH 31, 1999 DECEMBER 31, 1998 DECEMBER 31, 1997
-------------- ----------------- -----------------
COST OR COST OR COST OR
AMORTIZED AMORTIZED AMORTIZED
(in thousands) COST FAIR VALUE COST FAIR VALUE COST FAIR VALUE
------ ---------- ------------ ---------- ------------- ----------
Fixed maturity securities:
<S> <C> <C> <C> <C> <C> <C>
U.S. government obligations $157,137 $158,863 $155,166 $161,007 $152,551 $154,165
Corporate securities 356,582 359,390 345,733 356,579 261,739 264,863
Mortgage-backed and other asset-backed 288,599 290,730 285,929 289,930 307,854 311,001
securities
States, territories and
possessions, and public utilities 12,303 12,441 12,307 12,675 6,694 6,787
------ ------ --------- --------- ---------- ----------
Total fixed maturity securities: 814,621 821,424 799,135 820,191 728,838 736,816
Equity securities 18,993 22,241 15,975 17,969 0 0
------ ------ --------- --------- ------------ ------------
Total $833,614 $843,665 $815,110 $838,160 $728,838 $736,816
-------- -------- -------- -------- -------- --------
-------- -------- -------- -------- -------- --------
</TABLE>
The mortgage-backed and other asset-backed portfolio represents
approximately 35% of our total fixed maturity portfolio, and consists primarily
of "standard" and "more complex" securities. The mortgage-backed securities are
issued on and collateralized by an underlying pool of single-family home
mortgages. The asset-backed securities are collateralized by an underlying pool
of receivables or other assets. Pools are commonly home equity loans, credit
card and auto loans, and manufactured housing loans. Principal and interest
payments from the underlying pool are distributed pro rata to the security
holders. All of our mortgage-backed and other asset-backed securities are U.S.
agency securities or AAA rated. Our investment portfolio does not include any
"interest only" or "principal only" mortgage securities. Mortgage-backed and
other asset-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,
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mortgage-backed and other asset-backed securities 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.
Our investment portfolio of fixed maturity securities consists
primarily of intermediate-term, investment-grade securities. Our investment
policy provides that fixed maturity securities investments are limited to
purchases of investment-grade securities or unrated securities which, in the
opinion of a national investment advisor, should qualify for that rating. The
table below contains additional information concerning the investment ratings of
our fixed maturity investments at March 31, 1999:
<TABLE>
<CAPTION>
AS OF MARCH 31, 1999 AMORTIZED PERCENTAGE
COST FAIR VALUE OF FAIR VALUE
---- ---------- -------------
(in thousands)
<S> <C> <C> <C>
TYPE/RATING OF INVESTMENT
AAA (including U.S. government
obligations) $445,737 $449,599 54.7%
AA 43,684 43,648 5.3
A 271,448 274,340 33.4
BBB 53,752 53,837 6.6
-------- -------- ------
$814,621 $821,424 100.0%
-------- -------- ------
-------- -------- ------
</TABLE>
The following table sets forth information concerning the maturities of
fixed maturity securities in our investment portfolio as of March 31, 1999:
<TABLE>
<CAPTION>
As of March 31, 1999 AMORTIZED PERCENTAGE
COST FAIR VALUE OF FAIR VALUE
---- ---------- -------------
(in thousands)
<S> <C> <C> <C>
Years to maturity:
One year or less $ 5,065 $ 5,109 .6%
After one through five 220,999 222,567 27.1
After five through ten 285,934 289,322 35.2
After ten 14,024 13,696 1.7
Mortgage-backed securities and
other asset-backed securities 288,599 290,730 35.4
Totals $814,621 $821,424 100.0%
-------- -------- ------
-------- -------- ------
</TABLE>
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<PAGE>
MARKET RISK
The value of our fixed-maturity portfolio is subject to interest rate
risk. As market interest rates decrease, the value of the portfolio goes up with
the opposite holding true in rising interest rate environments. A common measure
of the interest sensitivity of fixed-maturity assets is modified duration, a
calculation that takes maturity, coupon rate, yield and call terms to calculate
an average age of the expected cash flows. The longer the duration, the more
sensitive the asset is to market interest rate fluctuations.
The value of our common stock equity investments is dependent upon
general conditions in the securities markets and the business and financial
performance of the individual companies in the portfolio. Values are typically
based on future economic prospects as perceived by investors in the equity
markets.
The first column of the following table shows the estimated fair values
of our fixedmaturity and common stock portfolios as of March 31, 1999. The
second column shows the effect on current estimated fair values assuming a 100
basis point increase in market interest rates and a 10% decline in equity price.
<TABLE>
<CAPTION>
ESTIMATED FAIR VALUE AT
ESTIMATED FAIR VALUE AT ADJUSTED MARKET
CURRENT MARKET RATES/PRICES AS INDICATED
(in thousands) RATES/PRICES BELOW
------------ -----
<S> <C> <C>
Interest rate risk(1)
Fixed-maturity securities
Available-for-sale $821,424 $789,023
Equity price risk (2)
Common stocks $22,241 $20,017
</TABLE>
(1) Adjusted interest rates assume a 100 basis point increase in market
rates at March 31, 1999
(2) Adjusted equity prices assume a 10 percent decline in values at
March 31, 1999
For all its financial assets and liabilities, ISMIE attempts to maintain
reasonable average durations, consistent with the maximization of income without
sacrificing investment quality and providing for liquidity and diversification.
The estimated fair values at the adjusted market rates (assuming a
100-basis point increase in market interest rates) are calculated using
discounted cash flow analysis and duration modeling where appropriate. The
estimated values do not consider the effect that changing interest rates could
have on prepayment activity.
This sensitivity analysis provides only a limited, point-in-time view of
the market risk sensitivity of our fixed-maturity and common stock investments.
The actual impact of market
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interest rate and price changes on our financial instruments may differ
significantly from those shown in the sensitivity analysis. The sensitivity
analysis is further limited as it does not consider any actions that we could
take in response to actual and/or anticipated changes in interest rates and
equity prices.
COMPETITION
The medical malpractice insurance market in Illinois is highly
competitive. We believe that the principal competitive factors include pricing,
financial stability, ratings, breadth and flexibility of coverage and the
quality and level of service provided. ISMIE competes with numerous insurance
companies in the Illinois market. Our principal competitors for physicians and
medical groups consist of several commercial insurance companies and,
increasingly, self-insurance programs by hospitals for acquired physician
practices. Each of these competitors is actively engaged in soliciting insureds
in Illinois, ISMIE's primary area of operations, and each has offered
assessments or premiums at very competitive rates during the past few years. The
number of licensed insurance carriers in the medical professional liability
insurance market in Illinois has dramatically increased from six in 1992 to
approximately thirty-two today. At the same time, a number of health care
professionals have left the insurance market because many become a part of
self-insurance programs instituted by hospitals that have acquired physician
practices. Despite substantial increases in competition over the past five years
and the increase in the use of self-insurance, ISMIE has experienced a reduction
of only 12.5% of persons or entities covered under existing policies since 1993.
We believe this favorable experience is a result of to our superior customer
service and the close relationships we have with our insured policyholders.
We expect to encounter similar competition from local physician-owned
insurance companies, commercial companies and self-insurance programs in other
states as we carry out our expansion plans. We plan to compete in other states
principally through offering superior policyholder service. All markets in which
we now write insurance and which we would expect to enter have competitors with
substantially greater financial and operating resources and higher ratings than
we do. See "Risk Factors -- Competition from other insurance companies could
hurt our business."
RELATIONSHIP WITH THE MEDICAL SOCIETY
ISMIE was organized in 1976 by the Illinois State Medical Society, and
has received the active support of the Medical Society in building its physician
and medical group policyholder base. Each of the executive officers of Holdings
also serves in an executive capacity for the Medical Society. Dr. Geline, a
director of Holdings, also serves as a trustee of the Medical Society. See
"Management - Directors and Executive Officers." We also have a shared services
agreement with the Medical Society under which we share the costs of office,
administrative, employee, lobbying and other services. See "Management--Related
Party Transactions--Services and Office Space."
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Our close relationship with the Medical Society has been critical to
the success of ISMIE. As a reciprocal insurance exchange, ISMIE has been wholly
owned and governed by its members. ISMIE has relied on its relationship with the
Medical Society in marketing its policies. In 1998, this relationship was
modified to eliminate the requirement that policyholders be members of the
Medical Society and to transfer the function of the attorney-in-fact from the
Medical Society to ISMIE. Following the conversion, we will endeavor to continue
our shared services agreement and, through personalized service, to maintain our
close relationship with the Medical Society.
REGULATION
GENERAL. Insurance companies are regulated by government agencies in
states in which they transact insurance. The extent of regulation varies by
state, but regulation usually includes:
- establishing standards of solvency which insurers must
maintain;
- regulating premium rates and policy forms;
- setting minimum capital and surplus requirements;
- requiring the licensing of companies and agents;
- approving accounting methods and methods of setting statutory
loss and expense reserves;
- setting requirements for and limiting the types and amounts of
investments;
- establishing requirements for the filing of annual statements
and other financial reports;
- conducting periodic statutory examinations of the affairs of
insurance companies;
- approving proposed changes of control; and
- limiting the amounts of dividends that may be paid without
prior regulatory approval.
State insurance departments also conduct periodic examinations of the
affairs of insurance companies. This regulation and supervision are primarily
for the benefit and protection of policyholders and not for the benefit of
investors.
Since ISMIE is an Illinois company and we write substantially all of
our insurance in Illinois, and will continue to write a large portion of our
insurance in Illinois following the conversion, Illinois laws and regulations
have the most significant impact on us and our operations.
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HOLDING COMPANY REGULATION. The Illinois Insurance Holding Company
System Act, or the Holding Company Act, requires us to file information
periodically with the Illinois Insurance Department, including information
relating to our capital structure, ownership, financial condition and general
business operations, and information relating to transactions and agreements
between ISMIE and its affiliates. We must also give the Illinois Insurance
Department prior notice of transactions between us and our affiliates, including
sales, loans, guarantees, transfer of assets or liabilities, investments,
reinsurance agreements, and management agreements and cost sharing arrangements.
These kinds of transactions may not be entered into if disapproved by the
Illinois Insurance Department.
The Holding Company Act also provides that the acquisition or change of
"control" of an Illinois insurance company or of any person or entity that
controls an insurance company cannot be consummated without the prior approval
of the Illinois Director of Insurance. 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 an Illinois insurance company or of a person or
entity that controls an Illinois insurance company, such as Holdings. A person
or entity seeking to acquire direct or indirect "control," of an Illinois
insurance company is generally required to file with the Illinois Director of
Insurance an application for change of control containing information required
by statute and published regulations and provide a copy of the application to
us. The Holding Company Act and other provisions of the Illinois Insurance Code
also effectively restrict us from consummating certain reorganizations or
business combinations without prior regulatory approval.
We will also be governed by insurance holding company laws in other
states that contain similar provisions and restrictions if we become licensed in
those states.
REGULATION OF DIVIDENDS FROM INSURANCE SUBSIDIARIES. Following the
conversion, the Holding Company Act will limit the ability of ISMIE to pay
dividends to Holdings. Without prior notice to and approval of the Illinois
Director of Insurance, ISMIE 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 ISMIE's statutory net income for the
preceding calendar year or 10% of our policyholder surplus as of the preceding
December 31. Regulations further require that policyholder surplus following a
dividend or other distribution be reasonable in relation to its outstanding
liabilities and adequate to its financial needs. The Illinois Insurance Code
permits the payment of dividends only out of statutory earned (unassigned)
surplus. In addition, an insurance company must provide notice to the Illinois
Insurance Department of all dividends after declaration, but prior to payment.
RISK-BASED CAPITAL. The NAIC has developed, and states including
Illinois have adopted, a methodology for assessing the adequacy of statutory
surplus of property and casualty insurers which includes a risk-based capital
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
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<PAGE>
companies. Under the formula, a company determines its risk-based capital 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 risk-based capital rules provide for
different levels of regulatory attention depending on the ratio of a company's
total adjusted capital to its "authorized control level" of risk-based capital.
NAIC-IRIS RATIOS. The NAIC Insurance Regulatory Information System, or
IRIS, was developed by a committee of state insurance regulators 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 departments of insurance.
REGULATION OF INVESTMENTS. State laws and regulations require Illinois
insurance companies to diversify 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 nonadmitted assets for purposes of
measuring statutory surplus. In some instances, this would require divestiture
of non-qualifying investments over specified time periods unless otherwise
permitted by the state insurance authority.
PRIOR APPROVAL OF POLICY FORMS. Illinois insurance laws require us to
submit policies and endorsements to the Illinois Director of Insurance for prior
approval. We may be unable to implement desired endorsements or forms if the
Illinois Director of Insurance does not approve them. See "Risk Factors -- If we
fail to comply with insurance regulatory requirements, or if those requirements
become burdensome to us, we may not be able to operate profitably." Following
the conversion, if we or any future subsidiary of Holdings become licensed in
other states, then policy forms and endorsements under those other states also
would have to be reviewed and approved by those states. Also, many other states,
but not Illinois, require notice to state insurance departments of, and in some
cases prior approval of, insurance rates before those rates can be implemented.
INSURANCE GUARANTY ASSOCIATIONS. All states, including Illinois,
require admitted property and casualty insurers to become members of guaranty
funds or associations which generally protect policyholders of member insurers
in the event of the insolvency of the insurers. Guaranty funds or associations
pay certain claims made against insolvent insurers, and guaranty funds assess
their members in order to fund the payment of those claims and related guaranty
fund expenses. Maximum assessments permitted by law in any one year vary by
state, and Illinois permits a maximum assessment of 1.0% of annual premiums
written by a member in that state during the preceding year. In 1998, ISMIE was
assessed $93,000.
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MEDICAL MALPRACTICE TORT REFORM. In cooperation with the Medical
Society, we have consistently advocated proposals for medical malpractice tort
reform and other legislation which we believe would benefit our policyholders.
It is our intent to continue to work with the Medical Society on these efforts.
Since its formation in 1976, ISMIE has worked closely with the Medical
Society to secure tort reform for the benefit of physicians, patients and its
operational results. In 1976 the initial efforts led successfully to legislation
reducing the time period within which individuals could file claims. A similar
reduction in the time period for filing claims for minors was achieved in 1987.
Over the course of several years beginning in 1977, ISMIE successfully
promoted legislation to provide confidentiality to peer review activities
including those of ISMIE and its agents. We believe that the confidential nature
of peer review reduces negligent incidents in medical practice by promoting the
frank evaluation of medical care and practice patterns.
In 1985, ISMIE and the Medical Society successfully initiated broad
malpractice reform legislation that withstood legal attack in the Illinois
Supreme Court. This legislation required the filing of Affidavits of Merit with
each malpractice case and prohibited the award of punitive damages in medical
malpractice cases. The legislation made several other substantive changes in the
way in which malpractice cases were filed, all of which contributed to providing
stability in the Illinois marketplace and in the frequency of claims.
Legislation providing additional reforms which we advocated was adopted in 1995
but was struck down by the Illinois Supreme Court in 1997.
ISMIE has continued its legislative efforts with the Medical Society
and we believe we are recognized as a leading force in efforts at malpractice
and tort reform.
MEDICAL MALPRACTICE REPORTS. We must report detailed information with
regard to settlements or judgments against our Illinois physician insureds to
the Illinois Department of Professional Regulation, which has responsibility for
investigations and initiation of proceedings relating to professional medical
conduct in Illinois. In addition, we must report all payments to the National
Practitioners' Data Bank and the reports are accessible by state licensing and
disciplinary authorities, hospital and other peer review committees and other
providers of medical care.
RATINGS
In 1998, A.M. Best, which rates insurance companies based on factors of
concern to policyholders, increased our rating to "B++ (Very Good)," from "B+
(Very Good)" citing improved profitability, adequate loss reserves and our
strong position in the Illinois medical professional liability market. The
improved rating also acknowledges the actions taken by our management to
position us to compete in the changing market. Our ability to maintain or
improve our ratings may depend on our ability to implement successfully our
business strategy. This rating is the fifth highest of 13 ratings that A.M. Best
assigns to solvent insurance
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companies, which currently range from "A++ (Superior)" to "D (Poor)."
Publications of A.M. Best indicate that the B++ rating is assigned to those
companies that in A.M. Best's opinion "have a good ability to meet their ongoing
obligations to policyholders." In evaluating a company's financial and operating
performance, A.M. Best reviews the company's profitability, leverage and
liquidity, as well as 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, the adequacy of its surplus, its capital structure, the
experience and competence of its management and its market presence. A.M. Best's
ratings reflect its opinion of an insurance company's financial strength,
operating performance and ability to meet its obligations to policyholders and
are not evaluations directed to purchasers of an insurance company's securities.
Standard & Poor's assigns ratings to insurance companies with respect
to their ability to pay under their insurance policies. Ratings assigned by
Standard & Poor's to solvent insurance companies currently range from "AAA
(Extremely Strong)" to "CC (Extremely Weak)." ISMIE received its first official
rating of "BBB (Good)" from Standard & Poor's in 1996. This rating is within the
"secure" range of Standard & Poor's rating hierarchy. Prior to that, Standard &
Poor's had given a rating of "BBq", based solely on quantitative analysis of
publicly available financial data.
EMPLOYEES
As of March 31, 1999, we had approximately 180 full time equivalent
employees. None of the employees is covered by a collective bargaining
agreement. We believe that our employee relations are good.
PROPERTIES
Our headquarters are located in Chicago, Illinois where we occupy
approximately 75,000 square feet under a lease expiring in 2011. We also have
office space in Springfield, Illinois in a building we own. The Springfield
office building contains approximately 40,000 square feet, of which we lease and
occupy approximately 10,000 square feet. ISMIE is both a general partner and a
limited partner in a limited partnership which owns the building containing our
Chicago headquarters. The Chicago building is currently encumbered by a mortgage
loan. We believe that our office space is adequate for its present needs and
that we will be able to secure additional office space in the future if
necessary.
LITIGATION
We are from time to time named as a defendant in various lawsuits
incidental to our insurance business. The most common litigation includes claims
where lawsuit verdicts exceed the available coverage. We vigorously defend these
actions, unless a reasonable settlement appears appropriate. We believe that
adverse results, if any, in the actions currently pending should not have a
material adverse effect on our cash flow, results of operation or financial
condition. Other than claims against our insureds, we are not currently involved
in any litigation.
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MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
The following table sets forth information concerning the individuals
who serve as directors and executive officers of Holdings.
<TABLE>
<CAPTION>
NAME POSITION
---- --------
<S> <C>
Harold L. Jensen, M.D. Chairman of the Board
Walter Whisler, M.D. Vice Chairman of the Board
Alexander R. Lerner President, Chief Executive Officer and Director
Donald A. Udstuen Chief Operating Officer and Director
Jeffrey M. Holden Chief Administrative Officer
Eugene J. Gross Chief Financial Officer and Assistant Treasurer
Saul J. Morse General Counsel and Assistant Secretary
Irwin A. Smith, M.D. Secretary and Director
Peter A. Brusca, M.D. Treasurer and Director
Richard A. Geline, M.D. Director
Henri S. Havdala, M.D. Director
Robert M. Reardon, M.D. Director
Jane Jackman, M.D. Director
</TABLE>
Holdings' Board of directors currently consists of ten persons, divided
into three classes of directors and elected for staggered terms as follows:
Class I, composed of three persons and elected for a term expiring at the 2000
annual meeting of stockholders; Class II, composed of four persons and elected
for a term expiring at the 2001 annual meeting of stockholders; and Class III,
composed of three persons and elected for a term expiring at the 2002 annual
meeting of stockholders. Class I directors are Mr. Udstuen and Drs. Reardon and
Jackman. Class II directors are Drs. Jensen, Geline, Havdala and Smith. Class
III directors are Mr. Lerner and Drs. Brusca and Whisler. Following the
expiration of the initial term as described above, directors will serve for
three-year terms.
