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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
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM __________ TO __________
COMMISSION FILE NUMBER: 0-25508
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
Series A Junior Participating Preferred Stock
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
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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: ( X )
As of March 15, 1999, 12,255,112 shares of Common Stock, no par value, were
outstanding. As of March 15, 1999, assuming as fair value the last sale price
of $5.875 per share on The Nasdaq Stock Market, the aggregate fair value of
shares held by non-affiliates was approximately $55,158,000.
DOCUMENTS INCORPORATED BY REFERENCE:
The Company's Proxy Statement for its annual meeting of shareholders to be
held in May 1999, a definitive copy of which will be filed with the
Securities and Exchange Commission within 120 days of December 31, 1998, is
incorporated by reference in Part III of this Report on Form 10-K.
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TABLE OF CONTENTS
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PART I PAGE
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Item 1. Business 3
Executive Officers of the Registrant 8
Item 2. Properties 9
Item 3. Legal Proceedings 9
Item 4. Submission of Matters for a Vote of Security Holders 9
PART II
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Item 5. Market for Registrant's Common Equity and Related Stockholder Matters 10
Item 6. Selected Financial Data 10
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations 11
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 23
Item 8. Financial Statements and Supplementary Data 23
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure 40
PART III
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Item 10. Directors and Executive Officers of the Registrant 40
Item 11. Executive Compensation 41
Item 12. Security Ownership of Certain Beneficial Owners and Management 41
Item 13. Certain Relationships and Related Transactions 41
PART IV
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Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 41
Signatures 43
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PART I
ITEM 1. BUSINESS
OVERVIEW
RTW, Inc. (the "Company") provided comprehensive management products and
services to employers for their workers' compensation programs in Minnesota,
Wisconsin, South Dakota, Colorado, Missouri, Illinois, Kansas, Michigan,
Indiana, Massachusetts, Connecticut, Rhode Island and New Hampshire during
1998. The Company also had obtained licenses but was not yet operating in
Pennsylvania, Tennessee, Maryland, Arkansas, Iowa and Florida. 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, as well as legal and judicial participants in the workers'
compensation system. 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.
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
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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 three nurses, 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 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 have 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
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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.
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 per policy decreased to $21,000 in
1998 from $22,000 in 1997 and $24,000 in 1996 due primarily to increased
association business with smaller average individual member premiums written
in 1998, 1997 and 1996 and decreases in premium rates on new and renewal
policies. The Company's ten largest customers accounted for approximately
$4.4 million or 5.3% of the Company's premiums in force in 1998 compared to
$5.3 million or 6.7% of the Company's premiums in force in 1997 and $5.1
million or 7.4% of premiums in force in 1996. No customer accounted for more
than 5% of in force premiums in 1998, 1997 or 1996. The Company renewed
approximately 72.5% of the policies scheduled to expire in 1998 whereas
approximately 78% and 83% were renewed in 1997 and 1996, respectively.
Currently, all of the Company's customers are in Minnesota, Wisconsin,
South Dakota, Colorado, Missouri, Illinois, Kansas, Michigan, Indiana,
Massachusetts, Rhode Island, Connecticut and New Hampshire. In addition to
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these states, the Company is also currently licensed in Pennsylvania,
Tennessee, Maryland, Arkansas, Iowa and Florida. The Company currently has no
intention to expand operations beyond the present states in which it is
currently operating 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 underwritten 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 sells its workers' compensation products and services
through independent insurance agencies, including several large national
agencies, as well as one- or two-person agencies. Agencies are paid a
commission, which averaged 8.0% of the Company's gross premiums earned in
1998 compared to 7.8% of gross premiums earned in 1997 and 7.3% of gross
premiums earned in 1996. The Company's ten highest producing agencies
accounted for approximately $19.1 million or 23.2% of premium in force in
1998 compared to $21.1 million or 26.9% of premiums in force in 1997 and
$25.7 million or 37.0% of premiums in force in 1996. No agency accounted for
more than 3.4% of premiums in force in 1998 compared to 4.3% of premiums in
force in 1997 and 6.2% of premiums in force in 1996. 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.
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 a reinsurer is paid a percentage of the Company's gross
premiums earned, and the reinsurer agrees to assume all risks relating to
injuries over a specific dollar amount on a per occurrence basis. Excess of
loss coverage in Minnesota is provided by a state established organization,
the Minnesota Workers' Compensation Reinsurance Association (WCRA). In
non-Minnesota states, excess of loss coverage is purchased through private
reinsurers.
In 1998, 1997 and 1996, the Company selected per occurrence levels in
Minnesota under the WCRA of $280,000, $1.1 million and $1.0 million,
respectively. In 1999, Minnesota excess of loss coverage under the WCRA
begins at $290,000.
In 1998 and 1997, the Company purchased non-Minnesota excess of loss
coverage primarily through General Reinsurance Corporation, rated A++
(Superior) by A.M. Best. The excess of loss policies in effect during 1998
and 1997 provided 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 $10 million per
occurrence ultimate net loss. This excess of loss policy was effective
January 1, 1997, and replaced excess of loss policies that were terminated on
December 31, 1996. Retention under this excess of loss was reduced to
$300,000 and coverage was expanded to cover claims to statutory limits
beginning January 1, 1999.
In 1996, the non-Minnesota excess of loss policies 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
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loss. Transatlantic Reinsurance Company, rated A++ (Superior) by A.M. Best,
is the only reinsurance company that received more than 15% of the premiums
paid for reinsurance coverage under the 1996 excess of loss coverage.
For claims occurring on or after July 1, 1998, the Company purchased
excess of loss coverage through First Excess and Reinsurance Corporation,
rated A (Excellent) by A.M. Best that provides reinsurance up to $275,000 in
excess of $25,000 in all states except Minnesota where the coverage is
$255,000 in excess of $25,000 for 1998 and $265,000 in excess of $25,000 for
1999. This coverage reduces risk and volatility in the Company's operating
performance and is in effect through December 2000.
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 1998, 1997, 1996 or 1995 and has none in effect for 1999. A.M.
Best currently rates Reliance A- (Excellent).
