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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 [NO FEE REQUIRED]
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
FOR THE TRANSITION PERIOD FROM TO
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COMMISSION FILE NUMBER: 0-25508
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RTW, INC.
(Exact name of registrant as specified in its charter)
MINNESOTA 41-1440870
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
8500 NORMANDALE LAKE BOULEVARD, SUITE 1400
BLOOMINGTON, MN 55437
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code:(612) 893-0403
Securities registered pursuant to 12(b) of the Act: None
Securities registered pursuant to 12(g) of the Act: Common Stock, no par value
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K: ( )
As of March 10, 1997, 11,807,726 shares of Common Stock, no par value, were
outstanding. As of March 10, 1997, assuming as fair value the last sale price
of $8.25 per share on The Nasdaq Stock Market, the aggregate fair value of
shares held by non-affiliates was approximately $41,082,000.
DOCUMENTS INCORPORATED BY REFERENCE:
The Company's Proxy Statement for its annual meeting of shareholders to be held
in May 1997, a definitive copy of which will be filed with the Securities and
Exchange Commission within 120 days of December 31, 1996, is incorporated by
reference in Part III of this Report on Form 10-K.
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TABLE OF CONTENTS
PART I PAGE
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Item 1. Business 3
Executive Officers of the Registrant 9
Item 2. Properties 10
Item 3. Legal Proceedings 10
Item 4. Submission of Matters for a Vote of Security Holders 10
PART II
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Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters 11
Item 6. Selected Financial Data 11
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 12
Item 8. Financial Statements and Supplementary Data 23
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 39
PART III
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Item 10. Directors and Executive Officers of the Registrant 39
Item 11. Executive Compensation 39
Item 12. Security Ownership of Certain Beneficial Owners
and Management 39
Item 13. Certain Relationships and Related Transactions 39
PART IV
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Item 14. Exhibits, Financial Statement Schedules, and Reports
on Form 8-K 40
Signatures 42
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PART I
ITEM 1. BUSINESS
OVERVIEW
RTW, Inc. (the "Company") provides comprehensive management products and
services to employers for their workers' compensation programs in Minnesota,
Colorado, Missouri, Michigan and Illinois and has obtained licenses but is not
yet operating in Massachusetts and Pennsylvania. The Company believes its
proprietary management approach substantially reduces wage replacement costs and
medical expenses resulting from workplace injuries. The Company focuses on
controlling costs by returning injured employees to work as soon as possible and
by actively managing all participants in the workers' compensation system,
including employers, employees and medical care providers. Elements of the
Company's management approach include:
- thorough on-site evaluation of potential customers;
- active training of customers in the Company's procedures;
- prompt identification of potentially high-cost injuries; and
- rapid intervention in, and intensive management of, potentially high-
cost injuries.
The Company also uses management techniques such as designated health care
providers, medical fee schedule review, utilization review and peer review to
control medical costs. In order to benefit directly from the use of its
proprietary methods, the Company combines its management services with workers'
compensation insurance products underwritten by its wholly owned subsidiary,
American Compensation Insurance Company ("ACIC").
INDUSTRY
Workers' compensation benefits are mandated and regulated by individual
states, and every state requires employers to provide wage replacement and
medical benefits to work accident victims regardless of fault. Virtually all
employers in the United States are required either to purchase workers'
compensation insurance from a private insurance carrier, to obtain coverage from
a state managed fund or, if permitted by their state, to be self-insured.
Workers' compensation laws generally mandate two types of benefits for injured
employees: (i) indemnity payments that consist of temporary wage replacement or
permanent disability payments and (ii) medical benefits that include expenses
related to diagnosis and treatment of the injury as well as rehabilitation, if
necessary. On an industry-wide basis, indemnity payments represent
approximately 60% of benefits paid, while medical benefits account for the
remaining 40%.
Workers' compensation costs grew approximately 11.5% annually from 1960 to
1990. Premium growth flattened from 1991 to 1992 and has since declined by
approximately 8% through 1996. Estimated insurance premiums and self-insurance
costs totaled approximately $53 billion nationwide in 1996. This $53 billion
includes: (i) the traditional, or private residual market, estimated at $25
billion, including commercial insurers and state operated assigned risk pools
established for high risk employers; (ii) state funds, estimated at $10 billion,
operated in 27 states in order to increase competition and stabilize the market;
and (iii) self-funded employers, estimated at $18 billion.
Indemnity payments, which are established by legislative action, have
risen, in part, because of higher wage levels and increased state mandated
benefits. Medical expenses have also increased due to the general rise in the
cost of health care and the statutory requirement that employers provide
coverage of all compensable medical costs, without any copayment by the
employee. The Company believes the most significant factor affecting the cost
of workers' compensation, however, results from incentives in the system for
injured employees to remain away from work and to continue collecting indemnity
payments and receiving medical treatment beyond the point that is necessary.
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The Company believes that workers' compensation insurance companies have
not effectively controlled costs in the industry. Traditional insurance company
practices have focused on managing specific aspects of the system, such as
workplace safety, and on implementing certain medical cost containment measures.
While traditional efforts have reduced costs in certain areas, the Company
believes these efforts have not had a significant effect on the overall system
because they have not focused effectively on controlling indemnity payments. In
addition, the Company believes traditional efforts have addressed only certain
components of the workers' compensation system, and have not provided a
comprehensive management approach specifically designed for the workers'
compensation system.
THE COMPANY'S MANAGEMENT APPROACH
The Company seeks to control workers' compensation costs through a
proprietary management approach that is specifically designed for the workers'
compensation system. The Company's management strategy seeks to reduce workers'
compensation costs significantly through early intervention in each employee
injury and intensive management of all participants in the system, including
employers, injured employees and medical care providers, as well as legal and
judicial participants in the workers' compensation system. Through early
intervention, the Company promptly identifies cases that have the potential to
result in significant expenses and acts to control these expenses before they
are incurred. The Company focuses on controlling indemnity payments for lost
wages, the largest component of workers' compensation costs, by quickly
returning employees to work. As part of this strategy, the Company attempts to
return an injured employee to his or her original position if the employee is
capable, or to place the employee in a transitional, light-duty position until
the employee is able to resume his or her former position. By promptly
returning an employee to work, the Company has found that not only indemnity
payments, but also medical expenses per injury, are substantially reduced. In
addition, the Company uses management techniques such as designated health care
providers, medical fee schedule review, utilization review and peer review to
control medical costs.
The Company uses six-person operating teams to implement its management
approach. An operating team handles all of the claims for a specific group of
customers and is accountable within the Company for the loss experience of these
customers. Each team generally consists of two registered nurses, a licensed
practical nurse, a statutory claims administrator, an assistant claims
administrator and a clerical support person. A team's nurses are responsible
for evaluating the medical condition of an injured employee and monitoring the
employee's medical treatment. The claims administrators are responsible for
determining the eligibility of claims, paying benefits in a timely manner and
following statutory requirements for administration of claims. The operating
teams meet regularly to discuss strategies for managing difficult claims and to
review strategies and procedures that have been particularly successful in
resolving disputes.
The following sections summarize the Company's approach to managing the
various participants in the system.
EMPLOYERS. Generally, each customer is assigned to an operating team
responsible for managing the customer relationship. Prior to accepting an
employer as a customer, members of an operating team conduct a risk assessment
and provide an explanation of the Company's methods and procedures to the
employer. The risk assessment forms a part of the Company's underwriting
process and includes an evaluation of the employer's willingness to follow the
Company's procedures. Before the Company accepts an employer as a customer, the
Company and the employer sign an agreement in which the employer agrees to
comply with the Company's early intervention methods and to provide
transitional, light-duty work for injured employees until such time as they are
able to resume their normal positions. To ensure that the Company's early
intervention techniques succeed, the Company requests prompt notification from
the employer of all injuries, typically 24 to 48 hours after the employer
learns of the injury.
The operating team is responsible for implementing a workers' compensation
program for the customer, training the customer's personnel in the Company's
methods and procedures and managing all reported injuries for this customer.
The operating team meets with the customer, provides loss reports showing
current claims status, conducts an annual account review and maintains active
communications on open injury matters. The operating team may make workplace
safety recommendations or retain a workplace safety engineering firm to assist
its customers to remedy work conditions that the operating team determines
constitute an inappropriate risk. In
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addition, the operating team may recommend to the Company's management the
cancellation or non-renewal of the policy for a customer that fails to comply
with the Company's procedures. To date, there has not been a material number of
policy cancellations or non-renewals due to the failure by customers to comply
with the Company's policies.
EMPLOYEES. The Company focuses on identifying injuries that have the
greatest potential to result in significant expenses and acts quickly to control
expenses resulting from these injuries. The Company's experience has been that
approximately 15% of all injuries result in 85% of all workers' compensation
expenses and that early identification of, and intervention in, these cases can
lead to significant cost savings. Within 48 hours of notice of an injury, the
operating team typically evaluates several factors, including the type of
injury, the employee's history of injuries and whether the employee is absent
from work, to determine whether the injury is likely to involve significant
expenses. In potentially high-cost cases, a member of the operating team
intervenes quickly by meeting with the injured employee to assess the injury,
assisting the injured employee in obtaining medical care and rehabilitation and
developing a plan to get the employee back to work as soon as is appropriate.
If the employee cannot immediately return to his or her original position, the
employer is required, according to the terms of the insurance agreement, to
provide a transitional light-duty job that is consistent with the limits defined
by the employee's medical care provider. If the employee refuses this
transitional position, the Company may terminate indemnity payments, but is
required to continue to provide appropriate medical benefits.
MEDICAL CARE PROVIDERS. The operating teams actively assess each injury,
monitor and manage the medical treatment and review the medical expenses of each
employee's injury. Each injury report is reviewed by one of the Company's
nurses. The nurse typically contacts the physician treating the employee in
cases that involved days off from work or injuries that could involve
significant expense. In these cases, the physician is asked to provide his or
her diagnosis, plan of treatment and assessment of the employee's physical
capabilities for transitional work. The Company has contracts with medical and
chiropractic physicians to provide consulting services and assessment of
proposed treatment plans for injured employees to the operating teams. These
physicians also discuss injured employee treatment plans with the employee's
medical care providers. The goal is to ensure both an accurate diagnosis and
treatment of the injury and an understanding of the nature and extent of the
limits the diagnosis places on the employee's ability to return to work in
either the original job or a transitional, light-duty position. The operating
team also monitors the health care provided to the injured employee to ensure
that the employee receives proper treatment for the injury and that the employee
does not receive services or procedures that are excessive, unnecessary or
unrelated to the particular injury. In addition, when the operating team
believes the diagnosis of an injury or the proposed rehabilitation treatment is
not appropriate, the operating team will arrange for a second opinion with an
independent medical examiner.
The medical cost management team reviews all bills submitted by medical
care providers to determine if the amounts charged for the treatments are
appropriate according to statutory fee schedules.
In Minnesota, Illinois and many other states, the Company cannot require
that an injured employee go to a specific physician or seek treatment from a
specific provider. Nevertheless, the Company attempts to assist the injured
employee in the selection of appropriate medical care providers. In Colorado,
Missouri and Michigan (for the first ten days after the injury) the Company can
require injured employees to go to a physician within a designated network of
medical care providers.
MANAGEMENT OF LEGAL AND JUDICIAL PARTICIPANTS. The Company, through early
intervention, seeks to limit the number of disputes with injured employees. As
part of its early intervention process, the Company identifies injuries that are
not eligible for medical or indemnity payments, and denies the claim. The
Company may also deny a claim for indemnity payments when it determines that no
further payments are appropriate (for example, when an employee has been offered
transitional, light-duty work and has refused it). In these and other sets of
circumstances, the employee may engage a lawyer to represent his or her
interests. Generally, if the parties are unable to resolve the matter, the
workers' compensation law mandates arbitration, subject to judicial review. For
cases that involve adversary proceedings, the Company engages one of several
lawyers who are familiar with the Company's philosophy and actively seeks to
resolve the dispute with the employee's attorney. The Company's policy is to
contest all cases where the Company believes benefits are not appropriate under
applicable law.
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CUSTOMERS
The Company targets employers and associations that operate in industries
with relatively high workers' compensation costs, such as manufacturing, retail,
wholesale, health care or hospitality industries, and employers with a history
of workers' compensation claim costs higher than the average in their industry.
The Company's average annual premium decreased to $24,000 in 1996 from
$52,000 in 1995 and $124,000 in 1994 due primarily to increased association
business with smaller average individual member premiums written in 1996 and
1995. The Company's ten largest customers accounted for approximately $5.1
million or 7.4% of the Company's premiums in force in 1996 as compared to $4.8
million or 9.3% of premiums in force in 1995. No customer accounted for more
than 5% of in force premiums in either year. Approximately 90% of the policies
scheduled to expire in 1996 and 1995 were renewed by the Company's customers.
Currently, all of the Company's customers are in Minnesota, Colorado,
Missouri, Michigan and Illinois. In addition to these states, the Company is
also licensed in Massachusetts and Pennsylvania. The Company is doing business
in Colorado as RTW Colorado, Inc.; Missouri as RTW Missouri, Inc.; Michigan as
RTW Michigan, Inc.; and Illinois as RTW Illinois, Inc. As the Company enters new
states, it intends to continue to add the name of the state to its name for
doing business within that state. The Company is applying for authorization to
begin insurance operations in 15 additional jurisdictions. The Company expects
it will primarily enter states that have a workers' compensation regulatory
structure that allows the Company to set its own premium rates and that also
have a substantial portion of the employers in that state insured through a
state sponsored fund. The Company currently has no intention to expand
operations internationally but will reevaluate the circumstances as
opportunities arise.
PRODUCTS
Substantially all of the Company's workers' compensation products and
services are guaranteed-cost insurance policies. Under a guaranteed-cost
policy, the customer purchases an insurance policy written by ACIC and pays the
Company a premium based on the customers' aggregate payroll. The Company
assumes responsibility for all the indemnity and medical costs associated with
the customers' workers' compensation injuries and works closely with the
customer in managing the employer's entire workers' compensation program.
The Company determines the premium to be charged a customer based on
several factors, including: (i) the expected dollar loss per $100 of payroll
for the customers' industry, (ii) the customer's experience modifier, a
measurement of the difference between the customer's past claims experience and
its industry average and (iii) an upward or downward adjustment to the premium
by the Company based on its assessment of the risks associated with providing
the coverage for the specific customer and on competitive market prices. A
customer's expected dollar loss and experience modifier are each determined by
an independent rating agency established by its state, based on a three-year
average of the claims experience of the customer and its industry.
In addition to standard guaranteed-cost policies, the Company offers, on a
limited basis, a deductible guaranteed-cost policy under which the customer is
responsible for all medical and indemnity expenses up to a specific dollar
amount, while the Company is responsible for medical and indemnity expenses over
this level. The Company provides the same comprehensive management services for
the deductible guaranteed-cost policies and the standard guaranteed-cost
policies.
SALES AND MARKETING
The Company's workers' compensation products and services are sold by
approximately 169 independent insurance agencies, including several large
national agencies, as well as one- or two-person agencies. Agencies are paid a
commission, which averaged 7.3% of the Company's gross premiums earned in 1996
compared to 5.1% of gross premiums earned in 1995. The Company's ten highest
producing agencies accounted for approximately $25.7 million or 37% of premiums
in force in 1996 compared to $22.3 million or 43% of premiums in force in 1995.
No agency accounted for more than 6.2% of premiums in force in 1996 and 8.3% of
premiums in force in 1995. The Company continually markets its products and
services to its agencies to keep them aware of developments in the Company's
business. Each state's management group and underwriting team is responsible
for establishing and maintaining agency relationships.