DIRECTORS AND EXECUTIVE OFFICERS. Set forth below is the description of
the business positions for the directors and executive officers of Holdings held
during at least the past five years. Each of the directors has been a director
of Holdings since it was organized in April 1999.
Harold L. Jensen, M.D., 72, is the Chairman of the Board of Holdings.
Dr. Jensen has been a member of the Board of Governors of ISMIE since 1987 and
Chairman since 1991. Dr.
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Jensen also has served as Vice-President of Medical Affairs at Ingalls Memorial
Hospital in Harvey since 1988. He has been an internist in Harvey, Illinois, for
more than 33 years. Dr. Jensen is a member of the Medical Society and the
American Medical Association.
Walter W. Whisler, M.D., 65, is Vice Chairman of the Board of Holdings.
He has been a member of the Board of Governors of ISMIE since 1977 and Vice
Chairman since 1992. He also served as Vice Chairman from 1982-1990. He has been
a Board certified neurosurgeon in Chicago, Illinois for over 30 years. He also
serves as Professor and Chairman of the Department of Neurosurgery at Rush
Medical College & Rush-Presbyterian St. Luke's Medical Center. Dr. Whisler is a
member of the Medical Society and the American Medical Association.
Alexander R. Lerner, 52, is President and Chief Executive Officer and a
director of Holdings. Mr. Lerner has served as Chief Executive Officer of ISMIE
since 1985 and Chief Executive Officer of the attorney-in-fact since its
formation in July, 1998. Mr. Lerner also has served as the Chief Executive
Officer of the Medical Society since 1981. Mr. Lerner also serves as chairman of
the Illinois Sports Facilities Authority and is a member of the American
Association of Medical Society Executives.
Donald A. Udstuen, 55, is Chief Operating Officer of Holdings. Mr.
Udstuen has served as Chief Operating Officer of ISMIE since 1991 and
Secretary/Treasurer and Chief Operating Officer of the attorney-in-fact since
its formation in July, 1998. Mr. Udstuen also has served as the Associate
Executive Vice President of the Medical Society since 1987, and previously
served as its chief financial officer and governmental affairs director and its
chief lobbyist.
Jeffrey M. Holden, 46, is Chief Administrative Officer of Holdings. Mr.
Holden has served as Chief Administrative Officer of ISMIE since July, 1998, and
Chief Administrative Officer of the attorney-in-fact since its formation in
July, 1998. Mr. Holden has also served as Chief Operating Officer of the Medical
Society since January, 1992, and previously served, at various times, as the
Assistant Executive Vice President, Vice President of Governmental Affairs, and
Chief Lobbyist of the Medical Society.
Eugene J. Gross, 47, is Chief Financial Officer and Assistant Treasurer
of Holdings. Mr. Gross has served as Chief Financial Officer of ISMIE since
1991, and Chief Financial Officer of the attorney-in-fact since its formation in
July, 1998. Mr. Gross also has served as Chief Financial Officer of the Medical
Society since 1991. Prior to joining ISMIE, Mr. Gross held senior management
positions with Allstate Insurance Company and Metropolitan Life.
Saul J. Morse, Esq., 51, is General Counsel and Assistant Secretary of
Holdings. Mr. Morse has served as General Counsel of ISMIE since 1992. Mr. Morse
has served as General Counsel of the attorney-in-fact since its formation in
July, 1998. He also has served as Vice President and General Counsel of the
Medical Society since 1992. Prior to joining ISMIE, Mr. Morse was managing
partner of the law firm of Morse, Giganti & Appleton, in Springfield, Illinois.
Mr. Morse is a Clinical Assistant Professor in the Department of Medical
Humanities at Southern Illinois University School of Medicine. Mr. Morse is a
member of the Sangamon
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County Bar Association, Illinois State Bar Association and the American Bar
Association, the Defense Research Institute, and the American Health Lawyers
Association.
Irwin A. Smith, M.D., 82, is Secretary and a director of Holdings. He
has served on the Board of Governors of ISMIE since 1977. Now retired, has been
a Board certified family physician in Northbrook, Illinois, for more than 50
years.
Peter A. Brusca, M.D., 58, is a director of Holdings. He has served on
the Board of Governors of ISMIE since 1990. He has been a Board certified
otolaryngologist in Carol Stream, Illinois, for over 20 years. Dr. Brusca is a
member of the Medical Society and the American Medical Association, and is a
fellow of the American College of Surgeons, the American Academy of
Otolaryngology, the American Academy of Facial, Plastic & Reconstructive
Surgery, and the American Academy of Cosmetic Surgery. He has also served as a
member of the Health Advisory Committee for United States Representative Dennis
Hastert.
Richard A. Geline, M.D., 61, is a director of Holdings. He has served
on the Board of Governors of ISMIE since 1989. He has been a Board certified
orthopaedic Surgeon in Skokie, Illinois, for over 28 years. Dr. Geline is the
immediate past president of the Medical Society and a member of the American
Medical Association. He is also a member of the American Academy of Orthopaedic
Surgeons.
Henri S. Havdala, M.D., 67, is a director of Holdings. He has served on
the Board of Governors of ISMIE since 1977. He has been a Board certified
anesthesiologist in Lincolnwood, Illinois, for over 35 years. Dr. Havdala is a
member of the Medical Society, the American Medical Association and the American
Society of Anesthesiologists.
Jane Jackman, M.D., 54, is a director of Holdings. She has served on
the Board of Governors of ISMIE since 1993. She has been a Board certified
family physician in Springfield, Illinois, for over 25 years. She is a past
president of the Medical Society, a member of the American Medical Association
and the American Academy of Family Physicians. Dr. Jackman is also a Clinical
Associate Professor, Department of Family practice, at the Southern Illinois
University School of Medicine.
Robert M. Reardon, M.D., 69, is a director of Holdings. He has served
on the Board of Governors of ISMIE since 1988. Now retired he has been a Board
certified ophthalmologist in Bloomington, Illinois, for over 35 years. Dr.
Reardon is a past president of the Medical Society, a member of the American
Medical Association and the American Academy of Ophthalmology. He is also a
member of the Board, and serves as Vice President, of Illinois Wesleyan
University.
COMMITTEES OF THE HOLDINGS BOARD
The Holdings Board will have the following standing committees
immediately following the conversion:
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EXECUTIVE COMMITTEE. The Executive Committee will have the authority to
exercise all powers of the Holdings Board between meetings of the Holdings
Board, except in cases where action of the entire Holdings Board is required by
the certificate of incorporation, the bylaws or applicable law.
AUDIT COMMITTEE. The Audit Committee will make recommendations
concerning the engagement of independent public accountants, review the scope of
audit engagement, review the services and reports of the accountants, review any
major accounting changes, consider the range of audit and non-audit fees and
review the adequacy of our internal accounting controls. The members of the
Audit Committee will be independent directors.
COMPENSATION COMMITTEE. The Compensation Committee will establish
compensation levels for the executive officers of Holdings, review significant
employee benefit programs and establish, as it considers appropriate, and
administer executive compensation programs, including bonus plans, stock option
and other equity-based programs, deferred compensation plans and any other cash
or stock incentive programs. The Chief Executive Officer will establish
remuneration levels for other employees.
STOCK OPTION COMMITTEE. The Stock Option Committee will administer our
employee stock option plans.
NOMINATING COMMITTEE. The Nominating Committee will recommend to the
Board of directors candidates for director and membership on committees of the
Board of directors of Holdings and its subsidiaries.
INVESTMENT COMMITTEE. The Investment Committee will oversee the
investment activities and portfolio management of Holdings and its subsidiaries.
INVESTOR RELATIONS COMMITTEE. The Investor Relations Committee will
review and make recommendations to management regarding policies and procedures
to be adopted by Holdings regarding communications with stockholders, analysts
and others.
The Holdings Board may from time to time establish other committees to
facilitate the management of Holdings.
DIRECTOR COMPENSATION
The Chairman of the Board will receive an annual retainer of $60,000
plus reimbursement of automobile and other expenses. Each non-employee director
will be paid $1,200 per day for attendance at meetings of the Board and
committees of the Board, meetings of a board of a subsidiary on which the
director serves, and each seminar or other meeting attended on special
assignment on our behalf. All non-employee directors will be reimbursed for
reasonable travel and other expenses incurred to attend meetings of the Holdings
Board and committees of the Board.
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EXECUTIVE COMPENSATION
Holdings was organized as a Delaware corporation in April, 1999, and
consequently did not pay any cash compensation to its executive officers for the
year ended December 31, 1998. The following Summary Compensation Table,
therefore, sets forth information concerning the compensation paid or accrued by
ISMIE and the attorney-in-fact for (i) the President and Chief Executive Officer
and (ii) and each of the other four most highly compensated executive officers
of ISMIE for services rendered during the year ended December 31, 1998:
ANNUAL COMPENSATION
-------------------
<TABLE>
<CAPTION>
SALARY($) BONUS($) OTHER ANNUAL ALL OTHER
NAME AND PRINCIPAL POSITION YEAR COMPENSATION(2) COMPENSATION($)(3)
- ---------------------------- ----- --------------- ------------------
<S> <C> <C> <C> <C> <C>
Alexander R. Lerner, President 1998 $588,812 $342,337(1) $305,813 $43,504
and Chief Executive Officer
Donald A. Udstuen, Chief 1998 $361,427 $24,188 $43,730
Operating Officer
Jeffrey M. Holden, Chief 1998 $247,708 $16,334 $23,635
Administrative Officer
Eugene J. Gross, Chief Financial 1998 $192,970 $10,000 $59,370 $15,985
Officer and Assistant Treasurer
Saul J. Morse, General Counsel 1998 $270,251 $1,426 $16,086
and Assistant Secretary
</TABLE>
(1) Includes $214,356 paid to Mr. Lerner to permit him to make an
installment of principal and interest on a loan from ISMIE. Mr. Lerner
will continue to receive the $214,356 bonus through the year 2000,
after which Mr. Lerner's compensation will be reduced by that amount.
(2) Represents amounts reimbursed for payment of taxes. For Mr. Lerner, the
amount includes $168,765 paid to reimburse taxes with respect to the
bonus of $214,356 paid to him. Mr. Lerner will continue to receive
reimbursement for taxes on this bonus through the year 2000, after
which Mr. Lerner's compensation will be reduced by the amount of the
reimbursement. For Mr. Gross, the amount includes $18,718 for
automobile and related expenses, and $10,162 for club dues.
(3) Represents contributions by ISMIE and the attorney-in-fact to a 401(k)
Plan in the amount $9,856, $15,312, $8,863, $14,766 and $14,960 for the
accounts of Messrs. Lerner, Udstuen, Holden, Gross and Morse,
respectively; and insurance premiums of $33,648, $28,418, $14,772,
$1,219 and $1,126, for Messrs. Lerner, Udstuen, Holden, Gross and
Morse, respectively.
EMPLOYMENT AGREEMENTS
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ISMIE and the attorney-in-fact have entered into employment agreements
with each of the named executives which will be assumed by Holdings after the
conversion. These agreements are intended to secure for us the continued
services of those executive officers and to provide them appropriate incentives
for their maximum efforts. The compensation levels under the employment
agreements have been established by the Boards of ISMIE and the attorney-in-fact
based on the executive officer's value to the enterprise and competitive
considerations, including the fact that until now the companies have been unable
to offer any equity incentives to them for their efforts. The Boards of ISMIE
and the attorney-in-fact have engaged independent compensation consultants to
assist in determining appropriate levels of compensation and benefits for the
executives.
The current terms of the employment agreements for Messrs. Lerner,
Udstuen, Holden, Morse and Gross are effective through December 31, 2004, March
15, 2001, March 18, 2001, April 30, 2002 and June 30, 2001, respectively. In the
case of Mr. Lerner, unless otherwise determined by the Boards, his employment
will be extended by one year during each year of the initial seven year term so
that, after each extension, a seven year term remains. Thereafter, the term will
be extended on a year to year basis unless ISMIE and the attorney-in-fact give
notice to Mr. Lerner by September 1 that they will not renew the employment
agreement for another year. The employment agreements provide for a current base
compensation payable by ISMIE and the attorney-in-fact to Messrs. Lerner,
Udstuen, Holden, Morse and Gross of $440,099, $173,744, $151,628, $221,352 and
$198,759, respectively, with annual increases of not less than 8%, 7%, 7%, 4%
and 4%, respectively. Mr. Lerner's annual compensation for each of 1998, 1999
and 2000 includes a bonus amount of $214,356, plus additional amounts to cover
taxes on the bonus amount, which Mr. Lerner intends to use to repay a loan from
ISMIE. Mr. Lerner's annual compensation will be reduced by the amount of this
annual bonus and tax reimbursement beginning January 1, 2001.
The employment agreements require the executives to devote at least a
majority of their time to ISMIE and the attorney-in-fact. Each of the named
executives is also employed by the Medical Society and spends the balance of his
working hours on the affairs of the Medical Society. Mr. Lerner's employment
agreement provides that if his employment with the Medical Society or the
attorney-in-fact terminates for any reason, he will increase the time he devotes
to ISMIE by the additional time that becomes available due to his termination,
and ISMIE will increase his compensation by the amount of compensation that he
had earned from the Medical Society or the attorney-in-fact under his employment
agreement with the Medical Society or the attorney-in-fact, as the case may be.
In no event will the increase exceed the amount of compensation that Mr. Lerner
is then receiving from ISMIE.
Upon termination of any of the employment agreements by ISMIE and the
attorney-in-fact without cause, or by any of the executive officers for good
reason, as those terms are defined in their employment agreements, the executive
officer will be entitled to receive the aggregate value of his compensation and
benefits for the remaining term of his employment agreement or for a minimum of
two years if the remaining term is less than two years.
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COMPENSATION PLANS
DEFERRED COMPENSATION AGREEMENTS. ISMIE has entered into deferred
compensation agreements with its executive officers and other key employees,
including the named executive officers, which will be assumed by Holdings
following the conversion. The deferred compensation agreements provide for a
deferment of a portion of the employer's compensation and for distributions to
be made in the event of death, severance of affiliation with ISMIE, disability
or other time as ISMIE or the trustee under the trust maintained in connection
with the deferred compensation arrangements may determine. The right of a
participant to receive distributions under the deferred compensation agreements
may be forfeited for acts contrary to the interests of ISMIE or for
insubordination.
401(k) PLAN. ISMIE participates in a 401(k) plan which offers eligible
employees the opportunity to contribute to the 401(k) plan on a regular basis
through payroll deductions. Also, ISMIE may make discretionary contributions to
the 401(k) plan to be allocated among the employees' accounts on the basis of
their relative levels of compensation. The 401(k) plan's benefits are based on
amounts contributed and individual account investment performance. All full-time
employees of ISMIE who have completed one year of service and are over the age
of 21 years are eligible to participate in the 401(k) plan.
1999 LONG-TERM EQUITY INCENTIVE PLAN. Directors, officers and key
employees of ISMIE are eligible to participate in our 1999 Long-Term Equity
Incentive Plan adopted by Holdings in May, 1999. Except as otherwise specified
in the long-term plan, the plan is administered by the Stock Option Committee of
the Board of Directors. Under the long-term plan, participants may be granted
nonqualified stock options, incentive stock options, stock appreciation rights,
restricted stock, phantom stock and other stock-based awards. Up to 1,000,000
shares of common stock may be issued or sold under the long-term plan, but this
number may be adjusted. Under the long-term plan, nonqualified stock options may
be granted to participants to purchase shares of common stock of Holdings at an
option price of not less than 85% of the fair market value of a share of common
stock at the time the option is granted. Options granted under the long-term
plan terminate no later than ten years from the date of grant.
RELATED PARTY TRANSACTIONS
DIRECTORS AS POLICYHOLDERS. The members of the Holdings Board, except
Mr. Lerner and Mr. Udstuen, are also policyholders of ISMIE and are eligible to
receive common stock in the conversion. See "Ownership of Common Stock." These
directors may experience claims requiring coverage under their insurance
policies.
SERVICES AND OFFICE SPACE. ISMIE, the attorney-in-fact and the Medical
Society share various support services under a shared services agreement. The
shared services agreement will be assumed by Holdings following the conversion.
Currently, services covered by the agreement are office space, administrative,
human resources, public relations, membership services, communications, mail and
other miscellaneous services. The agreement has a term
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of five years and thereafter is automatically renewed on an annual basis. Any
party may terminate the agreement upon six month's prior notice. Under the
agreement, each party pays its pro rata share of the estimated cost of providing
the services based on the amount of services expected to be used by each party.
If actual usage of the services varies from expected usage, adjustments to the
rates may be negotiated by the parties.
LOANS TO EXECUTIVE OFFICERS. Messrs. Lerner, Udstuen and Holden are
indebted to ISMIE and the attorney-in-fact under loans which will be assumed by
Holdings following the conversion. The loans are secured by mortgages on the
executives' homes. The principal balance remaining on the loans at January 31,
1999 was $272,573, $102,672, and $466,751 for Messrs. Lerner, Udstuen and
Holden, respectively. The loans are evidenced by notes which bear interest at 6%
and mature in 2021, in the case of Messrs. Lerner and Udstuen, and in 2020 in
the case of Mr. Holden (a portion of Mr. Holden's loan matures in 2024). ISMIE
believes the terms of the loans are substantially equivalent to what the
officers could have obtained from unaffiliated third parties.
OWNERSHIP OF COMMON STOCK
The following table sets forth information regarding beneficial
ownership of Holdings common stock as of the completion of the conversion by (i)
each director and executive officer named in the Summary Compensation Table and
(ii) all directors and executive officers of Holdings as a group. No person will
own more than 5% of the outstanding shares of common stock. The number of shares
of common stock beneficially owned by each physician director represents the
number of shares the director and persons and entities affiliated with the
director are expected to receive as eligible members under the terms of the
conversion. Except as noted below, each holder listed will have sole investment
and voting power with respect to the shares beneficially owned by the holder.
The address for all stockholders listed in the table is c/o ISMIE Holdings Inc.,
20 North Michigan Avenue, Suite 700, Chicago, Illinois 60602-4890.
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NUMBER OF SHARES
EXPECTED TO BE PERCENT
NAME BENEFICIALLY OWNED OF TOTAL
- ---- ------------------ --------
Harold L. Jensen, M.D...................... *
Walter Whisler, M.D........................ *
Alexander R. Lerner........................ -0- -0-
Donald A. Udstuen.......................... -0- -0-
Jeffrey M. Holden.......................... -0- -0-
Eugene J. Gross............................ -0- -0-
Saul J. Morse.............................. -0- *
Irwin A. Smith, M.D........................ *
Peter A. Brusca, M.D....................... *
Richard A. Geline, M.D..................... *
Henri S. Havdala, M.D...................... *
Robert M. Reardon, M.D..................... *
Jane Jackman, M.D.......................... *
All directors and executive officers
as a group (13 persons).................... *
--------
* Less than one percent
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DESCRIPTION OF CAPITAL STOCK
GENERAL
Upon completion of the conversion, the authorized capital stock of
Holdings will consist of 40,000,000 shares of common stock, $0.01 par value per
share, and 5,000,000 shares of preferred stock, par value $0.01 per share, the
rights, preferences and powers of which may be designated by the Holdings Board.
At present, there are no shares of preferred stock issued or outstanding.