A.M. Best ratings are ratings based on a comparative analysis of the
financial condition and operating performance of insurance companies. 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 1998, 1997 and 1996, the Company experienced increased market
pressure as new carriers, including large insurance companies and single line
workers' compensation insurance companies, entered the market.
These large insurance companies compete primarily with the Company for
customers that have lower past claims experience or lower experience
"modifiers." In Minnesota, decreases in statutory benefits during the past
three years 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 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
an A.M. Best 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. 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. In such instances, the Company can still compete by
writing these employers using an "A" rated insurer's paper. This process,
known as fronting, adds additional cost for ACIC but allows access to a
market we may not otherwise access.
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. This rating was reaffirmed in February 1998. An A.M. Best 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
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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 1998, 1997 and 1996, 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 280 full-time employees at December 31, 1998. Of the
Company's employees, approximately 138 work in the Company's administrative
and financial functions and 142 serve on approximately 26 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 Massachusetts and any
other state where the Company currently operates or may operate in the
future, including laws that require all employers to participate in state
sponsored funds or that mandate premium reductions, could have a material
adverse effect on the Company.
EXECUTIVE OFFICERS OF THE REGISTRANT
The following are the executive officers of the Company:
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Name Age Position
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David C. Prosser 74 Chairman of the Board
Carl B. Lehmann 45 President and Chief Executive Officer
Tim C. Chan 48 Chief Financial Officer, Secretary and Treasurer
Anthony J. Rotondi 53 Chief Operations Officer
Tanna L. Moore 44 Chief Marketing Officer
Marguerite K. Downey 48 Chief Information Officer
Daniel R. Haag 42 Vice President, Human Resources
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David C. Prosser, the founder of the Company and Chairman of the Board,
served as President and Chief Executive Officer through January 1998, and has
been a 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.
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Carl B. Lehmann became a Director of the Company in November 1997 and
was appointed President and Chief Executive Officer in January 1998. Mr.
Lehmann served as President of the Stored Value Group, a division of American
Express Travel Related Services, Inc. (AMEX) from 1993 to 1997. Prior to that
time, Mr. Lehmann served as Vice President of various departments at AMEX
from 1987 to 1993 and Citicorp Retail Services from 1982 to 1987.
Tim C. Chan joined the Company in July 1998 as the Chief Financial
Officer. Mr. Chan was the Vice President Finance and Controller of the U.S.
Grocery Division of Campbell Soup from 1997 to 1998. Prior to that time, Mr.
Chan served as Vice President - Finance Pillsbury Brands Group for the
Pillsbury Company from 1990 to 1997.
Anthony J. Rotondi joined the Company in November 1998 as Chief
Operations Officer. Before joining RTW, Mr. Rotondi managed CompuPros Inc., a
technology consulting firm in Dallas, Texas. Prior to that time, Mr. Rotondi
served as Senior Vice President Operations with Fortis Financial Group from
1993 to 1996. Mr. Rotondi also held several other leadership positions during
his over twenty year tenure with Fortis Financial Group.
Tanna L. Moore joined the Company in December 1998 as Chief Marketing
Officer. Prior to joining the Company, Ms. Moore was Vice President of Sales
and Marketing for Ontrack Data International, Inc. from 1997 to 1998. Ms.
Moore has prior experience as Vice President of Business Strategy for
Ceridian Corporation from 1991 to 1996, Senior Vice President at U.S.
Communications Corporation from 1982 to 1990 and in product management at
General Mills, Inc. from 1978 to 1982
Marguerite K. Downey joined the Company in December 1997 as Vice
President, Chief Information Officer. Prior to joining the Company, Ms.
Downey served as the Vice President of Technology for Performark, Inc. from
1996 to 1997 and as the Vice President, Information Services for Fortis from
1988 to 1996. Ms. Downey also served in other information system positions at
Fortis from 1972 to 1988.
Daniel R. 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 for SPX divisions from 1990 to 1994.
ITEM 2. PROPERTIES
The following is a summary of properties leased by the Company at December
31, 1998:
<TABLE>
<CAPTION>
Area leased
Location and description (in square feet) Termination
- ------------------------ ---------------- --------------
<S> <C> <C>
Bloomington, Minnesota; Headquarters space 41,918 September 2002
Brainerd, Minnesota; Minnesota satellite office 4,274 October 2000
Denver, Colorado; Colorado office space 19,779 February 2000
St. Louis, Missouri; Missouri office space 9,591 September 2000
Overland Park, Kansas; Missouri satellite office 3,604 November 2002
Detroit, Michigan; Michigan office space 11,008 June 2002
Grand Rapids, Michigan; Michigan satellite office 1,000 November 2000
Boston, Massachusetts; Massachusetts office space 12,381 May 2002
</TABLE>
ITEM 3. 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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
9
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The Company's 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 for the Company's stock for each quarter during the past two years. On
March 1, 1999, the Company had approximately 2,700 shareholders.
<TABLE>
<CAPTION>
First Second Third Fourth
Fiscal Year: Quarter Quarter Quarter Quarter
------------ ------- ------- ------- -------
<S> <C> <C> <C> <C>
1998 High 10-3/8 9-1/4 7-13/16 6-3/8
Low 5-5/8 7-1/2 4-3/8 3-13/16
1997 High 19-1/4 10-3/8 9-7/8 9-3/4
Low 7 7-3/8 6-7/8 5-1/4
</TABLE>
The Company has never paid cash dividends on its common stock. The
Company currently intends to retain any and all income for use in its
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 our $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 paying dividends.