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REINSURANCE
The Company shares the risks and benefits of the insurance it underwrites
through reinsurance. The Company has in effect "excess of loss" policies under
which the Company pays a reinsurer a percentage of its gross premiums earned,
and the reinsurer agrees to assume all risks relating to injuries over a
specific dollar amount on a per occurrence basis. The 1996 and 1995 per
occurrence levels in Minnesota were $1,040,000 and $450,000, respectively. The
Company elected to increase its exposure in Minnesota to $1,040,000 in 1996, in
part because it had not experienced any claims that exceeded the $450,000 level.
The level in Minnesota increased to $1,080,000 in 1997. The excess of loss
coverage in Minnesota is provided by a state established organization, the
Minnesota Workers' Compensation Reinsurance Association. In states other than
Minnesota, the excess of loss coverage is provided by private reinsurers.
Transatlantic Reinsurance Company, rated A+ (Superior) by A.M. Best, is the only
reinsurance company that is receiving more than 15% of the premiums paid for the
Company's reinsurance coverage under the excess of loss coverage states other
than Minnesota. The excess of loss coverage effective in states other than
Minnesota through December 31, 1996 provided reinsurance up to $9.5 million in
excess of $500,000 per person per any one loss and up to $49.5 million in excess
of $500,000 per occurrence ultimate net loss. This coverage was effective
January 1, 1995 and was terminated and replaced with new excess of loss policies
beginning January 1, 1997. These excess of loss policies provide reinsurance up
to $9.5 million in excess of $500,000 per person per any one loss and up to $40
million in excess of $500,000 per occurrence ultimate net loss.
During 1994, 1993 and 1992, the Company maintained a quota-share
reinsurance agreement with Reliance Insurance Company ("Reliance") under which
the Company ceded to Reliance a percentage of all written premium dollars, and
Reliance assumed that same percentage of all risks and related costs. The
Company did not have any quota-share reinsurance agreements in effect for 1996
or 1995 and has none in effect for 1997. Reliance currently is rated A-
(Excellent) by A.M. Best.
A.M. Best ratings are ratings based on a comparative analysis of the
financial condition and operating performance of insurance companies as
determined by their publicly available reports. A.M. Best ratings are based
upon factors of concern to insureds and are not directed toward the protection
of investors. See "Competition."
COMPETITION
The workers' compensation industry is highly competitive. The Company
competes with large insurance companies, managed health care organizations,
state sponsored insurance pools and risk management consultants. Unlike the
Company, which offers only workers' compensation products and services, these
competitors may offer additional products and services to employers, including
other forms of insurance. As a consequence, these competitors may have certain
advantages in pricing their workers' compensation products. In addition,
certain of these competitors are offering a management approach similar to that
offered by the Company. Many of the Company's competitors have greater
financial and operating resources than the Company.
Competitive factors in the industry include premium rates, level of service
and ability to reduce claims expense. The Company believes that its workers'
compensation insurance products are competitively priced and its premium rates
are typically lower than those for customers assigned to the state sponsored
risk pools. The Company also believes that its level of service and its ability
to reduce claims are strong competitive factors that have enabled it to retain
existing customers and attract new customers.
Large insurance companies exit and enter the workers' compensation market
in different states depending on their appraisal of current market conditions.
As a result, many insurance companies stopped underwriting workers' compensation
insurance during the early 1990's due to rising costs that were not matched by
reductions in statutory benefits or higher premium rates. In 1996 and 1995, the
Company experienced increased market pressure as new carriers entered the market
including large insurance companies and single line workers' compensation
insurance companies.
These large insurance companies compete primarily with the Company for
customers that have lower past claims experience or lower experience
"modifiers." In Minnesota, increases in premium rates relative to statutory
benefits during the past year have made it more attractive for large insurance
companies to underwrite workers' compensation policies for these lower
experience modifier customers. As a result, the Company has experienced
increased competition for the renewal of workers' compensation policies with
customers that have reduced their
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experience modifiers, and it expects to continue to experience increased
competition from large insurance companies.
An additional competitive factor results from the fact that some employers
will not purchase workers' compensation products from carriers with a rating
less than "A". In addition, certain insurance carriers that write umbrella
policies will not provide coverage to an employer if a portion of the employer's
underlying insurance policy, such as the workers' compensation portion is
written by a carrier with a less than "A" rating. Although some rated insurance
carriers currently provide umbrella policies to customers of the Company, the
Company believes that its B++ letter rating from A.M. Best may make it
difficult, in certain instances, for the Company to provide its products to
certain employers.
The Company's insurance subsidiary was assigned an initial rating of B++
(Very Good) on a scale of A++ (Superior) to F (In Liquidation) on December 16,
1996. A Best's Rating is assigned after an extensive quantitative and
qualitative evaluation of the Company's financial condition and operating
performance. A.M. Best ratings are based upon factors of concern to insureds
and are not directed toward the protection of investors. Furthermore, A.M. Best
ratings are not ratings of the Company or any of its securities. A.M. Best
ratings include Secure Ratings, consisting of A++ and A+ (Superior); A and A-
(Excellent); B++ and B+ (Very Good); Vulnerable Ratings, consisting of B and B-
(Adequate); C++ and C+ (Fair); C and C- (Marginal); D (Very Vulnerable); E
(Under State Supervision); and F (In Liquidation).
DATA MANAGEMENT
In 1996 and 1995, the Company contracted with unrelated third parties for
certain computer information systems and other software licenses. In 1996, the
Company developed and implemented its own proprietary claims management and
medical fee adjudicating systems to manage claims, audit medical fees, pay
claims, provide reports to policyholders and analyze claims data. These systems
replaced third party contracts for claims management and medical fee
adjudicating systems. In 1995, the Company developed and implemented its own
proprietary policy management system to process insurance applications and issue
policies and endorsements. This system replaced a third party contract for a
policy management system. The Company continues to utilize third party software
to maintain financial information, prepare accounting reports and financial
statements, perform billing and collections, pay vendors and track agent
commissions. The Company also contracts with a third party provider of payroll
services for payroll, benefit and human resource software services. The Company
utilizes other licensed software from national vendors to maintain its financial
records, file statutory statements with insurance regulators and perform other
general business.
EMPLOYEES
The company had 214 full-time employees at December 31, 1996. Of the
Company's employees, approximately 89 work in the Company's administrative and
financial functions and 125 serve on approximately 21 different operating teams.
None of the Company's employees are subject to collective bargaining agreements.
The Company believes its employee relations are good.
REGULATION
The Company's insurance subsidiary is subject to substantial regulation by
the governmental agencies in the states in which it operates, and will be
subject to such regulation in any state in which it provides workers'
compensation products and services in the future. State regulatory agencies
have broad administrative power with respect to all aspects of the business of
the Company, including premium rates, benefit levels, policy forms, dividend
payments, capital adequacy and the amount and type of its investments. These
regulations are primarily intended to protect covered employees and
policyholders rather than the insurance company. Both the legislation covering
insurance companies and the regulations adopted by state agencies are subject to
change.
Workers' compensation coverage is a creation of state law, subject to
change by the state legislature, and is influenced by the political processes in
each state. Several states have mandated that employers receive coverage only
from state operated funds. New laws affecting the workers' compensation system
in Minnesota, Colorado, Missouri, Michigan and any other state where the Company
may operate in the future, including laws that require
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all employers to participate in state sponsored funds or that mandate premium
reductions, could have a material adverse effect on the Company.
LEGAL PROCEEDINGS
In the ordinary course of administering its workers' compensation
management program, the Company is routinely involved in the adjudication of
claims resulting from workplace injuries. The Company is not involved in any
legal or administrative claims that it believes are likely to have a material
adverse effect on the Company's operations or financial condition.
EXECUTIVE OFFICERS OF THE REGISTRANT
The following are the executive officers of the Company:
Name Age Position
- ---- --- --------
David C. Prosser 72 Chairman, President and Chief Executive Officer
J. Alexander Fjelstad, III 45 Chief Operating Officer - Marketing and
Underwriting and Director
Vina L. Marquart 45 Chief Operating Officer - Operations
Alfred L. LaTendresse 48 Chief Financial Officer, Secretary and Treasurer
David N. Clinton 50 Vice President, Chief Information Officer
Daniel R. Haag 40 Vice President, Human Resources
David C. Prosser, the founder of the Company, has served as President,
Chief Executive Officer and Director of the Company since its formation in 1983.
From 1965 through 1985, Mr. Prosser was the owner and President of Vocational
Personnel Services, Inc., which merged into the Company in 1986.
J. Alexander Fjelstad, III, joined the Company in 1989 as a Vice President,
served as Chief Operating Officer beginning in 1993 and became Chief Operating
Officer - Marketing and Underwriting in October 1996. Mr. Fjelstad has been a
Director of the Company since 1989. From 1984 to 1988, Mr. Fjelstad was a vice-
president of ICS, Inc. a property and casualty insurance brokerage firm. He is
a member of the Chartered Property and Casualty Underwriters and the American
Institute for Property and Liability Underwriters.
Vina L. Marquart joined the Company in 1984 as a Workers' Compensation
Manager, served as Vice President, Operations beginning in 1990 and became Chief
Operating Officer - Operations in October 1996. Ms. Marquart served as Director
from October 1990 until January 1995. Prior to joining the Company, Ms.
Marquart progressed from staff nurse to head nurse at the Bethesda Hospital in
Saint Paul, Minnesota from 1974 to 1983. Ms. Marquart is a member of the
American Association of Occupational Health Nursing and Minnesota Association of
Occupational Health Nursing. She has held a registered nursing license since
1974.
Alfred L. LaTendresse joined the Company as Chief Financial Officer in 1990
and became Secretary and Treasurer in October 1990. Mr. LaTendresse served as
Director of the Company from July 1993 until January 1995. Prior to joining the
Company, Mr. LaTendresse served as the Chief Financial Officer for several
companies since 1982. Mr. LaTendresse is a member in the American Institute of
Certified Public Accountants and the Minnesota Society of Certified Public
Accountants.
David N. Clinton joined the Company in 1994 as Vice President, Chief
Information Officer. Prior to joining the Company, Mr. Clinton served as the
Vice President, Information Services for Rehability Corporation.
Dan Haag joined the Company in June 1996 as the Director of Human Resources
and became Vice President, Human Resources in August 1996. Prior to joining the
Company, Mr. Haag served as the Director of Human Resources, Scholastic and
Recognition Division for Jostens in 1994 and 1995 and served in numerous human
resource positions with SPX Corporation from 1979 to 1994 including Director of
Human Resource positions for SPX divisions from 1990 to 1994.
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ITEM 2. PROPERTIES
The following is a summary of properties leased by the Company at December 31,
1996:
Area leased
Location and description (in square feet) Termination
- ------------------------ ---------------- -----------
Bloomington, Minnesota; Headquarters space 41,918 September 1999(1)
Brainerd, Minnesota; Minnesota satellite office 2,634 October 2000
Denver, Colorado; Colorado office space 11,244 February 2000
St. Louis, Missouri; Missouri office space 4,725 September 2000
Detroit, Michigan; Michigan office space 5,947 June 2002
(1) The Company amended its lease in February 1997 to increase the area leased
in its Headquarters space by 6,013 square feet to 41,918 square feet. This
amendment extends to March 2000 only for the new space leased.
ITEM 3. LEGAL PROCEEDINGS
None.
ITEM 4. SUBMISSION OF MATTER TO A VOTE OF SECURITY HOLDERS
None.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company completed an initial public offering in April 1995 and its shares
are publicly traded on The Nasdaq Stock Market under the symbol RTWI. The table
below sets forth the range of high and low sales prices per share for the
Company's stock for quarters completed subsequent to the initial public offering
as reported by The Nasdaq Stock Market. These prices have been adjusted to
reflect a 3-for-2 stock split in the form of a 50 percent stock dividend to
shareholders of record on the close of business on May 6, 1996. There were
approximately 1,300 shareholders of record of the Company's common stock at the
close of trading on March 10, 1997.
First Second Third Fourth
Fiscal Year: Quarter Quarter Quarter Quarter
------- ------- ------- -------
1996 High 24 7/8 33 1/2 33 28 1/8
Low 16 1/3 23 2/3 23 3/4 14 3/4
1995 High 14 2/3 20 1/3 18 2/3
Low 9 11 1/3 13 2/3
The Company has never paid cash dividends on its Common Stock. The Board of
Directors currently intends to retain any and all income for use in the
Company's business and does not anticipate paying cash dividends in the
foreseeable future. Any future determination as to payment of dividends will
depend on the financial condition and results of operations of the Company and
such other factors deemed relevant by the Board of Directors. Under the
Indenture dated December 1, 1994, under which the Company issued its $10.0
million in Senior Notes, the Company is prohibited from paying cash dividends
unless it is able to maintain compliance with certain covenants after payment of
the dividends.
ITEM 6. SELECTED FINANCIAL DATA
The consolidated statements of income data set forth below for each of the three
years in the period ended December 31, 1996 and the consolidated balance sheet
data at December 31, 1996 and 1995, are derived from, and are qualified by
reference to, the audited consolidated financial statements included elsewhere
in this Form 10-K. The consolidated statements of income data set forth below
for each of the two years in the period ended December 31, 1993 and the
consolidated balance sheet data at December 31, 1994, 1993 and 1992, are derived
from audited consolidated financial statements not included herein. The
information set forth below should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the Company's consolidated financial statements and related notes included
elsewhere in this Form 10-K.
<TABLE>
<CAPTION>
1992 1993 1994 1995 1996
-------- --------- --------- --------- ----------
<S> <C> <C> <C> <C> <C>
Total revenues $ 3,744 $ 7,828 $ 28,241 $ 49,433 $ 68,725
Income from operations 511 2,571 7,879 12,569 14,808
Net income 158 1,450 4,195 7,058 8,982
Net income per share (1) 0.02 0.18 0.49 0.64 0.73
Premiums in force at year end 14,000 29,000 39,900 51,700 69,500
Total assets 10,850 28,224 56,765 101,124 123,731
Notes payable 1,472 933 9,993 8,891 6,739
Total shareholders' equity 1,136 2,466 6,136 41,438 51,311
</TABLE>
- ------------------------------
(1) Adjusted to reflect a three-for-two stock split in May 1996 and a five-for-
one stock split in 1995. For additional information relating to weighted
average common and common share equivalents outstanding, see Note 1 of
Notes to Consolidated Financial Statements.
11
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION
OVERVIEW
RTW, Inc. ("RTW" or the "Company") was organized in 1983 to provide workers'
compensation management products and services to employers. In 1989, the Company
began offering its workers' compensation management services combined with
workers' compensation insurance products provided by an unaffiliated insurance
company. Under its arrangement with this insurance company, RTW was responsible
for marketing and administering the insurance company's workers' compensation
insurance policies and was compensated on a fee-for-service basis.
In 1992, RTW phased out its agreement with this insurance company and began
offering workers' compensation management services combined with insurance
underwritten by its wholly owned subsidiary American Compensation Insurance
Company ("ACIC"). The ability to underwrite insurance allowed the Company to
directly benefit from the use of its proprietary methods in reducing workers'
compensation costs and afforded RTW more control over its customers' workers'
compensation programs. The Company's premiums in force grew to $69.5 million at
the end of 1996 from $51.7 million at the end of 1995 and $39.9 million at the
end of 1994. RTW currently provides workers' compensation management services
solely to employers insured through ACIC.
The Company's revenues consist of premiums earned and investment income.
Premiums earned during a period are the gross premiums earned by the Company on
outstanding workers' compensation policies less the amount of any premiums ceded
to reinsurers.
