<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON FEBRUARY 14, 2000
REGISTRATION NO. 333-78539
- -------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
AMENDMENT NO. 3
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>
<CAPTION>
DELAWARE 6719 36-4293113
<S> <C> <C>
(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 ________, 2000, 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
, 2000
<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:
o 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
o 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:
___________, 2000
_______ __.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 __________, 2000
and was first mailed to members on or about _______, 2000
<PAGE>
ORGANIZATIONAL STRUCTURE OF ISMIE BEFORE AND AFTER THE CONVERSION
BEFORE THE CONVERSION AFTER THE CONVERSION
------------------------------- -------------------------------
Policyholders Shareholders
------------------------------- -------------------------------
------------------------------- -------------------------------
Illinois State Medical
Inter-Insurance Exchange Holdings
"ISMIE"
------------------------------- -------------------------------
------------------------------- -------------------------------
ISMIE Holdings Inc. ISMIE Indemnity Company
"Holdings" "ISMIE"
------------------------------- -------------------------------
-------------------------------
ISMIE Indemnity Company
-------------------------------
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
ii
<PAGE>
affiliated or subsidiary insurers and must obtain the approval of the
Illinois Director of Insurance before completing the purchase.
iii
<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...........................................................................5
RISK FACTORS.............................................................................................................9
If regulatory or competitive conditions in the medical malpractice insurance industry
change, our revenues could decrease or our expenses could increase so that our
earnings are hurt......................................................................................9
Since we currently are licensed to write insurance only in Illinois, any adverse conditions
in Illinois will disproportionately hurt our revenues and profitability ...............................9
If present managed care trends to employ physicians on large staffs continue,
the number of physicians in our traditional markets will decline and our premiums,
revenues and profits could be adversely affected.......................................................9
If we are unable to improve our ratings, we could lose business to competitors in the
future.................................................................................................9
If we increase our loss and loss adjustment expense reserves, our income will
decrease in the period in which the adjustment occurs.................................................10
If interest rates fluctuate, our investment income, cash flows and the value of our
investment portfolio could decline, which in turn could adversely affect our ability
to meet our obligations...............................................................................10
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...................................................................................11
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...............................................11
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.....................................11
If ISMIE were unable to pay dividends to Holdings, our ability to meet our
</TABLE>
iv
<PAGE>
<TABLE>
<S> <C>
obligations and pay dividends to you would be adversely affected and our
stock price could decrease............................................................................11
Antitakeover provisions could discourage takeover attempts and decrease the value
of our stock..........................................................................................12
If an active or orderly trading market does not develop, you may not be able to
sell your shares promptly or at the desired price.....................................................12
FORWARD-LOOKING INFORMATION.............................................................................................13
WHERE YOU CAN FIND MORE INFORMATION.....................................................................................13
THE SPECIAL MEETING.....................................................................................................14
Time, Date and Place...........................................................................................14
Purpose ......................................................................................................14
Record Date, Quorum and Vote Required..........................................................................14
Recommendation of the Board of Governors.......................................................................14
Interests of the Board of Governors in the Conversion..........................................................14
Proxies ......................................................................................................14
Proxy Solicitation.............................................................................................15
Questions About the Conversion.................................................................................15
THE CONVERSION..........................................................................................................16
General ......................................................................................................16
Background of the Conversion...................................................................................16
Determination of Eligible Members..............................................................................18
Conversion of Membership Interests.............................................................................18
Consideration..................................................................................................18
Opinion of Salomon Smith Barney................................................................................19
Recommendation of the Board of Governors.......................................................................23
Description of the Merger Agreement............................................................................26
Dissenters' Rights.............................................................................................28
Additional Aspects of the Merger Agreement and the Conversion..................................................28
COMPARISON OF RIGHTS OF MEMBERS BEFORE AND AFTER THE CONVERSION.........................................................30
MARKET FOR COMMON STOCK.................................................................................................43
DIVIDEND POLICY.........................................................................................................43
CAPITALIZATION..........................................................................................................44
FEDERAL INCOME TAX CONSEQUENCES OF THE CONVERSION.......................................................................44
General ......................................................................................................45
</TABLE>
v
<PAGE>
<TABLE>
<S> <C>
Eligible Members....................................................................................45
ISMIE and ISMIE Indemnity Company...................................................................46
Issuance of Rules Dealing with Inversions...........................................................46
Possible Policyholder Dividend Treatment............................................................46
Taxpayer Identification Number......................................................................47
SELECTED FINANCIAL AND OPERATING DATA........................................................................48
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS ..............................................................................51
Liquidity and Capital Resources.....................................................................57
Effect of Inflation.................................................................................59
Year 2000...........................................................................................59
Recent Accounting Pronouncement Not Yet Adopted.....................................................59
BUSINESS ....................................................................................................59
Overview ...........................................................................................59
History and Structure...............................................................................60
Business Strategy...................................................................................61
Products ...........................................................................................64
Marketing and Policyholder Services.................................................................66
Premium Rates and Discount Programs.................................................................68
Underwriting........................................................................................69
Risk Management Services............................................................................70
Claims .............................................................................................71
Loss Reserves.......................................................................................73
Reinsurance.........................................................................................77
Investment Portfolio................................................................................80
Market Risk.........................................................................................82
Competition.........................................................................................83
Relationship with the Medical Society...............................................................83
Regulation..........................................................................................84
Ratings ...........................................................................................87
Employees...........................................................................................88
Properties..........................................................................................88
Litigation..........................................................................................88
MANAGEMENT...................................................................................................89
Directors and Executive Officers....................................................................89
Committees of the Holdings Board....................................................................91
Director Compensation...............................................................................92
Executive Compensation..............................................................................92
Employment Agreements...............................................................................93
vi
<PAGE>
Compensation Plans.............................................................................................94
Related Party Transactions.....................................................................................95
OWNERSHIP OF COMMON STOCK...............................................................................................96
DESCRIPTION OF CAPITAL STOCK............................................................................................98
General ......................................................................................................98
Common Stock...................................................................................................98
Preferred Stock................................................................................................98
Statutory, Charter and Bylaw Provisions Which Could Have an Anti-Takeover Effect...............................99
Transfer Agent and Registrar..................................................................................101
LEGAL MATTERS..........................................................................................................101
EXPERTS ..............................................................................................................101
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>
vii
<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 ____________, 2000 (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 2000. 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 approval of the merger is affirmed by the Illinois Director
of Insurance.
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. YOU SHOULD READ THE ENTIRE PROXY
STATEMENT/PROSPECTUS CAREFULLY, INCLUDING THE "RISK FACTORS" SECTION AND THE
FINANCIAL STATEMENTS AND THE NOTES TO THOSE STATEMENTS.
<TABLE>
<S> <C>
WHO WE ARE (PAGE 63).................... 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
nine months ended September 30, 1999, our total revenue was
$141.8 million and our net income was $15.9 million. As of
September 30, 1999, we had $1.17 billion of total assets, no debt
outstanding and $231.8 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.
OUR REASONS FOR THE
CONVERSION (PAGE 24).................... 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 improve our ability to compete effectively in this
changing market. As a reciprocal insurance exchange, which is an
organization similar to a mutual insurance company but without
corporate form, we have limited access to the capital markets for
raising new capital. We believe the conversion to a holding
company structure will permit us to grow and diversify, improve
our ability to raise capital in the future, enable us to use stock for
acquisitions if and when the opportunities arise and permit our
eligible members to become stockholders of a publicly-traded
Delaware corporation.
3
<PAGE>
OUR BOARD'S
RECOMMENDATIONS TO
MEMBERS (PAGE 24)....................... 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 19)............................... 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.
THE SPECIAL MEETING (PAGE
15)..................................... TIME, DATE AND PLACE. The special meeting will be held at
_______ p.m., local time, on _____________, 2000 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.
4
<PAGE>
TAX CONSEQUENCES OF THE
MERGER (PAGE 48)........................ 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. YOU ARE URGED TO
CONSULT YOUR TAX ADVISER FOR A FULL UNDERSTANDING OF THE TAX
CONSEQUENCES OF THE MERGER.
REGULATORY APPROVALS (PAGE
29)..................................... 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.
DISSENTERS' RIGHTS
(PAGE 29)............................... 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 15)............................... 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 30)............................... 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.
SELECTED FINANCIAL AND OPERATING DATA
</TABLE>
5
<PAGE>
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. The selected financial data for
the nine month periods ended September 30, 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, unless otherwise indicated. you should read all of the financial
statements and related notes beginning at page F-1 of this proxy
statement/prospectus in order to fully understand ISMIE's financial
situation. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations."