ITEM 6. SELECTED FINANCIAL DATA
The consolidated statements of operations data set forth below for each of
the three years in the period ended December 31, 1998, and the consolidated
balance sheet data at December 31, 1998 and 1997 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
operations data set forth below for each of the two years in the period ended
December 31, 1995, and the consolidated balance sheet data at December 31,
1996, 1995 and 1994, 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>
1994 1995 1996 1997 1998
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
(In thousands, except per share data)
Total revenues $ 28,241 $ 49,433 $ 68,725 $ 88,263 $ 90,152
Income (loss) from operations 7,879 12,569 14,808 9,446 (10,485)
Net income (loss) 4,195 7,058 8,982 5,799 (7,081)
Basic income (loss) per share (1) 0.49 0.67 0.76 0.49 (0.59)
Diluted income (loss) per share (1) 0.49 0.64 0.74 0.48 (0.59)
Premiums in force at year end 39,900 51,700 69,500 78,400 82,100
Total assets 56,765 101,124 123,731 142,997 170,945
Notes payable 9,993 8,891 6,739 4,875 2,461
Total shareholders' equity 6,136 41,438 51,311 58,357 52,618
</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
income (loss) per share, see Note 2 of Notes to Consolidated Financial
Statements.
10
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
THE COMPANY - RTW, Inc. (RTW) and its wholly owned insurance subsidiary,
American Compensation Insurance Company (ACIC), provide disability management
services to employers. Collectively, "we," "our" and "us" refers to these
entities in this "Management's Discussion and Analysis of Financial Condition
and Results of Operations."
We developed a proprietary management system, the RTW
SOLUTION-Registered Trademark-, designed to lower employers' workers'
compensation costs and return injured employees to work as soon as possible.
We combine our management system with insurance products underwritten by our
insurance subsidiary to offer services to customers. We currently provide
workers' compensation management services solely to employers insured through
our insurance subsidiary. We operated in Minnesota, Wisconsin, South Dakota,
Colorado, Missouri, Illinois, Kansas, Michigan, Indiana, Massachusetts,
Connecticut, New Hampshire and Rhode Island during 1998.
Financial Summary
This financial summary presents our discussion and analysis of the
consolidated financial condition and results of operations of RTW, Inc. This
review should be read in conjunction with the Consolidated Financial
Statements.
The following table provides an overview of our key operating results (000's):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1998 1997 1996
---------- --------- ----------
<S> <C> <C> <C>
Total revenues $ 90,152 $ 88,263 $ 68,725
Claim and claim settlement expenses 75,294 55,543 39,080
Net income (loss) (7,081) 5,799 8,982
</TABLE>
RTW reported total revenues of $90.2 million in 1998, a 2.1 percent
increase over total revenues of $88.3 million reported for 1997. Total
revenues in 1998 were significantly reduced by premiums ceded under an excess
of loss reinsurance agreement entered into during the fourth quarter of 1998.
This agreement was effective for claims occurring on or after July 1, 1998,
however the effect of the transaction was recorded entirely in the fourth
quarter of 1998. Total revenues were also positively affected by a refund of
$2.3 million from the Minnesota Workers' Compensation Reinsurance
Association, which was recorded in the first quarter of 1998; a similar
refund of $358,000 was recorded in the third quarter of 1997. Excluding the
effects of reinsurance and refunds, adjusted total revenues increased 7.5
percent in 1998 versus the reported increase of 2.1 percent. We also reported
a net loss of $7.1 million in 1998, compared to net income of $5.8 million
reported for 1997, and basic and diluted net loss per share of ($0.59) in
1998 versus basic net income per share of $0.49 and diluted income per share
of $0.48 in 1997.
The single largest item affecting our 1998 operating results was the
addition of $11.0 million to unpaid claim and claim settlement expenses to
cover adverse development of 1997 and prior year open claims in Minnesota,
Colorado and Missouri. This addition was recorded $3.0 million to the first
quarter of 1998, $400,000 to the second quarter of 1998 and the remainder to
the fourth quarter of 1998. This adverse development was the result of
changes in our internal claim reserving standards, new claim petitions for
previously injured workers, the need for further surgical procedures and
rehabilitation treatment, as well as new litigation on existing claims. The
adjustment made for 1997 and prior years also increased our estimate for 1998
unpaid claim and claim settlement expenses. We will continue to aggressively
manage prior year open claims to diminish the likelihood that prior year
reserves will increase in the future. We believe that our reserves are
adequate to cover costs for claims reported and for those incurred but not
reported at December 31, 1998.
In the following pages, we take a look at the 1998, 1997 and 1996
operating results for items in our Consolidated Statement of Operations and
also explain key balance sheet accounts in greater detail.
RESULTS OF OPERATIONS
TOTAL REVENUES: Our total revenues include premiums earned, investment income
and net realized investment gains.
The following table summarizes the components of our revenues and premiums in
force (000's);
11
<PAGE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Gross premiums earned $ 89,881 $ 81,385 $ 63,755
Premiums ceded (8,489) (342) (697)
-------- -------- --------
Premiums earned 81,392 81,043 63,058
Investment income 7,714 6,821 5,667
Net realized investment gains (losses):
Gains 1,591 479 -
Losses (545) (80) -
-------- -------- --------
Net realized investment gains 1,046 399 -
-------- -------- --------
Total revenues $ 90,152 $ 88,263 $ 68,725
-------- -------- --------
-------- -------- --------
1998 1997 1996
-------- -------- --------
Premiums in force by regional office at year-end
Minnesota $ 34,800 $ 44,600 $ 52,400
Colorado 12,300 12,900 12,000
Missouri 16,300 14,300 4,700
Michigan 9,700 5,200 400
Massachusetts 9,000 1,400 -
-------- -------- --------
Total premiums in force $ 82,100 $ 78,400 $ 69,500
-------- -------- --------
-------- -------- --------
</TABLE>
GROSS PREMIUMS EARNED: Premiums on workers' compensation insurance policies
are our largest source of revenue. Premiums earned are the gross premiums
earned by us on in force workers' compensation policies, net of the effects
of ceded premiums under reinsurance agreements.
The premium we charge a policyholder is a function of their payroll,
industry and prior workers' compensation claims experience. In underwriting a
policy, we receive policyholder payroll estimates for the ensuing year. We
record premiums written on an installment basis matching our billing to the
policyholder and earn premiums on a daily basis over the life of each
insurance policy based on the payroll estimate. We record the excess of
premiums billed over premiums earned for each policy as unearned premiums on
our balance sheet. When a policy expires, we audit employer payrolls for the
policy period and adjust the estimated payroll to its actual value. The
result is a "final audit" adjustment recorded to premiums earned when the
adjustment becomes known. Final audit premiums recognized during the period
include billed final audit premiums plus (or minus) the change in estimate
for premiums on unexpired and expired unaudited policies.