- - ACIC ceded, on a pro rata basis, a portion of its insurance business to
Reliance Insurance Company ("Reliance"), an unaffiliated reinsurance
company, under which Reliance assumed 25% of the 1994 and 66 2/3% of the
1993 and 1992 claim and claim settlement expenses in consideration for a
proportionate share of eligible premiums. In addition, the Company received
a fee from Reliance for claims administration, which the Company applied to
reduce its claim and claim settlement expenses. The Company entered into
this quota-share reinsurance agreement because it enabled the Company to
provide management services and workers' compensation insurance products to
a greater number of customers than its capital and surplus would have
otherwise allowed. As a consequence of additions to ACIC's capital and
surplus from the net proceeds of the Company's Senior Note offering in 1994
and its initial public offering in 1995, the Company determined that it no
longer required quota-share reinsurance to expand its operations and
terminated the agreement for 1995 and subsequent years.
- - The Company also cedes a portion of its premiums for excess of loss
reinsurance coverage that limits the Company's per incident exposure.
If Reliance or any of the Company's excess of loss reinsurers are unable to meet
any of their obligations to the Company under their reinsurance policies, the
Company would be responsible for the payment of all claim and claim settlement
expenses covered by the workers' compensation policies that the Company had
underwritten, including those expenses covered by reinsurance. The Company is
not aware of any developments with respect to any of its reinsurers that would
prevent them from honoring any of their obligations to the Company.
Investment income represents the earnings on the Company's investment portfolio.
The Company's expenses are comprised of claim and claim settlement expenses,
policy acquisition costs, general and administrative expenses, interest expense
and income taxes.
- - Claim and claim settlement expenses include payments and reserves for
future payments for medical care and rehabilitation costs, indemnity costs
for lost wages and third party claim settlement expenses such as
independent medical examinations, surveillance costs and legal expenses,
second injury fund charges based on claim outcomes, as well as staff and
related expenses incurred to administer and settle claims. Because the
Company has limited historical data for use in its estimates of unpaid
claim and claim settlement expenses, the Company has used industry data to
supplement its experience in determining the reserve for unpaid claim and
claim settlement expenses. As a result of the use of industry data, the
ultimate amount of unpaid claim and
12
<PAGE>
claim settlement expenses recognized by the Company may differ from the
amount estimated. See Note 4 of Notes to Consolidated Financial Statements.
- - Policy acquisition costs consist of agents' commissions, premium taxes,
certain state administrative and second injury fund charges based on
premiums and underwriting and marketing expenses, offset by any ceding
commissions received from Reliance. Ceding commissions consist of
provisional ceding commissions paid to the Company by Reliance for
adjustments based on actual claim and claim settlement expenses related to
premiums ceded in prior years. Under the reinsurance agreement, the
Company's ceding commission is adjusted to the extent that actual claim and
claim settlement expenses vary from levels specified in the agreement.
RESULTS OF OPERATIONS
The relationship of total revenues to each item in the statement of income
varies from period to period due, in part, to the fact that the Company did not
have a quota-share reinsurance agreement in effect in 1996 and 1995, whereas,
the Company had a 25% quota-share reinsurance agreement in effect in 1994. The
absence of a quota-share reinsurance agreement in 1996 and 1995 increased
premiums earned as a percent of gross premiums earned.
The following table summarizes the components of revenues and premiums in force
for 1996, 1995 and 1994:
YEAR ENDED DECEMBER 31,
1996 1995 1994
--------- --------- ---------
(IN THOUSANDS)
Gross premiums earned $ 63,755 $ 47,507 $ 38,099
Premiums ceded to reinsurers:
Excess of loss reinsurance (697) (2,099) (2,177)
Quota-share reinsurance - - (9,308)
--------- --------- ---------
Premiums ceded (697) (2,099) (11,485)
--------- --------- ---------
Premiums earned 63,058 45,408 26,614
Investment income 5,667 4,025 1,627
--------- --------- ---------
Total revenues $ 68,725 $ 49,433 $ 28,241
--------- --------- ---------
--------- --------- ---------
Premiums in force at year-end
Minnesota $ 52,400 $ 47,700 $ 39,900
Colorado 12,000 4,000 -
Missouri 4,700 - -
Michigan 400 - -
--------- --------- ---------
Total premiums in force $ 69,500 $ 51,700 $ 39,900
--------- --------- ---------
--------- --------- ---------
PREMIUMS EARNED. Premiums earned increased to $63.1 million in 1996 from $45.4
million in 1995 due to the following:
- - Gross premiums earned increased 34.2% to $63.8 million in 1996 from $47.5
million in 1995. The increase in gross premiums earned resulted from an
increase in the amount of premiums in force as the Company's customer base
grew to 2,914 customers at the end of 1996 from 998 customers at the end of
1995. The Company's average annual premium decreased to approximately
$24,000 at December 31, 1996 from $52,000 at December 31, 1995 due primarily
to increased association business with smaller average individual member
premiums written. The Company expects continued growth in gross premiums
earned in 1997 fueled by growth in premiums in force in its newer markets
including Michigan, Missouri and Colorado.
- - Premiums ceded to reinsurers decreased 66.8% to a cost of $697,000 in 1996
from a cost of $2,099,000 in 1995. The decrease in premiums ceded to
reinsurers resulted from (i) the increase to approximately $1.0 million in
1996 from $450,000 in 1995 in the Minnesota retention level under the
Minnesota Workers' Compensation Reinsurance Association (the "WCRA") excess
of loss reinsurance coverage, (ii) reduced rates charged for excess of loss
reinsurance in Minnesota during 1996, (iii) the recognition of a benefit of
$251,000 in the second quarter of 1996 due to an over-estimate of ceded
premiums at December 31, 1995, and (iv) the decrease in ceded premium cost in
Colorado and Missouri due to exceeding the minimum premium threshold.
Colorado, Missouri and Michigan retention levels remained at $500,000 in
1996. Premiums ceded is expected to decrease in 1997 as a percentage of
13
<PAGE>
gross premiums earned due to reduced rates charged for excess of loss
reinsurance in Minnesota in 1997 and reduced rates negotiated for excess of
loss reinsurance in non-Minnesota locations beginning January 1, 1997.
The following factors have resulted in premium reductions on renewal accounts
and reduced premiums on new accounts.
- Legislative action reduced estimated loss costs in 1996, 1995 and 1994,
ultimately reducing premiums charged for workers' compensation insurance.
- From October 1995 through September 1996, the Company attempted to write
more customers with credit experience modifiers and experienced increased
competition in this customer base (including traditional insurance
companies competing in greater numbers for accounts). The Company began
repositioning its marketing efforts in the fourth quarter of 1996 to
refocus on its traditional debit experience modifier customer base.
- The Company continues, as anticipated, to experience reduced pricing on
renewal policies due to its success in lowering customers' loss
experience which reduces customer experience modifiers and, in some
cases, increases competition for the customers' business.
The impact of legislative changes in estimated loss costs, increased competition
in credit modifier customers and decreasing customer loss experience may
continue to result in lower premiums generated on new and renewal policies for
1997.
Premiums earned increased to $45.4 million in 1995 from $26.6 million in 1994 as
follows:
- Gross premiums earned increased 24.7% to $47.5 million in 1995 from $38.1
million in 1994. The increase in gross premiums earned resulted from an
increase in the amount of premiums in force as the Company's customer
base grew to 998 customers at the end of 1995 from 321 customers at the
end of 1994. The Company's average annual premium decreased to
approximately $52,000 at December 31, 1995 from $124,000 at
December 31, 1994 due primarily to increased association business
with smaller average individual member premiums written.
- Premiums ceded to reinsurers decreased 81.7% to a cost of $2.1 million
in 1995 from a cost of $11.5 million in 1994. The decrease in premiums
ceded to reinsurers resulted from (i) terminating the quota-share
reinsurance agreement, reducing premiums ceded by $9.3 million, and
(ii) the increase in ceded premium cost for excess of loss reinsurance
in Colorado and Missouri.
INVESTMENT INCOME. Investment income increased to $5.7 million in 1996 from
$4.0 million in 1995, due to increased funds available for investment and
increased yields on amounts invested. Funds available for investment increased
to $89.8 million at December 31, 1996 from $68.5 million at December 31, 1995,
due to increased net cash provided by operating activities. Investment yields
increased to 6.2% in 1996 from 6.1% in 1995 due to higher interest rates on U.S.
Treasury Securities purchased in 1996 from rates on U.S. Treasury Securities
purchased in prior years. The investment yield realized in future periods will
be affected by yields attained on new investments. The Company expects that the
investment yield will be consistent with the yield attained during 1996.
Investment income increased to $4.0 million in 1995 from $1.6 million in 1994,
due to increased funds available for investment and increased yields on amounts
invested. Funds available for investment increased to $68.5 million at December
31, 1995 from $33.1 million at December 31, 1994, due to the addition of
approximately $27.0 million of net proceeds from a $29.9 million initial public
offering in April 1995 and increased net cash provided by operating activities.
The net proceeds from the initial public offering were received and invested
during the second quarter of 1995. Investment yields increased to 6.1% in 1995
from 5.7% in 1994 due to higher interest rates on U.S. Treasury Securities
purchased in 1995 from rates on U.S. Treasury Securities purchased in prior
years. Investment income for 1995 also includes approximately $97,000 of other
revenue amounts recognized during 1995.
CLAIM AND CLAIM SETTLEMENT EXPENSES. Claim and claim settlement expenses
increased to $39.1 million in 1996 from $28.1 million in 1995. As a percentage
of premiums earned, claim and claim settlement expenses increased to 62.0% in
1996 from 61.8% in 1995. These changes are due to the following:
- Premiums earned increased in 1996 from 1995 resulting in increased claim
and claim settlement expenses.
- Operating results for 1996 claim and claim settlement expenses in
Colorado were higher than expected. The Company has made changes in
Colorado designed to bring the operations there up to its expected level
14
<PAGE>
of performance but the results of these changes may not be fully
effective until the second half of 1997.
- During the fourth quarter, the Company experienced the four largest
claims in its history, incurring approximately $2.0 million with
respect to these claims, three of which were Minnesota and one of
which was Missouri.
- Average claim cost decreased in 1996 from 1995 due to efficiencies
within the Company and legislative changes in benefits to claimants.
The effects of legislative changes in benefits, as estimated by
various state regulatory agencies, for periods the Company operated,
by state, including known future periods, are as follows:
Increase (decrease) in estimated loss costs
-------------------------------------------
1997 1996 1995 1994
------- ------- ------ ----
Minnesota (14.8%) (15.6%) (5.6%) 1.3%
Colorado (1.5%) (8.6%) (9.6%) N/A
- During 1996, the Company reduced its estimate of the pre-1996 liability
for unpaid claim and claim settlement expenses by $8.1 million as a
result of favorable claims experience for those periods, which resulted
in an $8.1 million reduction in 1996 claim and claim settlement
expenses. The Company believes that continued application of its
claims management technology and methods to all open claims at
December 31, 1996 will benefit future periods. The magnitude of
that benefit, if any, can not be quantified. At December 31,
1996, the Company had net reserves for unpaid claim and claim
settlement expenses of $49.3 million including $33.2 million for 1996
claims and $16.1 million for years prior to 1996.
The Company believes that, in the current environment (reduced premiums due to
legislative changes in estimated costs of losses, increased competition in
credit modifier customers written from October 1995 through September 1996,
decreasing customer loss experience and decreasing average claim costs), it may
continue to experience upward pressure on claim and claim settlement expenses as
a percentage of premiums earned.
Claim and claim settlement expenses increased to $28.1 million in 1995 from
$16.6 million in 1994. As a percentage of premiums earned, claim and claim
settlement expenses decreased to 61.8% in 1995 from 62.4% in 1994. These changes
are due to the following:
- Premiums earned increased in 1995 from 1994 resulting in increased claim
and claim settlement expenses.
- The Company terminated its quota-share reinsurance agreement for 1995,
which increased the amount of claim and claim settlement expenses
retained by the Company. Under the quota-share reinsurance agreement,
Reliance paid the Company a ceding commission for providing claims
administrative services. Since the Company used these ceding
commissions to reduce claim and claim settlement expenses, reducing
the level of reinsurance had the effect of increasing claim and claim
settlement expenses as a percentage of premiums earned.
- During 1995, the Company reduced its estimate of the pre-1995 liability
for unpaid claim and claim settlement expenses by $1.5 million as a
result of favorable claims experience for those periods, which resulted
in a $1.5 million reduction in 1995 claim and claim settlement expenses.
- The decrease in claim and claim settlement expenses as a percentage of
premiums earned in the 1995 period resulted from the Company's ability
to achieve improved expense results in current periods. This decrease
was partially offset by an increase in claim and claim settlement
expenses resulting from the termination of the quota-share reinsurance
agreement.
15
<PAGE>
POLICY ACQUISITION COSTS. The following table summarizes policy acquisition
costs for 1996, 1995 and 1994:
YEAR ENDED DECEMBER 31,
1996 1995 1994
-------- -------- --------
(IN THOUSANDS)
Commission expense $ 4,670 $ 2,443 $ 1,631
Premium tax expense 1,312 955 762
Other policy acquisition costs 2,216 1,024 413
-------- -------- --------
Direct policy acquisition costs 8,198 4,422 2,806
Ceding commissions
Provisional ceding commissions - - (2,018)
Favorable claims experience adjustments
from 1992 to 1994 (1,871) (1,733) (318)
Re-negotiation adjustment - - (642)
-------- -------- --------
Total ceding commissions (1,871) (1,733) (2,978)
-------- -------- --------
Policy acquisition costs $ 6,327 $ 2,689 $ (172)
-------- -------- --------
-------- -------- --------
Policy acquisition costs increased to $6.3 million in 1996 from $2.7 million in
1995 and a benefit of $172,000 in 1994 for the following reasons:
- - Commission expense increased to 7.3% of gross premiums earned in 1996 from
5.1% in 1995 and 4.3% in 1994. The Company initiated marketing programs
during the fourth quarter of 1995 and the first quarter of 1996, including
volume based incentive programs and higher commissions for new business,
that increased commission rates to agents resulting in increased average
commissions and increased commission expense. Additionally, as the Company
entered new markets, it introduced higher commission rates to attract
business from established agents. The Company expects commission expense
as a percent of gross premiums earned to increase during 1997.
- - Premium tax expense increased slightly to 2.1% of gross premiums earned in
1996 from 2.0% of gross premiums earned in 1995 and 1994 due to higher
premium tax rates paid in Colorado. The Company expects premium tax
expense as a percent of gross premiums earned in 1997 to remain consistent
with 1996.
- - Other policy acquisition costs increased to 3.5% of gross premiums earned
in 1996 from 2.2% in 1995 and 1.1% in 1994, due to increased focus on
marketing programs as the Company expands into new states and continues to
grow in its more established markets and increased personnel costs
necessary for the growth in premiums in force.
- - Total ceding commissions increased to a benefit of $1.9 million in 1996
from a benefit of $1.7 million in 1995 and decreased from a benefit of $3.0
million in 1994. Provisional ceding commissions were not recognized in
1996 and 1995 due to terminating the quota-share reinsurance agreement in
1995. The Company recognized favorable adjustments on its ceding commission
estimates of $1.9 million in 1996, $1.7 million in 1995 and $318,000 in
1994 due to favorable claims experience for accident years 1992 through
1994. In addition, 1994 included a favorable adjustment of $642,000 to
ceding commissions as a result of renegotiating the Company's 1993 quota-
share reinsurance agreement.
The Company believes that the continued application of its claims management
technology to 1992 through 1994 open claims will continue to provide future
favorable ceding commission adjustments. These adjustments are expected to
decrease significantly from the levels attained in 1996 and 1995 due to the
reduced number of open claims remaining for those years.
GENERAL AND ADMINISTRATIVE EXPENSES. The Company's general and administrative
expenses increased to $8.5 million in 1996 from $6.1 million in 1995 and $3.9
million in 1994. This increase reflects:
- additional personnel costs for new employees,
- higher compensation for existing employees,
- expenses incurred for growth in Minnesota and Colorado,
- startup expenses incurred for expansion in Missouri and Michigan, and
- increased fees for professional services.