The following description sets forth the significant aspects of the
capital stock of Holdings should not be considered to be complete or to give
full effect to Delaware statutory or common law and is, in all respects,
qualified by reference to the applicable provisions of the DGCL, and the
certificate of incorporation and the bylaws of Holdings.
COMMON STOCK
Holders of shares of common stock have one vote per share on matters to
be voted upon by the stockholders and, except for the prior rights of the
holders of preferred stock, to receive dividends ratably when and as declared by
the Holdings Board out of legally available funds. Stockholders are also
entitled to share ratably in the assets of Holdings legally available for
distribution to the stockholders in the event of liquidation or dissolution,
after payment of all debts and other liabilities. Holders of the common stock do
not have preemptive rights and will have no subscription, redemption or
conversion privileges. The common stock does not have cumulative voting rights,
which means the holder or holders of more than one-half of the shares of common
stock voting for the election of directors can elect all of the directors then
being elected. All of the shares of common stock to be issued in the conversion
when issued will be fully paid and nonassessable. The rights, preferences and
powers of holders of common stock are secondary to the rights of the holders of
shares of any series of preferred stock which Holdings may issue in the future.
Pursuant to Section 160 of the DGCL, ISMIE Indemnity Company will not be
entitled to vote the shares of common stock issued to it in the conversion. See
"The Conversion -- Additional Aspects of the Conversion and the Merger Agreement
- -Issuance of Shares to ISMIE Indemnity Company."
PREFERRED STOCK
The Holdings Board will have the authority, without further stockholder
approval, to issue up to 5,000,000 shares of preferred stock in one or more
series and to determine the dividend rights, any conversion rights or rights of
exchange, voting powers, rights and terms of redemption (including sinking fund
provisions), liquidation preferences and any other rights, preferences, powers
and restrictions. The number of shares constituting a series of preferred stock
and the designation must be stated in a resolution or resolutions providing for
the issuance of the series of preferred stock in accordance with the laws of the
State of Delaware.
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The issuance of preferred stock may have the effect of delaying,
deferring or preventing a change in control of Holdings, making removal of the
present management more difficult, restricting the payment of dividends and
other distributions to the holders of common stock, diluting the voting power of
the common stock to the extent that the preferred stock has voting rights or
diluting the equity interests of the common stock to the extent that the
preferred stock is convertible into common stock. In addition, issuance of
preferred stock, while providing desirable flexibility in connection with
possible acquisitions and other corporate purposes, could make it more difficult
for a third party to acquire a majority of the outstanding shares of voting
stock. Accordingly, the issuance of preferred stock may be used as an
"anti-takeover" device without further action on the part of the stockholders of
Holdings.
STATUTORY, CHARTER AND BYLAW PROVISIONS WHICH COULD HAVE AN ANTI-TAKEOVER EFFECT
The following is a description of provisions of the DGCL, Illinois law
and the certificate of incorporation and bylaws of Holdings which could have an
anti-takeover effect. This summary should not be considered complete and should
be read with reference to the complete text of the DGCL, the certificate of
incorporation and the bylaws.
Holdings is governed by the provisions of Section 203 of the DGCL.
Section 203 of the DGCL prohibits a publicly held Delaware corporation from
engaging in a "business combination" with an "interested stockholder" for a
period of three years after the time that the person became an "interested
stockholder," unless the business combination is approved in a prescribed
manner. A "business combination" includes mergers, asset sales and other
transactions resulting in a financial benefit to the "interested stockholder."
Subject to exceptions, an "interested stockholder" is a person who, together
with affiliates and associates, owns, or within the past three years did own,
15% of the corporation's voting stock.
Illinois Insurance laws and regulations provide that no person may
acquire control of Holdings, and thus indirect control of its insurance
subsidiary, ISMIE Indemnity Company, unless the person has obtained the prior
approval of the Illinois Director of Insurance. Under Illinois law, any
purchaser of 10% or more of the voting stock of an insurance holding company is
presumed to have acquired control of affiliated or subsidiary insurers and is
required to obtain the approval of the Illinois Director of Insurance before
consummating the purchase.
Some provisions of the Certificate of incorporation and bylaws could
have anti-takeover effects. These provisions are intended to improve the
likelihood of continuity and stability in the composition of the policies
formulated by the Holdings Board. In addition, these provisions also are
intended to ensure that the Holdings Board will have sufficient time to act in
what the Board of directors believes to be in the best interests of ISMIE and
its stockholders. These provisions also are designed to reduce the vulnerability
of Holdings to an unsolicited proposal for a takeover that does not contemplate
the acquisition of all of its outstanding shares or an unsolicited proposal for
the restructuring or sale of all or part of Holdings. The provisions are also
intended to discourage tactics that may be used in proxy fights. However, these
provisions could delay or frustrate the removal of incumbent directors
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or the assumption of control of Holdings by the holder of a large block of
common stock, and could also discourage or make more difficult a merger, tender
offer or proxy contest, even if the event would be favorable to the interest of
stockholders.
CLASSIFIED BOARD OF DIRECTORS. The certificate of incorporation
provides for the Holdings Board to be divided into three classes of directors,
with each class as nearly equal in number as possible, serving staggered
three-year terms (other than directors which may be elected by holders of
preferred stock). As a result, approximately one-third of the Holdings Board
will be elected each year. The classified board provision will help to assure
the continuity and stability of the Holdings Board and the business strategies
and policies of Holdings as determined by the Holdings Board. The classified
board provision could have the effect of discouraging a third party from making
an unsolicited tender offer or otherwise attempting to obtain control of
Holdings without the approval of the Holdings Board. In addition, the classified
board provision could delay stockholders who oppose the policies of the Holdings
Board from electing a majority of the Holdings Board for two years.
NO STOCKHOLDER ACTION BY WRITTEN CONSENT; SPECIAL MEETINGS. The
certificate of incorporation provides that stockholder action can be taken only
at an annual or special meeting of stockholders and prohibits stockholder action
by written consent in lieu of a meeting. The certificate of incorporation also
provides that special meetings of stockholders may be called only by the
President or Secretary at the request of a majority of the Holdings Board, or by
the Chairman. Stockholders are not permitted to call a special meeting of
stockholders or to require that the Holdings Board call a special meeting.
ADVANCE NOTICE REQUIREMENTS FOR STOCKHOLDER PROPOSALS AND DIRECTOR
NOMINEES. The certificate of incorporation establishes an advance notice
procedure for stockholders to make nominations of candidates for election as
directors or to bring other business before an annual meeting of stockholders of
Holdings. The stockholder notice procedure provides that only persons who are
nominated by, or at the direction of, the Holdings Board, or by a stockholder
who is entitled to vote at the meeting and who has given timely written notice
to the Secretary of Holdings prior to the meeting at which directors are to be
elected, will be eligible for election as directors. The stockholder notice
procedure also provides that at an annual meeting only the business may be
conducted as has been brought before the meeting by, or at the direction of, the
Holdings Board or by a stockholder who is entitled to vote at the meeting and
who has given timely written notice to the Secretary of the stockholder's
intention to bring the business before the meeting. Under the stockholder notice
procedure, if a stockholder desires to submit a proposal or nominate persons for
election as directors at an annual meeting, the stockholder must submit written
notice to Holdings not less than 60 days nor more than 90 days prior to the
first anniversary of the previous year's annual meeting. In addition, under the
stockholder notice procedure, a stockholder's notice to Holdings proposing to
nominate a person for election as a director or relating to the conduct of
business other than the nomination of directors must contain specified
information. If the chairman of a meeting determines that business was not
properly brought before the meeting, in accordance with the stockholder notice
procedure, that business shall not be discussed or transacted.
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NUMBER OF DIRECTORS; REMOVAL; FILLING VACANCIES. The certificate of
incorporation provides that the Holdings Board will consist of not less than
three and not more than fifteen members (other than directors elected by holders
of preferred stock), the exact number to be fixed from time to time by
resolution adopted by the directors of Holdings. The Holdings Board currently
consists of ten directors. Further, unless affected by the rights of the holders
of any series of preferred stock then outstanding, the certificate of
incorporation authorizes the Holdings Board to fill newly created directorships.
If a number of vacancies existed in the Holdings Board, this provision could
delay the ability of a stockholder from obtaining majority representation on the
Holdings Board by permitting the Holdings Board to enlarge the Holdings Board in
certain circumstances and fill the new directorships with its own nominees. A
director so elected by the Holdings Board holds office until the next election
of the class for which the director has been chosen and until his successor is
elected and qualified. Subject to the rights of the holders of any series of
preferred stock then outstanding, the certificate of incorporation also provides
that directors may be removed only for cause and only by the favorable vote of
holders of two-thirds of the outstanding shares of voting securities. The effect
of these provisions is to preclude a stockholder from removing incumbent
directors without cause and simultaneously gaining control of the Holdings Board
by filling the vacancies created by the removal with its own nominees.
EXCULPATION; INDEMNIFICATION. Holdings has included in its certificate
of incorporation provisions to (i) eliminate the personal liability of its
directors for monetary damages resulting from breaches of their fiduciary duty
to the extent permitted by the DGCL and (ii) indemnify its directors and
officers to the fullest extent permitted by Section 145 of the DGCL, including
circumstances in which indemnification is otherwise discretionary. We believe
that these provisions are necessary to attract and retain qualified persons as
directors and officers.
BYLAWS. The certificate of incorporation provides that the directors
shall have concurrent power with the stockholders to make, alter, amend, change,
add or repeal the bylaws.
TRANSFER AGENT AND REGISTRAR
______________ has been appointed as the transfer agent and registrar
for the common stock.
LEGAL MATTERS
The validity of the common stock to be issued in the conversion will be
passed on for us by our counsel, Lord, Bissell & Brook.
EXPERTS
The consolidated financial statements of the Illinois State Medical
Inter-Insurance Exchange and subsidiary at December 31, 1998 and 1997, and for
each of the three years in the period ended December 31, 1998 and the balance
sheet of ISMIE Holdings Inc. at April 14,
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1999 appearing in this proxy statement/prospectus and registration statement
have been audited by Ernst & Young LLP, independent auditors, as set forth in
their reports thereon, appearing elsewhere in this document, and are included in
reliance upon the reports given the authority of that firm as experts in
accounting and auditing.
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GLOSSARY OF SELECTED INSURANCE TERMS
Cede To transfer risk and related premium in
connection with a reinsurance transaction.
Claims made and reported basis A liability insurance policy written on a
basis that generally insures only claims
that are reported to the insurer during the
policy period, or reported during any
extended reporting period provided in the
policy or any endorsement to the policy, but
only if the claims arise from incidents that
occurred after a retroactive date stated in
the policy. A claims made and reported
policy is to be distinguished from an
"occurrence policy" which generally insures
claims that arise from incidents that
occurred during the policy period
irrespective of when the claims are
reported.
Combined ratio The sum of the loss ratio and the expense
ratio expressed as a percentage.
Generally, a combined ratio below 100%
indicates an underwriting profit and a
combined ratio above 100% indicates an
underwriting loss.
Direct premiums written Total premiums written by an insurer
other than premiums for reinsurance
assumed by an insurer.
Excess of loss reinsurance A generic term describing reinsurance
that indemnifies the reinsured against
all or a specified portion of losses on
underlying insurance policies in excess
of a specified dollar amount, called a
"layer" or "retention."
Expense ratio Policy acquisition costs and other
underwriting expenses, divided by net
premiums earned under GAAP accounting or
by net premiums written under statutory
accounting, expressed as a percentage.
Frequency Refers to the rate of occurrence. The number
of times a claim or a loss by a specific
peril occurs to a given body of exposures or
insureds during a particular time period.
GAAP Generally accepted accounting principles in
use throughout the United States in the
preparation of financial statements,
including the financial statements presented
in this proxy statement/prospectus.
G-1
<PAGE>
Incurred but not reported The estimated liabilities for future
(IBNR) reserves payments of losses and loss adjustment
expense that have occurred, but
have not yet been reported to the insurer.
Loss adjustment expense (LAE) Expenses incurred in the settlement of
claims, including outside adjustment
expenses, legal fees and internal
administration costs associated with the
claims adjustment process, but not
including general overhead expenses.
Loss adjustment expense reserves Liabilities established for loss adjustment
expense. Loss adjustment expense includes an
estimated provision for incurred but not
reported losses.
Loss ratio The ratio of net incurred losses and loss
adjustment expense to net premiums
earned. Net incurred losses include an
estimated provision for incurred but not
reported losses.
Net premiums written Gross premiums written less premiums ceded.
Premiums ceded The consideration paid to reinsurers
in connection with reinsurance transactions.
Premiums earned The portion of premiums written
applicable the expired period of policies
and, accordingly, recognized as revenue
during a given period.
Quota share basis Reinsurance wherein the insurer
cedes an agreed fixed percentage of
liabilities, premiums and losses for each
policy covered on a pro rata basis.
Redundancy (deficiency) Estimates in reserves change as more
information becomes known about the
frequency and severity of claims for each
year. A redundancy (deficiency) exists when
the original liability estimate is greater
(less) than the reestimated liability. The
cumulative redundancy (deficiency) is the
aggregate net change in estimates over time
subsequent to establishing the original
liability estimate.
Reinsurance A procedure whereby an original insurer
cedes a portion of the premium to a
reinsurer as payment for the reinsurer's
assumption of a portion of the risk;
referred
G-2
<PAGE>
to as reinsurance ceded by the original
insurer and as reinsurance assumed by the
reinsurer.
Reserves Liabilities established by insurers to
reflect the estimated cost of claims and the
related LAE expenses that the insurer will
ultimately be required to pay in respect of
insurance it has written.
Retention The amount or portion of risk that an
insurer retains for its own account. Losses
in excess of the retention level are paid by
the reinsurer. In quota share treaties, the
retention may be a percentage of the
original policy's limit. In excess of loss
reinsurance, the retention is a dollar
amount of loss, a loss ratio or a percentage
of loss.
Risk-Based Capital (RBC) Regulatory and rating agency targeted
Requirements surplus based on the relationship of
statutory surplus, with certain adjustments,
to the sum of slated percentages of each
element of a specified list of company risk
exposures.
Severity The average claim cost, statistically
determined by dividing dollars of losses by
the number of claims.
Statutory Accounting Practices The accounting rules and procedures
(SAP) promulgated or permitted by the National
Association of Insurance Commissioners
(NAIC) for financial reporting by insurers
licensed in one or more states of the United
States.
Statutory surplus Total assets less total liabilities
as determined in accordance with SAP.
Underwriting The process whereby an insurer, directly or
through its agent, reviews applications
submitted for insurance coverage and
determines whether it will accept all or
part of the coverage being requested, and
the applicable premium.
G-3
<PAGE>
ISMIE Holdings, Inc.
April 14, 1999
<TABLE>
<CAPTION>
CONTENTS
<S> <C>
Report of Independent Auditors................................................F-2
Balance Sheet.................................................................F-3
Note to Balance Sheet.........................................................F-4
</TABLE>
F-1
<PAGE>
Report of Independent Auditors
Board of Directors
ISMIE Holdings Inc.
We have audited the accompanying balance sheet of ISMIE Holdings Inc. as of
April 14, 1999. This balance sheet is the responsibility of the Company's
management. Our responsibility is to express an opinion on this balance sheet
based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the balance sheet is free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the balance sheet. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall balance sheet presentation. We believe that our audit
provides a reasonable basis for our opinion.
In our opinion, the balance sheet referred to above presents fairly, in all
material respects, the financial position of ISMIE Holdings Inc. as of April 14,
1999, in conformity with generally accepted accounting principles.
/s/ Ernst & Young LLP
Chicago, Illinois
April 14, 1999
F-2
<PAGE>
ISMIE Holdings, Inc.
Balance Sheet
April 14, 1999
<TABLE>
<CAPTION>
ASSETS
<S> <C>
Investment in subsidiary $1,000
--------------------
Total assets $1,000
--------------------
--------------------
STOCKHOLDER'S EQUITY
Preferred stock, $.01 par value, 5,000,000 shares authorized;
no shares issued and outstanding $ -
Common stock, $.01 par value, 40,000,000 shares authorized; 100,000 shares issued
and outstanding 1,000
--------------------
Total stockholder's equity $1,000
--------------------
--------------------
SEE ACCOMPANYING NOTE.
</TABLE>
F-3
<PAGE>
ISMIE Holdings, Inc.
Note to Balance Sheet
April 14, 1999
1. ORGANIZATION
ISMIE Holdings Inc. (ISMIE Holdings) is a Delaware corporation that is a wholly
owned subsidiary of Illinois State Medical Inter-Insurance Exchange (Exchange).
ISMIE Holdings has no historic operations and was organized in April 1999 as
part of the Exchange's plan to reorganize its corporate structure.
In April 1999, ISMIE Holdings acquired the outstanding stock of ISMIE Indemnity
Company, a newly organized Illinois stock insurer.
2. RELATED PARTIES
Certain of the members of the ISMIE Holdings Board of Directors are also
policyholders of the Exchange and eligible to receive Common Stock of ISMIE
Holdings. These directors may experience claims requiring coverage under their
respective insurance policies.
F-4
<PAGE>
Illinois State Medical Inter-Insurance Exchange and Subsidiary
Index to Consolidated Financial Statements
CONTENTS
<TABLE>
<S> <C>
Report of Independent Auditors......................................................F-6
Consolidated Balance Sheets as of December 31, 1998, 1997 and as of
March 31, 1999...................................................................F-7
Consolidated Statements of Income for the years ended December 31, 1998,
1997, 1996, and for the three months ended March 31, 1999 and 1998...............F-8
Consolidated Statements of Changes in Members' Equity for the years ended
December 31, 1998, 1997, 1996, and for the three months ended March 31, 1999.....F-9
Consolidated Statements of Cash Flows for the years ended December 31, 1998,
1997, 1996, and for the three months ended March 31, 1999 and 1998...............F-10
Notes to Consolidated Financial Statements..........................................F-11
</TABLE>
F-5
<PAGE>
Report of Independent Auditors
Board of Governors
Illinois State Medical Inter-Insurance Exchange
We have audited the accompanying consolidated balance sheets of the Illinois
State Medical Inter-Insurance Exchange and subsidiary as of December 31, 1998
and 1997, and the related consolidated statements of income, changes in members'
equity, and cash flows for each of the three years in the period ended December
31, 1998. These financial statements are the responsibility of the Companies'
management. Our responsibility is to express an opinion on these 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 financial statements referred to above present fairly, in
all material respects, the consolidated financial position of the Illinois State
Medical Inter-Insurance Exchange and subsidiary at December 31, 1998 and 1997,
and the consolidated 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.