Our gross premiums earned in 1998 increased 10.4% to $89.9 million from
$81.4 million in 1997. This increase resulted from the 4.7% increase in
premiums in force to $82.1 million at December 31, 1998, from $78.4 million
at December 31, 1997. Additionally, in force premiums grew less rapidly in
1998 than in 1997 resulting in a more stable, higher average in force premium
during the year generating increased gross premiums earned. Final audit
premiums earned during 1998 decreased to $7.2 million from $7.5 million in
1997.
Gross premiums earned in 1997 increased 27.6% to $81.4 million from
$63.8 million in 1996. This increase resulted, in part, from the 12.8%
increase in premiums in force to $78.4 million at December 31, 1997, from
$69.5 million at December 31, 1996. Additionally, gross premiums earned
increased as we recognized $7.5 million of final audit premiums in 1997
compared to $970,000 recognized in 1996.
Underlying these increases in gross premiums earned is another trend.
The premium rate that we charge policyholders per payroll dollar has declined
for several years. This is the result, in part, of the following:
- Many state legislatures where we provide coverage have reduced
benefits that injured employees are paid, resulting in lower loss
costs of workers' compensation insurance and decreased corresponding
premiums to the policyholder;
- As the loss cost structure of workers' compensation has declined,
more insurance companies have entered or re-entered the workers'
compensation insurance market, resulting in increased competition;
and
- We continue to experience reduced pricing on renewal policies due, in
part, to our success in lowering our policyholders' loss experience
which then improves their claims history, lowering the premium that
they have to pay for insurance.
12
<PAGE>
PREMIUMS CEDED: Reinsurance agreements allow us to share certain risks with
other insurance companies. The primary purpose of ceded reinsurance is to
protect us from potential losses in excess of the level we are willing to
accept. Our primary ceded reinsurance is excess of loss coverage that limits
our per incident exposure. We expect the companies to which we have ceded
reinsurance to honor their obligations. In the event that these companies are
unable to honor their obligations to us, we will be required to pay these
obligations ourselves. We are not aware of any developments with respect to
any of our reinsurers that would prevent them from honoring any of their
obligations to us.
Under our excess of loss reinsurance policies, we pay reinsurers to
limit our per incident exposure and record this cost as a reduction to gross
premiums earned. In Minnesota, we are required to purchase excess of loss
coverage for Minnesota policies from the Minnesota Workers' Compensation
Reinsurance Association (WCRA). Our selected retention levels in Minnesota
were $280,000 in 1998, $1.1 million in 1997 and $1.0 million in 1996. In
other states, we continued to limit our per incident exposure to $500,000 and
purchased this coverage from various reinsurers. Additionally, for claims
occurring on or after July 1, 1998, we further limited our per incident
exposure by purchasing excess of loss coverage for losses from $25,000 to
$280,000 in Minnesota and from $25,000 to $300,000 in other states from a
single reinsurer. This agreement was finalized after its effective date. As a
result, activity occurring from July 1, 1998 through October 1, 1998 has been
recorded on a retroactive basis resulting in the deferral of a gain totaling
$2.0 million. Activity occurring on or after October 1, 1998 has been
recorded prospectively. This gain will be amortized into income in future
years using the effective interest rate inherent in the amounts paid to the
reinsurer and the estimated timing and amounts of recoveries from the
reinsurer.
The following table summarizes the components of premiums ceded (000's):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1998 1997 1996
-------- ------ -------
<S> <C> <C> <C>
Premiums ceded, net:
Non-WCRA excess of loss policies $ (7,805) $ (682) $ (571)
WCRA (2,931) (18) (377)
Refund from the WCRA on prior years' activity 2,247 358 251
-------- ------ -------
Premiums ceded $ (8,489) $ (342) $ (697)
-------- ------ -------
-------- ------ -------
</TABLE>
Premiums ceded to reinsurers increased to $8,489,000 in 1998 from
$342,000 in 1997. This increased cost resulted from (i) reducing our selected
Minnesota excess of loss reinsurance coverage levels to $280,000 in 1998 from
$1.1 million in 1997; (ii) increased excess of loss premium rates in
Minnesota in 1998 from 1997, (iii) increased excess of loss costs resulting
from increased premiums earned in non-Minnesota states, and (iv) increased
excess of loss costs resulting from further limiting our exposure to $25,000.
This increase was offset by recognizing a $2.2 million refund received from
the WCRA in 1998 as a reduction of premiums ceded, compared to a refund of
$358,000 from the WCRA in 1997.
Premiums ceded to reinsurers decreased to $342,000 in 1997 from $697,000
in 1996. The decrease in premiums ceded resulted from (i) reduced premium
rates in 1997 from 1996 for our selected excess of loss reinsurance coverage
levels in Minnesota, (ii) reduced premiums for excess of loss coverage in
other states, and (iii) the recognition of a refund received from the WCRA of
$358,000 in 1997.
1999 OUTLOOK: The 1999 outlook for gross premiums earned and premiums ceded
include the following factors:
- We expect continued growth in premiums in force in our non-Minnesota
markets offset by decreasing premiums in force in Minnesota which will
lead to moderate overall growth in premiums in force and moderate
growth in gross premiums earned;
- We expect continued downward pressure on the amount we charge for our
products and services;
- Premiums ceded will increase due to reducing our selected retention
level to $25,000 in all our states from $280,000 in Minnesota and
$500,000 in our non-Minnesota states. This reduction will result in
additional excess of loss policy cost and significantly reduce
premiums earned; and
- We believe the recent events within the workers' compensation
reinsurance market will have no impact on our reinsurance program for
1999.