16
<PAGE>
The Company anticipates that general and administrative expenses will continue
to increase in cost in 1997 as it continues to expand into new states and grows
in its existing states.
INTEREST EXPENSE. Interest expense decreased to $1.1 million in 1996 from $1.3
million in 1995 and 1994 due to principal payments on the Series 1991A and 1991B
Notes in December 1996, 1995 and 1994 and payment on the Senior Notes in
December 1996 and 1995. The Series 1991A and 1991B Notes were paid in full in
1996. Interest expense on the Senior Notes is anticipated to be $777,000 in
1997 as a result of principal payments made in December 1996.
QUARTERLY RESULTS
The following tables present summarized quarterly operating results for the
eight quarters ended December 31, 1996:
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
-------- -------- -------- --------
1996 (IN THOUSANDS, EXCEPT PER SHARE DATA)
Premiums in force:
Minnesota $ 46,800 $ 51,100 $ 52,900 $ 52,400
Colorado 8,700 9,600 10,600 12,000
Missouri 600 1,500 3,000 4,700
Michigan - - - 400
-------- -------- -------- --------
Premiums in force at period end $ 56,100 $ 62,200 $ 66,500 $ 69,500
-------- -------- -------- --------
-------- -------- -------- --------
Gross premiums earned $ 14,040 $ 15,242 $ 17,161 $ 17,312
-------- -------- -------- --------
-------- -------- -------- --------
Premiums earned $ 13,764 $ 15,344 $ 16,914 $ 17,036
-------- -------- -------- --------
-------- -------- -------- --------
Total revenues $ 15,052 $ 16,722 $ 18,379 $ 18,572
Claim and claim settlement expenses 7,858 8,503 10,025 12,694
Policy acquisition costs 1,420 1,877 2,132 898
General and administrative expenses 1,844 2,108 1,815 2,743
-------- -------- -------- --------
Income from operations $ 3,930 $ 4,234 $ 4,407 $ 2,237
-------- -------- -------- --------
-------- -------- -------- --------
Net income $ 2,283 $ 2,481 $ 2,582 $ 1,636
-------- -------- -------- --------
-------- -------- -------- --------
Net income per common and common
share equivalent $ 0.19 $ 0.20 $ 0.21 $ 0.13
-------- -------- -------- --------
-------- -------- -------- --------
1995
Premiums in force:
Minnesota $ 42,600 $ 44,600 $ 44,700 $ 47,700
Colorado 800 1,300 1,600 4,000
-------- -------- -------- --------
Premiums in force at period end $ 43,400 $ 45,900 $ 46,300 $ 51,700
-------- -------- -------- --------
-------- -------- -------- --------
Gross premiums earned $ 10,653 $ 12,272 $ 12,163 $ 12,419
-------- -------- -------- --------
-------- -------- -------- --------
Premiums earned $ 10,308 $ 11,847 $ 11,652 $ 11,601
-------- -------- -------- --------
-------- -------- -------- --------
Total revenues $ 10,868 $ 12,913 $ 12,816 $ 12,836
Claim and claim settlement expenses 6,649 7,515 7,139 6,759
Policy acquisition costs 893 1,071 803 (78)
General and administrative expenses 1,242 1,473 1,467 1,931
-------- -------- -------- --------
Income from operations $ 2,084 $ 2,854 $ 3,407 $ 4,224
-------- -------- -------- --------
-------- -------- -------- --------
Net income $ 1,117 $ 1,592 $ 1,898 $ 2,451
-------- -------- -------- --------
-------- -------- -------- --------
Net income per common and common
share equivalent $ 0.13 $ 0.14 $ 0.16 $ 0.20
-------- -------- -------- --------
-------- -------- -------- --------
The Company's premiums in force have increased in each of the last eight
quarters. Quarterly revenues are affected by (i) premiums in force at the
beginning of the quarter, (ii) new policies written in a quarter and (iii) the
Company's policy renewal rate in each quarter. Historically, a majority of new
policies written and policy renewals
17
<PAGE>
have occurred in the first, second and fourth quarters. In addition, the
Company's quarterly results for 1996 and 1995 were affected favorably by
adjustments to the liability for unpaid claim and claim settlement expenses and
ceding commissions relating to those years and prior years as follows:
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
-------- -------- -------- --------
1996 (IN THOUSANDS)
Claim and claim settlement expenses,
net $ 425 $ 650 $ 608 $ 6,392
Policy acquisition costs 225 50 142 1,454
-------- -------- -------- --------
Quarterly effect on income from
operations $ 650 $ 700 $ 750 $ 7,846
-------- -------- -------- --------
-------- -------- -------- --------
1995
Claim and claim settlement expenses,
net $ - $ - $ 300 $ 1,174
Policy acquisition costs - - 100 1,633
-------- -------- -------- --------
Quarterly effect on income from
operations $ - $ - $ 400 $ 2,807
-------- -------- -------- --------
-------- -------- -------- --------
With respect to the fourth quarter of 1996, see previous discussions in Claim
and Claim Settlement Expenses.
UNPAID CLAIM AND CLAIM SETTLEMENT EXPENSES
The Company establishes reserves to cover its estimated liability for claim and
claim settlement expenses with respect to reported claims and claims incurred
but not yet reported as of the end of each accounting period. The Company
establishes its reserves based on facts then known, estimates of future trends
in claims severity and other factors, including the Company's experience with
similar cases and historical trends such as reserving patterns, loss payments
and pending levels of unpaid claims. See Note 1 of Notes to Consolidated
Financial Statements.
The following two tables reconcile the beginning and ending insurance reserves,
displayed individually for each of the last three years.
The following table sets forth reserves on a gross (before reinsurance) basis:
YEAR ENDED DECEMBER 31,
1996 1995 1994
--------- --------- -------
(IN THOUSANDS)
GROSS RESERVES FOR CLAIM AND CLAIM SETTLEMENT EXPENSES:
Gross reserves for claim and claim
settlement expenses, beginning of year $ 37,138 $ 28,165 $ 13,279
Provision increases (decreases) for claim
and claim settlement expenses:
Current year 49,440 30,137 26,034
Prior years (11,051) (4,701) (196)
--------- --------- -------
Total provision 38,389 25,436 25,838
Payments for claim and claim settlement
expenses:
Current year 16,239 8,860 6,887
Prior years 10,032 7,603 4,065
--------- --------- -------
Total payments 26,271 16,463 10,952
--------- --------- --------
Gross reserves for claim and claim settlement
expenses, end of year $ 49,256 $ 37,138 $28,165
--------- --------- -------
--------- --------- -------
18
<PAGE>
The following table sets forth reserves on a net (after reinsurance) basis :
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1996 1995 1994
--------- --------- -------
(IN THOUSANDS)
<S> <C> <C> <C>
NET RESERVES FOR CLAIM AND CLAIM SETTLEMENT EXPENSES:
Net reserves for claim and claim settlement
expenses, beginning of year $ 28,826 $ 14,263 $ 3,686
Provision increases (decreases) for claim and claim
settlement expenses:
Current year 47,155 29,536 16,505
Prior years (8,075) (1,474) 98
--------- --------- -------
Total provision 39,080 28,062 16,603
Payments for claim and claim settlement expenses:
Current year 16,238 8,860 4,590
Prior years 8,595 4,639 1,436
--------- --------- -------
Total payments 24,833 13,499 6,026
--------- --------- -------
Net reserves for claim and claim settlement expenses,
end of year $ 43,073 $ 28,826 $ 14,263
--------- --------- -------
--------- --------- -------
</TABLE>
As determined under Generally Accepted Accounting Principles ("GAAP"), the 1996
year-end reserves of $49.3 million for claim and claim settlement expenses were
$6.2 million more than the reserves of $43.1 million recorded on the basis of
statutory accounting principles for reports provided to state regulatory
authorities. The difference is the reinsurance recoverable from third-party
reinsurance carriers totaling $6.2 million that reduces reserves for statutory
reporting and is recorded as an asset, reinsurance receivable, for GAAP
reporting.
The following loss reserve development table sets forth the change, over time,
of reserves established for claim and claim settlement expenses at the end of
the last five years. The following loss reserve development table is cumulative
and, therefore, ending balances should not be added since the amount at the end
of each calendar year includes activity for both the current and prior years.
<TABLE>
<CAPTION>
DECEMBER 31,
1996 1995 1994 1993 1992
--------- --------- --------- --------- --------
<S> <C> <C> <C> <C> <C>
LOSS RESERVE DEVELOPMENT: (IN THOUSANDS)
Gross reserves for unpaid claim and claim
settlement expenses $ 49,256 $ 37,138 $ 28,165 $ 13,279 $ 2,688
Deduct reinsurance recoveries 6,183 8,312 13,902 9,593 1,886
--------- --------- --------- --------- --------
Reserves for unpaid claim and
claim settlement expenses $ 43,073 $ 28,826 $ 14,263 $ 3,686 $ 802
--------- --------- --------- --------- --------
--------- --------- --------- --------- --------
Paid (cumulative) as of:
One year later $ 8,595 $ 4,639 $ 1,436 $ 583
Two years later 6,476 2,150 678
Three years later 2,348 815
Four years later 856
Reserves re-estimated as of:
End of year $ 43,073 $ 28,826 $ 14,263 $ 3,686 $ 802
One year later 20,751 12,789 3,784 1,075
Two years later 9,318 3,416 1,008
Three years later 2,782 950
Four years later 912
Initial reserves in excess of (less than)
re-estimated reserves
Amount $ 8,075 $ 4,945 $ 904 $ (110)
Percent 28.0% 34.7% 24.5% (13.7%)
</TABLE>
The following table is derived from the loss reserve development table and
summarizes the effect of reserve re-estimates, net of reinsurance, on calendar
year operations for the same five-year period ended December 31, 1996. The total
of each column details the amount of reserve re-estimates made in the indicated
calendar year and shows
19
<PAGE>
the accident years to which the re-estimates are applicable. The amounts in the
total accident year column represent the cumulative reserve re-estimates for the
indicated accident year.
<TABLE>
<CAPTION>
CUMULATIVE
RE-ESTIMATES
FOR EACH
CALENDAR YEAR ACCIDENT
1996 1995 1994 1993 YEAR
------- ------- ------- --------- -----------
<S> <C> <C> <C> <C> <C>
EFFECT OF RESERVE RE-ESTIMATES ON (IN THOUSANDS)
CALENDAR YEAR OPERATIONS:
Accident Years:
1992 $ 38 $ 58 $ 67 $ (273) $ (110)
1993 596 310 (165) 741
1994 2,837 1,106 3,943
1995 4,604 4,604
------- ------- ------- --------- -----------
Total $8,075 $ 1,474 $ (98) $ (273) $ 9,178
------- ------- ------- --------- -----------
------- ------- ------- --------- -----------
</TABLE>
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of cash are premiums and investment income, while
its cash requirements consist primarily of payments for claim and claim
settlement expenses, policy acquisition costs, general and administrative
expenses, capital expenditures, income taxes, principal repayment and debt
service on its outstanding Senior Notes. The Company generates positive net cash
from operations due, in part, to the timing differences between the receipt of
premiums and the payment of claim and claim settlement expenses. Cash is
invested pending future payments for such expenses as indemnity, medical
benefits and other operating expenses. The Company's investment portfolio
currently consists of U.S. Treasury and Agency Securities. Cash and cash
equivalents consist primarily of U. S. Treasury or Agency Securities acquired
under repurchase agreements with maturities of 90 days or less, with the
remaining balances in cash and a money market fund that invests in short-term
government securities.
Cash provided by operating activities in 1996 was $23.1 million. This is
primarily a result of the Company's net income of $9.0 million, an increase of
$12.1 million in unpaid claim and claim settlement expenses which are non-cash
accruals for future claims, and an increase of $2.1 million in unearned
premiums, net of premiums receivable. Net cash used in investing activities was
$23.8 million, primarily the result of purchases of $25.3 million of available-
for-sale securities, $3.5 million of maturities of held-to-maturity securities
and $2.0 million purchases of furniture and equipment. Net cash used in
financing activities was $1.9 million, primarily due to payments totaling $2.4
million on outstanding Senior Notes and Series 1991A and 1991B Notes in December
1996.
The Company's investments increased to $89.8 million at December 31, 1996 from
$68.5 million at December 31, 1995, primarily from cash provided by operating
activities. Of the Company's investments at December 31, 1996, $54.0 million
were classified as held-to-maturity and valued at amortized cost, while $35.9
million were classified as available-for-sale and valued at fair value. All of
the Company's investment securities at December 31, 1996 were U. S. Treasury and
Agency Securities. Of the held-to-maturity securities, $44.3 million had
remaining maturities of one to five years and $9.7 million had maturities of
five to ten years (see Note 2 of Notes to Consolidated Financial Statements).
The Company's current investment policy is to invest only in U.S. Treasury and
Agency Securities, and it does not invest in derivative securities.
Historically, changes in market interest rates have caused fluctuations in the
fair value of securities. During 1996, the Company invested solely in
available-for-sale securities and intends to continue this investment strategy
for the foreseeable future. Additionally, the Company intends to broaden its
investment policy during 1997 to increase investment income consistent with
prudent risk. As a result of the increased holdings in securities classified as
available-for-sale, and thus carried at fair value, the Company expects
increased volatility in shareholders' equity as market interest rates and other
factors change.
The Company's need for additional capital is primarily the result of regulations
which require certain ratios of capital to premiums written. In order for ACIC
to begin operations, the Company had to raise capital and contribute it to ACIC.
As ACIC grew, additional capital was required to support the higher premium
levels. As a result, the Company raised approximately $27.0 million in April
1995 through an initial public offering and $9.2 million in January 1994 through
the issuance of Senior Notes and contributed $18.0 million in 1995 and $9.0
million in 1994 to ACIC. In the future, the Company expects that its need for
additional capital will be primarily related to the growth of ACIC and the need
to maintain appropriate capital to premium ratios as defined by state regulatory
20
<PAGE>
bodies. As an alternative to raising additional capital, the Company believes it
could secure quota-share or other reinsurance which would have the effect of
reducing the ratio of premiums to capital and could be used to satisfy state
regulatory requirements. The Company entered into its reinsurance agreements
with Reliance during 1992, 1993 and 1994 for that purpose.
State insurance regulations limit distributions, including dividends, from ACIC
to the Company. The maximum amount of dividends that can be paid by ACIC to the
Company in any year is equal to the lesser of: (i) 10% of ACIC's statutory
surplus as of the end of the previous fiscal year, or (ii) the statutory net
gain from operations (not including realized capital gains) of ACIC in its most
recent fiscal year. Based on this limitation, the maximum dividend that ACIC
could pay to the Company in 1997, without regulatory approval, is approximately
$4.0 million. (See Note 8 of Notes to Consolidated Financial Statements.) ACIC
may be subject to more restrictive limitations on dividends as it enters
additional states. ACIC has never paid a dividend to the Company and, for the
foreseeable future, the Company intends to retain capital in ACIC to enable the
Company to expand its operations.
The Company believes that cash flow generated by its operations and its cash and
investment balances will be sufficient to fund continuing operations, principal
repayments and debt service on its outstanding Senior Notes and capital
expenditures for the next 12 months.
On January 30, 1997, the Minnesota Workers' Compensation Reinsurance
Association, of which ACIC is required to be a member, declared a refund of
approximately $323 million to its insured members. The method of calculating
the refund and the amount of the refund must be approved by the Minnesota
Department of Commerce. The Company can not quantify, at this time, the amount
of refund, if any, that it will receive.