/s/ Ernst & Young LLP
March 1, 1999,
except for Note 12, as to which the date is
May 5, 1999
F-6
<PAGE>
Illinois State Medical Inter-Insurance Exchange and Subsidiary
Consolidated Balance Sheets
(IN THOUSANDS)
<TABLE>
<CAPTION>
MARCH 31 DECEMBER 31
1999 1998 1997
---------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Investments (NOTE 3):
Fixed maturities - At fair value (amortized cost:
1999 - $814,621; 1998 - $799,135; 1997 - $728,838) $ 821,424 $ 820,191 $ 736,816
Equity securities - At fair value (cost: 1999 -
$18,993; 1998 - $15,975) 22,241 17,969 --
Other invested assets 10,230 10,581 11,422
---------- ---------- ----------
853,895 848,741 748,238
Cash and cash equivalents 39,668 38,920 39,095
Premiums receivable 10,422 9,134 12,015
Accrued investment income 9,180 10,957 9,721
Income taxes recoverable 3,373 3,373 12,605
Reinsurance receivables (NOTE 7) 227,074 232,613 335,426
Funds held by reinsurers 9,951 9,290 25,797
Deferred income taxes (NOTE 4) 38,148 32,682 37,200
Other assets (NOTE 5) 25,721 25,718 26,409
---------- ---------- ----------
$1,217,432 $1,211,428 $1,246,506
---------- ---------- ----------
---------- ---------- ----------
LIABILITIES AND MEMBERS' EQUITY
Liabilities:
Losses and loss adjustment expenses (NOTES 6 AND 7) $ 895,835 $ 895,275 $ 946,082
Unearned premiums 21,579 24,343 22,126
Funds held for or payable to reinsurers 15,089 15,461 25,617
Accrued expenses and other liabilities (NOTE 5) 24,080 24,626 23,415
Income taxes payable 1,938 888 455
Advanced premiums billed but not collected 9,295 8,145 8,642
Payable for securities 11,840 -- --
---------- ---------- ----------
979,656 968,738 1,026,337
Commitments and contingencies (NOTES 7 AND 10)
Members' equity:
Unassigned members' equity 231,242 227,707 214,982
Accumulated other comprehensive income 6,534 14,983 5,187
---------- ---------- ----------
237,776 242,690 220,169
---------- ---------- ----------
$1,217,432 $1,211,428 $1,246,506
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
SEE ACCOMPANYING NOTES.
F-7
<PAGE>
Illinois State Medical Inter-Insurance Exchange and Subsidiary
Consolidated Statements of Income
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS YEAR ENDED
ENDED MARCH 31 DECEMBER 31
1999 1998 1998 1997 1996
--------- --------- --------- --------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
INCOME
Premiums earned $ 35,788 $ 28,479 $ 131,998 $ 97,667 $ 85,817
Net investment income 12,067 11,456 45,361 46,663 46,436
Net realized gains (losses) on investments (NOTE 3) 283 13 (104) (401) 2,406
Other income -- -- 5,095 -- --
--------- --------- --------- --------- ---------
48,138 39,948 182,350 143,929 134,659
LOSSES AND EXPENSES
Losses and loss adjustment expenses 40,221 32,884 153,660 117,816 105,403
Other underwriting expenses 4,249 3,571 16,222 10,878 6,296
--------- --------- --------- --------- ---------
44,470 36,455 169,882 128,694 111,699
--------- --------- --------- --------- ---------
Income before income taxes 3,668 3,493 12,468 15,235 22,960
Income taxes (credit) (NOTE 4):
Current 1,050 1,050 500 3,900 --
Deferred (917) (970) (757) (7,106) 19,541
--------- --------- --------- --------- ---------
133 80 (257) (3,206) 19,541
--------- --------- --------- --------- ---------
Net income $ 3,535 $ 3,413 $ 12,725 $ 18,441 $ 3,419
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Earnings per share (pro forma) - Unaudited (NOTE 12) $ .35 $ .34 $ 1.27
--------- --------- ---------
--------- --------- ---------
</TABLE>
SEE ACCOMPANYING NOTES.
F-8
<PAGE>
Illinois State Medical Inter-Insurance Exchange and Subsidiary
Consolidated Statements of Changes in Members' Equity
(IN THOUSANDS)
<TABLE>
<CAPTION>
ACCUMULATED
UNASSIGNED OTHER
MEMBERS' COMPREHENSIVE
EQUITY INCOME (LOSS) TOTAL
-------- ------------- ---------
<S> <C> <C> <C>
BALANCE AT DECEMBER 31, 1995 $193,122 $ 7,847 $ 200,969
1996 activity:
Net income 3,419 -- 3,419
Other comprehensive income:
Change in unrealized loss on
investments, net of tax -- (11,052) (11,052)
---------
Comprehensive loss -- -- (7,633)
-------- --------- ---------
BALANCE AT DECEMBER 31, 1996 196,541 (3,205) 193,336
1997 activity:
Net income 18,441 -- 18,441
Other comprehensive income:
Change in unrealized gain on
investments, net of tax -- 8,392 8,392
---------
Comprehensive income -- -- 26,833
-------- --------- ---------
BALANCE AT DECEMBER 31, 1997 214,982 5,187 220,169
1998 activity:
Net income 12,725 -- 12,725
Other comprehensive income:
Change in unrealized gain on
investments, net of tax -- 9,796 9,796
---------
Comprehensive income -- -- 22,521
-------- --------- ---------
BALANCE AT DECEMBER 31, 1998 227,707 14,983 242,690
1999 activity (unaudited):
Net income 3,535 -- 3,535
Other comprehensive income:
Change in unrealized gain on
investments, net of tax -- (8,449) (8,449)
---------
Comprehensive loss -- -- (4,914)
-------- --------- ---------
BALANCE AT MARCH 31, 1999 (UNAUDITED)
$231,242 $ 6,534 $ 237,776
-------- --------- ---------
-------- --------- ---------
</TABLE>
SEE ACCOMPANYING NOTES.
F-9
<PAGE>
Illinois State Medical Inter-Insurance Exchange and Subsidiary
Consolidated Statements of Cash Flows
(IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS
ENDED MARCH 31 YEAR ENDED DECEMBER 31
1999 1998 1998 1997 1996
-------- -------- --------- --------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net income $ 3,535 $ 3,413 $ 12,725 $ 18,441 $ 3,419
Adjustments to reconcile net income to net cash provided by
(used in) operating activities:
Deferred income tax (917) (970) (757) (7,106) 19,541
Amortization of net premium on investments 250 344 1,381 1,724 2,185
Net realized (gains) losses on investments (283) (13) 104 401 (2,406)
Decrease in book value of other invested assets 41 41 166 166 176
(Increase) decrease in receivables and other assets 5,364 (873) 121,656 43,470 (20,444)
Increase (decrease) in unpaid losses and loss adjustment
expenses 560 (1,698) (50,807) (34,135) (41,430)
Increase (decrease) in unearned premiums, funds held for or
payable to reinsurers, advanced premiums billed but not
collected, accrued expenses and other liabilities, and
payable for securities 9,308 1,593 (7,223) (29,986) (27,792)
Increase in income taxes payable, net of amounts
recoverable 1,050 1,397 9,665 3,538 2,776
-------- -------- --------- --------- ---------
Net cash provided by (used in) operating activities 18,908 3,234 86,910 (3,487) (63,975)
INVESTING ACTIVITIES
Purchase of investments (96,976) (69,573) (302,135) (128,722) (120,049)
Proceeds from sale or maturity of investments 78,816 61,827 215,052 150,397 183,932
-------- -------- --------- --------- ---------
Net cash provided by (used in) investing activities (18,160) (7,746) (87,083) 21,675 63,883
FINANCING ACTIVITIES - OTHER -- -- (2) (8) (284)
-------- -------- --------- --------- ---------
Increase (decrease) in cash and cash equivalents 748 (4,512) (175) 18,180 (376)
Cash and cash equivalents, at beginning of period 38,920 39,095 39,095 20,915 21,291
-------- -------- --------- --------- ---------
Cash and cash equivalents, at end of period $ 39,668 $ 34,583 $ 38,920 $ 39,095 $ 20,915
-------- -------- --------- --------- ---------
-------- -------- --------- --------- ---------
</TABLE>
SEE ACCOMPANYING NOTES
F-10
<PAGE>
Illinois State Medical Inter-Insurance Exchange and Subsidiary
Notes to Consolidated Financial Statements
1. ORGANIZATION AND OPERATIONS
The Illinois State Medical Inter-Insurance Exchange (Exchange) provides
comprehensive professional liability insurance to Illinois physicians. The
Exchange is an inter-insurance exchange, or reciprocal, formed under the
Illinois Insurance Code. An inter-insurance exchange is an organization under
which policyholders "exchange" insurance contracts and thereby insure each other
and become members of the Exchange. The Exchange is managed under contract by
Illinois State Medical Insurance Services, Inc. (Services), which was formed on
July 1, 1998, as a wholly owned subsidiary of the Exchange, subject to the
general supervision of the Exchange's Board of Governors. Prior to July 1, 1998,
the Exchange was managed by an affiliated entity, Illinois Medical Physician
Insurance Services, Inc. (IMPIS), which is a wholly owned subsidiary of the
Illinois State Medical Society (Society). Services and IMPIS are compensated by
the Exchange on a cost-reimbursement basis. The Exchange and Services were
organized solely for the purpose of providing insurance for Illinois physicians.
Generally, the Exchange has not been operated to generate a profit. Earnings
that the Exchange has generated through its history have been used to write
additional business and absorb losses. The Exchange was organized with capital
contributed by members in the form of guaranty fund certificates. These
certificates were redeemed before 1989.
Since July 1, 1986, all insurance policies issued by the Exchange are on a
"claims made" basis and provide coverage for the policyholder for claims first
made against the policyholder and reported to the Exchange during the policy
period for claims which occurred on or after the retroactive date stated in the
policy. Prior to July 1986, all insurance policies issued by the Exchange were
on an "occurrence" basis and provided coverage for the policyholder for claims
incurred during the policy period regardless of when the claims were reported to
the Exchange. The Exchange also provides, upon payment of an additional premium,
a reporting endorsement that extends the period in which claims otherwise
covered by the "claims made" policy may be reported to the Exchange. In the
event of death or permanent disability of a policyholder, the reporting
endorsement is issued without additional premium. Upon retirement of a
policyholder, as defined in the policy, the policyholder may be eligible for a
credit toward the additional premium for the reporting endorsement calculated at
one-ninetieth of the additional premium for each consecutive month that the
policyholder was insured by the Exchange. In no event will the credit exceed
100% of the additional premium. The Exchange establishes reserves to fund the
reporting endorsements that are issued without additional premium or with
reduced premiums.
F-11
<PAGE>
Illinois State Medical Inter-Insurance Exchange and Subsidiary
Notes to Consolidated Financial Statements (continued)
2. ACCOUNTING POLICIES
BASIS OF PRESENTATION
The accompanying consolidated financial statements include the financial
statements of the Exchange, Services (since date of inception) and IMPIS (prior
to July 1, 1998), collectively, the "Company." These financial statements have
been prepared in conformity with generally accepted accounting principles. All
transactions between the Exchange, Services, and IMPIS have been eliminated in
the preparation of the consolidated financial statements.
USE OF ESTIMATES
The preparation of the consolidated financial statements of the Company requires
management to make estimates and assumptions that affect amounts reported in the
financial statements and accompanying notes. Actual results could differ from
those estimates and assumptions, and such differences may be material to the
financial statements.
INVESTMENTS
The Company has designated its entire fixed-maturities and equity securities
portfolio as available-for-sale. These available-for-sale investments are
carried at fair value. Changes in fair value for these investments, after
adjustment for deferred income taxes, are reported as other comprehensive income
directly in members' equity.
Fair values for fixed maturities and equity securities are based on quoted
market prices, or, if they are not actively traded, on estimated values
obtained from independent pricing services. Realized gains or losses are
determined on the basis of specific identification and are included in the
determination of net income or loss. The discount or premium on investments
is amortized using the interest method.
LOSSES AND LOSS ADJUSTMENT EXPENSES
The liability for losses and loss adjustment expenses represents an estimate of
the ultimate net cost of all such amounts that are unpaid at the balance sheet
dates. The Company does not discount the liability for losses and loss
adjustment expenses. The liability is based on loss and loss adjustment expense
factors determined by independent consulting actuaries using statistical
analyses and projections and the historical loss experience of the Company, and
gives effect to estimates of trends in claim severity and
F-12
<PAGE>
Illinois State Medical Inter-Insurance Exchange and Subsidiary
Notes to Consolidated Financial Statements (continued)
2. ACCOUNTING POLICIES (CONTINUED)
frequency. These estimates are continually reviewed and, as adjustments become
necessary, such adjustments are included in current operations. Although
management believes that the estimate of the liability for losses and loss
adjustment expenses is reasonable in the circumstances, it is possible that the
actual incurred losses and loss adjustment expenses will not conform to the
assumptions inherent in the determination of the liability. Accordingly, the
ultimate settlement of losses and the related loss adjustment expenses may vary
significantly from the estimated amounts included in the financial statements.
PREMIUMS
Premiums are earned ratably over the policy period to which they apply. Net
premiums written totaled $134,215,000, $104,953,000, and $85,532,000 in 1998,
1997, and 1996, respectively.
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. Premiums ceded to other companies have been
reported as a reduction of premium revenue. Reinsurance receivables are reported
as assets in the accompanying consolidated balance sheets. There are no
restrictions on the funds paid to or held for reinsurers.
DEFERRED POLICY ACQUISITION COSTS
Policy acquisition costs (primarily commissions and beginning in 1998, the
Illinois privilege tax), which vary with and are directly related to the
production of business, are capitalized and amortized over the effective period
of the related policies. Included in other underwriting expenses were policy
acquisition costs of $1,188,000 and $898,000 for the three months ended March
31, 1999 and 1998, and $3,413,000, $2,253,000, and $1,303,000 for the years
ended December 31, 1998, 1997, and 1996, respectively.
There were no unamortized policy acquisition costs at any of the balance sheet
dates.
OTHER INCOME
During 1998, the Company received $5,095,000 representing interest on federal
income taxes recoverable from prior tax years.
F-13
<PAGE>
Illinois State Medical Inter-Insurance Exchange and Subsidiary
Notes to Consolidated Financial Statements (continued)
2. ACCOUNTING POLICIES (CONTINUED)
CASH AND CASH EQUIVALENTS
Cash and cash equivalents includes cash balances and investments with initial
maturities of three months or less.
FINANCIAL INSTRUMENTS
The fair values of investments are reported in Note 3. The fair values of other
financial instruments approximate their carrying values at the balance sheet
dates.
SEGMENT INFORMATION
In 1997, the Financial Accounting Standards Board (FASB) issued Statement No.
131, "Disclosures about Segments of an Enterprise and Related Information,"
which became effective on December 31, 1998. The Company operates in only one
reportable industry segment and therefore Statement No. 131 did not require
disclosure of any significant information beyond that previously provided in the
Company's consolidated financial statements.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued Statement No. 133, "Accounting for Derivative
Instruments and Hedging Activities." The Company plans to adopt Statement No.
133 on the effective date. Statement No. 133 provides a comprehensive and
consistent standard for the recognition and measurement of derivatives and
hedging activities. The Company does not anticipate that the adoption of this
Statement will have a significant effect on its results of operations or
financial position.
In 1998, the Accounting Standards Executive Committee of the AICPA issued
Statement of Position 98-1 (SOP 98-1), "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use," SOP 98-1, which has been
adopted prospectively as of January 1, 1999, requires the capitalization of
certain costs incurred in connection with developing or obtaining internal use
software. Prior to the adoption of SOP 98-1, the Company expensed all internal
use software related costs as incurred. The effect of adopting SOP 98-1 was not
material to the Company's consolidated operating results.
F-14
<PAGE>
Illinois State Medical Inter-Insurance Exchange and Subsidiary
Notes to Consolidated Financial Statements (continued)
2. ACCOUNTING POLICIES (CONTINUED)
UNAUDITED INTERIM INFORMATION
The accompanying financial statements and notes as of March 31, 1999 and for the
three months ended March 31, 1998 and 1999 are unaudited. In the opinion of
management, such information contains all adjustments, consisting only of normal
recurring adjustments, necessary for a fair presentation of the Company's
financial statements. The results of operations for the interim period are not
necessarily indicative of results that may be expected for the entire year.
3. INVESTMENTS
The amortized cost, gross unrealized gains and losses, and fair value of
investments in fixed maturities and equity securities are summarized as follows:
<TABLE>
<CAPTION>
COST OR GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
-------- -------- --------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
AT MARCH 31 , 1999 (UNAUDITED)
Fixed maturity securities:
U.S. government obligations $157,137 $ 2,874 $ (1,148) $158,863
Corporate securities 356,582 4,820 (2,012) 359,390
Mortgage-backed and other
asset-backed securities 288,599 3,100 (969) 290,730
States, territories, and
possessions 6,691 124 -- 6,815
Public utilities 5,612 14 -- 5,626
-------- -------- --------- --------
Total fixed maturities 814,621 10,932 (4,129) 821,424
Total equity securities 18,993 3,507 (259) 22,241
-------- -------- --------- --------
$833,614 $ 14,439 $ (4,388) $843,665
-------- -------- --------- --------
-------- -------- --------- --------
AT DECEMBER 31, 1998
Fixed maturity securities:
U.S. government obligations $155,165 $ 5,848 $ (7) $161,006
Corporate securities 345,733 10,965 (119) 356,579
Mortgage-backed and other
asset-backed securities 285,930 4,191 (190) 289,931
States, territories, and
possessions 6,691 319 -- 7,010
Public utilities 5,616 49 -- 5,665
-------- -------- --------- --------
Total fixed maturities 799,135 21,372 (316) 820,191
Total equity securities 15,975 2,440 (446) 17,969
-------- -------- --------- --------
-------- -------- --------- --------
$815,110 $ 23,812 $ (762) $838,160
-------- -------- --------- --------
-------- -------- --------- --------
</TABLE>
F-15
<PAGE>
Illinois State Medical Inter-Insurance Exchange and Subsidiary
Notes to Consolidated Financial Statements (continued)
3. INVESTMENTS (CONTINUED)
<TABLE>
<CAPTION>
COST OR GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
-------- ------ ------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
AT DECEMBER 31, 1997
Fixed maturity securities:
U.S. government obligations $152,551 $1,809 $ (195) $154,165
Corporate securities 261,739 3,781 (657) 264,863
Mortgage-backed and other
asset-backed securities 307,854 4,074 (927) 311,001
States, territories, and 6,694 93 -- 6,787
possessions
-------- ------ ------- --------
Total fixed maturities $728,838 $9,757 $(1,779) $736,816
-------- ------ ------- --------
-------- ------ ------- --------
</TABLE>
The amortized cost and fair value of fixed maturities, by contractual maturity,
are summarized as follows (in thousands):
<TABLE>
<CAPTION>
MARCH 31 , 1999 DECEMBER 31, 1998
AMORTIZED FAIR AMORTIZED FAIR
MATURITY COST VALUE COST VALUE
- -------- -------- -------- -------- --------
(UNAUDITED)
<S> <C> <C> <C> <C>
Due in one year or less $ 5,065 $ 5,109 $ -- $ --
Due after one year through five years 220,999 222,567 261,404 265,674
Due after five years through ten years 285,934 289,322 237,777 250,166
Due after ten years 14,024 13,696 14,024 14,420
-------- -------- -------- --------
526,022 530,694 513,205 530,260
Mortgage-backed and other asset-backed
securities 288,599 290,730 285,930 289,931
-------- -------- -------- --------
$814,621 $821,424 $799,135 $820,191
-------- -------- -------- --------
-------- -------- -------- --------
</TABLE>
The expected maturities in the foregoing table will differ from contractual
maturities because borrowers may have the right to call or prepay obligations
with or without call or prepayment penalties.
The components of the equity securities are as follows (in thousands):
<TABLE>
<CAPTION>
MARCH 31 DECEMBER 31
1999 1998
------- -------
(UNAUDITED)
<S> <C> <C>
Equity securities:
Common stock:
Banks, trust, and insurance companies $ 3,339 $ 2,501
Industrial, miscellaneous, and all other 18,902 15,468
------- -------
Total equity securities $22,241 $17,969
------- -------
------- -------
</TABLE>
F-16
<PAGE>
Illinois State Medical Inter-Insurance Exchange and Subsidiary
Notes to Consolidated Financial Statements (continued)
3. INVESTMENTS (CONTINUED)
Proceeds from the sales of fixed maturities were $60,013,000 and $46,970,000 for
the three months ended March 31, 1999 and 1998, and $135,390,000, $105,489,000,
and $123,388,000 for the years ended December 31, 1998, 1997, and 1996,
respectively. Proceeds from the sales of equity securities were $1,108,000 for
the three months ended March 31, 1999, and $1,810,000 for the year ended
December 31, 1998.