INVESTMENT INCOME AND NET REALIZED INVESTMENT GAINS: Our investment income
includes earnings on our investment portfolio. Net realized investment gains
include gains and losses from sales of available-for-sale securities and are
13
<PAGE>
displayed separately on our Consolidated Statement of Operations. We
currently invest entirely in U.S. domiciled investment grade taxable and
tax-exempt fixed maturity investments and classify our investments as
available-for-sale. We intend to hold our available-for-sale investments to
maturity, but may sell before maturity in response to changes in interest
rates, prepayment risk and funding sources or terms, or to address liquidity
needs. Our primary investment objective is to maintain a diversified,
high-quality, fixed-investment portfolio structured to maximize our after-tax
investment income without taking inappropriate credit risk. For further
discussion of investments, see the "Investments" section of this Management's
Discussion and Analysis.
Investment income and net realized investment gains increased 21.3% to
$8.8 million in 1998 from $7.2 million in 1997, due to increased funds
available for investment and increased net realized investment gains totaling
$1.0 million in 1998 compared to $399,000 realized in 1997. Investment income
has been significantly affected by growth of tax-exempt municipal securities
included in our portfolio that earn lower pre-tax yields than taxable
securities but earn higher comparable yields on a tax adjusted basis. Funds
available for investment increased to $126.6 million at December 31, 1998,
from $112.3 million at December 31, 1997, due to increased net cash provided
by operating activities resulting primarily from (i) the difference in timing
between the receipt of premiums and the payment of claim and claim settlement
expenses and (ii) net cash provided by investment income. Pre-tax investment
yields decreased to 6.0% in 1998 from 6.3% in 1997 due to purchasing
tax-exempt municipal securities, which have lower yields on a pre-tax basis
offset by portfolio diversification during 1998 and 1997. The investment
yield realized in future periods will be affected by yields attained on new
investments.
Investment income and net realized investment gains increased 27.4% to
$7.2 million in 1997 from $5.7 million in 1996, due to increased funds
available for investment and net realized investment gains totaling $399,000.
Funds available for investment increased to $112.3 million at December 31,
1997, from $89.8 million at December 31, 1996, due to increased net cash
provided by operating activities, resulting primarily from (i) the difference
in timing between the receipt of premiums and the payment of claim and claim
settlement expenses and (ii) net cash provided by investment income.
Investment yields increased to 6.3% in 1997 from 6.2% in 1996.
1999 OUTLOOK: Barring significant changes in interest rates or operational
cash flows, we expect that the 1999 pre-tax yield from our investment
portfolio will be affected by the following:
- Increased funds will become available for investment due to increased
net cash provided by operating and investment activities. The
increase, however, will decrease from levels attained in prior years
due to ceded premiums on excess of loss policies for losses in excess
of $25,000;
- Our recognition of realized gains and losses will depend on the
repositioning of the portfolio, if any, that occurs in 1999 as we
continue to diversify our portfolio from U.S. government securities to
other taxable and tax-exempt fixed maturity securities; and
- We will continue to include fixed maturity tax-exempt securities in
our investment portfolio to increase after-tax yields. Fixed maturity,
tax-exempt securities may have the effect of reducing investment
income recognized and decrease pre-tax investment yields but are
expected to contribute more to after-tax net income as a result of the
favorable treatment tax-exempt municipal income receives for federal
income tax purposes.
CLAIM AND CLAIM SETTLEMENT EXPENSES: Claim expenses refer to medical and
indemnity amounts that we paid or expect to pay to claimants for events that
have occurred. The costs of investigating, resolving and processing these
claims are referred to as claim settlement expenses. We record these
expenses, net of amounts recoverable under reinsurance contracts, to claim
and claim settlement expenses in the Consolidated Statements of Operations.
Claim and claim settlement expenses are our largest expense and result
in our largest liability. We establish reserves that reflect our estimates of
the total claim and claim settlement expenses we will ultimately have to pay
under our workers' compensation insurance policies. These include claims that
have been reported but not settled and claims that have been incurred but not
yet reported to us. For further discussion of reserve determination, see the
"Unpaid Claim and Claim Settlement Expenses" section of this Management's
Discussion and Analysis.
Claim and claim settlement expenses increased to $75.3 million in 1998
from $55.5 million in 1997. As a percent of premiums earned, claim and claim
settlement expenses increased to 92.5% in 1998 from 68.5% in 1997. These
changes are due to the following:
- Gross premiums earned increased to $89.9 million in 1998 from $81.4
million in 1997 resulting in increased claim and claim settlement
expenses as we provided coverage for more employers;
14
<PAGE>
- During 1998, we increased our estimate of the pre-1998 liability for
unpaid claim and claim settlement expenses by $11.0 million as a
result of unfavorable claims experience for those periods. This
increase was $14.1 million more than the $3.1 million reduction that
we recorded in 1997. Additionally, we increased our estimate for the
1998 liability for unpaid claim and claim settlement expenses as a
result of the 1997 and prior year adjustment. At December 31, 1998, we
had gross reserves for unpaid claim and claim settlement expenses of
$97.3 million including $53.2 million for 1998 claims and $44.1
million for claims relating to years prior to 1998;
- Reduced premiums due to legislative changes in estimated loss costs,
increased competition and improving customer loss experience, have
resulted in an increase in claim and claim settlement expenses as a
percentage of premiums earned; and
- Average claim cost continued to decrease in 1998 due to realized
operating efficiencies and effectiveness and legislative changes in
benefits to claimants. These decreases did not keep pace, however,
with decreases in pricing.
Claim and claim settlement expenses increased to $55.5 million in 1997
from $39.1 million in 1996. As a percent of premiums earned, claim and claim
settlement expenses increased to 68.5% in 1997 from 62.0% in 1996.
These changes are due to the following:
- Gross premiums earned increased to $81.4 million in 1997 from $63.8
million in 1996 resulting in increased claim and claim settlement
expenses as we provided coverage for more employers;
- During 1997, we reduced our estimate of the pre-1997 liability for
unpaid claim and claim settlement expenses by $3.1 million as a result
of favorable claims experience for those periods. This reduction was
$5.0 million less than the reduction that we recorded in 1996. At
December 31, 1997, we had gross reserves for unpaid claim and claim
settlement expenses of $61.1 million including $36.7 million for 1997
claims and $24.4 million for claims relating to years prior to 1997;
- Reduced premiums due to legislative changes in estimated loss costs,
increased competition and improving customer loss experience, have
resulted in an increase in claim and claim settlement expenses as a
percentage of premiums earned; and
- Average claim cost continued to decrease in 1997 due to realized
operating efficiencies and effectiveness and legislative changes in
benefits to claimants. These decreases did not keep pace, however,
with decreases in pricing.