NAIC RISK-BASED CAPITAL STANDARDS
The National Association of Insurance Commissioners ("NAIC") has recently
adopted risk-based capital standards to determine the capital requirements of a
property and casualty insurance carrier based upon the risks inherent in its
operations. Such standards require the computation of a risk-based capital
amount which is then compared to a carrier's actual total adjusted capital. The
computation involves applying factors to various financial data to address four
primary risks: asset risk, insurance underwriting risk, credit risk and off-
balance sheet risk. These standards provide for regulatory intervention when the
percent of total adjusted capital to authorized control level risk-based capital
is below certain levels. Based upon the risk-based capital standards, the
Company's percent of total adjusted capital is substantially in excess of
authorized control level risk-based capital.
REGULATION
The Company's insurance subsidiary is subject to substantial regulation by the
governmental agencies in the states in which it operates, and will be subject to
such regulation in any state in which it provides workers' compensation products
and services in the future. State regulatory agencies have broad administrative
power with respect to all aspects of the business of the Company and its
insurance subsidiary, including premium rates, benefit levels, policy forms,
dividend payments, capital adequacy and the amount and type of investments.
These regulations are primarily intended to protect covered employees and
policyholders rather than the insurance company. Both the legislation covering
insurance companies and the regulations adopted by state agencies are subject to
change. The Company's insurance subsidiary is currently licensed to do business
in Minnesota, Colorado, Missouri, Michigan, Massachusetts, Pennsylvania and
Illinois.
The NAIC is in the process of codifying statutory accounting principles. The
ultimate completion date and impact of this project on current statutory
policies and practices is unknown.
FORWARD LOOKING STATEMENTS
Information included in this annual report which can be identified by the use of
forward-looking terminology such as "may", "will", "expect", "anticipate",
"estimate", or "continue" or the negative thereof or other variations thereon or
comparable terminology constitutes forward-looking information. The following
important factors, among others, in some cases have affected and in the future
could affect the Company's actual results and could cause the Company's actual
financial performance to differ materially from that expressed in any forward-
looking statement: (i) the
21
<PAGE>
Company's ability to expand into new states and attract customers in those
states, (ii) the Company's ability to manage both its existing claims and its
new claims in an effective manner, (iii) the Company's ability to further
penetrate the market in its existing states, (iv) competition from traditional
workers' compensation insurance carriers, (v) the Company's ability to retain
its existing customers at favorable beneficial premium rates when their policies
renew and (vi) changes in workers' compensation regulation by states, including
changes in mandated benefits or insurance company regulation.
22
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS
FINANCIAL STATEMENTS Page
Independent Auditors' Report for Years Ended December 31,
1996, 1995 and 1994 24
Consolidated Balance Sheets - December 31, 1996 and 1995 25
Consolidated Statements of Income - Years Ended December 31,
1996, 1995 and 1994 26
Consolidated Statements of Shareholders' Equity - Years Ended
December 31, 1996, 1995 and 1994 27
Consolidated Statements of Cash Flows - Years Ended December 31,
1996, 1995 and 1994 28
Notes to Consolidated Financial Statements - Years Ended
December 31, 1996, 1995 and 1994 29
23
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders
RTW, Inc.
Minneapolis, Minnesota
We have audited the accompanying consolidated balance sheets of RTW, Inc.
and subsidiary (the "Company") as of December 31, 1996 and 1995 and the related
statements of income, shareholders' equity, and cash flows for each of the years
in the period ended December 31, 1996. These consolidated financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements based on our
audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
the Company at December 31, 1996 and 1995, and the results of its operations and
its cash flows for each of the years in the period ended December 31, 1996 in
conformity with generally accepted accounting principles.
DELOITTE & TOUCHE LLP
Minneapolis, Minnesota
February 5, 1997
24
<PAGE>
RTW, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1996 AND 1995
(IN THOUSANDS, EXCEPT SHARE DATA)
1996 1995
--------- ---------
ASSETS
Investments:
Held-to-maturity, at amortized cost, fair value
of $54,396 and $59,571 $ 53,977 $ 57,662
Available-for-sale, at fair value, amortized
cost of $35,854 and $10,674 35,872 10,868
--------- ---------
Total investments 89,849 68,530
Cash and cash equivalents 10,410 12,962
Accrued investment income 1,724 1,376
Premiums receivable, less allowance of $105 and $73 4,476 2,903
Reinsurance receivable 6,183 8,312
Reinsurance premiums receivable, net 2,555 1,569
Deferred policy acquisition costs 1,624 858
Furniture and equipment, net 3,423 1,957
Other assets 3,487 2,657
--------- ---------
$ 123,731 $ 101,124
--------- ---------
--------- ---------
LIABILITIES AND SHAREHOLDERS' EQUITY
Unpaid claim and claim settlement expenses $ 49,256 $ 37,138
Unearned premiums 13,308 9,606
Accrued expenses and other liabilities 3,117 4,051
Notes payable 6,739 8,891
--------- ---------
Total liabilities 72,420 59,686
Shareholders' equity:
Common Stock, no par value; authorized 25,000,000
shares; issued and outstanding 11,807,576 and
11,709,199 shares 28,610 27,606
Retained earnings 22,690 13,708
Unrealized appreciation on securities
available-for-sale 11 124
--------- ---------
Total shareholders' equity 51,311 41,438
--------- ---------
$ 123,731 $ 101,124
--------- ---------
--------- ---------
See notes to consolidated financial statements.
25
<PAGE>
RTW, INC.
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
1996 1995 1994
--------- --------- ---------
Revenues:
Premiums earned $ 63,058 $ 45,408 $ 26,614
Investment income 5,667 4,025 1,627
--------- --------- ---------
Total revenues 68,725 49,433 28,241
Expenses:
Claim and claim settlement expenses 39,080 28,062 16,603
Policy acquisition costs 6,327 2,689 (172)
General and administrative expenses 8,510 6,113 3,931
--------- --------- ---------
Total expenses 53,917 36,864 20,362
--------- --------- ---------
Income from operations 14,808 12,569 7,879
Interest expense 1,086 1,285 1,306
--------- --------- ---------
Income before income taxes 13,722 11,284 6,573
Provision for income taxes 4,740 4,226 2,378
--------- --------- ---------
Net income $ 8,982 $ 7,058 $ 4,195
--------- --------- ---------
--------- --------- ---------
Net income per common and common
share equivalent $ 0.73 $ 0.64 $ 0.49
--------- --------- ---------
--------- --------- ---------
Weighted average common and common
share equivalents outstanding 12,256,833 11,087,831 8,516,895
---------- ---------- ---------
---------- ---------- ---------
See notes to consolidated financial statements.
26
<PAGE>
RTW, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
(IN THOUSANDS)
<TABLE>
<CAPTION>
UNREALIZED
APPRECIATION
(DEPRECIATION)
ON SECURITIES TOTAL
COMMON RETAINED AVAILABLE- SHAREHOLDERS'
STOCK EARNINGS FOR-SALE EQUITY
--------- ---------- --------- ---------
<S> <C> <C> <C> <C>
Balance at January 1, 1994 $ 108 $ 2,358 $ 2,466
Net income - 4,195 4,195
Change in fair value of Common
Stock held by ESOP - (602) (602)
Unrealized depreciation on securities
available-for-sale - - $ (14) (14)
Non-qualified stock options exercised,
including tax benefit of $39 91 - - 91
--------- ---------- --------- ---------
Balance at December 31, 1994 199 5,951 (14) 6,136
Net income - 7,058 - 7,058
Net proceeds from initial public offering 27,039 - - 27,039
Reclassification of ESOP liability 322 699 - 1,021
Unrealized appreciation on securities
available-for-sale, including tax
benefit of $70 - - 138 138
Qualified stock options and warrants
exercised 48 - - 48
Retirement of Common Stock (2) - - (2)
--------- ---------- --------- ---------
Balance at December 31, 1995 27,606 13,708 124 41,438
Net income - 8,982 - 8,982
Unrealized depreciation on securities
available-for-sale, including tax
liability of $63 - - (113) (113)
Non-qualified stock options exercised,
including tax benefit of $510 608 - - 608
Qualified stock options and warrants
exercised 32 - - 32
Issuance of shares to ESOP 236 - - 236
Issuance of shares under ESPP 129 - - 129
Retirement of Common Stock (1) - - (1)
--------- ---------- --------- ---------
Balance at December 31, 1996 $ 28,610 $ 22,690 $ 11 $ 51,311
--------- ---------- --------- ---------
--------- ---------- --------- ---------
</TABLE>
See notes to consolidated financial statements.
27
<PAGE>
RTW, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
(IN THOUSANDS)
<TABLE>
<CAPTION>
1996 1995 1994
--------- --------- ----------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Reconciliation of net income to net cash provided
by operating activities:
Net income $ 8,982 $ 7,058 $ 4,195
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 1,071 933 722
Deferred income taxes (767) (992) (1,080)
ESOP stock compensation - - 153
Changes in assets and liabilities:
Amounts due from reinsurers 1,143 5,131 (3,580)
Unpaid claim and claim settlement expenses 12,118 8,973 14,886
Unearned premiums, net of premiums
receivable 2,129 1,669 1,026
Other, net (1,540) (1,847) (830)
--------- --------- ----------
Net cash provided by operating
activities 23,136 20,925 15,492
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of held-to-maturity securities - (27,828) (21,038)
Maturities of held-to-maturity securities 3,500 500 500
Purchases of available-for-sale securities (25,273) (8,176) (2,552)
Purchases of furniture and equipment (2,047) (1,265) (539)
--------- --------- ----------
Net cash used in investing activities (23,820) (36,769) (23,629)
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on notes payable (2,362) (1,362) (362)
Proceeds from initial public offering - 29,900 -
Proceeds from notes payable - - 10,000
Debt issue costs - - (831)
Equity financing costs - (2,861) (35)
Stock options and warrants exercised 130 48 91
Issuance of Common Stock to ESOP 236 - -
Issuance of Common Stock under ESPP 129 - -
Retirement of Common Stock (1) (2) -
--------- --------- ----------
Net cash provided by (used in)
financing activities (1,868) 25,723 8,863
--------- --------- ----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (2,552) 9,879 726
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 12,962 3,083 2,357
--------- --------- ----------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 10,410 $ 12,962 $ 3,083
--------- --------- ----------
--------- --------- ----------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for:
Interest $ 898 $ 1,042 $ 1,031
--------- --------- ----------
--------- --------- ----------
Income taxes $ 6,338 $ 5,285 $ 3,813
--------- --------- ----------
--------- --------- ----------
</TABLE>
See notes to consolidated financial statements.
28
<PAGE>
RTW, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1995, AND 1994
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION - In 1992, RTW, Inc. (the "Company") through its wholly-owned
subsidiary, American Compensation Insurance Company ("ACIC"), began providing
workers' compensation insurance coverage to benefit from the Company's ability
to reduce workers' compensation costs and to provide more control over its
insureds' workers' compensation programs. ACIC is domiciled in Minnesota and
licensed in Minnesota, Colorado, Missouri, Michigan, Pennsylvania, Illinois and
Massachusetts. The Company wrote business primarily in Minnesota, Colorado and
Missouri during 1996.
In April 1995, the Company raised $27,039,000 (net of underwriting discounts and
other offering expenses totaling $2,861,000) through an initial public offering
of 3,450,000 shares of Common Stock at $8.67 per share. The Company contributed
$18,000,000 of the net proceeds of the offering to ACIC to enable ACIC to expand
its operations to Colorado, Missouri and other states, as well as to support the
expansion of its business in Minnesota. The Company retained the remaining net
proceeds for working capital and general corporate purposes, including, if
appropriate, additional future contributions to ACIC.
In January 1994, the Company raised $9,169,000 (net of underwriting discounts
and other offering expenses totaling $831,000) through a $10,000,000 Senior
Note. The Company contributed $9,000,000 of the net proceeds of the offering to
ACIC to support expansion of its business in Minnesota.
PRINCIPLES OF CONSOLIDATION AND BASIS OF REPORTING - The consolidated financial
statements include RTW, Inc. and ACIC. All significant intercompany accounts
and transactions have been eliminated in the consolidation.
USE OF ESTIMATES IN PREPARING THE FINANCIAL STATEMENTS - Preparing financial
statements in conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
INVESTMENTS - In 1994, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and
Equity Securities." SFAS No. 115 requires a company to classify its securities
into categories based upon the company's intent relative to the eventual
disposition of the securities. SFAS No. 115 established three categories of
securities. The first category, held-to-maturity, is composed of debt securities
which a company has the positive intent and ability to hold to maturity. These
securities are carried at amortized cost. The second category, available-for-
sale securities, may be sold to address the liquidity and other needs of a
company. Debt and equity securities classified as available-for-sale are carried
at fair value on the balance sheet with unrealized gains and losses excluded
from income and reported as a separate component of shareholders' equity. The
third category, trading securities, is for debt and equity securities acquired
for the purpose of selling them in the near term. The Company has not classified
any of its securities as trading securities.
No provision is made for temporary declines in fair values of the held-to-
maturity debt securities as the Company does not expect to realize any
significant losses. If, however, an impairment that is other than temporary
occurs in a security, the Company would write the security down to the new
value.
Realized gains or losses on disposition of investments are included in the
computation of net income. Cost of investments sold is determined by the
specific identification method.
Included in investments at December 31, 1996 and 1995 are securities on deposit
with various regulatory authorities as required by law with a carrying value of
$2,073,000 and $1,493,000, respectively.
CASH AND CASH EQUIVALENTS - The Company generally considers all highly liquid
investments with a maturity of three months or less when purchased to be cash
equivalents.
29
<PAGE>
DEFERRED POLICY ACQUISITION COSTS - Certain costs of acquiring new business and
renewing existing business, principally commissions and premium taxes, have been
deferred. Such costs are amortized as premium revenue is recognized. The method
followed in computing deferred policy acquisition costs limits the amount of
such deferred costs to their estimated realizable value, which gives effect to
the premium to be earned, claim and claim settlement expenses, and certain other
costs expected to be incurred as the premium is earned.
DEPRECIATION - Furniture and equipment is depreciated over the estimated useful
lives of the assets (five to ten years) by the straight-line method of
depreciation. Accumulated depreciation at December 31, 1996 and 1995 was
$1,366,000 and $788,000, respectively.
UNPAID CLAIM AND CLAIM SETTLEMENT EXPENSES - The undiscounted reserve for unpaid
claim and claim settlement expenses is based on estimates of reported and
unreported claims and the related claim and claim settlement expenses. The
Company has limited historical data for use in its estimate of the reserve for
unpaid claim and claim settlement expenses. This is attributable to ACIC's
commencement of operations in 1992, and accordingly, ACIC's reported experience
does not reflect the full emergence or payment of losses due to the length of
the settlement period associated with workers' compensation claims. Because of
the Company's limited data with respect to the ultimate emergence of claims,
management also utilizes external industry data sources, as adjusted to reflect
anticipated differences between the Company and the industry, to supplement the
Company's experience. While the Company considers its estimate of the reserve
for unpaid claim and claim settlement expenses to be reasonable, the ultimate
amount of claim and claim settlement expenses may differ from the amounts
estimated as a result of the additional variability of such estimates associated
with the need to utilize this industry data. These reserves and the related
assumptions utilized in their development are continually reviewed and, as
adjustments become necessary, are reflected in current operations.
REINSURANCE - In the normal course of business, the Company seeks to reduce the
losses that may arise from catastrophes or other events that cause unfavorable
underwriting results by reinsuring certain levels of risk in various areas of
exposure with other insurance enterprises or reinsurers. Amounts recoverable
from reinsurers are estimated in a manner consistent with the claim liability
associated with the reinsured policy.
DEBT ISSUE COSTS - Debt issue costs associated with the Senior Notes payable are
reported as a reduction in notes payable. These costs are being amortized over
the terms of the Senior Notes.
PREMIUMS - Premiums written are recorded on an installment basis to match the
billing to the policyholder. Premiums are earned on a daily basis over the life
of the insurance policy. Premiums earned include an estimate for earned but
unbilled audit premiums. Unearned premium reserves are established for the
portion of premiums billed applicable to the unexpired term of the premium.