<TABLE>
<CAPTION>
As of or for the Nine
Months Ended
September 30 As of or for the Year Ended December 31,
1999 1998 1998 1997 1996 1995 1994
---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C>
Income Statement
Data: (in thousands, except per share, ratios and percentage data)
Premiums written
Direct and
assumed premiums
written $122,538 $134,510 $179,668 $196,152 $207,578 $197,241 $203,756
======== ======== ======== ======== ======== ======== ========
Net premiums
written $103,100 $95,873 $134,215 $104,953 $85,532 $96,809 $140,504
======== ======= ========= ======== ======= ======= ========
Direct and assumed
premiums earned $124,430 $133,995 $177,451 $188,866 $207,857 $221,491 $200,285
Reinsurance (19,438) (38,637) (45,453) (91,199) (122,040) (100,432) (63,252)
premiums ceded -------- -------- --------- -------- --------- --------- ---------
Net premiums earned 104,992 95,358 131,998 97,667 85,817 121,059 137,033
Net investment
income 36,502 33,922 45,361 46,663 46,436 50,927 49,140
Other income 104 0 5,095 0 0 0 0
Realized investment
gains (losses) 180 61 (104) (401) 2,406 322 12,141
-------- ------- --------- -------- --------- --------- ---------
6
<PAGE>
<CAPTION>
As of or for the Nine
Months Ended
September 30 As of or for the Year Ended December 31,
1999 1998 1998 1997 1996 1995 1994
---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C>
Total revenues 141,778 129,341 182,350 143,929 134,659 172,308 198,314
--------- --------- ------- ------- ------- ------- -------
Losses and loss
adjustment expenses 110,355 108,862 153,660 117,816 105,403 177,273 210,046
Other operating
expenses 12,640 11,561 16,222 10,878 6,296 8,793 11,870
---------- --------- -------- -------- --------- --------- ---------
Total expenses 122,995 120,423 169,882 128,694 111,699 186,066 221,916
--------- -------- ------- ------- ------- ------- -------
Income (loss) before
Income taxes 18,783 8,918 12,468 15,235 22,960 (13,758) (23,602)
Income taxes (benefit) 2,874 (429) (257) (3,206) 19,541 6,007 (8,564)
----------- ------------ ---------- ---------- ------- ----------- -----------
Net income (loss) $15,909 $9,347 $12,725 $18,441 $3,419 ($19,765) ($15,038)
======= ====== ======= ======= ====== ========= =========
Balance Sheet Data:
Total investments and
invested cash $840,863 $801,592 $887,661 $787,333 $780,209 $861,428 $780,362
Total assets 1,165,501 1,241,999 1,211,428 1,246,506 1,287,514 1,362,798 1,263,586
Members' Equity 231,794 241,734 242,690 220,169 193,336 200,969 175,200
Additional Data:
Gross ratios (GAAP)
(1):
Loss & LAE 101.2% 98.7% 94.5% 95.1% 77.4% 128.6% 142.0%
Expense 10.5% 9.6% 10.1% 8.8% 7.4% 6.4% 6.2%
Combined 111.7% 108.3% 104.6% 103.9% 84.8% 135.0% 148.2%
Net ratios (GAAP) (2):
Loss & LAE 105.1% 114.2% 116.4% 120.6% 122.8% 146.4% 153.3%
Expense 12.0% 12.1% 12.3% 11.1% 7.3% 7.3% 8.7%
Combined 117.1% 126.3% 128.7% 131.8% 130.2% 153.7% 161.9%
Pro forma earnings
per share (3) $ 1.59 $1.27
7
<PAGE>
<CAPTION>
As of or for the Nine
Months Ended
September 30 As of or for the Year Ended December 31,
1999 1998 1998 1997 1996 1995 1994
---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C>
Pro forma book value
per share $23.18
Pro forma book value
per share, net of FAS
115(4) $24.36
Retention rate (5) 91.9% 89.1% 86.0% 90.1% 90.8% 92.4% 93.4%
Investment yield (6) 5.57% 5.76% 5.60% 6.07% 5.77% 6.10% 6.00%
Statutory combined
ratio(7) 117.4% 126.2% 128.5% 131.0% 130.2% 155.5% 161.9%
Statutory surplus $201,756 $177,884 $187,224 $172,713 $158,622 $134,432 $135,339
</TABLE>
(1) Gross 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 period.
(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.
8
<PAGE>
9
<PAGE>
RISK FACTORS
IN CONSIDERING THE MATTERS INCLUDED IN THIS PROXY
STATEMENT/PROSPECTUS, YOU SHOULD CAREFULLY CONSIDER THE FOLLOWING RISK
FACTORS, TOGETHER WITH THE OTHER INFORMATION IN THIS DOCUMENT.
IF REGULATORY OR COMPETITIVE CONDITIONS IN THE MEDICAL MALPRACTICE
INSURANCE INDUSTRY CHANGE, OUR REVENUES COULD DECREASE OR OUR EXPENSES COULD
INCREASE SO THAT OUR EARNINGS ARE 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 regulatory or competitive
changes affecting rates or other aspects of medical malpractice insurance to
a greater extent than if our business were diversified.
SINCE WE CURRENTLY ARE LICENSED TO WRITE INSURANCE ONLY IN ILLINOIS,
ANY ADVERSE CONDITIONS IN ILLINOIS WILL DISPROPORTIONATELY HURT OUR REVENUES
AND PROFITABILITY.
Our revenues and profitability are affected by Illinois regulatory,
economic and other conditions and could be hurt by negative developments 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.
IF PRESENT MANAGED CARE TRENDS TO EMPLOY PHYSICIANS ON LARGE STAFFS
CONTINUE, THE NUMBER OF PHYSICIANS IN OUR TRADITIONAL MARKETS WILL DECLINE
AND OUR PREMIUMS, REVENUES AND PROFITS COULD BE ADVERSELY AFFECTED.
Our strongest position in the market for physician malpractice
coverage historically has been among self-employed individual practitioners
and those involved in small groups and clinics. The development of managed
care is leading to greater concentrations of physicians employed by hospitals
and other providers. Hospitals and large corporate providers of health care
services arrange for malpractice coverage of their own employees. Therefore,
as physicians move from self-employed medical practices to hospitals or large
clinics in employed staff positions, the market traditionally served by ISMIE
will shrink.
Our marketing to hospitals and large groups has been limited to date
and the competition for these types of risks is more intense. Many hospitals
operate self insured programs covering their employed physicians, and larger,
national insurers such as St. Paul Fire & Marine Insurance Company, CNA
Financial Corporation and Zurich American Insurance Company compete for
bigger corporate and hospital accounts. Some of these competitors have
greater financial resources and higher ratings than we do. As we expand into
new markets, new product lines and new geographical markets, pursuant to our
strategy discussed under "Business -- Business Strategy," we will need to
compete with established companies in these new markets, many of which have
existing relationships with the doctors and medical groups we will seek to
insure.
10
<PAGE>
IF WE ARE UNABLE TO IMPROVE OUR RATINGS, WE COULD LOSE BUSINESS TO
COMPETITORS IN THE FUTURE.
ISMIE is rated "B++ (Very Good)" by A.M. Best and "BBB+ (Good)" by
Standard & Poor's Ratings Services, a division of The McGraw-Hill Companies,
Inc. Many of the larger insurance companies with which we compete such as St.
Paul Fire & Marine Insurance Company, CNA Financial Corporation and Zurich
American Insurance Company, currently have higher insurance ratings. In
connection with our rating, A.M. Best and Standard & Poor's have commented on
our narrow product line and geographic concentration. Our ability to maintain
or improve our rating may depend on our ability to implement our conversion
and business strategy to grow and diversify. If we are unable to increase our
ratings, it could weaken our competitive position in the future because some
medical groups and other health care providers require that their medical
malpractice insurance providers have an "A" rating.
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.
11
<PAGE>
IF INTEREST RATES FLUCTUATE, OUR INVESTMENT INCOME, CASH FLOWS AND
THE VALUE OF OUR INVESTMENT PORTFOLIO COULD DECLINE, WHICH IN TURN COULD
ADVERSELY AFFECT OUR ABILITY TO MEET OUR OBLIGATIONS.
Over 95% of our invested assets, which represent 70% of our total
assets, consist of fixed maturity securities. We earn our investment income
primarily from interest income on these fixed income investments. Lower
interest rates reduce the return on our portfolio. Reduced investment income
would also reduce our cash flows. Higher interest rates could reduce the
market value of our fixed income investments. If investment income and cash
flows were reduced or the value of our investments declined, our ability to
meet our obligations could be adversely affected.
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 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."
12
<PAGE>
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."
IF ISMIE WERE UNABLE TO PAY DIVIDENDS TO HOLDINGS, OUR ABILITY TO
MEET OUR OBLIGATIONS AND PAY DIVIDENDS TO YOU WOULD BE ADVERSELY AFFECTED AND
OUR STOCK PRICE COULD DECREASE.
As a stock insurer, ISMIE will be restricted by Illinois law in the
amount of shareholder dividends it can pay in relation to earnings or
surplus, without consent of the Illinois Insurance Department. ISMIE may pay
dividends in any year out of its earned surplus, 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.
ANTITAKEOVER PROVISIONS COULD DISCOURAGE TAKEOVER ATTEMPTS AND
DECREASE THE VALUE OF OUR 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, 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.
IF AN ACTIVE OR ORDERLY TRADING MARKET DOES NOT DEVELOP, YOU MAY NOT
BE ABLE TO SELL YOUR SHARES PROMPTLY OR AT THE DESIRED PRICE.
Before the conversion is completed, there will be no public market
for the common stock and we cannot control whether an active or orderly
trading market will develop or be sustained. We
13
<PAGE>
have applied to have the Holdings common stock listed on the Nasdaq National
Market once the conversion is completed. However, we cannot predict 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.
FORWARD-LOOKING INFORMATION
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 risks described above under the heading
"Risk Factors."
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 attached to the registration
14
<PAGE>
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.
15
<PAGE>
THE SPECIAL MEETING
TIME, DATE AND PLACE
The special meeting will be held at _______ p.m., local time, on
__________, 2000 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."
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
16
<PAGE>
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.
17
<PAGE>
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 ________, 2000, 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.
18
<PAGE>
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
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
19
<PAGE>
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:
(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
20
<PAGE>
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.
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."
21
<PAGE>
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;
- 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;
22
<PAGE>
- 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;
- 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.
23
<PAGE>
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;
- 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.
24
<PAGE>
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, 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
25
<PAGE>
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.
- 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
26
<PAGE>
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
- 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
27
<PAGE>
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.
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
28
<PAGE>
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:
- 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.
29
<PAGE>
- 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 affirmation of the merger by the Illinois Director
of Insurance following a hearing 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;
- 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
30
<PAGE>
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 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.
31
<PAGE>
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.
DESCRIPTION OF RIGHTS OF MEMBERS OF ISMIE
GENERAL. Membership in ISMIE is limited to and composed of those
persons who are "named insureds" or "additional named insureds" in ISMIE.