1999 OUTLOOK: We expect that claim and claim settlement expenses will be
affected by the following factors:
- Claim costs will be affected by (i) increases in medical and indemnity
costs resulting from inflationary changes, (ii) severity experienced
in future periods in our policy holder base, (iii) changes resulting
from increases in operating efficiency and effectiveness realized
through enhancements to our internal processes and procedures,
including changes to our proprietary computer systems, and (iv)
legislative changes in estimated loss costs;
- Claim and claim settlement expenses will decrease due to reducing our
selected retention level to $25,000 in all our states from $280,000 in
Minnesota and $500,000 in our non-Minnesota states. This reduction
will result in additional ceding of paid and unpaid claim and claim
settlement expenses and significantly reduce claim and claim
settlement expenses; and
- Continued application of our claims management technology and methods
to all open claims at December 31, 1998, may benefit future periods.
The magnitude of any benefit realized cannot be quantified at this
time.
The ultimate result of the above factors, combined with the change in
premium rates, on 1999 claim and claim settlement expenses as a percent of
premiums earned is unknown at this time.
POLICY ACQUISITION COSTS: Policy acquisition costs are costs directly related
to writing an insurance policy and consist of commissions, state premium
taxes, underwriting personnel costs and expenses, sales and marketing costs
and other underwriting expenses, offset by ceding commissions received from
our reinsurers. Ceding commissions are amounts that reinsurers pay to us for
placing reinsurance with them. Ceding commissions represent adjustments based
on actual claim and claim settlement expenses related to premiums ceded in
prior years. Under our
15
<PAGE>
reinsurance agreements, ceding commission is adjusted to the extent that
actual claim and claim settlement expenses vary from levels specified in the
agreements.
The following table summarizes policy acquisition costs (000's):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1998 1997 1996
------- ------- --------
<S> <C> <C> <C>
Commission expense $ 7,171 $ 6,369 $ 4,670
Premium tax expense 1,839 1,651 1,312
Other policy acquisition costs 4,964 3,637 2,216
------- ------ -------
Direct policy acquisition costs 13,974 11,657 8,198
Ceding commissions resulting from unpaid claim and claim
settlement liability adjustments from 1992 to 1994 - 1 (1,871)
------- ------ -------
Policy acquisition costs $13,974 $11,658 $ 6,327
------- ------ -------
------- ------ -------
</TABLE>
Policy acquisition costs increased to $14.0 million in 1998 from $11.7
million in 1997 and $6.3 million in 1996. As a percent of gross premiums
earned, policy acquisition costs increased to 15.5% in 1998 from 14.3% in
1997 and 9.9% in 1996. These increases reflect the following:
- Commission expense increased to 8.0% of gross premiums earned in 1998
from 7.8% in 1997 and 7.3% in 1996. The increased commission percent
is the result of marketing programs initiated in prior years,
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 we entered new markets, we introduced higher
commission rates to attract business from established agents. These
rates have continued into current policy periods and will have a
greater impact on the commission expense percent as the non-Minnesota
states continue to grow relative to Minnesota. In all of our markets,
we believe the commission rates we pay are marketplace competitive;
- Premium tax expense remained consistent at 2.0% of gross premiums
earned in 1998 compared to 2.0% in 1997 and 2.1% in 1996. Premium tax
expense was slightly higher in 1996 due to higher premium tax rates
paid for premiums earned in Colorado;
- Other policy acquisition costs increased to 5.5% of gross premiums
earned in 1998 from 4.5% in 1997 and 3.5% in 1996, due to (i)
increased personnel and overhead costs associated with improving our
underwriting function, (ii) increased personnel costs necessary for
the growth in premiums in force, and (iii) increased spending on
marketing programs; and
- There were no ceding commissions in 1998 compared to a cost of $1,000
in 1997 from a benefit of $1.9 million in 1996. We recognized
favorable adjustments to our claims experience for accident years 1992
through 1994 resulting in the 1996 benefits realized.
1999 OUTLOOK: We expect that policy acquisition costs as a percent of gross
premiums earned will stabilize or remain relatively constant as a percent of
gross premiums earned during 1999 due to the following:
- We expect commission expense as a percent of gross premiums earned to
increase during 1999 as the non-Minnesota states continue to grow in
size relative to Minnesota;
- We expect premium tax expense as a percent of gross premiums earned in
1999 to remain consistent with 1998; and
- We expect that other policy acquisition costs will be consistent with
1998 as a percent of gross premiums earned as we continue to improve
our underwriting skills, increase premiums in force and generate
additional revenues to cover the relatively fixed policy acquisition
costs. We also expect that these costs will be offset on a limited
basis from increases in operating efficiency and effectiveness during
1999 realized through enhancements to our internal processes and
procedures, including changes to our proprietary computer systems.
GENERAL AND ADMINISTRATIVE EXPENSES: Our general and administrative expenses
include personnel costs, office rent, certain state administrative charges
based on premiums and other costs and expenses not specific to claim and
claim settlement expenses or policy acquisition costs.
16
<PAGE>
Our general and administrative expenses decreased to $11.4 million in
1998 from $11.6 million in 1997 and increased from $8.5 million in 1996. As a
percent of gross premiums earned, general and administrative expenses
decreased to 12.6% in 1998 from 14.3% in 1997 and 13.3% in 1996. General and
administrative expenses for 1998 and 1997 include benefits of $1.1 million
recorded in the second quarter of 1998, $695,000 recorded in the fourth
quarter of 1998 and $842,000 recorded in the third quarter of 1997, resulting
from the reversal of 1998, 1997 and 1996 accruals for assessments by the
Minnesota Insurance Guarantee Association (MIGA), an organization formed to
fund Minnesota claims for insolvent insurance companies. MIGA did not assess
its members in 1998 or 1997 for workers' compensation claim liabilities
arising from current or prior insolvencies resulting in the accrual reversals
and we do not expect an assessment in 1999. After adjusting for the accrual
reversals, our general and administrative expenses increased to $12.4 million
in 1998 from 11.4 million in 1997 and $7.7 million in 1996. These increases
reflect:
- expenses incurred for expansion in Michigan and Massachusetts in 1998
and 1997 and Missouri in 1996, not offset by revenues from premiums in
force in those states;
- additional personnel costs for new employees resulting from the growth
in in force premium; and
- General and administrative expenses continue to improve as a percent
of premiums earned, after adjusting for MIGA accrual reversals and
one-time charges. Actions to reduce personnel costs were initiated in
the first quarter of 1998 to bring operating expenses more in line
with revenues. Other expenses continue to be managed aggressively and
reduced where appropriate.