INCOME TAXES - Provisions for federal and state income taxes include amounts
currently payable and deferred income taxes resulting from the cumulative
temporary differences in assets and liabilities determined on a tax return and
financial statement basis. No valuation allowance was provided against the
deferred tax assets recorded in 1996 or 1995, as the Company expects to generate
sufficient taxable income in the future to offset reversing temporary
differences.
STOCK BASED COMPENSATION - Statement of Financial Accounting Standards No. 123,
"Accounting for Stock Based Compensation," encourages, but does not require
companies to record compensation cost for stock-based employee compensation
plans at fair value. The Company has elected to continue to account for stock-
based compensation plans using the intrinsic value method prescribed in
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees," and related Interpretations. Accordingly, compensation cost for
stock options is measured as the excess, if any, of the quoted market price of
the Company's stock at the date of the grant over the amount an employee must
pay to acquire the stock. See Note 7 - Employee Benefits and Plans.
NET INCOME PER COMMON AND COMMON SHARE EQUIVALENT - Net income per common and
common share equivalent is computed by dividing net income by the weighted
average common and common share equivalents outstanding during the year. Common
share equivalents consist of options and warrants. Stock and stock options
issued subsequent to April 1995 have been considered outstanding from the date
of grant after applying the treasury stock method for determining the dilutive
effect of the stock options. Stock and stock options issued prior to that
30
<PAGE>
date have been considered outstanding for all periods after applying the
treasury stock method for determining the dilutive effect of the stock options.
NOTE 2 - INVESTMENTS
Investment income includes the following at December 31 (000's):
<TABLE>
<CAPTION>
1996 1995 1994
--------- -------- ---------
<S> <C> <C> <C>
U.S. Treasury Securities $ 5,004 $ 3,337 $ 1,510
Cash Equivalents 663 591 117
Other - 97 -
--------- -------- ---------
$ 5,667 $ 4,025 $ 1,627
--------- -------- ---------
--------- -------- ---------
</TABLE>
There were no significant investment expenses associated with the above
investment income.
The Company's held-to-maturity and available-for-sale debt securities are all
U.S. Treasury Securities. The amortized cost and fair values of U.S. Treasury
Securities at December 31 are as follows (000's):
<TABLE>
<CAPTION>
HELD-TO-MATURITY AVAILABLE-FOR-SALE COMBINED
------------------- -------------------- -------------------
1996 1995 1996 1995 1996 1995
-------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Amortized Cost $ 53,977 $ 57,662 $ 35,854 $ 10,674 $ 89,831 $ 68,336
Gross Unrealized Gains 732 1,938 128 194 860 2,132
Gross Unrealized Losses (313) (29) (110) - (423) (29)
-------- -------- -------- -------- -------- --------
Fair Value $ 54,396 $ 59,571 $ 35,872 $ 10,868 $ 90,268 $ 70,439
-------- -------- -------- -------- -------- --------
-------- -------- -------- -------- -------- --------
</TABLE>
The amortized cost and fair value of U.S. Treasury Securities at December 31,
1996 by contractual maturities, are as follows (000's):
<TABLE>
<CAPTION>
1996
----------------------------------------------------------------
HELD-TO-MATURITY AVAILABLE-FOR-SALE COMBINED
------------------- -------------------- --------------------
AMORTIZED FAIR AMORTIZED FAIR AMORTIZED FAIR
MATURING: COST VALUE COST VALUE COST VALUE
-------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
One year or less $ - $ - $ 7,556 $ 7,586 $ 7,556 $ 7,586
One year through five years 44,252 44,331 18,582 18,567 62,834 62,898
Five years through ten years 9,725 10,065 9,716 9,719 19,441 19,784
-------- -------- -------- -------- -------- --------
Total $ 53,977 $ 54,396 $ 35,854 $ 35,872 $ 89,831 $ 90,268
-------- -------- -------- -------- -------- --------
-------- -------- -------- -------- -------- --------
</TABLE>
There were no sales of debt securities during 1996, 1995 or 1994.
NOTE 3 - REINSURANCE
Prior to 1995, ACIC ceded a portion of its insurance business to another
insurance company on a pro rata basis. Under its reinsurance agreement, the
reinsurer assumed one-quarter of the accident year 1994 claim and claim
settlement expenses in consideration for a proportionate share of eligible
premiums. In addition, Minnesota claims in excess of $1,040,000, $450,000 and
$240,000 per occurrence during 1996, 1995 and 1994, respectively, are ceded to
the Minnesota Workers' Compensation Reinsurance Association. In 1996 and 1995,
Colorado, Missouri, Michigan and other state claims in excess of $500,000 were
ceded to various reinsurers. Reinsurance contracts do not relieve ACIC from
its obligations to policyholders. Failure of the reinsurers to honor their
obligation could result in losses to ACIC. Management does not anticipate any
such losses, and accordingly, no provision for amounts deemed uncollectible are
included in these financial statements. ACIC evaluates the financial condition
of its reinsurers and monitors concentrations of credit risk arising from
similar activities or economic characteristics of the reinsurers to minimize its
exposure to significant losses from reinsurer insolvency. At December 31,
reinsurance receivables are associated with reinsurers as follows (000's):
1996 1995
-------- --------
Quota-share reinsurance for 1992 to 1994
through a single insurer $ 1,673 $ 4,812
Excess of loss reinsurance through various
reinsurers 4,510 3,500
-------- --------
Reinsurance receivable $ 6,183 $ 8,312
-------- --------
-------- --------
The effect of reinsurance on premiums written and earned are as follows (000's):
31
<PAGE>
WRITTEN EARNED
-------- ---------
Year Ended December 31, 1996:
Direct $ 67,457 $ 63,755
Ceded (697) (697)
-------- ---------
Net premiums $ 66,760 $ 63,058
-------- ---------
-------- ---------
Year Ended December 31, 1995:
Direct $ 50,070 $ 47,507
Ceded (2,099) (2,099)
-------- ---------
Net premiums $ 47,971 $ 45,408
-------- ---------
-------- ---------
Year Ended December 31, 1994:
Direct $ 39,892 $ 38,099
Ceded (11,895) (11,485)
-------- ---------
Net premiums $ 27,997 $ 26,614
-------- ---------
-------- ---------
The effect of reinsurance on claim and claim settlement expenses for the years
ended December 31 are as follows (000's):
1996 1995 1994
--------- -------- ---------
Direct $ 38,389 $ 25,436 $ 25,838
Ceded 691 2,626 (9,235)
--------- -------- ---------
Net claim and claim settlement
expenses $ 39,080 $ 28,062 $ 16,603
--------- -------- ---------
--------- -------- ---------
Reinsurance premiums payable have been offset by amounts receivable from the
reinsurer in accordance with the reinsurance agreement and consist of the
following at December 31 (000's):
1996 1995
-------- ---------
Premiums payable to reinsurer $ - $ (262)
Reinsurance recoverable from paid claim and
claim settlement expenses 75 615
Ceding commission receivable 2,480 1,216
-------- ---------
Reinsurance premiums receivable, net $ 2,555 $ 1,569
-------- ---------
-------- ---------
The ceding commission earned, which will be based upon final settlement of claim
and claim settlement expenses, will range between 10% and 48% during accident
years 1994 and 1993 and 15% and 25% during accident year 1992. Ceding
commissions earned of $1,871,000, $1,733,000, and $2,978,000 for fiscal years
1996, 1995 and 1994, respectively, are reported as a reduction in policy
acquisition costs on the consolidated statements of income.
NOTE 4 - UNPAID CLAIM AND CLAIM SETTLEMENT EXPENSES
Activity in the liability for unpaid claim and claim settlement expenses is
summarized as follows (000's):
1996 1995 1994
--------- -------- ---------
Gross balance at January 1 $ 37,138 $ 28,165 $ 13,279
Less reinsurance recoverables 8,312 13,902 9,593
--------- -------- ---------
Net balance at January 1 28,826 14,263 3,686
Incurred (benefit) related to:
Current year 47,155 29,536 16,505
Prior years (8,075) (1,474) 98
--------- -------- ---------
Total incurred 39,080 28,062 16,603
Paid related to:
Current year 16,238 8,860 4,590
Prior years 8,595 4,639 1,436
--------- -------- ---------
Total paid 24,833 13,499 6,026
--------- -------- ---------
Net balance at December 31 43,073 28,826 14,263
Plus reinsurance recoverables 6,183 8,312 13,902
--------- -------- ---------
Gross balance at December 31 $ 49,256 $ 37,138 $ 28,165
--------- -------- ---------
--------- -------- ---------
32
<PAGE>
As a result of changes in estimates of unpaid claim and claim settlement
expenses for prior years, the provision for claim and claim settlement expenses
(net of reinsurance expense of $691,000 and $2,626,000 in 1996 and 1995,
respectively) decreased by $8,075,000 and $1,474,000 in 1996 and 1995,
respectively. The favorable development in 1996 and 1995 reflects the ability
of the Company to manage and close prior year claims more favorably than
anticipated. Future favorable development, if any, will depend on the ability
of the Company to continue managing and closing claims in such a manner.
In 1994, as a result of changes in estimates of unpaid claim and claim
settlement expenses in prior years, the provision for claim and claim settlement
expenses (and net of reinsurance recoveries of $9,235,000 in 1994) increased by
$98,000 in 1994 because of higher than anticipated losses on workers'
compensation cases for that year.
NOTE 5 - NOTES PAYABLE
Unsecured notes payable consist of the following at December 31 (000's):
1996 1995
------- -------
Senior Notes payable to registered investors
with principal maturities and monthly interest
due as follows:
Maturity Interest Rate
- ----------------- -------------
December 15, 1996 8.75% $ 2,000
December 15, 1997 9.00% $ 2,000 2,000
December 15, 1998 9.25% 2,500 2,500
December 15, 1999 9.50% 2,500 2,500
Series 1991A Notes payable, paid in full
in December 1996 - 157
Series 1991A Notes payable to related parties,
paid in full in December 1996 - 56
Series 1991B Notes payable, paid in full
in December 1996 - 120
Series 1991B Notes payable to related parties,
paid in full in December 1996 - 29
------- -------
Notes payable - Principal 7,000 9,362
Less: Unamortized bond issuance cost (261) (471)
------- -------
Notes payable $ 6,739 $ 8,891
------- -------
------- -------
The Company may, at its option, redeem some or all of the Senior Notes payable
on any interest date at the principal amount of the redeemed notes plus accrued
interest and a premium ranging from 1%-3% depending on the redemption date.
Interest expense to related parties for the years ended December 31, 1996, 1995,
and 1994 was $14,000, $28,000, and $45,000, respectively.
SENIOR NOTES PAYABLE - The Senior Notes payable contain various restrictive
provisions which require that certain financial ratios, primarily debt coverage
and net worth restrictions, be met before the incurrence of additional
indebtedness or the payment of dividends or other distributions to shareholders.
At December 31, 1996, the Company was in compliance with these covenants.
Based on borrowing rates currently available to the Company for loans with
similar terms and average maturities (prime at December 31, 1996 and 1995 was
8.25%), the fair value of notes payable was approximately $7,254,000 and
$9,805,000 at December 31, 1996 and 1995, respectively.
33
<PAGE>
NOTE 6 - INCOME TAXES
Income tax expense for the years ended December 31 consisted of the following
(000's):
1996 1995 1994
--------- -------- --------
Current:
Federal $ 5,165 $ 4,787 $ 3,281
State 342 501 177
--------- -------- --------
Total current 5,507 5,288 3,458
Deferred:
Federal (650) (949) (1,070)
State (117) (113) (10)
--------- -------- --------
Total deferred (767) (1,062) (1,080)
--------- -------- --------
Income tax expense $ 4,740 $ 4,226 $ 2,378
--------- -------- --------
--------- -------- --------
The differences between taxes computed at the federal statutory rate and
recorded income tax expense are as follows (000's):
1996 1995 1994
--------- -------- --------
Federal income tax at statutory rate $ 4,803 $ 3,949 $ 2,301
Increase (reduction) in income taxes
resulting from:
State income taxes, net of federal
income tax benefit 126 310 109
Other (189) (33) (32)
--------- -------- --------
Total $ 4,740 $ 4,226 $ 2,378
--------- -------- --------
--------- -------- --------
The effect of temporary differences that gave rise to net deferred tax asset
balances, included within other assets at December 31, were as follows (000's):
1996 1995
-------- --------
Unpaid claim and claim settlement expenses $ 2,731 $ 1,859
Unearned premiums 1,001 698
Other 124 95
-------- --------
Deferred tax assets 3,856 2,652
Deferred policy acquisition costs (611) (312)
Other (266) (128)
-------- --------
Deferred tax liabilities (877) (440)
-------- --------
Net deferred tax asset $ 2,979 $ 2,212
-------- --------
-------- --------
Income taxes receivable (payable) at December 31, 1996 and 1995 were
approximately $1,059,000 and ($281,000), respectively.
NOTE 7 - EMPLOYEE BENEFITS AND PLANS
1995 EMPLOYEE STOCK PURCHASE PLAN - The RTW, Inc. 1995 Employee Stock Purchase
Plan (the "ESPP") was adopted by the Board of Directors of the Company during
1995. The Company reserved 75,000 shares for distribution under the ESPP. The
ESPP terminates in ten years and will be carried out in phases, each consisting
of one year or a period of time approved by the Board. Any employee completing
two weeks of service prior to the commencement of a phase of the plan may
participate. The participant may elect to contribute from $10 to 10% of monthly
salary to the plan through payroll withholdings. Contributors purchase shares
of the Company's Common Stock at the option price set forth in the plan. The
first one year ESPP phase began in April 1995 and expired in April 1996. Under
the first phase, participants purchased 14,891 shares at $8.67 per share. The
second one year ESPP phase began in April 1996 and expires in April 1997.
Employee contributions withheld by the Company for the purchase of shares in
April 1997 and April 1996 under the ESPP were approximately $154,000 and $98,000
at December 31, 1996 and 1995, respectively.
34
<PAGE>
1994 STOCK PLAN - During 1994, the Company adopted a qualified stock option plan
providing for Incentive Stock Options and Non-Qualified Stock Options. At
December 31, 1996, the Company had 375,000 shares reserved for distribution
under the plan. In January 1997, by action of the Board of Directors, the shares
reserved for distribution under the plan were increased to 1,500,000. The
option price, term, vesting provisions and other limits and restrictions are
determined at the time of grant by the Board of Directors or, if established, by
a separate committee.
The options granted, exercised, terminated and outstanding under the 1994 Stock
Plan as of and for the years ended December 31, 1994, 1995 and 1996 are as
follows:
<TABLE>
<CAPTION>
QUALIFIED NON-QUALIFIED
---------------------------------------- -------------------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
OPTION EXERCISE EXERCISE OPTION EXERCISE EXERCISE
SHARES PRICE PRICE SHARES PRICE PRICE
---------- --------------- --------- ------- ---------- --------
<S> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1994: - -
Granted 75,000 $2.67 $2.67 7,500 $2.67 $2.67
Exercised - - - (3,750) 2.67 2.67
---------- --------------- --------- ------- ---------- --------
Balance, December 31, 1994: 75,000 2.67 2.67 3,750 2.67 2.67
Granted 85,875 8.67 - 16.67 9.49 - - -
Exercised (300) 8.67 8.67 - - -
---------- --------------- --------- ------- ---------- --------
Balance, December 31, 1995: 160,575 2.67 - 16.67 8.06 3,750 2.67 2.67
Granted 60,000 19.33 - 28.75 21.13 - - -
Exercised (2,400) 8.67 8.67 - - -
Terminated (300) 8.67 8.67 - - -
---------- --------------- --------- ------- ---------- --------
Balance, December 31, 1996 217,875 $ 2.67 - 28.75 $8.34 3,750 $2.67 $2.67
---------- --------------- --------- ------- ---------- --------
---------- --------------- --------- ------- ---------- --------
Exercisable,
December 31, 1996 51,425 $ 2.67 - 16.67 $8.13 3,750 $2.67 $2.67
---------- --------------- --------- ------- ---------- --------
---------- --------------- --------- ------- ---------- --------
Weighted average remaining
contractual life for
outstanding and
exercisable shares 8 years 8 years
---------- -------
---------- -------
</TABLE>
Each of the options expire ten years from the date of grant, subject to
continued employment with the Company. Certain of these options are subject to
vesting provisions which restrict exercise of the option.