"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 to the policy other than a reporting endorsement. Each "named
insured" or "additional named insured" under a policy of insurance issued by
ISMIE becomes a member when the policy is issued and the period of coverage
commences under the policy.
Membership interests in ISMIE have no preemptive or conversion
rights, redemption rights, or sinking fund provisions.
DESCRIPTION OF RIGHTS OF HOLDERS OF ISMIE
HOLDING STOCK AFTER THE CONVERSION
GENERAL. The authorized capital stock of Holdings consists of (i)
40,000,000 shares of common stock, par value $0.01 per share, and (ii)
5,000,000 shares of preferred stock, par value $0.01 per share. Immediately
after the consummation of the conversion, it is expected that there will be
approximately 10,000,000 shares of common stock outstanding and no shares of
preferred stock outstanding.
Shares of common stock have no preemptive rights, conversion rights,
or redemption rights. No shares of preferred stock will be issued or
outstanding immediately following the conversion. When and if issued, the
preferred stock will have the rights, powers and preferences as may be
established by the Holdings Board. See "Description of Capital Stock --
Preferred Stock."
32
<PAGE>
DESCRIPTION OF RIGHTS OF MEMBERS OF ISMIE
LIQUIDITY/MARKETABILITY. A membership interest is not transferable
and ceases when the coverage period or certificate period of the member under
the policy issued by ISMIE a terminates.
DISTRIBUTIONS. The Board of Governors may declare dividends to
qualifying members of ISMIE. The qualifications of members to receive
dividends declared may be determined by the Board of Governors, except that a
dividend may only be paid to a member who has been insured during four (4)
continuous policy periods.
If ISMIE is liquidated, any assets remaining after payment of all
liabilities would be distributed to members in accordance with the provisions
of Article 13 of the Illinois Insurance Code.
INCOME TAXATION. ISMIE, as a reciprocal insurance exchange, is
taxable under the Internal Revenue Code as a "mutual insurance company." A
holder of a membership interest is not taxed with respect to ISMIE's income,
but may realize taxable income to the extent that ISMIE makes actual
distributions (in the form of premium credits or other dividends) to the
holder out of current or accumulated earnings and profits of ISMIE. As a
"mutual insurance company" for federal income tax purposes, ISMIE will
receive a deduction in the amount of the distributions when accrued.
DESCRIPTION OF RIGHTS OF HOLDERS OF HOLDINGS
STOCK AFTER THE CONVERSION
LIQUIDITY/MARKETABILITY. Holdings has applied for listing of the
shares of common stock on the Nasdaq National Market. As a result, Holdings
anticipates that there will be public market for the shares of common stock,
although we cannot be sure of the price at which the common stock will trade.
See "Risk Factors -- If an active or orderly trading market does not develop,
you may not be able to sell your shares promptly or at the desired price."
DISTRIBUTIONS. Subject to the rights of holders of preferred stock,
if any, holders of common stock will be entitled to participate equally in
dividends if, as and when declared by the Holdings Board, and in the
distribution of assets in the event of dissolution. See "Dividend Policy."
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 to the extent that Holdings pays dividends to
the holder out of current or accumulated earnings and profits. As a stock
corporation, Holdings will not receive a deduction for dividends.
Accordingly, to the extent distributed, earnings and profits of Holdings
generally will face two levels of federal income tax.
33
<PAGE>
DESCRIPTION OF RIGHTS OF MEMBERS OF ISMIE
ASSESSMENTS. Members may not be assessed on policies issued or
renewed by ISMIE.
MEETINGS AND ACTIONS. Action required to be taken by the members may
be taken at a duly called annual or special meeting of members of ISMIE.
Annual meetings are held during, and at the same place as, the annual meeting
of the Illinois State Medical Society. Special meetings of the members may be
called only by (i) the Chairman of the Board of Governors or (ii) one-third
of the total number of Governors and twenty (20) members of ISMIE.
The business transacted at any special meeting of the members is
confined to matters specified in the notice of meeting.
The Rules and Regulations of ISMIE provide for an advance notice
procedure with respect to the nomination by members of candidates for
election as members of the Board of Governors. Nominations by members require
a nominee to be nominated by an ISMIE policyholder and seconded by two other
members of ISMIE.
The Rules and Regulations of ISMIE may be amended by the Board of
Governors at any regular or special meeting by a vote of two-thirds of the
total Governors holding office or at a meeting of members of ISMIE upon the
favorable vote of two-thirds of the members represented at the meeting either
in person or by proxy.
DOMICILIARY STATE. Illinois
DESCRIPTION OF RIGHTS OF HOLDERS OF HOLDINGS
STOCK AFTER THE CONVERSION
ASSESSMENTS. Shares of common stock and preferred stock will not be
callable or assessable by Holdings.
MEETINGS AND ACTIONS. Any action required or permitted to be taken
by the stockholders of Holdings must be taken by vote of the stockholders at
a duly called annual or special meeting of stockholders and not by written
consent. Special meetings of stockholders may be called only by (i) the
President or Secretary at the request of a majority of the Holdings Board or
(ii) the Chairman of the Holdings Board.
The business transacted at any special meeting of stockholders is
confined to matters specified in the notice of meeting.
The certificate of incorporation establishes an advance notice
procedure with regard to the nomination by stockholders of candidates for
election as directors and with regard to proposals of business to be brought
before an annual meeting of stockholders of Holdings. Notice as to any
stockholder nomination or other proper proposal must be received by Holdings
not less than 60 days nor more than 90 days prior to the anniversary date of
the immediately preceding annual meeting. In the event that the date of the
annual meeting is more than 30 days before or more than 60 days after the
anniversary date, however, the Certificate of incorporation provides
additional time for notice. In addition, the notice must 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.
STATE OF INCORPORATION. Delaware
34
<PAGE>
DESCRIPTION OF RIGHTS OF MEMBERS OF ISMIE
VOTING. Each member entitled to vote is entitled to one vote at all
meetings of members on all matters submitted to the members for action. The
Rules and Regulations of ISMIE generally require the favorable vote of a
majority of members voting to approve matters submitted to the members. There
is no cumulative voting, and, therefore, a majority of the members voting at
the meeting will be entitled to elect all of the members of the Board of
Governors to be elected at the meeting.
DESCRIPTION OF RIGHTS OF HOLDERS OF HOLDINGS
STOCK AFTER THE CONVERSION
VOTING. Holders of common stock are entitled to one vote per share
on all matters with respect to which the holders of common stock are entitled
to vote (including the election of directors) and, except as otherwise
required by law or by the terms of any series of preferred stock then
outstanding, the holders of common stock will exclusively possess all voting
power. Under the DGCL, in the absence of specific requirements in a
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.
35
<PAGE>
DESCRIPTION OF RIGHTS OF MEMBERS OF ISMIE
QUORUM. One hundred (100) members represented in person or by proxy
constitutes a quorum for the transaction of business at any meeting of the
members.
PREFERRED STOCK. Not applicable.
LIMITED LIABILITY. The liability of a member generally is limited to
the premiums accrued under the current policies of insurance issued by ISMIE
to the member. Members of ISMIE are not assessable by ISMIE.
DESCRIPTION OF RIGHTS OF HOLDERS OF HOLDINGS
STOCK AFTER THE CONVERSION
QUORUM. The holders of a majority of the stock issued and
outstanding and entitled to vote, represented in person or by proxy, will
constitute a quorum for the transaction of business at all meetings of
stockholders.
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 holders of common stock is
generally limited to the price paid for the common stock by the holder.
36
<PAGE>
DESCRIPTION OF RIGHTS OF MEMBERS OF ISMIE
MANAGEMENT. ISMIE is a reciprocal insurance exchange and management
responsibility is divided between the Board of Governors and the
attorney-in-fact, Illinois State Medical Insurance Services, Inc. The
attorney-in-fact is designated as the attorney-in-fact for each subscriber
under an agreement which each subscriber signs when making application for
insurance. The power of attorney agreement between the attorney-in-fact and
ISMIE, describes the allocation of powers and duties between the
attorney-in-fact and the Board of Governors.
The attorney-in-fact is under the control and supervision of the
Board of Governors, is 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.
DESCRIPTION OF RIGHTS OF HOLDERS OF HOLDINGS
STOCK AFTER THE CONVERSION
MANAGEMENT. The Holdings Board has the power and duty to manage the
business and affairs of Holdings and, indirectly, all its subsidiaries. The
Holdings Board may designate committees, each committee to consist of one or
more directors, and has established an audit committee, a compensation
committee, an executive committee, a stock option committee, a nominating
committee and an investor relations committee. Directors are elected by the
stockholders of Holdings. See "--Voting" and "--Election of Directors."
The officers of Holdings serve at the discretion of the Holdings
Board.
37
<PAGE>
DESCRIPTION OF RIGHTS OF MEMBERS OF ISMIE
BOARD OF GOVERNORS. The Rules and Regulations of ISMIE provide that
the Board of Governors shall consist of twenty-one members, each of whom must
be a physician member. The Board of Governors is divided into three classes
who serve for staggered terms. Each class is composed of seven governors, who
serve for a term of three years, with one class being elected at each annual
meeting.
ELECTION OF GOVERNORS. ISMIE's Rules and Regulations provide that
nominations for election of members of the Board of Governors must be made by
members who comply with specified notice procedures. A Nominating Committee
composed of at least three but no more than five members of the Board of
Governors reviews the nominees and presents its recommendations to the
Executive Committee of the Board of Governors which ultimately approves a
slate of recommended nominees for consideration by the members. The Rules and
Regulations also provide that members who comply with specified procedures
may run without being recommended by the Nominating Committee. See "--
Meetings and Actions."
DESCRIPTION OF RIGHTS OF HOLDERS OF HOLDINGS
STOCK AFTER THE CONVERSION
BOARD OF DIRECTORS. The Holdings Board consists of not less than
three and more than fifteen directors, the exact number to be fixed from time
to time by the favorable vote of a majority of the Holdings Board.