Major categories of net investment income are summarized as follows (in
thousands):
<TABLE>
<CAPTION>
THREE MONTHS YEAR ENDED
ENDED MARCH 31 DECEMBER 31
1999 1998 1998 1997 1996
------- ------- ------- ------- -------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Fixed maturities $12,374 $11,844 $47,171 $47,373 $48,373
Equity securities 36 -- 50 -- --
Cash and cash equivalents 383 383 1,390 2,060 1,738
Other 160 152 601 621 602
------- ------- ------- ------- -------
Total investment income 12,953 12,379 49,212 50,054 50,713
Investment expenses 886 923 3,851 3,391 4,277
------- ------- ------- ------- -------
Net investment income $12,067 $11,456 $45,361 $46,663 $46,436
------- ------- ------- ------- -------
------- ------- ------- ------- -------
</TABLE>
Realized gains and losses on investments are summarized as follows (in
thousands):
<TABLE>
<CAPTION>
THREE MONTHS YEAR ENDED
ENDED MARCH 31 DECEMBER 31
1999 1998 1998 1997 1996
----- ----- ----- ----- ------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Fixed maturities:
Gross realized gains $ 361 $ 107 $ 853 $ 545 $1,852
Gross realized losses -- -- 478 537 576
----- ----- ----- ----- ------
Net realized gains on
fixed maturities 361 107 375 8 1,276
Equity securities:
Gross realized gains -- -- 81 -- --
Gross realized losses 1 -- 157 -- --
----- ----- ----- ----- ------
Net realized losses on
equity securities (1) -- (76) -- --
Other invested assets:
Gross realized gains -- -- -- -- 1,269
Gross realized losses 77 94 403 409 139
----- ----- ----- ----- ------
Net realized gains
(losses) on other
invested assets (77) (94) (403) (409) 1,130
----- ----- ----- ----- ------
Net realized gains
(losses) on investments $ 283 $ 13 $(104) $(401) $2,406
----- ----- ----- ----- ------
----- ----- ----- ----- ------
</TABLE>
F-17
<PAGE>
Illinois State Medical Inter-Insurance Exchange and Subsidiary
Notes to Consolidated Financial Statements (continued)
3. INVESTMENTS (CONTINUED)
The change in the Company's unrealized appreciation (depreciation) on fixed
maturities was $15,071,000, $12,909,000, and $(17,003,000), for the years ended
December 31, 1998, 1997, and 1996, respectively.
At December 31, 1998 and 1997, fixed maturities with an aggregate amortized cost
of $3,134,000 and $3,027,000, respectively, were held on deposit to meet
statutory and reinsurance escrow requirements.
The Company participates, through a trustee, in a securities lending program
with major securities brokers. Investment securities with an aggregate fair
value of $94,852,000 (unaudited) were loaned to various brokers in connection
with a securities lending program at March 31, 1999. These securities are
returnable on demand and collateralized by cash deposits amounting to
approximately 102% of the market value of the securities loaned. Since the
Company may demand that a counterparty return the securities which it has
borrowed at any time, the Company retains effective control of all assets
participating in the securities lending program. The Company receives lending
fees and continues to earn interest on the loaned securities.
There were no investment securities loaned at December 31, 1998 or 1997.
F-18
<PAGE>
Illinois State Medical Inter-Insurance Exchange and Subsidiary
Notes to Consolidated Financial Statements (continued)
4. INCOME TAXES
Deferred tax assets and liabilities are determined based on differences between
financial reporting and tax bases of assets and liabilities, and are measured
using the enacted tax rates.
Significant components of deferred tax assets and liabilities are as follows (in
thousands):
<TABLE>
<CAPTION>
MARCH 31 DECEMBER 31
1999 1998 1997
-------- -------- --------
(UNAUDITED)
<S> <C> <C> <C>
Deferred tax assets:
Tax-basis loss reserve discounting adjustment $ 42,566 $ 42,486 $ 47,408
Alternative minimum tax credit carryforward 3,774 4,674 4,046
Tax-basis unearned premium reserve adjustment 51 793 1,233
Tax-basis fixed asset adjustment 1,369 1,396 1,367
Other 3,047 1,765 1,176
-------- -------- --------
Total deferred tax assets 50,807 51,114 55,230
Valuation allowance for deferred tax assets (8,625) (9,857) (14,758)
-------- -------- --------
Deferred tax assets net of valuation allowance 42,182 41,257 40,472
Deferred tax liabilities:
Discount amortization on bonds and other (516) (508) (480)
Net unrealized appreciation on securities (3,518) (8,067) (2,792)
-------- -------- --------
Total deferred tax liabilities (4,034) (8,575) (3,272)
-------- -------- --------
Net deferred tax asset $ 38,148 $ 32,682 $ 37,200
-------- -------- --------
-------- -------- --------
</TABLE>
The nature of the deferred tax assets and liabilities are such that the reversal
pattern for these temporary differences should result in realization of a
portion of the deferred tax assets. The Company establishes a "valuation
allowance" for any portion of the deferred tax asset where management believes
that it is more likely than not that the asset will not be realized. The Company
evaluates a number of factors when determining the valuation allowance. A
principal factor includes the Company's estimate of future taxable income. The
changes in the valuation allowance were due principally to changes in the
Company's estimate of future taxable income. These estimates are influenced by
the Company's actual financial reporting-basis results. The valuation allowance
decreased by $1,232,000 for the three months ended March 31, 1999, decreased by
$4,901,000 and $8,597,000 in 1998 and 1997, respectively, and increased by
$8,914,000 in 1996.
F-19
<PAGE>
Illinois State Medical Inter-Insurance Exchange and Subsidiary
Notes to Consolidated Financial Statements (continued)
4. INCOME TAXES (CONTINUED)
A reconciliation of income tax computed at the United States federal statutory
tax rate of 35% to income tax expense is as follows (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS YEAR ENDED
ENDED MARCH 31 DECEMBER 31
1999 1998 1998 1997 1996
------- ------- ------- -------- -------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Federal income tax at 35% $ 1,284 $ 1,223 $ 4,364 $ 5,332 $ 8,036
Prior-period tax return adjustments
-- -- (170) 68 1,740
Change in valuation allowance
(1,232) (1,225) (4,901) (8,597) 8,914
Other 81 82 450 (9) 851
------- ------- ------- -------- -------
Total income tax expense (benefit)
$ 133 $ 80 $ (257) $ (3,206) $19,541
------- ------- ------- -------- -------
------- ------- ------- -------- -------
</TABLE>
At December 31, 1998, the Company has alternative minimum tax credits of
approximately $4,674,000 that have no expiration date. The Company received
refunds of income taxes of $11,665,000, $3,737,000, and $3,842,000 in 1998,
1997, and 1996, respectively, and made tax payments of $2,500,000 in 1998.
5. ANNUITIES PURCHASED TO FUND CERTAIN OBLIGATIONS
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 $17,356,000 and $17,222,000 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 guaranty funds are not available.
F-20
<PAGE>
Illinois State Medical Inter-Insurance Exchange and Subsidiary
Notes to Consolidated Financial Statements (continued)
6. LOSSES AND LOSS ADJUSTMENT EXPENSES
The following table provides a reconciliation of the beginning and ending loss
and loss adjustment expenses (LAE) reserve balances, net of reinsurance
receivables, as follows (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS YEAR ENDED
ENDED MARCH 31 DECEMBER 31
1999 1998 1998 1997 1996
-------- -------- --------- --------- --------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Liability for losses and LAE, net of
reinsurance receivables, at
beginning of period $673,516 $614,225 $ 614,225 $ 585,113 $658,669
Add: Provision for losses and LAE for
claims, net of reinsurance, occurring
during:
Current period 40,221 32,884 163,962 121,912 99,373
Prior periods -- -- (10,302) (4,096) 6,030
-------- -------- --------- --------- --------
Incurred losses and LAE during the
current period, net of reinsurance 40,221 32,884 153,660 117,816 105,403
Effect of commutation -- -- 79,130 81,080 --
Deduct: Loss and LAE payments for claims,
net of reinsurance, occurring during:
Current period 16 10 4,379 6,436 3,449
Prior periods 35,542 43,533 169,120 163,348 175,510
-------- -------- --------- --------- --------
Claim payments during the current period,
net of reinsurance 35,558 43,543 173,499 169,784 178,959
-------- -------- --------- --------- --------
Liability for losses and LAE, net of
reinsurance receivables, at end of period 678,179 603,566 673,516 614,225 585,113
Reinsurance receivable on losses and LAE,
at end of period 217,656 340,818 221,759 331,857 395,104
-------- -------- --------- --------- --------
Liability for losses and LAE, gross of
reinsurance receivables, at end of period $895,835 $944,384 $ 895,275 $ 946,082 $980,217
-------- -------- --------- --------- --------
-------- -------- --------- --------- --------
</TABLE>
The incurred development related to prior years for the years ended December 31,
1998 and 1997, was principally a result of the Company's methodology of
reallocating reserves for death, permanent disability, or retirement (DDR)
policies from prior years to the current year upon issuance of a DDR policy.
This reallocation has no effect on the Company's total incurred losses. For
1996, the incurred development related to prior years was a result of higher
than expected losses and related expenses in 1996.
F-21
<PAGE>
Illinois State Medical Inter-Insurance Exchange and Subsidiary
Notes to Consolidated Financial Statements (continued)
6. LOSSES AND LOSS ADJUSTMENT EXPENSES (CONTINUED)
During 1998 and 1997, the Exchange received proceeds of $79,130,000 and
$81,080,000, respectively, related to the commutation of a ceded reinsurance
agreement in each year. At the time of the commutations, the Exchange reduced
reinsurance receivables totaling $62,784,000 and $30,992,000 related to the 1998
and 1997 periods, respectively. Favorable net loss reserve development related
to the commutations was substantially offset by increases in gross loss reserves
on other accident years.
7. REINSURANCE
Certain premiums and losses and loss adjustment expenses are ceded to other
insurance companies under various reinsurance agreements. These reinsurance
agreements provide the Company with increased capacity to write additional risks
and maintain its exposure to loss within its capital resources.
The Company's ceded reinsurance arrangements reduced certain items in the
accompanying consolidated financial statements as follows (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS YEAR ENDED
ENDED MARCH 31 DECEMBER 31
1999 1998 1998 1997 1996
------- ------- ------- ------- --------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Premiums earned $ 6,564 $15,763 $45,453 $91,199 $122,040
Losses and loss adjustment expenses
5,277 15,239 13,951 61,820 55,577
</TABLE>
Amounts reported as reinsurance receivables represent estimates of the ultimate
losses which will exceed the Company's retention levels. Included in reinsurance
receivables at March 31, 1999, and December 31, 1998 and 1997 were amounts due
from Cologne Re (Dublin) totaling $10,075,000, $10,075,000, and $85,686,000,
respectively. The majority of the remaining reinsurance receivables are due from
other United Kingdom-based reinsurers. The Company would remain liable to the
extent that the reinsuring companies were unable to meet their obligations.
Premiums ceded to reinsurers represent the estimated ultimate reinsurance
premiums based on estimated losses to be reinsured.
F-22
<PAGE>
Illinois State Medical Inter-Insurance Exchange and Subsidiary
Notes to Consolidated Financial Statements (continued)
8. STATUTORY ACCOUNTING PRACTICES
The statutory accounting practices prescribed or permitted by regulatory
authorities for the Exchange differ in some respects from generally accepted
accounting principles. Members' equity and net income, as reported to the
domicillary state insurance department in accordance with statutory accounting
practices, are summarized as follows:
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Statutory surplus at year-end $187,224 $172,712 $158,621
Statutory net income for the year 11,968 11,335 22,960
</TABLE>
9. COMPREHENSIVE INCOME
As of January 1, 1998, the Company adopted Statement No. 130, "Reporting
Comprehensive Income." Statement 130 establishes new rules for the reporting and
display of comprehensive income and its components; however, the adoption of
this Statement had no impact on the Company's net income or members' equity.
Statement 130 requires unrealized gains or losses on the Company's
available-for-sale securities, which prior to adoption were reported separately
in members' equity, to be included in other comprehensive income. Prior year
financial statements have been reclassified to conform to the requirements of
Statement 130.
F-23
<PAGE>
Illinois State Medical Inter-Insurance Exchange and Subsidiary
Notes to Consolidated Financial Statements (continued)
9. COMPREHENSIVE INCOME (CONTINUED)
The components of comprehensive income, and the related tax effects, are as
follows (in thousands):
<TABLE>
<CAPTION>
AMOUNT AMOUNT
BEFORE INCOME NET OF
TAXES TAXES TAXES
-------- ------- --------
<S> <C> <C> <C>
THREE MONTHS ENDED MARCH 31, 1999
(UNAUDITED)
Unrealized holding losses arising during the
period $(12,639) $(4,423) $ (8,215)
Reclassification adjustment (360) (126) (234)
-------- ------- --------
Total other comprehensive income $(12,999) $(4,549) $ (8,449)
-------- ------- --------
-------- ------- --------
YEAR ENDED DECEMBER 31, 1998
Unrealized holding gains arising during
the year $ 15,370 $ 5,380 $ 9,990
Reclassification adjustment (299) (105) (194)
-------- ------- --------
Total other comprehensive income $ 15,071 $ 5,275 $ 9,796
-------- ------- --------
-------- ------- --------
YEAR ENDED DECEMBER 31, 1997
Unrealized holding gains arising during
the year $ 12,918 $ 4,521 $ 8,397
Reclassification adjustment (8) (3) (5)
-------- ------- --------
Total other comprehensive income $ 12,910 $ 4,518 $ 8,392
-------- ------- --------
-------- ------- --------
YEAR ENDED DECEMBER 31, 1996
Unrealized holding losses arising during the
year $(15,728) $(5,505) $(10,223)
Reclassification adjustment (1,276) (447) (829)
-------- ------- --------
Total other comprehensive income $(17,004) $(5,952) $(11,052)
-------- ------- --------
-------- ------- --------
</TABLE>
10. COMMITMENTS AND CONTINGENCIES
The Company has entered into certain lease and related agreements for office
space. The principal lease agreement is through November 2011, and contains
certain escalation clauses. At December 31, 1998, future minimum annual payments
under these agreements are $1,675,000.
F-24
<PAGE>
Illinois State Medical Inter-Insurance Exchange and Subsidiary
Notes to Consolidated Financial Statements (continued)
10. COMMITMENTS AND CONTINGENCIES (CONTINUED)
Rent expense for 1998, 1997, and 1996 amounted to $1,704,000, $1,700,000, and
$1,667,000, respectively. The Company received rental income of $377,000,
$371,000, and $381,000 in 1998, 1997, and 1996, respectively, from the Society
for office space made available for their use. The rental rates paid by the
Society for office space were based on current market rates.
The Company has been named as defendant in various legal actions in which
plaintiffs are seeking material amounts. Management intends to defend these
actions vigorously and believes that the actions should not have a material
adverse effect on the Company's financial position, results of operations, or
cash flows.
11. RELATED PARTIES
The Exchange, Services, and Society share various support services pursuant to a
Shared Services Agreement (the Shared Services Agreement). The services covered
by the Agreement are office space, administrative, human resources, public
relations, membership services, communications, mail, and other miscellaneous
services. The Shared Services Agreement has a term of five years, and,
thereafter is automatically renewed on an annual basis. Any party may terminate
the Shared Services Agreement upon six month's prior notice. All such services
are provided at rates established from time to time by negotiation among the
parties. If actual usage of the services varies from expected usage, adjustments
to the rates may be negotiated by the parties.
12. CONVERSION
On May 5, 1999, the Board of Governors of the Exchange adopted a Plan and
Agreement of Merger (the Merger Agreement) whereby the Exchange will reorganize
from a reciprocal insurer to a stock insurance company and become a wholly owned
subsidiary of ISMIE Holdings Inc. (the Conversion). Pursuant to the Conversion,
the Exchange will merge with and into ISMIE Indemnity Company (ISMIE Indemnity),
a newly organized Illinois stock insurer and a wholly owned subsidiary of ISMIE
Holdings Inc. that will be the surviving corporation of the Conversion. The
assets and liabilities of the Exchange that will be merged into ISMIE Indemnity
will be accounted for at a historical cost in a manner similar to that in a
pooling of interests. ISMIE Indemnity is licensed to write property and casualty
insurance lines in the state of Illinois, but has not conducted business prior
to the Conversion.
F-25
<PAGE>
Illinois State Medical Inter-Insurance Exchange and Subsidiary
Notes to Consolidated Financial Statements (continued)
12. CONVERSION (CONTINUED)
The principal purpose of the Conversion is to enhance the Exchange's ability to
achieve its strategic goals by providing greater operating flexibility and
access to the capital markets. The Conversion will also provide Members of the
Exchange with shares of Common Stock in exchange for their membership interests
in the Exchange.
Certain of the members of the ISMIE Holdings Inc. Board of Directors are also
policyholders of the Exchange and eligible to receive Common Stock in the
Conversion. These directors may experience claims requiring coverage under their
respective insurance policies.
A special meeting of the Exchange Members will be held to approve the Merger
Agreement.
The Exchange incurred expenses related to the Conversion of $717,000 and $67,000
for the year ended December 31, 1998 and three months ended March 31, 1999,
respectively. The costs of the Conversion are expensed as incurred.
Unaudited pro forma net income per share included in the consolidated statements
of income gives effect to the Conversion and the issuance of 10,000,000 shares
of Common Stock to Eligible Members of the Exchange.
F-26
<PAGE>
ANNEX I
PLAN AND AGREEMENT OF MERGER
THIS PLAN AND AGREEMENT OF MERGER (the "Plan"), dated as of May 5, 1999,
is among ISMIE HOLDINGS INC., a Delaware corporation ("Holdings"), ISMIE
INDEMNITY COMPANY, an Illinois corporation and a wholly owned subsidiary of
Holdings ("New Insurer"), and ILLINOIS STATE MEDICAL INTER-INSURANCE
EXCHANGE, an Illinois reciprocal insurance exchange (the "Company").
RECITALS
WHEREAS, the Company is an Illinois reciprocal insurance exchange
organized pursuant to the provisions of Article IV of the Insurance Code of
the State of Illinois (the "Illinois Insurance Code");
WHEREAS, New Insurer is an Illinois stock insurance company organized to
transact insurance under the Illinois Insurance Code;
WHEREAS, Holdings is a corporation incorporated in the State of Delaware
and a wholly owned subsidiary of the Company;
WHEREAS, Article X of the Illinois Insurance Code authorizes the merger
of the Company with and into the New Insurer;
WHEREAS, the Board of Governors of the Company (the "Board of
Governors") and the respective Boards of Directors of New Insurer and
Holdings have each proposed and duly approved the merger of the Company with
and into New Insurer (the "Merger") upon the terms and subject to the
conditions set forth in this Plan and in accordance with the Illinois
Insurance Code;
WHEREAS, in the Merger, the Membership Interests (as hereinafter
defined) of the Company shall be cancelled and extinguished in exchange for
the consideration described herein;
WHEREAS, the Company intends to prepare and mail to all Eligible Members
of the Company a proxy statement with respect to a special meeting (the
"Special Meeting") of Members of the Company at which Eligible Members will
be asked to approve this Plan;
I-1
<PAGE>
NOW, THEREFORE, in consideration of the premises and the mutual
covenants herein contained and for other good and valuable consideration, the
receipt and adequacy of which are hereby acknowledged, Holdings, New Insurer
and the Company hereby agree as follows:
ARTICLE I
THE MERGER
1.1 THE MERGER. Subject to the conditions of Article VII of this
Agreement being satisfied or duly waived, and in accordance with and subject
to the provisions of this Plan and the Illinois Insurance Code, at the
Effective Time (as defined in Section 1.2) the Company shall be merged with
and into New Insurer in the Merger. At and after the Effective Time, the
separate existence of the Company shall cease, and New Insurer shall continue
as the surviving corporation, sometimes hereinafter referred to as the
"Surviving Corporation," under the corporate name it possesses immediately
prior to the Effective Time. The Company and New Insurer are sometimes
hereinafter referred to as the "Constituent Entities."