The Company applies Opinion No. 25 and related interpretations in accounting for
its plans. Accordingly, no compensation expense has been recognized for its
stock-based compensation plans. Had compensation cost for the Company's 1996
and 1995 option grants under the 1994 Stock Plan and 1996 and 1995 stock
purchases under the ESPP been determined consistent with Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation," the
Company's net income and net income per common and common share equivalent for
the years ended December 31 would approximate the pro forma amounts as follows
(in 000's, except per share data):
1996 1995
------- -------
Net income:
As reported $ 8,982 $ 7,058
Pro forma $ 8,788 $ 6,924
Net income per common and common share equivalent:
As reported $ 0.73 $ 0.64
Pro forma $ 0.71 $ 0.63
The pro forma effect on net income for 1996 and 1995 is not representative of
the pro forma effect on net income in future years because it does not take into
consideration pro forma compensation expense related to grants prior to 1995.
35
<PAGE>
The weighted average fair value of options granted under the ESPP and 1994 Stock
Plan during 1996 and 1995 is estimated at $12.36 and $5.29, respectively, on the
date of grant using the Black-Scholes option-pricing model with the following
assumptions: no dividend yield; volatility of 65.3%; risk-free interest rates
ranging from 5.41% to 7.70%; and an expected life of 1 to 5 years.
NON-QUALIFIED COMMON STOCK OPTIONS - The non-qualified options granted,
exercised and outstanding as of and for the years ended December 31, 1994, 1995
and 1996 are as follows:
WEIGHTED
AVERAGE
OPTION EXERCISE EXERCISE
SHARES PRICE PRICE
--------- ------------- --------
Balance, January 1, 1994 512,903 $ 0.22 - 2.00 $1.69
Exercised (99,000) 0.22 - 2.00 0.43
--------- ------------- -----
Balance, December 31, 1994 413,903 0.53 - 2.00 2.00
Exercised (1,403) 0.53 0.53
--------- ------------- -----
Balance, December 31, 1995 412,500 2.00 2.00
Exercised (49,000) 2.00 2.00
--------- ------------- -----
Balance, December 31, 1996 363,500 $2.00 $2.00
--------- ------------- -----
--------- ------------- -----
Exercisable, December 31, 1996 363,500 $2.00 $2.00
--------- ------------- -----
--------- ------------- -----
Weighted average remaining contractual life
for outstanding and exercisable shares 7 years
---------
---------
Each of the non-qualified options expires ten years from the date of grant
subject to early termination when the optionee leaves the Company's employment.
For the remaining outstanding non-qualified stock options, the Company is
permitted a tax deduction equal to the difference between the option exercise
price and the fair value on the option exercise date. Upon exercise, the
proceeds and the amount of the deduction are recorded to Common Stock. In 1996,
the Company recorded a reduction in income taxes payable and increased Common
Stock by $510,000 to reflect exercises during the year. Future exercises of
these non-qualified options would reduce future taxes payable based on the fair
value of the options at the date of exercise.
EMPLOYEE CONTRACT - The Company entered into a five-year Employment and Salary
Continuation Agreement (the "Agreement") with its President and Chief Executive
Officer beginning November 1993. Under the Agreement, he receives a base salary
of $357,500, which amount is to be increased each year by a cost of living
adjustment or other such amount as determined by the Company's Board of
Directors. This base salary is in addition to bonuses, reimbursements and fringe
benefits including payment for the lease of and insurance for the use of an
automobile. The Company also provides the President and CEO with health and
dental insurance. Under this Agreement, the Company has agreed to indemnify the
President and CEO with respect to his actions on behalf of the Company. In the
event of his disability, the Company is obligated to continue to pay his then-
current base salary and bonuses consistent with other officers for the remaining
term of the Agreement.
EMPLOYEE BENEFIT PLANS - The Company sponsors a defined contribution retirement
plan under Section 401(K) of the Internal Revenue Code for eligible employees.
Employees become eligible for participation in the 401(K) as of the first day of
the calendar quarter following completion of 3 months service and attainment of
age 21. Company contributions to the plan are discretionary and are based on
the contribution made by the employee to the plan. Expense recognized under the
plan for the years ended December 31, 1996, 1995 and 1994, was $52,000, $35,000
and $22,000, respectively.
In addition to the defined contribution plan, the Company had bonus plans in
1996, 1995 and 1994 under which all employees, including officers, were paid a
monthly bonus based on the prior month's results of the Company. These bonuses
aggregated $498,000, $350,000, and $265,000 for the years ended December 31,
1996, 1995 and 1994, respectively.
36
<PAGE>
EMPLOYEE STOCK OWNERSHIP PLAN - The RTW, Inc. Employee Stock Ownership Plan and
Trust (the "ESOP") was adopted by the Board of Directors of the Company during
1993. Any individual who had attained age 21 and was employed on May 1, 1993
became a participant in the ESOP on its effective date, May 1, 1993. All other
employees are eligible for participation under the ESOP as of the first day of
the calendar quarter following completion of 1,000 hours of service during 12
consecutive months at the Company and attainment of age 21. Company
contributions to the plan are discretionary. Contributions may be made in cash
or shares of the Company's Common Stock.
In December 1994, the Company made a contribution of 23,490 shares of the
Company's Common Stock to the ESOP at an estimated fair value of $6.53 per
share. In January 1996, the Company contributed 12,196 shares to the plan for
fiscal 1995 at a fair value of $19.33 per share. Compensation expense
recognized under the plan for 1996, 1995 and 1994 was $116,000, $236,000 and
$153,000, respectively.
NOTE 8 - SHAREHOLDERS' EQUITY
On April 25, 1996, the Company's Board of Directors approved a 3-for-2 stock
split in the form of a 50 percent stock dividend to shareholders of record on
the close of business on May 6, 1996. The shares were distributed to
shareholders on May 17, 1996. Additionally, on February 2, 1995, the Company
declared a 5-for-1 stock split, effective as of that date. All share and
per share amounts have been adjusted to reflect the effect of the stock splits.
DIVIDENDS AND RETAINED EARNINGS RESTRICTIONS - Dividends are paid as determined
by the Board of Directors. No dividends have ever been paid by the parent
company or received from ACIC.
The ability of the Company to pay cash dividends to shareholders may be
dependent upon the amount of dividends received from its insurance subsidiary,
ACIC. ACIC's ability to pay dividends is restricted by law or subject to
approval of the insurance regulatory authorities of Minnesota.
Under Minnesota insurance law regulating the payment of dividends by ACIC,
dividends must be paid solely from the adjusted earned surplus of ACIC.
Adjusted earned surplus is defined as earned surplus, as determined in
accordance with statutory accounting practices (unassigned funds), less 25%
of the amount of such earned surplus which is attributable to unrealized
capital gains. Further, pursuant to Minnesota legal requirements, dividend
payments from ACIC to the Company are limited in any year to 10% of statutory
capital and surplus at the prior year end. In addition, any dividends paid
which, when combined with other dividends paid within the previous 12 month
period, exceed the greater of 10% of statutory capital and surplus at the
prior year end or 100% of ACIC's statutory net gain from operations (not
including realized capital gains) for the preceding year, require the prior
consent of the Minnesota Department of Commerce (the "MDC"). For 1997,
dividends in excess of $3,954,000 would require prior consent of the MDC.
Statutory policyholders' surplus as of December 31, 1996 and 1995, and statutory
net income of ACIC for the years then ended are as follows (000's):
STATUTORY STATUTORY
POLICYHOLDERS' NET
SURPLUS INCOME
-------------- ---------
December 31, 1996 $ 39,543 $ 6,658
December 31, 1995 36,015 4,551
December 31, 1994 1,514
STOCK WARRANTS - The Series 1991B notes payable, paid in full in December 1996,
included attached warrants to purchase Common Stock of the Company at an
exercise price of $.53 per share. Investors received a warrant to purchase
17,332 shares of the Company's Common Stock with every $100,000 invested in
Series 1991B notes. The total number of shares that could be purchased by
exercising the warrants was 19,935 at December 31, 1995. All remaining warrants
were exercised in 1996.
37
<PAGE>
NOTE 9 - COMMITMENTS AND CONTINGENCIES
OPERATING LEASES - The Company conducts its operations in leased office
facilities under various operating lease agreements. The agreements provide for
monthly base lease payments plus contingent rentals based on an allocable
portion of certain operating expenses incurred by the lessor.
Future minimum (base) rental payments required under the leases, as of December
31, 1996, are as follows for the year ending December 31 (000's):
1997 $ 934
1998 1,068
1999 958
2000 259
2001 140
Thereafter 70
-------
$ 3,429
-------
-------
Rent expense, including contingent rentals, was $1,063,000, $803,000 and
$488,000 for the years ended December 31, 1996, 1995 and 1994, respectively.
The selected quarterly financial data is included in the Sub-Section entitled
"Quarterly Results" contained in the Section entitled "Management's Discussion
and Analysis of Financial Condition and Results of Operations" in Part II, Item
7 of this Report.
38
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information with respect to Directors is contained in the Section entitled
"Election of Directors" in the Company's 1997 Proxy Statement and is
incorporated herein by reference.
Information with respect to Executive Officers of the Company is included in
PART I of this Report on Form 10-K.
ITEM 11. EXECUTIVE COMPENSATION
Information required under this item is contained in the Section entitled
"Executive Compensation and Other Information" in the Company's 1997 Proxy
Statement and is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information required under this item is contained in the Section entitled
"Security Ownership of Principal Shareholders and Management" in the Company's
1997 Proxy Statement and is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information required under this item is contained in the Section entitled
"Certain Transactions" in the Company's 1997 Proxy Statement and is incorporated
herein by reference.
39
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) DOCUMENTS FILED AS PART OF THIS REPORT
(1) FINANCIAL STATEMENTS. The following consolidated financial
statements of the Company are set forth on pages 23 through 37
of Part II, Item 8 of this Report.
Independent Auditors' Report for Years Ended December 31, 1996,
1995 and 1994
Consolidated Balance Sheets - December 31, 1996 and 1995
Consolidated Statements of Income - Years Ended December 31,
1996, 1995 and 1994
Consolidated Statements of Shareholders' Equity - Years Ended
December 31, 1996, 1995 and 1994
Consolidated Statements of Cash Flows - Years Ended December 31,
1996, 1995 and 1994
Notes to Consolidated Financial Statements - Years Ended December
31, 1996, 1995 and 1994
(2) FINANCIAL STATEMENT SCHEDULES FOR THE THREE YEARS ENDED DECEMBER
31, 1996
Page
----
Independent Auditors' Report on Schedules for the Years
Ended December 31, 1996, 1995 and 1994. . . . . . . . . . S-1
Schedule I - Summary of Investments . . . . . . . . . . . . S-2
Schedule II - Condensed Financial Information (Parent
Company). . . . . . . . . . . . . . . . . . . . . . . . . S-3
Schedule IV - Reinsurance . . . . . . . . . . . . . . . . . S-7
Schedule V - Valuation and Qualifying Accounts. . . . . . . S-8
Schedule VI - Supplemental Information Concerning Insurance
Operations . . . . . . . . . . . . . . . . . . . . . . . S-9
All other schedules are omitted because they are not applicable or the
required information is presented in the Financial Statements or the
notes thereto.
(b) REPORTS ON FORM 8-K
None.
(c) LISTING OF EXHIBITS (*indicates compensatory plan)
3.1 Amended Articles of Incorporation (1)
3.2 Amended Bylaws (1)
4.1 Indenture dated December 1, 1993 between RTW, Inc. and First Trust
National Association, Trustee (2)
4.2 Registration Rights Agreement (2)
10.1* Employment and Salary Continuation Agreement between RTW and David C.
Prosser (2)
10.2* Employment Contract between RTW and J. Alexander Fjelstad, III (2)
10.3* Stock Option Agreement between RTW and J. Alexander Fjelstad, III (2)
10.4* RTW, Inc. Employee Stock Ownership Plan (2)
10.5* Amended RTW, Inc. 1994 Stock Plan (1)
10.6* RTW, Inc. 1995 Employee Stock Purchase Plan (3)
10.7 Reinsurance Contract between RTW and Reliance Insurance Company
effective April 15, 1992 (2)
10.7.1 Amendment Nos. 1 and 2, each effective as of April 15, 1992, to the
Reinsurance Contract (1)
10.8 Contract between RTW and ACIC dated January 1, 1992 (2)
10.9 Service Agreement between RTW and ACIC dated February 1, 1992 (2)
10.10* Description of Cash Bonus Program (2)
10.11* Description of Cash Bonus Program for 1996 (4)
10.12* Description of the 1997 Bonus Program
10.13 Election Forms for Minnesota Workers' Compensation Reinsurance
Association for 1992, 1993 and 1994 (2)
10.14 Election Form for Minnesota Workers' Compensation Reinsurance
Association for 1995 (1)
40
<PAGE>
10.15 Election Form for Minnesota Workers' Compensation Reinsurance
Association for 1996 (4)
10.16 Election Form for Minnesota Workers' Compensation Reinsurance
Association for 1997
10.17 Minnesota Workers' Compensation Reinsurance Association Reinsurance
Agreement (4)
10.18 Colorado Excess of Loss Reinsurance Agreement for 1995 (1)
10.19 Colorado, Missouri and Michigan Excess of Loss Reinsurance Agreement
for 1996 (4)
10.20* 401(k) Plan Adoption Agreement (1)
11 Statement re Computation of Income Per Share
21 Subsidiaries of the Registrant:
The Company has one wholly-owned subsidiary, American Compensation
Insurance Company, a Minnesota corporation.
23 Consent of Deloitte & Touche LLP
24 Power of Attorney, included in Signature page
27 Financial Data Schedule
- ---------------
(1) Incorporated by reference to the Company's Registration Statement on
Form S-1 (Reg. No. 33-89164).
(2) Incorporated by reference to the Company's Registration Statement on
Form SB-2 (Reg. No. 33-2002C).
(3) Incorporated by reference to the Company's Registration Statement on
Form S-8 (Reg. No. 33-91372).
(4) Incorporated by reference to the Company's 1995 Report on Form 10-K.
41
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 15(d) or the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
RTW, INC.
Date: March 27, 1997 By /s/ David C. Prosser
--------------------------------
David C. Prosser
Chairman, President, Chief
Executive Officer and Director
(Principal Executive Officer)
SIGNATURES AND POWER OF ATTORNEY
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed by the following persons on behalf of the Registrant, in
the capacities, and on the dates, indicated. Each person whose signature
appears below constitutes and appoints David C. Prosser and Alfred L.
LaTendresse as his true and lawful attorney-in-fact and agents, each acting
alone, with full power of substitutions and resubstitution, for him and in his
name, place, and stead, in any and all capacities, to sign any or all amendments
to this Annual Report on Form 10-K and to file the same, with the exhibits
thereto, and other documents in connection therewith, with the Securities and
Exchange Commission.