Immediately following the consummation 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 DIRECTORS. The Certificate of incorporation provides
that nominations for election of directors may be made only by or at the
direction of the Holdings Board or by any stockholder of Holdings entitled to
vote on the election of directors who complies with specified notice
procedures and who was a stockholder of record at the time of giving notice.
See "-- Meetings and Actions." Directors are elected at the annual meeting of
stockholders except when filling vacancies or newly-created vacancies. See
"-- Vacancies." A plurality of votes present in person or by proxy and
entitled to vote on the election of directors is required for election.
38
<PAGE>
DESCRIPTION OF RIGHTS OF MEMBERS OF ISMIE
REMOVAL OF GOVERNORS. ISMIE's Rules and Regulations do not contain
any provisions relating to the removal of a member of the Board of Governors.
VACANCIES. Vacancies in the Board of Governors are filled by a vote
of the majority of the remaining Governors (1) for the remaining term if the
remaining term is less than 18 months, or (2) only until the next annual
meeting of members if the remaining term is more than 18 months.
DESCRIPTION OF RIGHTS OF HOLDERS OF HOLDINGS
STOCK AFTER THE CONVERSION
REMOVAL OF DIRECTORS. The Certificate of incorporation provides that
directors can be removed from office only for cause and only 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 incorporation provides that vacancies
on the Holdings Board and any newly-created directorships resulting from an
increase in the authorized number of directors may be filled for the
remainder of a term only by an favorable vote of a majority of the remaining
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.
39
<PAGE>
DESCRIPTION OF RIGHTS OF MEMBERS OF ISMIE
INDEMNIFICATION. ISMIE's Rules and Regulations provide that ISMIE
shall indemnify the members of the Board of Governors, the officers of ISMIE,
the employees of ISMIE and any person serving as a director, trustee,
officer, or employee of another enterprise at the request of ISMIE, from and
against expenses (including attorneys' fees), judgments, decrees, fines,
penalties, and amounts paid in settlement actually and reasonably incurred in
connection with any actions, suits or proceedings relating to claims or
liabilities asserted against the management or operations of ISMIE, including
any derivative actions brought in the name of or on behalf of ISMIE. However,
indemnification may be made only if the person acted in good faith and in a
manner reasonably believed to be in, or not opposed to, the best interests of
ISMIE and, with respect to any criminal proceeding, had no reasonable cause
to believe the conduct was unlawful. In a derivative action, no
indemnification will be made if the person shall have been finally adjudged
to be liable for negligence or misconduct unless the court in which the
action was brought shall determine that the person is fairly and reasonably
entitled to indemnity for the expenses.
AMENDMENTS TO GOVERNING DOCUMENTS. Members of ISMIE may adopt,
alter, amend or repeal provisions of ISMIE's Rules and Regulations by the
vote of two-thirds of the members voting at an annual or special meeting or
by the vote of two-thirds of the number of Governors holding office at any
regular or special meeting of the Board.
DESCRIPTION OF RIGHTS OF HOLDERS OF HOLDINGS
STOCK AFTER THE CONVERSION
INDEMNIFICATION. The Certificate of incorporation provides that
Holdings shall indemnify its directors, officers and any person serving at
the request of the corporation as a director, officer employee or agent of
another corporation, and may indemnify its employees and agents, who are
parties or threatened to be made parties to any action, suit or proceeding by
reason of the person's capacity as a director, officer, employee or agent of
Holdings, from and against expenses (including attorneys' fees), judgments,
fines and settlements arising from the action, suit or proceeding to the
fullest extent authorized by the DGCL. Section 145(a) of the DGCL provides
that a corporation may indemnify a director, officer, employee or agent if
the person acted in good faith and in a manner reasonably believed to be in,
or not opposed to, the best interests of the corporation and, with respect to
any criminal proceeding, had no reasonable cause to believe the conduct was
unlawful. As permitted by the DGCL, the Certificate of incorporation
eliminates in specified circumstances the monetary liability of the directors
of Holdings for a breach of their fiduciary duties as directors.
AMENDMENTS TO GOVERNING DOCUMENTS. Stockholders of Holdings are
entitled to adopt, alter, amend, rescind or repeal provisions of the Holdings
Bylaws by the favorable vote of a majority of the stockholders present in
person or by proxy at a duly called meeting of stockholders at which a quorum
is present. The Holdings Board is also entitled to alter, amend, change or
repeal provisions of the Holdings Bylaws by majority vote. Generally, under
Section 242 of the DGCL, an amendment to
40
<PAGE>
DESCRIPTION OF RIGHTS OF MEMBERS OF ISMIE
FINANCIAL REPORTING. ISMIE is not required to provide the members
with any annual or quarterly income and expense statements or balance sheets.
ISMIE is required to file annual and quarterly financial statements prepared
in accordance with statutory accounting practices (SAP) with the Illinois
Insurance Department, which are open to public inspection. ISMIE provides to
members an annual report of its financial condition and results of
operations, prepared in accordance with GAAP and audited by independent
auditors.
BUSINESS COMBINATIONS. The Rules and Regulations of ISMIE do not
contain any provisions relating to business combinations. The Illinois
Insurance Code generally requires a vote of two-thirds of the members voting
in person or by proxy to approve a merger, consolidation or plan of exchange.
DESCRIPTION OF RIGHTS OF HOLDERS OF HOLDINGS
STOCK AFTER THE CONVERSION
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. Holdings will file annual and quarterly reports
with the Securities and Exchange Commission and with the Nasdaq National
Market. Holdings will also provide to the holders of common stock annual and
quarterly reports of its financial condition and results of operations,
prepared in accordance with GAAP and, with respect to the annual reports,
audited by independent auditors. Following the conversion, ISMIE will file
annual and quarterly financial statements under SAP with the Illinois
Insurance Department.
BUSINESS COMBINATIONS. The DGCL generally requires that a majority
of the stockholders approve a merger, consolidation or the sale, lease or
exchange of all or substantially all of a corporation's property and assets.
The DGCL contains additional restrictions where the action or transaction is
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."
41
<PAGE>
DESCRIPTION OF RIGHTS OF MEMBERS OF ISMIE
ANTI-TAKEOVER PROVISIONS. As a reciprocal insurance exchange, ISMIE
has no capital stock or other transferable ownership interests and therefore
could not be acquired by a hostile bidder. The Board of Governors is divided
into three classes of directors, serving staggered three-year terms. As a
result, one third of the Board of Governors is elected each year. This
classified board provision could delay a majority of members who do not favor
the policies of the Board of Governors from removing a majority of the Board
of Governors for two years.
DESCRIPTION OF RIGHTS OF HOLDERS OF HOLDINGS
STOCK AFTER THE CONVERSION
ANTI-TAKEOVER PROVISIONS. Holdings is a Delaware corporation and is
subject to the provisions of Section 203 of the DGCL. In general, Section 203
prevents an "interested stockholder" (defined generally as a person owning
15% or more of Holdings' outstanding voting stock) from engaging in a
"business combination" (as defined in Section 203) with Holdings for three
years following the time that person became an interested stockholder unless:
- 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
42
<PAGE>
DESCRIPTION OF RIGHTS OF MEMBERS OF ISMIE
DESCRIPTION OF RIGHTS OF HOLDERS OF HOLDINGS
STOCK AFTER THE CONVERSION
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.
43
<PAGE>
DESCRIPTION OF RIGHTS OF MEMBERS OF ISMIE
DESCRIPTION OF RIGHTS OF HOLDERS OF HOLDINGS
STOCK AFTER THE CONVERSION
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.
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."
44
<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 -- If an active or orderly trading
market does not develop, you may not be able to sell your shares promptly or
at the desired price."
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".
45
<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 September 30, 1999; and (2) Holdings, adjusted to
reflect, on a pro forma basis as if the conversion had occurred as of
September 30, 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 September 30, 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............................................ - 243,506
Policyholders' surplus/retained earnings.............................. 243,616 -
Accumulated other comprehensive loss.................................. (11,822) (11,822)
---------- ---------
Total Equity..................................................... $231,794 $231,794
------- -------
Total capitalization.................................................. $231,794 $231,794
======= ========
</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."
46
<PAGE>
FEDERAL INCOME TAX CONSEQUENCES OF THE CONVERSION
The following discussion is a summary of material 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 ARE URGED TO 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.
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
47
<PAGE>
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.
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.
48
<PAGE>
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 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.