1.2 EFFECTIVE TIME OF THE MERGER. The Merger shall be effected and
become effective at the time (herein called the "Effective Time") the
Illinois Director of Insurance issues a certificate of merger as provided for
in Section 163 of the Illinois Insurance Code. The day on which the Effective
Time occurs is hereinafter called the "Effective Date."
1.3 EFFECT OF THE MERGER. At the Effective Time, the effect of the
Merger shall be as provided in the applicable provisions of the Illinois
Insurance Code, including, without limitation, Section 166 of the Illinois
Insurance Code. Without limiting the generality of the foregoing, and subject
thereto, at the Effective Time the Surviving Corporation shall have all of
the rights, privileges, immunities and powers and shall be subject to all of
the duties and liabilities granted or imposed by the Illinois Insurance Code.
The Surviving Corporation shall thereupon and thereafter possess all the
rights, privileges, immunities, powers and franchises of a public as well as
of a private nature, of each of the Constituent Entities; and all property,
real, personal and mixed, and all debts due on whatever account, including
subscriptions to shares, assessments payable from members or policyholders,
and all other choses in action and all and every other interest of, or
belonging to or due to, each of the Constituent Entities shall be deemed to
be transferred to and vested in the Surviving Corporation without further act
or deed; and the title to any real estate, or any interest therein, under the
laws of the State of Illinois vested in any of such companies shall not
revert or be in any way impaired by reason of such Merger. The Surviving
Corporation shall thenceforth be responsible and liable for all the
liabilities and obligations of the Constituent Entities; any
I-2
<PAGE>
claim existing or action or proceeding pending by or against any of the
Constituent Entities may be prosecuted to judgment as if such merger or
consolidation had not taken place, or the Surviving Corporation may be
substituted in its place; neither the rights of creditors nor any liens upon
the property of any of the Constituent Entities shall be impaired by such
Merger, but such liens shall be limited to the property upon which they were
liens immediately prior to the time of such Merger, unless otherwise provided
herein.
1.4 SUBSEQUENT ACTIONS. If, at any time after the Effective Time, the
Surviving Corporation shall consider or be advised that any deed, bill of
sale, assignment, assurance or any other action or thing is necessary or
desirable to vest, perfect or confirm of record or otherwise in the Surviving
Corporation its right, title or interest in, to or under any of the rights,
properties or assets of the Company acquired or to be acquired by the
Surviving Corporation as a result of, or in connection with, the Merger or
otherwise to carry out this Plan, the officers and directors of the Surviving
Corporation shall be authorized to execute and deliver, in the name and on
behalf of the Company, all such deeds, bill of sale, assignments and
assurances and to take and do, in the name and on behalf of such corporation
or otherwise, all such other actions and things as may be necessary or
desirable to vest, perfect or confirm any and all right, title and interest
in, to and under such rights, properties or assets in the Surviving
Corporation or otherwise to carry out this Plan.
1.5 GOVERNING DOCUMENTS. The Articles of Incorporation and Bylaws of
New Insurer shall be the Articles of Incorporation and Bylaws of the
Surviving Corporation, as in effect immediately prior to the Effective Time,
until thereafter amended as provided therein and under the Illinois Insurance
Code.
1.6 DIRECTORS AND OFFICERS. The members of the Board of Directors of
New Insurer immediately prior to the Effective Time shall be the initial
directors of the Surviving Corporation, and the officers of New Insurer
immediately prior to the Effective Time shall be the initial officers of the
Surviving Corporation, in each case until their successors are duly elected
and qualified.
ARTICLE II
CONVERSION OF MEMBERSHIP INTERESTS,
ALLOCATION AND PAYMENT OF MERGER CONSIDERATION
2.1 CERTAIN DEFINITIONS. As used in this Article II and elsewhere in
this Plan, the terms listed below shall have the following meanings:
I-3
<PAGE>
"Adoption Date" means May 5, 1999, the date that the Board of Governors
adopted this Plan.
"Attorney-in-Fact" means Illinois State Medical Insurance Services,
Inc., an Illinois corporation, a wholly owned subsidiary of the Company and
the Company's attorney-in-fact.
"Director" means the Director of Insurance of the Illinois Department,
or such governmental officer, body or authority as may succeed such Director
as the primary regulator of the Company's insurance business under applicable
law.
"Earned Premiums" means earned premiums (exclusive of any premium
surcharges) in respect of a Policy at any time during the period beginning on
July 1, 1995 and ending on and including the Adoption Date.
"Eligible Member" means a Person who is a Member of the Company on the
Adoption Date.
"Holdings Common Stock" means the common stock, par value $.01 per
share, of Holdings.
"Illinois Department" means the Department of Insurance of the State of
Illinois.
"Member" means a Person who is a Named Insured or Additional Named
Insured under a Policy. A Named Insured or Additional Named Insured ceases
to be a Member when the period of time (without regard to any extended
reporting period) which commences with the Policy effective date specified on
the declarations page expires or terminates, either upon cancellation,
non-renewal of the Policy, or otherwise.
"Named Insured" or "Additional Named Insured" means any Person who is
specifically identified by name in the declarations page of a Policy as a
"named insured" or as an "additional named insured" on any endorsement
attached thereto other than a reporting endorsement. The Named Insured or
Additional Named Insured in any Policy as of any date shall be determined on
the basis of the Company's records as of such date, and the Company shall not
be required to examine or consider any other facts or circumstances. The
identity of the Named Insured or Additional Named Insured in a Policy shall
be determined by the Company without giving effect to any interest of any
other Person in such Policy and such determination shall be binding.
"Membership Interests" means rights of Members of the Company arising
under the APPLICANT SUBSCRIBER'S REPRESENTATION, AUTHORIZATION AND RELEASE,
APPLICATION FOR MEMBERSHIP--POWER OF ATTORNEY between Members and the Company
(the "Subscription
I-4
<PAGE>
Agreements"), the Company's Rules and Regulations, the Illinois Insurance
Code or otherwise, including, without limitation, the right to vote for
members of the Board of Governors and on other matters and the right they may
have in any assets of the Company and to participate in any distribution of
surplus on liquidation of the Company (but not including claim obligations of
the Company arising under Policies).
"Merger Shares" means the shares of Holdings Common Stock to be
delivered by virtue of the Merger (i) to Eligible Members and (ii) to New
Insurer as consideration for the cancellation of the shares of Holdings
Common Stock held by the Company, which cancellation shall occur by virtue of
the Merger.
"Person" means an individual, corporation, joint venture, limited
liability company, partnership, association, trust, trustee, unincorporated
entity, organization or government or any department or agency thereof.
"Policy" means an insurance policy issued by the Company but does not
include (i) any agreement pursuant to which the Company has ceded or assumed
reinsurance or (ii) a reporting endorsement.
2.2 CANCELLATION AND CONVERSION OF INTERESTS. At the Effective Time,
by virtue of the Merger and without any action on the part of the Company,
New Insurer, Holdings, the Surviving Corporation or any other Person, and
subject to Section 2.6 hereof regarding dissenter's rights:
(a) All Membership Interests in existence immediately prior to the
Effective Time shall be cancelled and extinguished.
(b) Membership Interests of Eligible Members shall be converted into
the right to receive the number of Merger Shares as provided in Section
2.3(a) and Section 2.4 below.
(c) The Holdings Common Stock held by the Company immediately prior
to the Effective Time shall be cancelled and converted into the right to
receive the number of Merger Shares as provided in Section 2.3(b) below.
(d) Each share of common stock of New Insurer issued and outstanding
immediately prior to the Effective Time shall be converted into one validly
issued, fully paid and nonassessable share of common stock of the Surviving
Corporation.
I-5
<PAGE>
2.3 ALLOCATION OF MERGER SHARES. The Merger Shares issuable in the
Merger shall be allocated among the Eligible Members and New Insurer as
follows:
(a) The number of Merger Shares allocable to each Eligible Member
shall be determined as follows:
(i) Each Eligible Member shall be allocated a number of shares
of Holdings Common Stock equal to the product of x and y, where "x"
equals 9,000,000 shares of Holdings Common Stock and "y" equals the
ratio of the Earned Premiums of such Eligible Member to the total
Earned Premiums of all Eligible Members during the period beginning on
July 1, 1995 and ending on and including the Adoption Date, plus
(ii) Each Eligible Member shall be allocated a number of shares
of Holdings Common Stock equal to 1,000,000 shares of Holdings Common
Stock divided by the total number of Eligible Members.
(b) The number of Merger Shares allocable to New Insurer shall be (i)
100,000 or (ii) such other number as the Board of Directors of Holdings and
the Board of Governors of the Company determine is appropriate in order to
insure that the Merger Shares issued to New Insurer pursuant to the Merger
have a fair market value equivalent to the fair market value of the shares
of Holdings Common Stock held by the Company which are to be cancelled in
the Merger pursuant to Section 2.5 hereof.
2.4 FRACTIONAL SHARES. No fractional shares of Holdings Common Stock
shall be issued upon consummation of the Plan. The number of shares of
Holdings Common Stock calculated in accordance with Section 2.3 in respect of
each Eligible Member and New Insurer shall be the sum of the number of shares
of Holdings Common Stock after rounding such number to the nearest integral
number of shares (with one-half being rounded upward). Because of such
rounding, the aggregate number of shares of Holdings Common Stock issued to
Eligible Members in the Merger may be slightly more or less than 10,000,000.
2.5 ISSUANCE, DELIVERY, VOTING AND DIVIDENDS. Subject to Section 2.6
hereof, the Merger Shares allocated to the Eligible Members and New Insurer
shall be deemed to have been issued at the Effective Time. The Merger Shares
shall be delivered to the recipients thereof on the thirty-first day after
the Effective Date, or as soon as reasonably practicable thereafter, unless
the petition specified in Section 2.6 hereof has been filed with the Director
prior thereto. If such a petition has been filed, the Merger Shares shall be
delivered only upon the conclusion of the Director's review of dissenting
policyholder rights or the issuance of an order permitting or confirming the
effectiveness of the Merger in accordance with
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Section 168 of the Illinois Insurance Code. No recipient shall have the
right to vote the Merger Shares, and no dividends or other distributions with
respect to the Merger Shares shall be paid to any recipient, until the Merger
Shares are delivered as provided herein. Following delivery of the Merger
Shares, (i) each recipient other than New Insurer shall have the right to
vote its Merger Shares at any meeting the record date of which is after the
date of such delivery, and (ii) there shall be paid, without interest, to
each recipient in whose name the certificates representing the Merger Shares
are registered, all dividends and other distributions payable in respect of
such Merger Shares on a date subsequent to, and in respect of a record date
after, the Effective Time and prior to such delivery. Such recipient shall
also be entitled to receive, on the payment date therefor, any dividend or
distribution the record date for which occurs prior to such delivery and the
payment date for which occurs following such delivery.
2.6 DISSENTING MEMBERS' RIGHTS. If five percent or more of all
Eligible Members who do not vote in favor of the Plan at the Special Meeting
at which this Plan was adopted by the Eligible Members, at any time within
thirty days after the Effective Date, shall file a petition with the Director
for a hearing upon the Plan, the Director shall then order a hearing upon
said petition, fix the time and place of such hearing, and give written
notice to the Constituent Entities (as defined in Section 1.1), at least
fifteen days before the date of such hearing, all as provided in Section 168
of the Illinois Insurance Code. Any Eligible Member so petitioning may appear
before the Director at such hearing, either in person or by an attorney, and
be heard with reference to the Plan. If, upon such hearing being had, the
Director finds that the interests of the Members of the Company are not
properly protected, or if he finds that any reasonable objection exists to
this Plan, he shall enter an order revoking the approval already given, and
the Merger, and this Plan, shall, thereupon, become null and void. In the
event of the entry of such an order by the Director, no party hereto nor any
Eligible Member shall have any further rights under this Agreement. The
Director shall also have the power to revoke any approval of the Merger if
any officer, director or employee of any Constituent Entity shall, after
reasonable notice, fail or refuse without reasonable cause to attend and
testify at such hearing, or to produce any books or papers called for by the
Director.
2.7 NO FURTHER INTEREST IN THE COMPANY. Subject to Section 2.6 hereof,
as of the Effective Time, each Member of the Company shall cease to be a
Member, and shall have no further Membership Interest or any other interest
in the Company or any interest in the Surviving Corporation, except for any
interest that a Member may have as a holder of Holdings Common Stock or
rights as a policyholder under any Policy issued by the Company.
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ARTICLE III
APPROVAL BY THE DIRECTOR
3.1 DIRECTOR'S APPROVAL. This Plan is subject to the approval of the
Director pursuant to Article X of the Illinois Insurance Code. The change of
control of Holdings and New Insurer contemplated by the Plan is subject to
the standards established under Article VIII 1/2 of the Illinois Insurance
Code.
ARTICLE IV
REPRESENTATIONS AND WARRANTIES BY THE COMPANY
The Company represents and warrants to Holdings that, as of the date of
this Plan and as of the Effective Time:
4.1 ORGANIZATION AND QUALIFICATION. The Company is a reciprocal
insurance exchange duly organized, validly existing and in good standing
under the laws of the State of Illinois. The Company has all requisite power
and authority required for it to hold, lease, convey or dispose of assets
held for subscribers and carry on its business as presently conducted. The
Company is duly qualified or licensed to do business, and is in good
standing, in each jurisdiction where the nature of business or the character
of its properties makes necessary such qualifications or licensing, except
where the failure to so qualify would not materially adversely affect the
condition (financial or otherwise), results of operations, business,
properties or prospects of the Company taken as a whole.
4.2 AUTHORITY RELATIVE TO THIS PLAN; RECOMMENDATION TO ELIGIBLE
MEMBERS. The Company has full right, power, and authority to execute, deliver
and perform the terms of this Plan. Subject only to favorable action by the
Company's Eligible Members at the Special Meeting referred to in Section 6.2,
the execution, delivery and performance of this Plan by the Company have been
duly and validly authorized and approved by all required action on the part
of the Company. The Company's Board of Governors has approved the execution,
delivery and performance of this Plan and recommends the approval of this
Plan by the Eligible Members. Subject only to approval of the Company's
Eligible Members and the Director as described above, this Plan constitutes
the valid and binding agreement of the Company and is enforceable in
accordance with its terms.
4.3 COMPLIANCE. Neither the execution and delivery of this Plan by the
Company nor the consummation of the transactions contemplated hereby nor
compliance by the Company with any of the provisions hereof will (i) violate,
conflict with, or result in a breach of any provision of, or constitute a
default (or an event which, with notice or lapse of time
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or both, would constitute a default) under, or result in the termination of,
or accelerate the performance required by, or result in a right of
termination or acceleration under, or result in the creation of any lien,
security interest, charge or encumbrance upon any of the properties or assets
of the Company under any of the terms, conditions or provisions of (a) the
Power of Attorney Agreement between the Company and the Attorney-in-Fact, or
the Company's Rules and Regulations or (b) any material note, bond, mortgage,
indenture, deed of trust, license, lease, agreement or other instrument or
obligation to which the Company or any direct or indirect subsidiary of the
Company is a party, or to which any of them, or any of their respective
properties or assets, may be subject, or (ii) subject to compliance with the
statutes and regulations referred to in the next paragraph, violate any
judgment, ruling, order, writ, injunction, decree, statute, rule or
regulation applicable to the Company or any direct or indirect subsidiary of
the Company or any of their respective properties or assets, except, in the
case of each of clauses (i) and (ii) above, for such violations, conflicts,
breaches, defaults, terminations, accelerations or creations of liens,
security interests, charges or encumbrances, which, in the aggregate, would
not have a material adverse effect on the transactions contemplated hereby or
on the condition (financial or other), business or operations of the Company
and its subsidiaries taken as a whole.
Other than in connection with or in compliance with the provisions of
the Illinois Insurance Code, the Securities Exchange Act of 1934, as amended
(the "Exchange Act"), the Securities Act of 1933, as amended (the "Securities
Act"), and the "takeover" or "blue sky" laws of the various states, no notice
to, filing with, or authorization, consent or approval of, any domestic or
foreign public body or authority is necessary for the consummation by the
Company of the transactions contemplated by this Plan, except where the
failure to give such notice, make such filings, or obtain such
authorizations, consents or approvals would, individually or in the
aggregate, not have a material adverse effect on the transactions
contemplated hereby or on the condition (financial or other), business or
operations of the Company taken as a whole.
ARTICLE V
REPRESENTATIONS AND WARRANTIES OF HOLDINGS AND NEW INSURER
Each of Holdings and New Insurer, jointly and severally, represents and
warrants to the Company as follows:
5.1 ORGANIZATION AND QUALIFICATION. Holdings is a corporation duly
organized, validly existing and in good standing under the laws of the State
of Delaware. New Insurer is a stock insurance corporation duly organized,
validly existing and in good standing under the laws of the State of
Illinois. At the Effective time, each of Holdings and New Insurer will be
duly qualified or licensed to do business, and will be in good standing, in
each jurisdiction
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where the nature of their respective businesses or the character of their
respective properties makes necessary such qualifications or licensing,
except where the failure to so qualify would not materially adversely affect
the condition (financial or otherwise), results of operations, business,
properties or prospects of Holdings and New Insurer, taken as a whole. At
the Effective Time, New Insurer will hold a certificate of authority from the
Director to transact Class 2 and Class 3 insurance in the State of Illinois,
and such certificate of authority will be in full force and effect at the
Effective Time.
5.2 CAPITALIZATION. As of the date of this Plan, Holdings has an
authorized capital stock of 40,000,000 shares of Holdings Common Stock, par
value $.01 per share, of which 1,000 shares are duly and validly issued and
outstanding, fully paid and nonassessable, all of which are held by the
Company, and 5,000,000 shares of Preferred Stock, par value $.01 per share,
none of which is issued and outstanding. As of the date of this Plan, New
Insurer has an authorized capital stock of 500,000 shares of common stock,
par value $100 per share, of which 10 shares are duly and validly issued and
outstanding, fully paid, nonassessable, all of which are held by Holdings.
At the Effective Time, 25,000 shares of New Insurer will be duly and validly
issued and outstanding, fully paid and nonassessable, all of which will be
held by Holdings.
5.3 AUTHORITY RELATIVE TO THIS PLAN. Each of Holdings and New Insurer
has full corporate power and authority to execute and deliver this Plan and
to perform its respective obligations hereunder. All corporate action
required on the part of Holdings and New Insurer in order to authorize such
execution, delivery and performance has been taken. This Plan constitutes the
valid and binding obligation of each of Holdings and New Insurer, enforceable
against each in accordance with its terms.