1999 OUTLOOK: We expect that general and administrative expenses will be
affected by the following:
- We will continue to aggressively manage all general and administrative
expenses in 1999;
- We have no plans to open additional state offices in 1999 and expect
that growth in premiums in force in Michigan and Massachusetts will
result in additional revenues to cover the fixed costs in those states;
and
- We expect to increase operational efficiency during 1999 through
enhancements to our internal processes and procedures, including
changes to our internal proprietary computer systems.
INTEREST EXPENSE: We incurred interest charges on our Senior Notes in 1998,
1997 and 1996 and our Series 1991A and 1991B Notes in 1996. The Series 1991A
and 1991B Notes were paid in full in December 1996. The Senior Notes mature
in series during the years 1995 through 1999. We paid interest at rates
ranging from 9.25% to 9.50% on the outstanding balance on our Senior Notes
during 1998.
Interest expense decreased to $546,000 in 1998 from $777,000 in 1997 and
$1.1 million in 1996 due to principal payments on the Senior Notes in
December 1998, 1997 and 1996 and payments on the Series 1991A and 1991B Notes
in December 1996. The Series 1991A and 1991B Notes were paid in full in 1996.
1999 OUTLOOK: Interest expense on the Senior Notes is expected to decrease
from $546,000 in 1998 to $266,000 in 1999 as a result of principal payments
of $2.5 million made in December 1998.
INCOME TAXES: We incur federal income taxes on our combined service
organization (RTW) operations and insurance (ACIC) operations. We incur state
income taxes on the results of our service organization's operations and
incur premium taxes in lieu of state income taxes for substantially all of
our insurance operations. In certain instances, we may incur state income
taxes on our insurance operations. Additionally, certain provisions of the
Internal Revenue Code adversely affect our taxable income by accelerating
recognition and payment of income taxes. Adjustments to book income
generating current tax liabilities include limitations on the deductibility
of unpaid claim and claim settlement expenses, limitations on the
deductibility of unearned premium reserves and limitations on deductions for
bad debt reserves.
Income taxes were a benefit of $4.0 million in 1998 compared to expense
of $2.9 million in 1997 and $4.7 million in 1996. As a percent of income
(loss) before income taxes, the income tax expense (benefit) was (35.8%) of
the loss before income taxes in 1998 compared to 33.1% and 34.5% of income
before income taxes in 1997 and 1996 respectively. The income tax expense
(benefit) percent in 1998 has been affected by (i) our loss from operations
which resulted in a credit against taxes previously paid, (ii) decreased
taxable net income from the service organization (RTW) which is subject to
both federal and state income taxes, (iii) decreases in the profitability of
ACIC, and (iv) the introduction of tax-exempt municipal income beginning in
the second quarter of 1998.
17
<PAGE>
1999 OUTLOOK: Income tax expense (benefit) will vary based on (i) the income
(loss) from operations we recognize for 1999, and will (ii) decrease as a
percent of income (loss) before taxes relative to the statutory effective
rate as we purchase additional tax-exempt municipal fixed investments for our
investment portfolio. The ultimate change is unknown at this time.
INVESTMENTS
Our portfolio of fixed maturity securities at December 31, 1998 included
tax-exempt municipal securities (52.6%), corporate securities (17.0%),
mortgage-backed securities (15.3%), U.S. government securities (11.5%), and
asset-backed securities (3.6%). After several years of purchasing solely U.S.
government securities, we engaged an investment manager in the second quarter
of 1997 to diversify our portfolio to other taxable fixed maturity
investments and to maximize our after-tax investment income without taking
inappropriate credit risk. During the second quarter of 1998, we transferred
our portfolio to a new investment manager and further diversified our
portfolio to include investment grade tax-exempt fixed maturity investments.
We manage our fixed maturity portfolio conservatively, investing only in
investment grade (BBB or better rating from Standard and Poor's) securities
of U.S. domiciled issuers. We do not invest in derivative securities.
Additionally, in December 1997, we reclassified our entire held-to-maturity
portfolio, invested in U.S. government securities with a historical cost, net
of amortization, of $53.8 million and a fair value of $54.7 million, to
available-for-sale investments. We reclassified these securities to enable us
to more actively manage our investment yield and overall portfolio risk.
Funds provided by our operating cash flows and investment cash flows are
the source of growth in our investment portfolio. Operating cash flows
consist of the excess of premiums collected over claim and claim settlement
expenses and other operating expenses paid. Investment cash flows consist of
income on existing investments and proceeds from sales and maturities of
investments. Our investment portfolio grew 12.8% or $14.3 million to $126.6
million at December 31, 1998, from $112.3 million at December 31, 1997, as a
result of these factors.
We record investments on our balance sheet at fair value, with the
corresponding appreciation or depreciation from amortized cost recorded in
shareholders' equity, net of taxes. Because value is based on the
relationship between the portfolio's stated yields and prevailing market
yields at any given time, interest rate fluctuations can have a swift and
significant impact on the carrying value of these securities. As a result of
the increased holdings in securities classified as available-for-sale, and
thus carried at fair value, we expect to encounter larger adjustments in
shareholders' equity as market interest rates and other factors change.