49
<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. The selected financial data for
the nine month periods ended September 30, 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, unless otherwise indicated. You should
read all of the financial statements and related notes beginning at page F-1
of this proxy statement/prospectus in order to fully understand ISMIE's
financial situation. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
<TABLE>
<CAPTION>
As of or for the Nine
Months Ended
September 30 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)
<S> <C> <C> <C> <C> <C> <C> <C>
Premiums written
Direct and
assumed premiums
written $122,538 $134,510 $179,668 $196,152 $207,578 $197,241 $203,756
======== ======== ======== ======== ======== ======== ========
Net premiums
written $103,100 $95,873 $134,215 $104,953 $85,532 $96,809 $140,504
======== ======= ======== ======== ======= ======= ========
Direct and assumed
premiums earned $124,430 $133,995 $177,451 $188,866 $207,857 $221,491 $200,285
Reinsurance
premiums ceded (19,438) (38,637) (45,453) (91,199) (122,040) (100,432) (63,252)
------- -------- -------- -------- --------- --------- ---------
Net premiums earned 104,992 95,358 131,998 97,667 85,817 121,059 137,033
</TABLE>
50
<PAGE>
<TABLE>
<CAPTION>
As of or for the Nine
Months Ended September 30 As of or for the Year Ended December 31,
1999 1998 1998 1997 1996 1995 1994
--------- --------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Net investment income 36,502 33,922 45,361 46,663 46,436 50,927 49,140
--------- ---------
Other income 104 0 5,095 0 0 0 0
---------
Realized investment
gains (losses) 180 61 (104) (401) 2,406 322 12,141
--------- --------- --------- --------- --------- --------- ---------
Total revenues 141,778 129,341 182,350 143,929 134,659 172,308 198,314
--------- --------- --------- --------- --------- --------- ---------
Losses and loss
adjustment expenses 110,355 108,862 153,660 117,816 105,403 177,273 210,046
--------- ---------
Other operating expenses 12,640 11,561 16,222 10,878 6,296 8,793 11,870
--------- --------- --------- --------- --------- --------- ---------
Total expenses 122,995 120,423 169,882 128,694 111,699 186,066 221,916
--------- --------- --------- --------- --------- --------- ---------
Income (loss) before
income taxes 18,783 8,918 12,468 15,235 22,960 (13,758) (23,602)
--------- ---------
Income taxes (benefit) 2,874 (429) (257) (3,206) 19,541 6,007 (8,564)
--------- --------- --------- --------- --------- --------- ---------
Net income (loss) $15,909 $9,347 $12,725 $18,441 $3,419 ($19,765) ($15,038)
--------- ========= ========= ========= ========= ========= =========
Balance Sheet Data:
Total investments and
invested cash $840,863 $801,592 $887,661 $787,333 $780,209 $861,428 $780,362
--------- ---------
Total assets 1,165,501 1,241,999 1,211,428 1,246,506 1,287,514 1,362,798 1,263,586
--------- ---------
Members' Equity 231,794 241,734 242,690 220,169 193,336 200,969 175,200
--------- ---------
Additional Data:
Gross ratios (GAAP)
(1):
Loss & LAE 101.2% 98.7% 94.5% 95.1% 77.4% 128.6% 142.0%
--------- ---------
Expense 10.5% 9.6% 10.1% 8.8% 7.4% 6.4% 6.2%
--------- ---------
Combined 111.7% 108.3% 104.6% 103.9% 84.8% 135.0% 148.2%
--------- ---------
Net ratios (GAAP) (2):
Loss & LAE 105.1% 114.2% 116.4% 120.6% 122.8% 146.4% 153.3%
--------- ---------
Expense 12.0% 12.1% 12.3% 11.1% 7.3% 7.3% 8.7%
--------- ---------
</TABLE>
51
<PAGE>
<TABLE>
<CAPTION>
As of or for the Nine
Months Ended September 30 As of or for the Year Ended December 31,
1999 1998 1998 1997 1996 1995 1994
--------- --------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Combined 117.1% 126.3% 128.7% 131.8% 130.2% 153.7% 161.9%
--------- --------
Pro forma earnings
per share (3) $ 1.59 $1.27
---------
Pro forma book value
per share $23.18
---------
Pro forma book value per
share, net of FAS 115(4) $ 24.36
---------
Retention rate (5) 91.9% 89.1% 86.0% 90.1% 90.8% 92.4% 93.4%
--------- ---------
Investment yield (6) 5.57% 5.76% 5.60% 6.07% 5.77% 6.10% 6.00%
--------- ---------
Statutory combined ratio (7) 117.4% 126.2% 128.5% 131.0% 130.2% 155.5% 161.9%
--------- ---------
Statutory surplus $201,756 $177,884 $187,224 $172,713 $158,622 $134,432 $135,339
--------- ---------
</TABLE>
(1) Gross 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 period.
52
<PAGE>
(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.
53
<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.
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
54
<PAGE>
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. See "Business --
Reinsurance" for a description of our reinsurance programs. 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 the current level of $1 million per
medical incident, which generally reduced our ceded premiums and losses for
such coverage. At the same time, we have maintained our reinsurance
protection for $1 million excess of $1 million per claim. 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 and1997/1998 policy
years. During the period the treaties 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
55
<PAGE>
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. We commuted the third and final
treaty in December 1999 and recovered cash of $36.5 million.
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.
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
56
<PAGE>
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
NINE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO NINE MONTHS ENDED
SEPTEMBER 30, 1998
PREMIUMS. Direct and assumed premiums written decreased $12.0
million to $122.5 million for the nine months ended September 30, 1999 from
$134.5 million for the same period in 1998, due primarily to premium
discounts associated with the conversion of group practices to the Clinic
Option program. Net premiums earned increased $9.6 million to $105.0 million
for the nine months ended September 30, 1999 from $95.4 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 $2.6 million
to $36.5 million for the nine months ended September 30, 1999 from $33.9
million for the same period in 1998. Average invested assets for nine months
ended September 30, 1999 were 11.2% higher than the same period in 1998, due
primarily to funds received from commuting a portion of the quota share
reinsurance program. The overall pre-tax investment yield was 5.57% for the
nine months ended September 30, 1999, a decrease from a yield of 5.76% for
the same period in 1998.
57
<PAGE>
LOSSES AND LAE. Losses and loss adjustment expenses, net of
reinsurance, increased $1.5 million to $110.4 million for the nine months
ended September 30, 1999 from $108.9 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 105.1% for the nine months ended September 30, 1999 from
114.2% 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
but also reflects favorable development of losses and LAE reserved for prior
years. 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 nine months
ended September 30, 1999 and 1998 was 101.2% and 98.7%, respectively,
attributable primarily to a fairly stable frequency of claims.
OTHER OPERATING EXPENSES. Other operating expenses increased $1.0
million to $12.6 million for the nine months ended September 30, 1999 from
$11.6 million for the same period in 1998. This was due primarily to a $0.8
million decrease in the commission ceding allowance associated with the quota
share reinsurance program and increased expenses relating to the conversion.
Commissions paid to brokers as a result of increased brokerage transactions
increased somewhat for the nine months 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 10.5% for the nine months ended September 30,
1999, up 0.9 percentage point from 9.6% for the nine months ended September
30, 1998.
FEDERAL INCOME TAXES. Our income tax expense was approximately
$2.9 million for the nine months ended September 30, 1999 compared to a
benefit of $0.4 million 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 $6.6 million to $15.9 million
for the nine months ended September 30, 1999 from $9.3 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 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
58
<PAGE>
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 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
59
<PAGE>
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 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.
60
<PAGE>
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,
enabled it to commute all three years of this reinsurance program, thereby
recovering cash of $81.1 million in 1997, $79.1 million in 1998 and $36.5
million in December 1999.
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."
Approximately 42% 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
61
<PAGE>
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.
YEAR 2000
Prior to January 1, 2000, we completed an upgrade of all internal
information technology systems that we believed could be significantly affected
by the Year 2000 issue. We have not experienced any disruption in our systems
since January 1, 2000. As a result, we believe that these systems are Year 2000
compliant. We have not been made aware that any of our vendors or suppliers have
suffered disruptions in their systems.
We utilized internal and external resources to reprogram or replace,
test, and implement the software modifications for Year 2000 compliance. We
incurred costs of approximately $175,000 in connection with our Year 2000
compliance program. 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. Year 2000 compliance costs were
expensed as they were incurred.
62
<PAGE>
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.
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.
63
<PAGE>
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 nine months ended September 30, 1999 our total revenue was
$141.8 million and our net income was $15.9 million. As of September 30,
1999, we had $1.17 billion of total assets, no debt outstanding and $231.8
million of total equity. In 1998, A.M. Best upgraded our insurer financial
strength rating to "B++ (Very Good)." In 1999, Standard & Poor's upgraded our
rating to "BBB+ (Good)", citing our strong leading market position as a
provider of medical malpractice insurance in Illinois, and our strong
capitalization.
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 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 ISME is managed by its Borad 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
64
<PAGE>
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
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;
65
<PAGE>
- 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:
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.
66
<PAGE>
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 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
67
<PAGE>
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
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.
Prefessional 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.
68
<PAGE>
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 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:
69
<PAGE>
- 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
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
70
<PAGE>
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 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.
71
<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]
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
experience of any professional liability insurer in Illinois. ISMIE has
various rating classifications based on medical
72
<PAGE>
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. Beginning in 1999, we plan to send
current practice questionnaires to approximately one-third of
73
<PAGE>
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.
74
<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.
75
<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
non- meritorious 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.
76
<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 its internal actuarial staff to establish and monitor its
reserves. ISMIE's external 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.
77
<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>
Nine Months Ended
September 30, 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 period 673,516 614,225 614,225 585,113 658,669
-------- -------- -------- -------- --------
Provision for losses and LAE for claims, net of
reinsurance, occurring in:
Current period 114,107 111,086 163,962 121,912 99,373
Prior periods (3,752) (2,224) (10,302) (4,096) 6,030
-------- -------- -------- -------- --------
Total incurred losses and LAE 110,355 108,862 153,660 117,816 105,403
-------- -------- -------- -------- --------
Effect of commutation 0 79,130 79,130 81,080 0
Less loss and LAE payments for claims, net of
reinsurance, occurring in:
Current period 870 1,050 4,379 6,436 3,449
Prior periods 126,719 131,708 169,120 163,348 175,510
-------- -------- -------- -------- --------
Total payments 127,589 132,758 173,499 169,784 178,959
-------- -------- -------- -------- --------
Net reserves for losses and LAE at end of period 656,282 669,459 673,516 614,225 585,113
Add reinsurance recoverables 209,318 238,225 221,759 331,857 395,104
-------- -------- -------- -------- --------
Reserves for losses and LAE at end of period $865,600 $907,684 $895,275 $946,082 $980,217
======== ======== ======== ======== ========
</TABLE>
The following tables reflect the development of loss and LAE reserves, on a
net basis and then on a gross basis, for the periods indicated at the end of
that year and each subsequent year. The first line shows the reserves as
originally reported at the end of the stated year. Each calendar year end
reserve includes the estimated unpaid liabilities for that report or accident
year and for all prior report or accident years. The section under the the
caption "liability reestimated as of" shows the original recorded reserve as
adjusted as of the end of the end of each subsequent year to reflect the
78
<PAGE>
cumulative amounts paid and all other facts and circustances discovered
during each year. The line "cumulative redundancy (deficiency)" reflects the
difference between the latest reestimated reserve amount and the reserve
amount as originally established. The section under the caption "cumulative
amount of liability paid through" shows the cumulative amounts paid related
to the reserves as of the end of each subsequent year. In evaluating the
information in the tables below, you should note that each amount includes
the effects of all changes in amounts of prior periods. The tables present
development data by calendar year and do not relate the data to the year in
which the claim was reported or the accident actually occurred. Conditions
and trends that have affected the development of these reserves in the past
will not necessarily recur in the future.