5.4 COMPLIANCE. Neither the execution and delivery of this Plan by
Holdings and New Insurer nor the consummation of the transactions
contemplated hereby nor compliance by Holdings and New Insurer with any of
the provisions hereof will (i) violate, conflict with, or result in a breach
of any provision of, or constitute a default (or an event which, with notice
or lapse of time or both, would constitute a default) under, or result in the
termination of, or accelerate the performance required by, or result in a
right of termination or acceleration under, or result in the creation of any
lien, security interest, charge or encumbrance upon any of the properties or
assets of Holdings or New Insurer or any other direct or indirect subsidiary
under any of the terms, conditions or provisions of (a) the respective
charters or bylaws of Holdings or New Insurer or (b) any material note, bond,
mortgage, indenture, deed of trust, license, lease, agreement or other
instrument or obligation to which Holdings or New Insurer is a party, or to
which either of them, or any of their respective properties or assets, may be
subject, or (ii) subject to compliance with the statutes and regulations
referred to in the next paragraph, violate any judgment, ruling, order, writ,
injunction, decree, statute, rule or regulation applicable to Holdings or New
Insurer or any
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of their respective properties or assets, except, in the case of each of
clauses (i) and (ii) above, for such violations, conflicts, breaches,
defaults, terminations, accelerations or creations of liens, security
interests, charges or encumbrances, which, in the aggregate, would not have a
material adverse effect on the transactions contemplated hereby or on the
condition (financial or other), business or operations of Holdings and its
subsidiaries taken as a whole.
Other than in connection with or in compliance with the provisions of
the Illinois Insurance Code, the Exchange Act, the Securities Act, and the
"takeover" or "blue sky" laws of the various states, no notice to, filing
with, or authorization, consent or approval of, any domestic or foreign
public body or authority is necessary for the consummation by Holdings or New
Insurer of the transactions contemplated by this Plan, except where the
failure to give such notice, make such filings, or obtain such
authorizations, consents or approvals would, individually or in the
aggregate, not have a material adverse effect on the transactions
contemplated hereby or on the condition (financial or other), business or
operations of Holdings and New Insurer taken as a whole.
ARTICLE VI
ADDITIONAL AGREEMENTS
6.1 COOPERATION. Subject to the terms and conditions herein provided,
each of the parties hereto agrees to use all reasonable efforts to take, or
cause to be taken, all actions and to do, or cause to be done, all things
necessary, proper or advisable to consummate and make effective as promptly
as practicable the transactions contemplated by this Plan and to cooperate
with each other in connection with the foregoing, including using its best
efforts to:
(a) prepare and file with the Illinois Department as soon as is
reasonably practicable all necessary requests for approval, applications
and other necessary registrations and filings, including, but not limited
to, all filings and other submissions of information to governmental
authorities with respect to the transactions contemplated by this Plan, and
use its best efforts to obtain such permits and approvals as promptly as
possible;
(b) prepare and file with the SEC as soon as is reasonably
practicable a Registration Statement, including a proxy
statement/prospectus (the "Registration Statement"), with respect to the
transactions contemplated by this Plan, and use its best efforts to have
such Registration Statement declared effective by the SEC under the
Securities Act as promptly as possible;
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(c) mail to Eligible Members, as soon as is reasonably practicable
after receiving any required regulatory approvals (other than approval of
this Agreement under Article X of the Illinois Insurance Code), a proxy
statement, together with a form of proxy, with respect to the meeting of
the Company's Eligible Members at which the Eligible Members of the Company
will vote upon this Plan and the Merger (the "Proxy Statement"). The term
"Proxy Statement" shall mean such proxy or information statement at the
time it initially is mailed to the Company's Eligible Members and all
amendments or supplements thereto, if any, similarly filed and mailed. The
information provided and to be provided by the Company, Holdings and New
Insurer, respectively, for use in the Proxy Statement shall not, on the
date the Proxy Statement is first mailed to the Company's Eligible Members
and on the date of the meeting of the Company's Eligible Members referred
to in Section 6.2, contain any untrue statement of a material fact or omit
to state any material fact necessary in order to make such information not
misleading, and each of the Company, Holdings and New Insurer agrees to
correct any information provided by it for use in the Proxy Statement that
shall have become false or misleading;
(d) take all such actions as may be required under state blue sky or
securities laws in connection with the transactions contemplated by this
Plan;
(e) arrange for the listing of the Holdings Common Stock on a
national securities exchange or the Nasdaq Stock Market;
(f) obtain all necessary waivers, consents and approvals from other
parties to material loan agreements, leases and other contracts;
(g) obtain all necessary consents, approvals and authorizations as
are required to be obtained under any Federal, state or foreign law or
regulations;
(h) defend all lawsuits or other legal proceedings, formal or
informal, challenging this Plan or the consummation of the transactions
contemplated hereby; and
(i) lift, rescind or mitigate the effect of any injunction or
restraining order or other order adversely affecting the ability of the
parties to consummate the transactions contemplated hereby.
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6.2 SPECIAL MEETING OF ELIGIBLE MEMBERS OF THE COMPANY.
(a) The Company shall take all action necessary, in accordance with
the Illinois Insurance Code, the Subscription Agreements and the Company's
Rules and Regulations, to convene the Special Meeting of the Eligible
Members as promptly as practicable to consider and vote upon this Plan and
the Merger.
(b) The record date for the Special Meeting shall be the Adoption
Date.
(c) Each Eligible Member shall be entitled to vote in person or by
proxy in a manner to be prescribed by the Director and the Company's Rules
and Regulations; provided, however, that any vote cast shall be by ballot
and not viva voce.
(d) The Proxy Statement shall contain the recommendation of the Board
of Governors that the Eligible Members of the Company vote to approve the
Merger and this Plan.
(e) The Company shall use its best efforts to solicit from Eligible
Members proxies or otherwise secure the vote or consent of the Eligible
Members in favor of approval of the Merger and the Plan.
(f) The Company shall mail notice of the Special Meeting to all
Eligible Members. Such notice shall set forth the reasons for the Special
Meeting and the time and place of the Special Meeting, and shall enclose a
proxy for each Eligible Member. Such notice and proxy shall be mailed by
first class mail to the address of each Eligible Member, as such address
appears on the records of the Company, at least 20 days prior to the
Special Meeting, and such notice and proxy shall be in a form satisfactory
to the Director. Notice of the Special Meeting shall be accompanied by
information relevant to the Special Meeting.
(g) The affirmative vote of the Eligible Members required for
approval of this Plan and the Merger shall be two-thirds of the votes cast
by Eligible Members.
6.3 OFFICERS' AND DIRECTORS' INSURANCE; INDEMNIFICATION. It is
understood and agreed that the Company shall indemnify and hold harmless and,
after the Effective Time, the Surviving Corporation shall indemnify and hold
harmless, each present and former member of the Board of Governors and
officer of the Company, and each director and officer of the Attorney-in-Fact
(the term "officer" including for this purpose the chief executive officer,
the chief operating officer, the chief administrative officer, the chief
financial officer and the chief legal officer)(the "Indemnified Parties") to
the fullest extent permitted by applicable
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law against any losses, claims, damages, liabilities, costs, expenses,
judgments and amounts paid in settlement in connection with any claim,
action, suit, proceeding or investigation arising out of or pertaining to any
action or omission which arises out of or relates to the transactions
contemplated by this Plan, and the Company and the Surviving Corporation, as
the case may be, will advance expenses to each such person upon receipt of an
undertaking to: (i) repay such amount if it shall be determined ultimately
that such person is not entitled to indemnification under the applicable law;
and (ii) reasonably cooperate with the Company (or, after the Effective Time,
the Surviving Corporation) concerning the action, suit, proceeding or
investigation. In the event any such claim, action, suit, proceeding or
investigation is brought against any Indemnified Party (whether arising
before or after the Effective Time), (a) the Indemnified Parties may retain
counsel satisfactory to them and the Company (or them and the Surviving
Corporation after the Effective Time), (b) the Company (or after the
Effective Time, the Surviving Corporation) shall pay all reasonable fees and
expenses of such counsel for the Indemnified Parties promptly as statements
therefor are received, and (c) the Company (or after the Effective Time, the
Surviving Corporation) will use its best efforts to assist in the vigorous
defense of any such matter, provided, that neither the Company nor the
Surviving Corporation shall be liable for any such settlement effected
without their written consent, which consent, however, shall not be
unreasonably withheld. Any Indemnified Party wishing to claim indemnification
under this Section 6.3, upon learning of any such claim, action, suit,
proceeding or investigation, shall notify the Company or the Surviving
Corporation thereof and shall deliver to the Company or the Surviving
Corporation an undertaking to repay any amounts advanced pursuant hereto when
and if a court of competent jurisdiction shall ultimately determine, after
exhaustion of all avenues of appeal, that such Indemnified Party was not
entitled to indemnification under this Section. In addition, upon the
occurrence of the Effective Time, New Insurer shall be deemed expressly to
have assumed any obligations of the Company to its directors and officers for
indemnification, whether under the Company's Rules and Regulations or the
Subscription Agreements, or otherwise, for acts or occurrences prior to the
Effective Time. This Section 6.3 shall survive the consummation of the Merger.
6.4 CONTINUITY OF OBLIGATIONS REGARDING POLICYHOLDERS. It is
understood and agreed that after the Effective Time: (i) the Surviving
Corporation shall be a corporation of the State of Illinois authorized to
transact insurance under the Illinois Insurance Code, (ii) the policyholders
of the Company immediately prior to the Effective Time shall become
policyholders of the Surviving Corporation; (iii) the Surviving Corporation
shall be available to such policyholders to obtain policy changes and
endorsements, to receive payment of premiums and refund unearned premiums, to
serve notice of claim, proof of loss, summons, process and other papers, and
for purposes of suit; and (iv) the Surviving Corporation shall timely file
with the Director the financial statements and tax returns required by the
Illinois Insurance Code, and shall timely pay all taxes found to be due
relating to the business of the
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Company in the State of Illinois during the calendar year of the Merger, in
accordance with the Illinois Insurance Code.
ARTICLE VII
CONDITIONS PRECEDENT
7.1 CONDITIONS TO OBLIGATIONS OF EACH PARTY TO EFFECT THE MERGER. The
respective obligations of each party to effect the Merger shall be subject to
the fulfillment at or prior to the Effective Time of the following conditions:
(a) the Registration Statement shall have become effective under the
Securities Act and no stop order with respect to the Registration Statement
shall have been issued;
(b) all consents, authorizations, orders or approvals of the Illinois
Department and any other governmental commission, board or other regulatory
body that the parties mutually agree are essential to effect the Merger and
for New Insurer to conduct the business of New Insurer and the Company in
substantially the same matter as now conducted shall have been received;
(c) this Plan and the Merger shall have been approved and adopted by
the requisite vote or consent of the Eligible Members of the Company
required by the Illinois Insurance Code, by the requisite vote or consent
of the shareholders of New Insurer required by the Illinois Insurance Code,
and by the requisite vote or consent of the stockholder of Holdings;
(d) the Company shall have received an opinion from a law firm of
recognized standing, to the effect that for Federal income tax purposes,
the Eligible Members generally will recognize no gain or loss on the
exchange of their Membership Interests for shares of Holdings Common Stock
pursuant to the Merger;
(e) no preliminary or permanent injunction or other order, decree or
ruling issued by a court of competent jurisdiction or by a governmental,
regulatory or administrative agency or commission nor any statute, rule,
regulation or executive order promulgated or enacted by any governmental
authority shall be in effect, which would prevent the consummation of the
Merger or make the consummation of the Merger illegal; and
(f) prior to the Effective Time, the Company and Holdings shall have
received from an investment banking firm of recognized standing an opinion
that the
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exchange of the aggregate Membership Interests for the Merger Shares in
the aggregate is fair, from a financial point of view, to the Eligible
Members as a group.
ARTICLE VIII
TERMINATION
8.1 TERMINATION. This Plan may be terminated, and the Merger
contemplated herein may be abandoned, at any time prior to the Effective
Time, whether prior to or after approval of the Merger by the Eligible
Members:
(a) by mutual written consent of the Board of Directors of Holdings,
the Board of Directors of New Insurer and the Board of Governors of the
Company; or
(b) by the Company, if New Insurer or Holdings breaches in any
material respect any of its covenants or agreements contained in this Plan;
or
(c) by Holdings, if the Company breaches in any material respect any
of its covenants or agreements contained in this Plan; or
(d) by either Holdings or the Company:
(i) if the Merger has not been consummated prior to December 31,
1999; or
(ii) if any court of competent jurisdiction or other governmental
body shall have issued an order, decree or ruling, or taken any other
action restraining, enjoining or otherwise prohibiting the Merger and
such order, decree, ruling or other action shall have become final and
non-appealable.
8.2 EFFECT OF TERMINATION. In the event of the termination of this
Plan as provided in Section 7.1, this Plan shall forthwith become void, and
there shall be no liability on the part of the Company, Holdings or New
Insurer, except as described in Section 6.3 and as set forth in the last
sentence of this Section 8.2. Nothing contained in this Section 8.2 shall
relieve the Company, Holdings or New Insurer from liability for any breach of
this Plan.
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ARTICLE IX
GENERAL PROVISIONS
9.1 AMENDMENT. This Plan may be amended by an instrument in writing
signed on behalf of each of the parties hereto; provided, however, that after
approval of the Merger by the Eligible Members, no amendment may be made
which under applicable law requires further approval of Eligible Members
without such further approval of Eligible Members.
9.2 EXTENSION; WAIVER. At any time prior to the Effective Time any
party hereto may (i) extend the time for the performance of any of the
obligations or other acts of any other party hereto; (ii) waive any
inaccuracies in the representations and warranties contained in this Plan and
(iii) waive compliance with any of the agreements of the other parties or
conditions to its own obligations contained in this Plan. Any agreement on
the part of a party hereto to any such extension or waiver shall be valid
only if set forth in an instrument in writing signed on behalf of such party
by a duly authorized officer.
9.3 NONSURVIVAL OF REPRESENTATIONS AND WARRANTIES. The respective
representations and warranties of the Company, New Insurer and Holdings
contained herein shall expire with, and be terminated and extinguished upon,
consummation of the Merger, and thereafter none of the Company, New Insurer
and Holdings or any officer, director or principal thereof shall be under any
liability whatsoever with respect to any such representation or warranty.
This Section 9.3 shall have no effect upon any other obligation of the
parties hereto, whether to be performed before or after the consummation of
the Merger.
9.4 ENTIRE PLAN. This Plan contains the entire agreement among the
Company, New Insurer and Holdings with respect to the subject matter hereof
and supersedes all prior arrangements and understandings, both written and
oral, among such parties with respect thereto.
9.5 COUNTERPARTS. This Plan may be executed in one or more
counterparts, all of which shall be considered one and same agreement and
shall become binding when one or more counterparts have been signed by each
of the parties and delivered to the other parties, it being understood that
all parties need not sign the same counterpart.
9.6 SEVERABILITY. It is the desire and intent of the parties that the
provisions of this Plan be enforced to the fullest extent permissible under
the law and public policies applied in each jurisdiction in which enforcement
is sought. Accordingly, in the event that any provision of this Plan would be
held in any jurisdiction to be invalid, prohibited or unenforceable for any
reason,
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such provision, as to such jurisdiction, shall be ineffective, without
invalidating the remaining provisions of this Plan or affecting the validity
or enforceability of such provision in any other jurisdiction.
Notwithstanding the foregoing, if such provision could be more narrowly drawn
so as not to be invalid, prohibited or unenforceable in such jurisdiction, it
shall, as to such jurisdiction, be so narrowly drawn, without invalidating
the remaining provisions of this Plan or affecting the validity or
enforceability of such provision in any other jurisdiction.
9.7 NOTICES. Any notice given by any party under this Plan (each, a
"notice") shall be in writing and shall be deemed duly given (i) when
personally delivered, or (ii) when five days have elapsed after its
transmittal by registered or certified mail, postage prepaid, return receipt
requested, addressed to the party to whom directed at that party's address as
it appears below or another address of which that party has given notice as
provided herein, or (iii) when transmitted by telex or telecopy (or
equivalent service), the sender's receiving apparatus having printed the
answerback (if any) of the addressee on a copy of the telex or telecopy
message. Notices of address change shall be effective only upon receipt
notwithstanding the previous sentence.
If to the Company, to:
Illinois State Medical Inter-Insurance Exchange
20 North Michigan Avenue, Suite 700
Chicago, Illinois 60602-4890
Attention: Chairman, Board of Governors
If to Holdings to:
ISMIE Holdings Inc.
20 North Michigan Avenue, Suite 700
Chicago, Illinois 60602-4890
Attention: Chairman, Board of Directors
If to New Insurer, to:
ISMIE Indemnity Company
20 North Michigan Avenue, Suite 700
Chicago, Illinois 60602-4890
Attention: Chairman, Board of Directors
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9.8 SECTION HEADINGS. The section headings contained in this Plan are
inserted for reference purposes only and shall not affect the meaning or
interpretation of this Plan.
9.9 BENEFITS AND ASSIGNMENT. This Plan is not intended to convey upon
any person other than the parties any rights or remedies hereunder. This Plan
shall not be assigned by operation of law or otherwise.
9.10 APPLICABLE LAW. This Plan and the legal relations between the
parties hereto shall be governed by and construed in accordance with the laws
of the State of Illinois applicable to contracts made and to be performed
therein.
[SIGNATURE PAGE FOLLOWS]
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IN WITNESS WHEREOF, each of the parties has caused this Plan to be
executed as of the date first above written, which is sometimes referred to
herein as "the date of this Plan."
ILLINOIS STATE MEDICAL INTER-INSURANCE EXCHANGE
By:
--------------------------------------------
Chairman
By:
--------------------------------------------
Secretary
ISMIE INDEMNITY COMPANY
By:
--------------------------------------------
Chairman
By:
--------------------------------------------
Secretary
ISMIE HOLDINGS INC.
By:
--------------------------------------------
Chairman
By:
--------------------------------------------
Secretary
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ANNEX II
[SALOMON SMITH BARNEY INC. LETTERHEAD]
May 5, 1999
The Board of Governors
Illinois State Medical Inter-Insurance Exchange
20 North Michigan Avenue, Suite 700
Chicago, IL 60602
Members of the Board of Directors:
You have requested our opinion as investment bankers as to the fairness,
from a financial point of view, to the Eligible Members of Illinois State
Medical Inter-Insurance Exchange ("ISMIE" or the "Company"), as a group, of
the exchange of the aggregate Membership Interests for shares of Common Stock
of ISMIE Holdings Inc. (the "Holding Company"), pursuant to the Plan and
Agreement of Merger among the Company, the Holding Company and ISMIE
Indemnity Company, an Illinois stock insurance company, dated May 5, 1999
(the "Plan"). Capitalized terms not otherwise defined herein are used as
defined in the Plan.
The Plan provides for a merger and related transactions pursuant to
Article X of the Illinois Insurance Code (the "Conversion") and further
provides, among other things, that: (1) the Company will merge with and into
ISMIE Indemnity Company, the surviving corporation of the Merger; (2)
following such merger, ISMIE Indemnity Company will be a wholly owned
subsidiary of the Holding Company; (3) the Membership Interests in ISMIE will
be extinguished; (4) Eligible Members will receive shares of Common Stock of
the Holding Company as compensation for relinquishing their Membership
Interests in ISMIE; and (5) at the discretion of the board of directors of
the Holding Company, shares of Common Stock of the Holding Company may be
offered to the public in an Initial Public Offering.
As you are aware, Salomon Smith Barney Inc. has acted as financial
advisor to the Company in connection with the Conversion and has received a
fee in connection with those services. In addition, the Company has agreed
to retain Salomon Smith Barney Inc. as lead underwriter in connection with a
possible initial public offering (the "IPO"). Salomon Smith Barney Inc. and
its affiliates (including Citigroup Inc. and The Robinson-Humphrey Company,
LLC) may have other business relationships with the Company. The Company has
agreed to indemnify us for certain liabilities arising out of the rendering
of this opinion.