Date Signature and Title
---- -------------------
March 27, 1997 By /s/ David C. Prosser
------------------------------------
David C. Prosser
Chairman, President, Chief
Executive Officer and Director
(Principal Executive Officer)
March 27, 1997 By /s/ Alfred L. LaTendresse
------------------------------------
Alfred L. LaTendresse
Secretary, Treasurer and Chief Financial
Officer (Principal Financial and
Accounting Officer)
March 27, 1997 By /s/ J. Alexander Fjelstad, III
------------------------------------
J. Alexander Fjelstad, III
Chief Operating Officer and Director
March 27, 1997 By /s/ William Cooper
------------------------------------
William Cooper
Director
March 27, 1997 By /s/ Mark E. Hegman
------------------------------------
Mark E. Hegman
Director
March 27, 1997 By /s/ Steven M. Rothschild
------------------------------------
Steven M. Rothschild
Director
42
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders
RTW, Inc.
Minneapolis, Minnesota
We have audited the consolidated statements of RTW, Inc. as of December 31,
1996, 1995 and 1994 and for the years then ended and have issued our report
thereon dated February 5, 1997. Our audits also included the consolidated
financial statement schedules listed in Item 14(a)(2) of this Report on Form 10-
K. These consolidated financial statement schedules are the responsibility of
RTW, Inc.'s management. Our responsibility is to express an opinion based on
our audits. In our opinion, such consolidated financial statement schedules,
when considered in relation to the basic consolidated financial statements taken
as a whole, present fairly in all material respects the information set forth
therein.
DELOITTE & TOUCHE, LLP
Minneapolis, Minnesota
February 5, 1997
<PAGE>
SCHEDULE I
RTW, INC.
SUMMARY OF INVESTMENTS
DECEMBER 31, 1996
(IN THOUSANDS)
<TABLE>
<CAPTION>
AMOUNT AT
WHICH SHOWN
AMORTIZED FAIR IN THE BALANCE
TYPE OF INVESTMENT COST VALUE SHEET
- --------------------------------------------------------------------- -------------- -------------- --------------
<S> <C> <C> <C>
FIXED MATURITIES:
Held-to-maturity:
United States government, government agencies and authorities $ 53,977 $ 54,396 $ 53,977
Available-for-sale:
United States government, government agencies and authorities 35,854 35,872 35,872
-------------- -------------- --------------
Total Investments $ 89,831 $ 90,268 $ 89,849
-------------- -------------- --------------
-------------- -------------- --------------
</TABLE>
S-2
<PAGE>
SCHEDULE II
RTW, INC.
CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
BALANCE SHEETS
DECEMBER 31, 1996 AND 1995
(IN THOUSANDS)
1996 1995
---------- ----------
ASSETS
Cash and cash equivalents 6,888 9,416
Furniture and equipment, net 3,423 1,957
Investment in and advances to subsidiary 48,391 39,273
Income tax receivable 99 49
Other assets 515 515
---------- ----------
$ 59,316 $ 51,210
---------- ----------
---------- ----------
LIABILITIES AND SHAREHOLDERS' EQUITY
Accrued expenses and other liabilities $ 1,085 $ 822
Deferred income taxes 181 59
Notes payable 6,739 8,891
---------- ----------
Total liabilities 8,005 9,772
Shareholders' equity 51,311 41,438
---------- ----------
$ 59,316 $ 51,210
---------- ----------
---------- ----------
See notes to condensed financial statements.
S-3
<PAGE>
RTW, INC.
CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
(IN THOUSANDS)
<TABLE>
<CAPTION>
1996 1995 1994
---------- ---------- ----------
<S> <C> <C> <C>
Revenues:
Intercompany fee income $ 17,699 $ 13,087 $ 10,017
Investment income 408 366 27
---------- ---------- ----------
Total revenues 18,107 13,453 10,044
Expenses:
General and administrative expenses 15,555 10,731 7,121
---------- ---------- ----------
Income from operations 2,552 2,722 2,923
Interest expense 1,086 1,285 1,306
---------- ---------- ----------
Income before income taxes and equity in
undistributed net income of subsidiary 1,466 1,437 1,617
Provision for income taxes 614 605 666
---------- ---------- ----------
Income before equity in undistributed net
income of subsidiary 852 832 951
Equity in undistributed net income of subsidiary 8,130 6,226 3,244
---------- ---------- ----------
Net income $ 8,982 $ 7,058 $ 4,195
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
See notes to condensed financial statements.
S-4
<PAGE>
RTW, INC.
CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
(IN THOUSANDS)
<TABLE>
<CAPTION>
1996 1995 1994
---------- ---------- ----------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Reconciliation of net income to net cash provided
by operating activities:
Net income $ 8,982 $ 7,058 $ 4,195
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 793 618 412
Equity in net income from subsidiary (8,130) (6,226) (3,244)
Deferred income taxes 122 32 (33)
ESOP stock compensation - - 153
Changes in assets and liabilities:
Accrued expenses and other liabilities 263 230 (233)
Other, net 345 (12) (330)
---------- ---------- ----------
Net cash provided by operating activities 2,375 1,700 920
CASH FLOWS FROM INVESTING ACTIVITIES:
Investment in and advances to subsidiary (988) (17,800) (9,000)
Purchases of furniture and equipment (2,047) (1,265) (539)
---------- ---------- ----------
Net cash used in investing activities (3,035) (19,065) (9,539)
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on notes payable (2,362) (1,362) (362)
Proceeds from initial public offering - 29,900 -
Proceeds from notes payable - - 10,000
Debt issue costs - - (831)
Equity financing costs - (2,861) (35)
Stock options and warrants exercised 130 48 91
Issuance of Common Stock to ESOP 236 - -
Issuance of Common Stock under ESSP 129 - -
Retirement of Common Stock (1) (2) -
---------- ---------- ----------
Net cash provided by (used in)
financing activities (1,868) 25,723 8,863
---------- ---------- ----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (2,528) 8,358 244
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 9,416 1,058 814
---------- ---------- ----------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 6,888 $ 9,416 $ 1,058
---------- ---------- ----------
---------- ---------- ----------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for:
Interest $ 898 $ 1,042 $ 1,031
---------- ---------- ----------
---------- ---------- ----------
Income taxes $ 45 $ 127 $ 1,327
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
See notes to condensed financial statements.
S-5
<PAGE>
RTW, INC.
CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
NOTES TO CONDENSED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
NOTE 1 - ACCOUNTING POLICIES
The accompanying condensed financial information should be read in conjunction
with the consolidated financial statements and notes included in the RTW, Inc.
1996 Annual Report.
NOTE 2 - RELATED PARTY TRANSACTIONS
RTW provides American Compensation Insurance Company ("ACIC") with management
services, including preparing and submitting filings, maintaining books and
records, collecting premiums, administering and adjudicating claims, and
performing other administrative services. RTW receives 10% of ACIC's gross
premiums earned each month for these services, which amounted to $6,327,000,
$4,724,000 and $3,779,000 for the years ended December 31, 1996, 1995 and 1994,
respectively. In addition, RTW receives 15% of ACIC's gross premiums earned for
claims administration during the year in which the premiums are earned and a
total of 4% of gross premiums earned in subsequent years which amounted to
$11,372,000, $8,363,000 and $6,238,000 for the years ended December 31, 1996,
1995 and 1994, respectively.
RTW files a consolidated federal tax return with ACIC. Taxes are allocated
between the companies based on a tax allocation agreement under which allocation
is made primarily on a separate return basis for taxes incurred with current
credit for any net operating losses or other items utilized in the consolidated
tax return. This allocation is settled annually after completing and filing the
federal tax return.
Amounts due from ACIC related to the above transactions are included in the
balance sheet account caption "Investment in and advances to subsidiary" and
totaled approximately $2,558,000 and $976,000 at December 31, 1996 and 1995,
respectively.
S-6
<PAGE>
SCHEDULE IV
RTW, INC.
REINSURANCE
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
(IN THOUSANDS)
<TABLE>
<CAPTION>
PREMIUMS EARNED
------------------------------------------------------------------- PERCENTAGE
CEDED TO ASSUMED OF AMOUNT
OTHER FROM OTHER ASSUMED
DESCRIPTION DIRECT COMPANIES COMPANIES NET TO NET
- --------------------------------------------- -------------- ---------------- -------------- ----------- -----------
<S> <C> <C> <C> <C> <C>
1996
PREMIUMS - Workers' Compensation $ 63,755 $ 697 $ - $ 63,058 - %
1995
PREMIUMS - Workers' Compensation $ 47,507 $ 2,099 $ - $ 45,408 - %
1994
PREMIUMS - Workers' Compensation $ 38,099 $ 11,485 $ - $ 26,614 - %
</TABLE>
S-7
<PAGE>
SCHEDULE V
RTW, INC.
VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
(IN THOUSANDS)
<TABLE>
<CAPTION>
ADDITIONS
----------------------------
BALANCE AT CHARGED TO CHARGED TO BALANCE AT
BEGINNING COSTS AND OTHER END
DESCRIPTION OF PERIOD EXPENSES ACCOUNTS WRITE-OFFS OF PERIOD
- --------------------------------------------- ----------------- -------------- ------------ -------------- ------------
<S> <C> <C> <C> <C> <C>
1996
Allowance for Doubtful Accounts $ 73 $ 128 $ - $ 96 $ 105
1995
Allowance for Doubtful Accounts $ - $ 120 $ - $ 47 $ 73
1994
Allowance for Doubtful Accounts $ - $ - $ - $ - $ -
</TABLE>
S-8
<PAGE>
SCHEDULE VI
RTW, INC.
SUPPLEMENTAL INFORMATION CONCERNING INSURANCE OPERATIONS
(IN THOUSANDS)
<TABLE>
<CAPTION>
(COLUMN C)
RESERVES FOR
DEFERRED UNPAID CLAIM DISCOUNT,
POLICY AND CLAIM IF ANY,
ACQUISITION SETTLEMENT DEDUCTED IN UNEARNED EARNED INVESTMENT
YEAR COSTS EXPENSES COLUMN C PREMIUMS PREMIUMS INCOME
- ---------- -------------- -------------- -------------- ------------ ------------ -------------
<S> <C> <C> <C> <C> <C> <C>
1996 $ 1,624 $ 49,256 - $ 13,308 $ 63,058 $ 5,259
1995 $ 858 $ 37,138 - $ 9,606 $ 45,408 $ 3,659
1994 $ 460 $ 28,165 - $ 7,043 $ 26,614 $ 1,600
<CAPTION>
CLAIM AND CLAIM AMORTIZATION
SETTLEMENT EXPENSES OF DEFERRED PAID CLAIM
INCURRED RELATED TO: POLICY AND CLAIM
CURRENT PRIOR ACQUISITION SETTLEMENT PREMIUMS
YEAR YEAR YEARS COSTS EXPENSES WRITTEN
- ---------- -------------- -------------- -------------- -------------- ------------
<S> <C> <C> <C> <C> <C>
1996 $ 47,155 $ (8,075) $ 6,327 $ 24,833 $ 66,760
1995 $ 29,536 $ (1,474) $ 2,689 $ 13,499 $ 47,971
1994 $ 16,505 $ 98 $ (172) $ 6,026 $ 27,997
</TABLE>
S-9
<PAGE>
1997 PERFORMANCE BONUS PLAN
All employees of the company are eligible to receive quarterly cash bonuses
based on quarterly results. The components used to determine the ultimate
quarterly bonus payment are as follows:
IN FORCE PREMIUM In force premium is the annualized total premiums in
effect at any one point in time.
LOSS RATIO Claim costs divided by earned premium.
NET INCOME Pre-tax, pre-bonus operating profit.
Targets were established for each of the identified components above based on
the 1997 business plan goals. The amount of the bonus payment is determined
based on actual performance compared to the established Bonus Plan targets.
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
CERTIFICATE OF REINSURANCE
FOR THE
AGREEMENT OF REINSURANCE
between the
WORKERS' COMPENSATION REINSURANCE ASSOCIATION
and
AMERICAN COMPENSATION INSURANCE COMPANY
January 1, 1997 - December 31, 1997 Retention Limit: $1,080,000
This certifies that the entity named above is a Member of the Workers'
Compensation Reinsurance Association (Association) as of the date indicated
below, and that the Association reinsures the Member's liability for benefits
pursuant to Minn. Stat. Ch. 176 in excess of the Member's retention limit for
the period indicated above. This certificate shall not be valid for any portion
of the indicated period during which the entity is not a Member of the
Association.
Workers' Compensation
Reinsurance Association
/s/ Jay Benanav
--------------------------------
Jay Y. Benanav
President and Chief Executive
Officer
Dated: Monday, February 17, 1997
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
[LETTERHEAD ADDRESS]
<PAGE>
EXHIBIT 11
RTW, INC. AND SUBSIDIARY
STATEMENT REGARDING COMPUTATION OF NET INCOME
PER COMMON AND COMMON SHARE EQUIVALENT
<TABLE>
<CAPTION>
1994 1995 1996
--------------- --------------- ---------------
<S> <C> <C> <C>
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING, UNADJUSTED 8,118,287 10,607,307 11,774,147
STOCK WARRANTS 90,099 54,944 4,325
STOCK OPTIONS
Options at $25.00 - - 57
Options at $19.33 - - 7,013
Options at $16.67 - 393 1,446
Options at $12.50 - 684 3,424
Options at $ 8.67 - 19,401 44,160
Options at $ 8.00 57,606 - -
Options at $ 2.67 - 61,119 69,619
Options at $ 2.00 219,919 343,233 352,642
Options at $ 0.53 1,227 750 -
Options at $ 0.40 16,516 - -
Options at $ 0.22 13,241 - -
--------------- --------------- ---------------
WEIGHTED AVERAGE COMMON AND COMMON
SHARE EQUIVALENTS OUTSTANDING 8,516,895 11,087,831 12,256,833
--------------- --------------- ---------------
--------------- --------------- ---------------
NET INCOME ($000'S) $4,195 $7,058 $8,982
--------------- --------------- ---------------
--------------- --------------- ---------------
NET INCOME PER COMMON AND COMMON
SHARE EQUIVALENT $0.49 $0.64 $0.73
--------------- --------------- ---------------
--------------- --------------- ---------------
</TABLE>
<PAGE>
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statement No.
33-91368 of RTW, Inc. on Form S-8/S-3, Registration Statement No. 33-91372 of
RTW, Inc. on Form S-8, and Registration Statement No. 33-98966 of RTW, Inc.
on Form S-8 of our report dated February 5, 1997, incorporated by reference
in this Annual Report on Form 10-K of RTW, Inc. for the year ended December
31, 1996.
DELOITTE & TOUCHE LLP
Minneapolis, Minnesota
March 27, 1997
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 7
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<DEBT-HELD-FOR-SALE> 35,872
<DEBT-CARRYING-VALUE> 53,977
<DEBT-MARKET-VALUE> 54,396
<EQUITIES> 0
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 89,849
<CASH> 10,410
<RECOVER-REINSURE> 6,183
<DEFERRED-ACQUISITION> 1,624
<TOTAL-ASSETS> 123,731
<POLICY-LOSSES> 49,256
<UNEARNED-PREMIUMS> 13,308
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 6,739
0
0
<COMMON> 28,610
<OTHER-SE> 22,701
<TOTAL-LIABILITY-AND-EQUITY> 123,731
63,058
<INVESTMENT-INCOME> 5,667
<INVESTMENT-GAINS> 0
<OTHER-INCOME> 0
<BENEFITS> 39,080
<UNDERWRITING-AMORTIZATION> 6,327
<UNDERWRITING-OTHER> 8,510
<INCOME-PRETAX> 13,722
<INCOME-TAX> 4,740
<INCOME-CONTINUING> 8,982
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 8,982
<EPS-PRIMARY> .73
<EPS-DILUTED> .73
<RESERVE-OPEN> 37,138
<PROVISION-CURRENT> 49,440
<PROVISION-PRIOR> (11,051)
<PAYMENTS-CURRENT> 16,239
<PAYMENTS-PRIOR> 10,032
<RESERVE-CLOSE> 49,256
<CUMULATIVE-DEFICIENCY> 8,075
</TABLE>