ISMIE RESERVE REDUNDANCY (DEFICIENCY) -- NET BASIS
<TABLE>
<CAPTION>
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998
---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ----
($ 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>
79
<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>
Cumulative
Amount of
Liability Paid
Through:
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>
80
<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 pricing
81
<PAGE>
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 the current level of $1,000,000 per medical incident. (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.)
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 of loss reinsurance: a per incident
treaty, 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 above $1 million up to
$5.0 million per incident. In addition, the per claim treaty covers $1.0
million excess of $1.0 million per insured per claim for insureds with $2.0
million/$4.0 million policy limits. These treaties were entered into on July
1, 1997 for a two year period through June 30, 1999. On July 1, 1998, the
treaties were amended to continue the coverage for the period from July 1,
1999 to June 30, 2000.
For each year in 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 these treaties were 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 all
three years of this reinsurance program and recover cash of $81.1 million in
1997, $79.1 million in 1998 and $36.5 million in December 1999.
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
82
<PAGE>
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.
<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.
83
<PAGE>
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.
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>
September 30, 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
--------- ---------- --------- ---------- --------- ----------
<S> <C> <C> <C> <C> <C> <C>
Fixed maturity securities:
U.S. government obligations $119,369 $117,144 $155,165 $161,006 $152,551 $154,165
Corporate securities 338,888 325,274 345,733 356,579 261,739 264,863
Mortgage-backed and other asset-backed 332,959 327,755 285,930 289,931 307,854 311,001
securities
States, territories and
possessions, and public utilities 12,292 11,896 12,307 12,675 6,694 6,787
-------- --------- -------- -------- -------- --------
Total fixed maturity securities: 803,508 782,069 799,135 820,191 728,838 736,816
Equity securities 19,644 22,896 15,975 17,969 0 0
-------- --------- -------- -------- -------- --------
Total $823,152 $804,965 $815,110 $838,160 $728,838 $736,816
-------- --------- -------- -------- -------- --------
-------- --------- -------- -------- -------- --------
</TABLE>
The mortgage-backed and other asset-backed portfolio represents
approximately 42% 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
84
<PAGE>
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,
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 September 30, 1999:
<TABLE>
<CAPTION>
As of September 30, 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) $452,328 $444,899 56.9%
AA 43,656 41,520 5.3
A 215,973 208,240 26.6
BBB 91,551 87,410 11.2
-------- --------- --------
$803,508 $782,069 100.0%
-------- --------- --------
-------- --------- --------
</TABLE>
The following table sets forth information concerning the maturities
of fixed maturity securities in our investment portfolio as of September 30,
1999:
<TABLE>
<CAPTION>
As of September 30, 1999 Amortized Percentage
Cost Fair Value of Fair Value
-------- ---------- -------------
(in thousands)
<S> <C> <C> <C>
Years to maturity:
One through five $212,082 $207,645 26.6%
After five through ten 244,444 233,696 29.9
85
<PAGE>
After ten 14,023 12,973 1.6
Mortgage-backed securities and
other asset-backed securities 332,959 327,755 41.9
-------- -------- -------
Totals $803,508 $782,069 100.0%
-------- -------- -------
-------- -------- -------
</TABLE>
86
<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 fixed- maturity and common stock portfolios as of September 30,
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 $782,069 $749,569
Equity price risk (2)
Common stocks $22,896 $20,606
</TABLE>
(1) Adjusted interest rates assume a 100 basis point increase in market
rates at September 30, 1999
(2) Adjusted equity prices assume a 10 percent decline in values at
September 30, 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.
87
<PAGE>
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 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.
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."
88
<PAGE>
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.
89
<PAGE>
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
90
<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.
91
<PAGE>
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
92
<PAGE>
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. In
1999, Standard & Poor's upgraded ISMIE's rating to "BBB+ (Good)," citing
ISMIE's strong leading market position as a provider of medical malpractice
insurance in Illinois, and its strong capitalization.
EMPLOYEES
As of September 30, 1999, we had approximately 172 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.
93
<PAGE>
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.
94
<PAGE>
Harold L. Jensen, M.D., 73, 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. 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, 53, 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, 56, 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, 47, 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, 48, 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
95
<PAGE>
Southern Illinois University School of Medicine. Mr. Morse is a member of the
Sangamon 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., 68, 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., 55, 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., 70, 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:
96
<PAGE>
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 $1,200 per day for attendance at meetings of the Board
and committees of the Board, meetings of a board of a subsidiary on which the
director serves, and each seminar or other meeting attended on special
assignment on our behalf. All non-employee directors will be reimbursed for
reasonable travel and other expenses incurred to attend meetings of the
Holdings Board and committees of the Board.
97
<PAGE>
EXECUTIVE COMPENSATION
Holdings was organized as a Delaware corporation in April, 1999, and
consequently did not pay any cash compensation to its executive officers for
the year ended December 31, 1998. The following Summary Compensation Table,
therefore, sets forth information concerning the compensation paid or accrued
by ISMIE and the attorney-in-fact for (i) the President and Chief Executive
Officer and (ii) and each of the other four most highly compensated executive
officers of ISMIE for services rendered during the year ended December 31,
1998:
<TABLE>
<CAPTION>
Annual Compensation
-------------------
Salary($) 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
98
<PAGE>
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.
99
<PAGE>
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
100
<PAGE>
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.
101
<PAGE>
<TABLE>
<CAPTION>
NUMBER OF SHARES
EXPECTED TO BE PERCENT
NAME BENEFICIALLY OWNED OF TOTAL
- ---- ------------------- ---------
<S> <C> <C>
Harold L. Jensen, M.D...................................... 197 *
Walter Whisler, M.D........................................ 4,237 *
Alexander R. Lerner........................................ -0- -0-
Donald A. Udstuen.......................................... -0- -0-
Jeffrey M. Holden.......................................... -0- -0-
Eugene J. Gross............................................ -0- -0-
Saul J. Morse.............................................. -0- -0-
Irwin A. Smith, M.D........................................ 535 *
Peter A. Brusca, M.D....................................... 1,729 *
Richard A. Geline, M.D..................................... 3,496 *
Henri S. Havdala, M.D...................................... 754 *
Robert M. Reardon, M.D..................................... 172 *
Jane Jackman, M.D.......................................... 560 *
All directors and executive officers
as a group (13 persons).................................... 11,680 *
</TABLE>
- --------
* Less than one percent
102
<PAGE>
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.
103
<PAGE>
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
104
<PAGE>
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.
105
<PAGE>
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,
106
<PAGE>
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.
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."
G-1
<PAGE>
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.
Incurred but not reported The estimated liabilities for future payments
(IBNR) reserves 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 Liabilities established for loss adjustment
reserves 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.
G-2
<PAGE>
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 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 surplus
Requirements 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
G-3
<PAGE>
coverage and determines whether it will
accept all or part of the coverage being
requested, and the applicable premium.
G-4
<PAGE>
ISMIE Holdings, Inc.
As of September 30, 1999 and as of April 14, 1999
CONTENTS
<TABLE>
<S> <C>
Report of Independent Auditors............................................F-2
Balance Sheets as of September 30, 1999 and as of April 14, 1999..........F-3
Notes to Balance Sheets...................................................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 auditing standards generally accepted
in the United States. 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 accounting principles generally accepted in the
United States.
/s/ Ernst & Young LLP
Chicago, Illinois
April 14, 1999
F-2
<PAGE>
ISMIE Holdings Inc.
Balance Sheets
<TABLE>
<CAPTION>
SEPTEMBER 30 APRIL 14
1999 1999
----------------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Investment in subsidiary $1,000 $1,000
----------------------
Total assets $1,000 $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;
1,000 shares issued and outstanding 10 10
Additional paid-in capital 990 990
----------------------
Total stockholder's equity $1,000 $1,000
----------------------
----------------------
</TABLE>
SEE ACCOMPANYING NOTES
F-3
<PAGE>
ISMIE Holdings Inc.
Notes to Balance Sheets
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. UNAUDITED INTERIM INFORMATION
The accompanying balance sheet and notes as of September 30, 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 ISMIE Holdings' balance sheet. There were no operations for the
period from April 14, 1999 (date of inception) through September 30, 1999.
3. 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
Consolidated Financial Statements
CONTENTS
<TABLE>
<S> <C>
Report of Independent Auditors..................................................................................F-6
Consolidated Balance Sheets as of December 31, 1998 and 1997, and as of September 30, ..........................F-7
Consolidated Statements of Income for the years ended December 31, 1998, 1997, and 1996,
and for the nine months ended September 30, 1999 and 1998..................................................F-8
Consolidated Statements of Changes in Members' Equity for the years ended December 31, 1998, 1997,
and 1996, and for the nine months ended September 30, 1999.................................................F-9
Consolidated Statements of Cash Flows for the years ended December 31, 1998, 1997, and 1996,
and for the nine months ended September 30, 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 auditing standards generally accepted
in the United States. 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
accounting principles generally accepted in the United States.