Pursuant to the Illinois Insurance Code, the Plan must be approved by
(a) the Illinois Director of Insurance (the "Director") and (b) not less than
two-thirds of the
II-1
<PAGE>
The Board of Governors
Illinois State Medical Inter-Insurance Exchange
May 5, 1999
Page 2
Eligible Members present in person or by proxy at the Special Meeting of the
policyholders. If approved by Eligible Members and the Director, and if the
other conditions set forth in the Plan or required by law are satisfied, the
Merger contemplated by the Plan will become effective on the Effective Date.
We do not express any opinion as to: (1) which of the Company's
policyholders are to be included among the Eligible Members; (2) the fairness
of the proposed consideration to be paid to any particular Eligible Member or
to any class of Eligible Members in connection with the Conversion, including
any provisions of the Plan relating to which Eligible Members receive Common
Stock of the Holding Company, the allocation of such Common Stock among
Eligible Members and other provisions of the Plan which distinguish among
Eligible Members; and (3) the fair market value of any shares of Common Stock
of the Holding Company to be issued pursuant to the Plan, the price at which
the Common Stock could be sold in an Initial Public Offering (the "IPO
Price"), or the price at which the Common Stock of the Holding Company issued
in connection with the Plan or pursuant to an Initial Public Offering will
trade. We note that the IPO Price would be a function of market conditions
and the recent performance of and outlook for the Company at that time. We
believe that trading in the Common Stock of the Holding Company for a period
following the completion of a distribution of the Common Stock of the Holding
Company, including an Initial Public Offering, would be characterized by a
redistribution of the Common Stock of the Holding Company among Eligible
Members that were issued shares of Common Stock and other investors. It is
possible that during these periods of redistribution, the Common Stock of the
Holding Company may trade at prices below the prices at which it would trade
on a fully distributed basis.
In arriving at our opinion, we have reviewed, analyzed and relied upon
material bearing upon the financial and operating condition and prospects of
the Company and material prepared in connection with the Plan and the
Conversion, and we have considered such financial and other factors as we
have deemed appropriate under the circumstances, including, among other
things, the following: (1) the statutory annual statements provided by the
Company for the years 1993 through 1998; (2) certain GAAP financial data
provided by the Company, including the audited income statements for each
year of the five year period ending December 31, 1998 and the audited balance
sheets for each year of the five year period ending December 31, 1998 (3)
certain consolidated financial projections for the Holding Company and its
subsidiaries after the Conversion provided to us by the Company; (4) the
draft Registration Statement on Form S-4 of the Company dated April 28, 1999;
(5) a copy of the Plan dated May 5, 1999; (6) certain financial data of the
Company which we compared with publicly available financial information and
market data of other companies which we believed to be comparable; and (7)
the financial terms of the transactions contemplated by the Plan and the
exhibits thereto which we compared with the financial terms of other
transactions we deemed to be relevant. We have also conducted discussions
with the management and advisors of the Company relating to the business of
the Company and certain financial and other aspects of the Plan and the
Conversion and such other matters we believe
II-2
<PAGE>
The Board of Governors
Illinois State Medical Inter-Insurance Exchange
May 5, 1999
Page 3
relevant to our inquiry. We have also taken into account our assessment of
general economic, market and financial conditions, our experience in
securities valuation and our knowledge of the insurance industry generally.
Furthermore, you have directed us to assume and we have assumed that:
(1) the Conversion will meet all applicable legal and regulatory requirements
and that all necessary action will have been taken to comply with all
applicable laws and requirements, including the receipt of all required
approvals by policyholders, regulators and otherwise; and (2) the terms of an
Initial Public Offering (which have not yet been determined), would not
affect the legal or tax treatment of the Plan or the Conversion. We have also
assumed that, as of the date hereof, the Conversion will be completed on the
basis described in the Plan. We have been advised as to certain legal and tax
matters by counsel to the Company and, with respect to such matters, we have
relied upon such counsel.
We have assumed that the Company will receive, prior to the Effective
Date, a private letter ruling from the Internal Revenue Service or an opinion
from its tax counsel as to certain tax matters as described in Section 7.1(d)
of the Plan. For purposes of our opinion, we have assumed that, if an opinion
from tax counsel is delivered, then such opinion of tax counsel is correct
and will be confirmed as of the Effective Date with no changes or exceptions
whatsoever.
In preparing our opinion, we have taken into account a number of factors
including, but not limited to, the following (in no particular order): (1)
the fact that the Company has advised us that growth is extremely important
to remain an effective and competitive insurer in the future; (2) the fact
that the Company has advised us that it is of significant strategic
importance that it have broader access to external capital to finance this
growth; (3) the Company's financial strength ratings and the considerations
on which such ratings are based; (4) in its present form as a reciprocal
insurer, the Company has limited access to the capital markets for new
capital; (5) following the Conversion, the Company will have a capital
structure potentially enabling it to access the capital markets for new
capital; and (6) the illiquidity of Membership Interests.
In conducting our review and arriving at our opinion, we have relied
upon and assumed the accuracy and completeness of the financial and other
information provided to us or publicly available and have not attempted to
independently verify the same. With respect to the financial projections, we
have assumed that such projections have been reasonably prepared on a basis
reflecting the best currently available estimates and judgments of the
Company, and we express no opinion with respect to such projections or the
assumptions on which they are based. We have not made or obtained any
evaluations or appraisals of the properties, assets, liabilities, reserves or
surplus of the Company. Our opinion as expressed herein is limited to the
fairness, from a financial point of view, to the Eligible Members of the
exchange of the aggregate membership interests for shares of Common Stock of
the Holding Company pursuant to the Plan, and does not address the Company's
underlying business decision to participate in the Plan and Conversion,
II-3
<PAGE>
The Board of Governors
Illinois State Medical Inter-Insurance Exchange
May 5, 1999
Page 4
and does not constitute a recommendation to any Eligible Member as to how
such Eligible Member should vote with respect to the Plan. Our opinion is
necessarily based upon conditions as they exist and can be evaluated on the
date hereof and the information made available to us through the date hereof.
It is understood that this letter is for the information of the Board of
Governors of the Company and is not to be quoted or referred to, in whole or
in part, in any document or used for any other purpose without the prior
written consent of Salomon Smith Barney Inc., except that it may be referred
to in, and attached as an exhibit to, the Proxy Statement/Prospectus to be
sent to Eligible Members, and copies of it may be provided to the Director.
Based upon and subject to the foregoing, it is our opinion as investment
bankers that, as of the date hereof, the exchange of the aggregate Membership
Interests for shares of Common Stock of the Holding Company pursuant to the
Plan is fair, from a financial point of view, to the Eligible Members of the
Company, as a group.
Very truly yours,
/s/ Salomon Smith Barney Inc.
Salomon Smith Barney Inc.
II-4
<PAGE>
ANNEX III
SECTION 168 OF THE ILLINOIS INSURANCE CODE
RIGHTS OF DISSENTING POLICYHOLDER OF DOMESTIC COMPANY
Section 168. Rights of Dissenting Policyholder of Domestic Company.
(1) If not less than five per centum of all the policyholders in any domestic
company who were entitled to vote with respect to any merger or consolidation
and who did not vote in favor of such merger or consolidation at the meeting
at which the agreement of merger or consolidation was adopted by the
policyholders of such company, or if not less than five per centum of the
members of any domestic fraternal benefit society party to a merger or
consolidation shall file, at any time within thirty days after the agreement
of merger or consolidation is effected, a petition with the Director for a
hearing upon such agreement of merger or consolidation, the Director shall
order a hearing upon said petition, fix the time and place of such hearing,
and give written notice to the companies that are parties to the merger or
consolidation, at least fifteen days before the date of such hearing. Any
member or policyholder so petitioning may appear before the Director at such
hearing, either in person or by an attorney, and be heard with reference to
said agreement. If, upon such hearing being had, the Director finds that the
interests of the members or policyholders, as the case may be, of such
company are not properly protected, or if he finds that any reasonble
objection exists to such agreement, he shall enter an order revoking the
approval already given, and the agreement of merger or consolidation shall,
thereupon, become null and void.
(2) The Director shall have like power to revoke any approval of any
such agreement if any officer, director or employee of any company party to
such agreement shall, after reasonable notice, fail or refuse without
reasonable cause to attend and testify at such hearing, or to produce any
books or papers called for by said Director.
<PAGE>
PART II
INFORMATION NOT REQUIRED
IN PROSPECTUS
ITEM 20. INDEMNIFICATION OF OFFICERS AND DIRECTORS. Under Delaware law, a
corporation may indemnify any person who was or is a party or is threatened to
be made a party to an action (other than an action by or in the right of the
corporation) by reason of his service as a director or officer of the
corporation, or his service, at the corporation's request, as a director,
officer, employee or agent of another corporation or other enterprise, against
expenses (including attorneys' fees) that are actually and reasonably incurred
by him ("Expenses"), and judgments, fines and amounts paid in settlement that
are actually and reasonably incurred by him, in connection with the defense or
settlement of the action, provided that he acted in good faith and in a manner
he reasonably believed to be in or not opposed to the corporation's best
interests, and, with respect to any criminal action or proceeding, had no
reasonable cause to believe that his conduct was unlawful. Although Delaware law
permits a corporation to indemnify any person referred to above against Expenses
in connection with the defense or settlement of an action by or in the right of
the corporation, provided that he acted in good faith and in a manner he
reasonably believed to be in or not opposed to the corporation's best interests,
if the person has been judged liable to the corporation, indemnification is only
permitted to the extent that the Court of Chancery (or the court in which the
action was brought) determines that, despite the adjudication of liability, the
person should be indemnified for the Expenses. The Delaware General Corporation
Law also provides for mandatory indemnification of any director, officer,
employee or agent against Expenses to the extent the person has been successful
in any proceeding covered by the statute. In addition, the Delaware General
Corporation Law provides the general authorization of advancement of a
director's or officer's litigation expenses in lieu of requiring the
authorization of the advancement by the board of directors in specific cases,
and that indemnification and advancement of expenses provided by the statute
shall not be considered exclusive of any other rights to which those seeking
indemnification or advancement of expenses may be entitled under any bylaw,
agreement or otherwise.
Article Ninth of the Certificate of incorporation of Holdings Inc. (the
"Registrant") provides for the broad indemnification of the directors and
officers of the Registrant and for advancement of litigation expenses to the
fullest extent permitted by current Delaware law.
Article Seventh of the Certificate of incorporation of the Registrant
eliminates the personal liability of a director to the Registrant or its
stockholders under certain circumstances, for monetary damages for breach of
fiduciary duty as a director.
II-1
<PAGE>
ITEM 21. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
A. EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DOCUMENT DESCRIPTION
<S> <C>
2 Plan and Agreement of Merger by and among Holdings Inc., ISMIE Indemnity
Company, and Illinois State Medical Inter-Insurance Exchange, dated May 5,
1999.**
3.1 Certificate of incorporation.**
3.2 Bylaws.**
5 Opinion of Lord, Bissell & Brook.*
8 Opinion of Lord, Bissell & Brook regarding tax matters.*
10.1 1999 Long-Term Equity Incentive Plan.*
10.2 Excess of Loss Reinsurance Agreement, effective July 1, 1997
among Illinois State Medical Inter-Insurance Exchange and the
reinsurers listed therein.*
10.3 First Excess Cession Reinsurance Agreement, effective July 1, 1997 among Illinois
State Medical Inter-Insurance Exchange and the reinsurers listed therein.*
Second Excess Cession Reinsurance Agreement, effective July 1, 1997 among Illinois
10.4 State Medical Inter-Insurance Exchange and the reinsurers listed therein.*
Physician's Business Practice Liability Quota Share Reinsurance Agreement, effective
July 1, 1997 among Illinois State Medical Inter-Insurance Exchange and the
10.5 reinsurers listed therein.*
10.6 Aggregate Stop Loss Reinsurance Contract, effective July 1, 1997 between Illinois
State Medical Inter-Insurance Exchange and Cologne Reinsurance Company
(Dublin) Ltd.**
10.7 Shared Services Agreement among the Illinois State Medical Inter-Insurance
Exchange, Illinois State Medical Services, Inc. and Illinois State Medical Society.*
10.8 Lease dated October 14, 1996, by and between U.S. Equities Realty, Inc., as agent
for the Beneficiary of LaSalle National Bank, as Trustee under Trust No. 106020 and
Illinois State Medical Inter-Insurance Exchange, as amended.*
</TABLE>
II-2
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DOCUMENT DESCRIPTION
<S> <C>
10.9 Amended and Restated Employment Agreement dated January 20, 1999, between
Illinois State Medical Inter-Insurance Exchange and Alexander R. Lerner.*
10.10 Amended and Restated Employment Agreement dated January 20, 1999, between
Illinois State Medical Inter-Insurance Exchange and Donald Udstuen.*
10.11 Amended and Restated Employment Agreement dated January 20,
1999, between Illinois State Medical Inter-Insurance Exchange
and Jeffrey M. Holden*.
10.12 Employment Agreement dated April 21, 1999, between Illinois State Medical Inter-
Insurance Exchange and Saul Morse.*
10.13 Amended and Restated Employment Agreement dated January 20, 1999, between
Illinois State Medical Inter-Insurance Exchange and Eugene J. Gross.*
11 Statement regarding computation of per share earnings, reference is made to page F-
----.
21 Subsidiaries of the registrant.**
23.1 Consent of Ernst & Young LLP.
23.2 Consent of Lord, Bissell & Brook (to be included in Exhibit 5).
23.3 Consent of Salomon Smith Barney Inc. (included in Annex II to the proxy
statement/prospectus).
24 Power of Attorney (included in signature page).**
27 Financial Data Schedule.
99.1 Form of Proxy Card.*
99.2 Form of Taxpayer Identification Card.*
99.3 Form of Record Card.*
- ----------------
* To be filed by amendment
** Previously filed
</TABLE>
B. FINANCIAL STATEMENT SCHEDULES Schedules I, II, III, IV and VI have
been omitted as all required data is included in the Financial Statements and
corresponding footnotes. All other schedules for which provision is made in the
applicable accounting
II-3
<PAGE>
regulations of the Securities and Exchange Commission are
not required under the related instructions or are not applicable and therefore
have been omitted.
ITEM 22. UNDERTAKINGS.
(a) (1) The undersigned Registrant hereby undertakes as follows: that
prior to any public reoffering of the securities registered hereunder through
use of a prospectus which is a part of this registration statement, by any
person or party who is deemed to be an underwriter within the meaning of Rule
145(c), the issuer undertakes that the reoffering prospectus will contain the
information called for by the applicable registration form with respect to
reofferings by persons who may be deemed underwriters, in addition to the
information called for by the other items of the applicable form.
(2) The Registrant undertakes that every prospectus (i) that is
filed pursuant to the paragraph immediately preceding, or (ii) that
purports to meet the requirements of section 10(a)(3) of the Securities
Act and is used in connection with an offering of securities subject to
Rule 415 (Section 230.415 of this chapter), will be filed as a part of
an amendment to the registration statement and will not be used until
the amendment is effective, and that, for purposes of determining any
liability under then Securities Act, each the post-effective amendment
shall be deemed to be a new registration statement relating to the
securities offered therein, and the offering of the securities at that
time shall be deemed to be the initial bona fide offering thereof.
(b) Insofar as indemnification for liabilities arising under the
Securities Act may be permitted to directors, officers and controlling persons
of the Registrant pursuant to the foregoing provisions, or otherwise, the
Registrant has been advised that in the opinion of the Commission the
indemnification is against public policy as expressed in the Securities Act and
is, therefore, unenforceable. In the event that a claim for indemnification
against the liabilities (other than the payment by the Registrant of expenses
incurred or paid by a director, officer or controlling person of the Registrant
in the successful defense of any action, suit or proceeding) is asserted by the
director, officer or controlling person in connection with the securities being
registered, the Registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether the indemnification by it is against public
policy as expressed in the Securities Act and will be governed by the final
adjudication of the issue.
(c) The undersigned Registrant hereby undertakes to supply by means of a
post-effective amendment all information concerning a transaction, and the
company being acquired involved therein, that was not the subject of and
included in the registration statement when it became effective.
II-4
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended,
the Registrant has duly caused this registration statement to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of Chicago,
State of Illinois, on August 6, 1999.
ISMIE Holdings, Inc.
BY: /s/ Alexander R. Lerner
-----------------------
Alexander R. Lerner
President and
Chief Executive Officer
II-5
<PAGE>
Pursuant to the requirements of the Securities Act of 1933, as amended,
this registration statement has been signed by the following persons in the
capacities indicated on August 6, 1999.
NAME TITLE
- --- -----
*
- ----------------------------
Harold L. Jensen, M.D. Chairman of the Board
*
- ----------------------------
Walter Whisler, M.D. Vice Chairman of the Board
/s/ Alexander R. Lerner
- ----------------------------
Alexander R. Lerner President, Chief Executive Officer
and Director (principal executive
officer)
*
- ----------------------------
Donald A. Udstuen Chief Operating Officer and
Director
*
- ----------------------------
Eugene J. Gross Chief Financial Officer and
Assistant Treasurer (principal
financial and accounting officer)
*
- ----------------------------
Irwin A. Smith, M.D. Secretary and Director
*
- ----------------------------
Peter A. Brusca, M.D. Treasurer and Director
*
- ----------------------------
Richard A. Geline, M.D. Director
*
- ----------------------------
Henri S. Havdala, M.D. Director
*
- ----------------------------
Robert M. Reardon, M.D. Director
*
- ----------------------------
Jane Jackman, M.D. Director
*By: /s/ Alexander R. Lerner
- ----------------------------
Alexander R. Lerner
as attorney-in-fact for
each of the persons indicated
II-6
<PAGE>
CONSENT OF INDEPENDENT AUDITORS
We consent to the references to our firm under the captions "Experts" and
"Selected Financial and Operating Data" and to the use of our reports dated
March 1, 1999 (except Note 12, as to which the date is May 5, 1999), and
April 14, 1999, included in the Proxy Statement of Illinois State Medical
Inter-Insurance Exchange that is made a part of Amendment No. 1 to the
Registration Statement (Form S-4 No. 333-78539) and Prospectus of ISMIE
Holdings Inc. for the registration of 10,100,000 shares of its common stock.
/s/ Ernst & Young LLP
Chicago, Illinois
August 6, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 7
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<DEBT-HELD-FOR-SALE> 821,424
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 22,241
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 853,895
<CASH> 39,668
<RECOVER-REINSURE> 0
<DEFERRED-ACQUISITION> 0
<TOTAL-ASSETS> 1,217,432
<POLICY-LOSSES> 895,835
<UNEARNED-PREMIUMS> 21,579
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 0
0
0
<COMMON> 0
<OTHER-SE> 237,776
<TOTAL-LIABILITY-AND-EQUITY> 1,217,432
35,788
<INVESTMENT-INCOME> 12,067
<INVESTMENT-GAINS> 283
<OTHER-INCOME> 0
<BENEFITS> 40,221
<UNDERWRITING-AMORTIZATION> 0
<UNDERWRITING-OTHER> 4,249
<INCOME-PRETAX> 3,668
<INCOME-TAX> 133
<INCOME-CONTINUING> 3,535
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,535
<EPS-BASIC> .35
<EPS-DILUTED> .35
<RESERVE-OPEN> 673,516<F1>
<PROVISION-CURRENT> 40,221<F1>
<PROVISION-PRIOR> 0<F1>
<PAYMENTS-CURRENT> 16<F1>
<PAYMENTS-PRIOR> 35,542<F1>
<RESERVE-CLOSE> 678,179<F1>
<CUMULATIVE-DEFICIENCY> 0
<FN>
<F1>Amounts are net of reinsurance recovered/recoverable.
</FN>
</TABLE>