/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>
SEPTEMBER 30 DECEMBER 31
1999 1998 1997
------------------------------------------------------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Investments (NOTE 3):
Fixed maturities - At fair value (amortized cost: 1999 -
$803,508; 1998 - $799,135; 1997 - $728,838) $ 782,069 $ 820,191 $ 736,816
Equity securities - At fair value (cost: 1999 -
$19,644; 1998 - $15,975) 22,896 17,969 -
Other invested assets 10,063 10,581 11,422
------------------------------------------------------
815,028 848,741 748,238
Cash and cash equivalents 25,835 38,920 39,095
Premiums receivable 8,187 9,134 12,015
Accrued investment income 9,433 10,957 9,721
Income taxes recoverable 610 3,373 12,605
Reinsurance receivables (NOTE 7) 219,505 232,613 335,426
Funds held by reinsurers 12,062 9,290 25,797
Deferred income taxes (NOTE 4) 49,642 32,682 37,200
Other assets (NOTE 5) 25,199 25,718 26,409
------------------------------------------------------
$ 1,165,501 $ 1,211,428 $ 1,246,506
------------------------------------------------------
------------------------------------------------------
LIABILITIES AND MEMBERS' EQUITY
Liabilities:
Losses and loss adjustment expenses (NOTES 6 AND 7) $ 865,600 $ 895,275 $ 946,082
Unearned premiums 22,451 24,343 22,126
Funds held for or payable to reinsurers 14,047 15,461 25,617
Accrued expenses and other liabilities (NOTE 5) 21,944 24,626 23,415
Income taxes payable 2,350 888 455
Advanced premiums billed but not collected 7,315 8,145 8,642
------------------------------------------------------
933,707 968,738 1,026,337
Commitments and contingencies (NOTES 7 AND 10)
Members' equity:
Unassigned members' equity 243,616 227,707 214,982
Accumulated other comprehensive income (loss) (11,822) 14,983 5,187
------------------------------------------------------
231,794 242,690 220,169
------------------------------------------------------
$ 1,165,501 $ 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>
NINE MONTHS
ENDED SEPTEMBER 30 YEAR ENDED DECEMBER 31
1999 1998 1998 1997 1996
------------------------------------------------------------------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
INCOME
Premiums earned $ 104,992 $ 95,358 $ 131,998 $ 97,667 $ 85,817
Net investment income 36,502 33,922 45,361 46,663 46,436
Net realized gains (losses) on investments (NOTE 3) 180 61 (104) (401) 2,406
Other income 104 - 5,095 - -
------------------------------------------------------------------------
141,778 129,341 182,350 143,929 134,659
LOSSES AND EXPENSES
Losses and loss adjustment expenses 110,355 108,862 153,660 117,816 105,403
Other underwriting expenses 12,640 11,561 16,222 10,878 6,296
------------------------------------------------------------------------
122,995 120,423 169,882 128,694 111,699
------------------------------------------------------------------------
Income before income taxes 18,783 8,918 12,468 15,235 22,960
Income taxes (credit) (NOTE 4):
Current 5,400 2,700 500 3,900 -
Deferred (2,526) (3,129) (757) (7,106) 19,541
------------------------------------------------------------------------
2,874 (429) (257) (3,206) 19,541
------------------------------------------------------------------------
Net income $ 15,909 $ 9,347 $ 12,725 $ 18,441 $ 3,419
------------------------------------------------------------------------
------------------------------------------------------------------------
Earnings per share (pro forma) - Unaudited (NOTE 12) $ 1.59 $ 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 15,909 - 15,909
Other comprehensive income:
Change in unrealized loss on
investments, net of tax - (26,805) (26,805)
--------
Comprehensive loss - - (10,896)
------------------------------------------------
BALANCE AT SEPTEMBER 30, 1999 (UNAUDITED) $ 243,616 $ (11,822) $ 231,794
------------------------------------------------
------------------------------------------------
</TABLE>
SEE ACCOMPANYING NOTES.
F-9
<PAGE>
Illinois State Medical Inter-Insurance Exchange and Subsidiary
Consolidated Statements of Cash Flows
(IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS
ENDED SEPTEMBER 30 YEAR ENDED DECEMBER 31
1999 1998 1998 1997 1996
--------------------------------------------------------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net income $ 15,909 $ 9,347 $ 12,725 $ 18,441 $ 3,419
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Deferred income tax (2,526) (3,129) (757) (7,106) 19,541
Amortization of net premium on investments 729 972 1,381 1,724 2,185
Net realized (gains) losses on investments (180) (61) 104 401 (2,406)
Decrease in book value of other invested assets 124 124 166 166 176
(Increase) decrease in receivables and other assets 13,326 14,577 121,656 43,470 (20,444)
Decrease in unpaid losses and loss adjustment expenses (29,675) (38,398) (50,807) (34,135) (41,430)
Increase (decrease) in unearned premiums, funds held for
or payable to reinsurers, advanced premiums billed but
not collected, and accrued expenses and other liabilities (6,818) 11,625 (7,223) (29,986) (27,792)
Increase in income taxes payable, net of amounts recoverable 4,225 1,438 9,665 3,538 2,776
--------------------------------------------------------------
Net cash provided by (used in) operating activities (4,886) (3,505) 86,910 (3,487) (63,975)
INVESTING ACTIVITIES
Purchase of investments (210,055) (182,881) (302,135) (128,722) (120,049)
Proceeds from sale or maturity of investments 201,856 178,023 215,052 150,397 183,932
--------------------------------------------------------------
Net cash provided by (used in) investing activities (8,199) (4,858) (87,083) 21,675 63,883
FINANCING ACTIVITIES - OTHER - (1) (2) (8) (284)
--------------------------------------------------------------
Increase (decrease) in cash and cash equivalents (13,085) (8,364) (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 $ 25,835 $ 30,731 $ 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>
2. ACCOUNTING POLICIES
BASIS OF PRESENTATION
The accompanying consolidated financial statements include the financial
statements of the Exchange and Services (since date of inception), collectively,
the "Company." These financial statements have been prepared in conformity with
generally accepted accounting principles. All transactions between the Exchange
and Services 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>
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 $2,860,000 and $2,568,021 for the nine months ended
September 30, 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.
F-13
<PAGE>
2. ACCOUNTING POLICIES (CONTINUED)
OTHER INCOME
During the nine months ended September 30, 1999, and the year ended December 31,
1998, the Company received $104,000 and $5,095,000, respectively, representing
interest on state and federal income taxes recoverable from prior tax years.
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
F-14
<PAGE>
2. ACCOUNTING POLICIES (CONTINUED)
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.
UNAUDITED INTERIM INFORMATION
The accompanying financial statements and notes as of September 30, 1999, and
for the nine months ended September 30, 1999 and 1998, 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 SEPTEMBER 30 , 1999 (UNAUDITED)
Fixed maturity securities:
U.S. government obligations $ 119,369 $ 499 $ (2,724) $ 117,144
Corporate securities 338,888 619 (14,233) 325,274
Mortgage-backed and other
asset-backed securities 332,959 735 (5,939) 327,755
States, territories, and
possessions 6,689 - (211) 6,478
Public utilities 5,603 - (185) 5,418
--------------------------------------------------------------
Total fixed maturities 803,508 1,853 (23,292) 782,069
Total equity securities 19,644 4,309 (1,057) 22,896
--------------------------------------------------------------
--------------------------------------------------------------
$ 823,152 $ 6,162 $ (24,349) $ 804,965
--------------------------------------------------------------
--------------------------------------------------------------
</TABLE>
F-15
<PAGE>
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, 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
--------------------------------------------------------------
--------------------------------------------------------------
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
possessions 6,694 93 - 6,787
--------------------------------------------------------------
Total fixed maturities $ 728,838 $ 9,757 $ (1,779) $ 736,816
--------------------------------------------------------------
--------------------------------------------------------------
</TABLE>
F-16
<PAGE>
3. INVESTMENTS (CONTINUED)
The amortized cost and fair value of fixed maturities, by contractual maturity,
are summarized as follows (in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30 , 1999 DECEMBER 31, 1998
AMORTIZED FAIR AMORTIZED FAIR
MATURITY COST VALUE COST VALUE
- ------------------------------------------------------------------------------------------------------
(UNAUDITED)
<S> <C> <C> <C> <C>
Due after one year through five years $212,082 $207,645 $261,404 $265,674
Due after five years through ten years 244,444 233,696 237,777 250,166
Due after ten years 14,023 12,973 14,024 14,420
--------------------------------------------------------
470,549 454,314 513,205 530,260
Mortgage-backed and other asset-backed
securities 332,959 327,755 285,930 289,931
--------------------------------------------------------
$803,508 $782,069 $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>
SEPTEMBER 30 DECEMBER 31
1999 1998
-------------------------
(UNAUDITED)
<S> <C> <C>
Equity securities:
Common stock:
Banks, trust, and insurance companies $ 3,216 $ 2,501
Industrial, miscellaneous, and all other 19,680 15,468
Total equity securities $22,896 $17,969
-------------------------
-------------------------
</TABLE>
Proceeds from the sales of fixed maturities were $139,352,000 and $115,460,000
for the nine months ended September 30, 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 $2,810,000
for the nine months ended September 30, 1999, and $1,810,000 for the year ended
December 31, 1998.
F-17
<PAGE>
3. INVESTMENTS (CONTINUED)
Major categories of net investment income are summarized as follows (in
thousands):
<TABLE>
<CAPTION>
NINE MONTHS
ENDED SEPTEMBER 30 YEAR ENDED DECEMBER 31
1999 1998 1998 1997 1996
-------------------------------------------------------------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Fixed maturities $37,847 $35,270 $47,171 $47,373 $48,373
Equity securities 130 10 50 - -
Cash and cash equivalents 1,243 461 1,390 2,060 1,738
Other 459 908 601 621 602
-------------------------------------------------------------------
Total investment income 39,679 36,649 49,212 50,054 50,713
Investment expenses 3,177 2,727 3,851 3,391 4,277
-------------------------------------------------------------------
Net investment income $36,502 $33,922 $45,361 $46,663 $46,436
-------------------------------------------------------------------
-------------------------------------------------------------------
</TABLE>
Realized gains and losses on investments are summarized as follows (in
thousands):
<TABLE>
<CAPTION>
NINE MONTHS
ENDED SEPTEMBER 30 YEAR ENDED DECEMBER 31
1999 1998 1998 1997 1996
------------------------------------------------------------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Fixed maturities:
Gross realized gains $ 666 $ 373 $ 853 $ 545 $1,852
Gross realized losses 124 - 478 537 576
------------------------------------------------------------------
Net realized gains on
fixed maturities 542 373 375 8 1,276
Equity securities:
Gross realized gains - - 81 - -
Gross realized losses 238 - 157 - -
------------------------------------------------------------------
Net realized losses on
equity securities (238) - (76) - -
Other invested assets:
Gross realized gains - - - - 1,269
Gross realized losses 124 312 403 409 139
------------------------------------------------------------------
Net realized gains
(losses) on other
invested assets (124) (312) (403) (409) 1,130
------------------------------------------------------------------
Net realized gains
(losses) on investments $ 180 $ 61 $ (104) $ (401) $2,406
------------------------------------------------------------------
------------------------------------------------------------------
</TABLE>
F-18
<PAGE>
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 $78,178,000 (unaudited) were loaned to various brokers in connection
with a securities lending program at September 30, 1999. These securities are
returnable on demand and collateralized by cash deposits amounting to
approximately 101% 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-19
<PAGE>
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>
SEPTEMBER 30 DECEMBER 31
1999 1998 1997
----------------------------------------------
(UNAUDITED)
<S> <C> <C> <C>
Deferred tax assets:
Tax-basis loss reserve discounting adjustment $ 41,310 $ 42,486 $ 47,408
Alternative minimum tax credit carryforward 87 4,674 4,046
Tax-basis unearned premium reserve adjustment 3,298 793 1,233
Tax-basis fixed asset adjustment 509 1,396 1,367
Net unrealized losses on securities 6,365 - -
Other 4,725 1,765 1,176
----------------------------------------------
Total deferred tax assets 56,294 51,114 55,230
Valuation allowance for deferred tax assets (6,107) (9,857) (14,758)
----------------------------------------------
Deferred tax assets net of valuation allowance 50,187 41,257 40,472
Deferred tax liabilities:
Discount amortization on bonds and other (545) (508) (480)
Net unrealized gains on securities - (8,067) (2,792)
----------------------------------------------
Total deferred tax liabilities (545) (8,575) (3,272)
----------------------------------------------
----------------------------------------------
Net deferred tax asset $ 49,642 $ 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 $3,750,000 for the nine months ended September 30, 1999, decreased
by $4,901,000 and $8,597,000 in 1998 and 1997, respectively, and increased by
$8,914,000 in 1996.
F-20
<PAGE>
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>
NINE MONTHS
ENDED SEPTEMBER 30 YEAR ENDED DECEMBER 31
1999 1998 1998 1997 1996
------------------------------------------------------------------------------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Federal income tax at 35% $ 6,573 $ 3,121 $ 4,364 $ 5,332 $ 8,036
Prior-period tax return adjustments (183) - (170) 68 1,740
Change in valuation allowance (3,750) (3,689) (4,901) (8,597) 8,914
Other 234 139 450 (9) 851
------------------------------------------------------------------------------------
Total income tax expense
(benefit) $ 2,874 $ (429) $ (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-21
<PAGE>
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>
NINE MONTHS
ENDED SEPTEMBER 30 YEAR ENDED 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 114,107 111,086 163,962 121,912 99,373
Prior periods (3,752) (2,224) (10,302) (4,096) 6,030
-------------------------------------------------------------------------
Incurred losses and LAE during the
current period, net of reinsurance 110,355 108,862 153,660 117,816 105,403
Effect of commutation - 79,130 79,130 81,080 -
Deduct: Loss and LAE payments for claims,
net of reinsurance, occurring during:
Current period 870 1,050 4,379 6,436 3,449
Prior periods 126,719 131,708 169,120 163,348 175,510
-------------------------------------------------------------------------
Claim payments during the current period,
net of reinsurance 127,589 132,758 173,499 169,784 178,959
-------------------------------------------------------------------------
Liability for losses and LAE, net of
reinsurance receivables, at end of period 656,282 669,459 673,516 614,225 585,113
Reinsurance receivable on losses and LAE,
at end of period 209,318 238,225 221,759 331,857 395,104
-------------------------------------------------------------------------
Liability for losses and LAE, gross of
reinsurance receivables, at end of period $ 865,600 $ 907,684 $ 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
F-22
<PAGE>
6. LOSSES AND LOSS ADJUSTMENT EXPENSES (CONTINUED)
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.
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. The proceeds received in 1998 were the result of the
commutation of a treaty that was in place from July 1, 1996 through June 30,
1997, while the 1997 proceeds related to a treaty that was in place from July 1,
1995 to June 30, 1996. 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 agreements
include excess of loss reinsurance contracts with retention limits that vary by
treaty year. For each of the three years in the three-year period from July 1,
1995 to July 1, 1998, ISMIE entered into reinsurance agreements that provided a
combination of quota share and stop-loss protection. 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>
NINE MONTHS
ENDED SEPTEMBER 30 YEAR ENDED DECEMBER 31
1999 1998 1998 1997 1996
----------------------------------------------------------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Premiums earned $ 19,438 $ 38,637 $ 45,453 $ 91,199 $122,040
Losses and loss adjustment expenses 15,602 13,383 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 September 30, 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-23
<PAGE>
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-24
<PAGE>
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>
NINE MONTHS ENDED SEPTEMBER 30, 1999
(UNAUDITED)
Unrealized holding losses arising during the
period $(40,933) $(14,326) $(26,607)
Reclassification adjustment (304) (106) (198)
----------------------------------------------
Total other comprehensive income $(41,237) $(14,432) $(26,805)
----------------------------------------------
----------------------------------------------
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-25
<PAGE>
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 months prior notice.
All such services are provided to each party. The total expenses incurred for
these services are allocated based on rates established and negotiated between
the parties. The rates are based on estimates of usage by entity. If actual
usage of the services varies from expected usage, adjustments to the rates may
be negotiated by the parties. Management believes the rates charged to the
Exchange are at competitive prices and the allocation method between the parties
is reasonable.
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
F-26
<PAGE>
12. CONVERSION (CONTINUED)
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 will
be licensed to write property and casualty insurance lines in the state of
Illinois, but has not conducted business, prior to the Conversion.
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
$966,000 for the year ended December 31, 1998, and nine months ended September
30, 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-27
<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
I-6
<PAGE>
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.
I-7
<PAGE>
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
I-8
<PAGE>
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
I-9
<PAGE>
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
I-10
<PAGE>
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;
I-11
<PAGE>
(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.
I-12
<PAGE>
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
I-13
<PAGE>
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
I-14
<PAGE>
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
I-15
<PAGE>
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.
I-16
<PAGE>
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,
I-17
<PAGE>
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
I-18
<PAGE>
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]
I-19
<PAGE>
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
I-20
<PAGE>
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.**
10.4 Second Excess Cession Reinsurance Agreement, effective July 1, 1997 among
Illinois State Medical Inter-Insurance Exchange and the reinsurers listed
therein.**
10.5 Physician's Business Practice Liability Quota Share Reinsurance Agreement,
effective July 1, 1997 among Illinois State Medical Inter-Insurance Exchange
and the 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.**
II-2
<PAGE>
EXHIBIT
NUMBER DOCUMENT DESCRIPTION
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.*
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.**
27 Financial Data Schedule.
99.1 Form of Proxy Card.**
99.2 Form of Taxpayer Identification Card.**
99.3 Form of Record Card.**
</TABLE>
- ----------------
* To be filed by amendment
** Previously filed
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 regulations of the Securities and Exchange Commission are
not required under the related instructions or are not applicable and therefore
have been omitted.
II-3
<PAGE>
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 February 14, 2000.
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 February 14, 2000.
<TABLE>
<CAPTION>
Name Title
- ---- -----
<S> <C>
*
- -----------------------------------
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
</TABLE>
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. 3 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
February 14, 2000
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 7
<CIK> 0001086428
<NAME> ISMIE HOLDINGS, INC.
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<DEBT-HELD-FOR-SALE> 782,069
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 22,896
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 815,028
<CASH> 25,835
<RECOVER-REINSURE> 0
<DEFERRED-ACQUISITION> 0
<TOTAL-ASSETS> 1,165,501
<POLICY-LOSSES> 865,600
<UNEARNED-PREMIUMS> 22,451
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 0
0
0
<COMMON> 0
<OTHER-SE> 231,794
<TOTAL-LIABILITY-AND-EQUITY> 1,165,501
104,992
<INVESTMENT-INCOME> 36,502
<INVESTMENT-GAINS> 180
<OTHER-INCOME> 104
<BENEFITS> 110,355
<UNDERWRITING-AMORTIZATION> 0
<UNDERWRITING-OTHER> 12,640
<INCOME-PRETAX> 18,783
<INCOME-TAX> 2,874
<INCOME-CONTINUING> 15,909
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 15,909
<EPS-BASIC> 1.59
<EPS-DILUTED> 1.59
<RESERVE-OPEN> 673,516<F1>
<PROVISION-CURRENT> 114,107<F1>
<PROVISION-PRIOR> (3,752)<F1>
<PAYMENTS-CURRENT> 870<F1>
<PAYMENTS-PRIOR> 126,719<F1>
<RESERVE-CLOSE> 656,282<F1>
<CUMULATIVE-DEFICIENCY> 0
<FN>
<F1>Amounts are net of reinsurance recovered/recoverable
</FN>
</TABLE>