UNPAID CLAIM AND CLAIM SETTLEMENT EXPENSES
Our unpaid claim and claim settlement expenses represent established,
undiscounted reserves for the estimated total unpaid cost of claim and claim
settlement expenses, which cover events that occurred in 1998 and prior
years. These reserves reflect our estimates of the total costs of claims that
were reported, but not yet paid, and the cost of claims incurred but not yet
reported (IBNR). For reported claims, we establish reserves on a "case"
basis. For IBNR claims, we estimate reserves using established actuarial
methods. Both our case and IBNR reserve estimates reflect such variables as
past claims experience, current claim trends and prevailing social, economic
and legal environments. Due to our commencing operations in 1992, we have
limited historical data to estimate our reserves for unpaid claim and claim
settlement expenses and accordingly supplement our experience with external
industry data, as adjusted, to reflect anticipated differences between our
results and the industry. We reduce the unpaid claim and claim settlement
expenses for estimated amounts of subrogation.
We believe our reserves for unpaid claim and claim settlement expenses
are adequate to cover the ultimate costs of claim and claim settlement
expenses. The ultimate cost of claim and claim settlement expenses may differ
from the established reserves, particularly when claims may not be settled
for many years. Reserves for unpaid claim and claim settlement expenses and
assumptions used in their development are continually reviewed. We record
adjustments to prior estimates of unpaid claim and claim settlement expenses
to operations in the year in which the adjustments are made. See Notes 1 and
5 of Notes to Consolidated Financial Statements.
18
<PAGE>
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
(000's):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
GROSS RESERVES FOR CLAIM AND CLAIM SETTLEMENT EXPENSES:
Gross reserves for claim and claim settlement expenses,
beginning of year $ 61,069 $ 49,256 $ 37,138
Provision increases (decreases) for claim and claim
settlement expenses:
Current year 78,520 60,265 49,440
Prior years 11,444 (4,394) (11,051)
-------- -------- --------
Total provision 89,964 55,871 38,389
Payments for claim and claim settlement expenses:
Current year 25,448 23,529 16,239
Prior years 28,316 20,529 10,032
-------- -------- --------
Total payments 53,764 44,058 26,271
-------- -------- --------
Gross reserves for claim and claim settlement expenses,
end of year $ 97,269 $ 61,069 $ 49,256
-------- -------- --------
-------- -------- --------
</TABLE>
The following table sets forth reserves on a net (after reinsurance) basis
(000's):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
NET RESERVES FOR CLAIM AND CLAIM SETTLEMENT EXPENSES:
Net reserves for claim and claim settlement expenses,
beginning of year $ 55,695 $ 43,073 $ 28,826
Provision increases (decreases) for claim and claim
settlement expenses:
Current year 64,268 58,675 47,155
Prior years 10,979 (3,085) (8,075)
-------- -------- --------
Total provision 75,247 55,590 39,080
Payments for claim and claim settlement expenses:
Current year 25,350 23,529 16,238
Prior years 27,737 19,439 8,595
-------- -------- --------
Total payments 53,087 42,968 24,833
-------- -------- --------
Net reserves for claim and claim settlement expenses,
end of year $ 77,855 $ 55,695 $ 43,073
-------- -------- --------
-------- -------- --------
</TABLE>
The 1998 net reserves for claim and claim settlement expenses shown in
the preceding table as determined under Generally Accepted Accounting
Principles (GAAP) were $3.3 million greater than the 1998 net reserves as
determined under statutory accounting principles (SAP). The difference arises
since SAP allows a reserves offset for retrospective reinsurance (see Results
of Operations -- Premiums ceded) while GAAP requires the offset to be recorded
prospectively over the life of the contract.
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 seven 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 current
and prior years (000's):
19
<PAGE>
<TABLE>
<CAPTION>
DECEMBER 31,
1998 1997 1996 1995 1994 1993 1992
--------- --------- --------- -------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
LOSS RESERVE DEVELOPMENT:
Gross reserves for unpaid claim
and claim settlement expenses $ 97,269 $ 61,069 $ 49,256 $37,138 $ 28,165 $ 13,279 $ 2,688
Deduct reinsurance recoveries 19,414 5,374 6,183 8,312 13,902 9,593 1,886
--------- --------- --------- ------- --------- --------- ---------
Net reserves for unpaid claim and
claim settlement expenses $ 77,855 $ 55,695 $ 43,073 $28,826 $ 14,263 $ 3,686 $ 802
--------- --------- --------- ------- --------- --------- ---------
--------- --------- --------- ------- --------- --------- ---------
Paid (cumulative) as of:
One year later $ 27,737 $ 19,439 $ 8,595 $ 4,639 $ 1,436 $ 583
Two years later 28,173 12,894 6,476 2,150 678
Three years later 15,521 7,863 2,348 815
Four years later 8,569 2,654 856
Five years later 2,816 925
Six years later 951
Reserves re-estimated as of:
End of year $ 77,855 $ 55,695 $ 43,073 $ 28,826 $ 14,263 $ 3,686 $ 802
One year later 66,674 39,988 20,751 12,789 3,784 1,075
Two years later 43,484 18,469 9,318 3,416 1,008
Three years later 19,796 8,984 2,782 950
Four years later 9,669 2,861 912
Five years later 2,972 949
Six years later 964
Initial reserves in excess
of (less than) re-estimated
reserves
Amount $ (10,979) $ (411) $ 9,030 $ 4,594 $ 714 $ (162)
Percent (19.7%) (1.0%) 31.3% 32.2% 19.4% (20.2%)
</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 seven-year period ended December 31,
1998. The total of each column details the amount of reserve re-estimates
made in the indicated calendar year and shows 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
(000's):
<TABLE>
<CAPTION>
CUMULATIVE
RE-ESTIMATES
FOR EACH
CALENDAR YEAR ACCIDENT
1998 1997 1996 1995 1994 1993 YEAR
-------- -------- -------- -------- -------- --------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
EFFECT OF RESERVE RE-ESTIMATES ON
CALENDAR YEAR OPERATIONS:
Accident Year:
1992 $ (15) $ (37) $ 38 $ 58 $ 67 $ (273) $ (162)
1993 (96) (42) 596 310 (165) 603
1994 (574) 413 2,837 1,106 3,782
1995 (642) 1,948 4,604 5,910
1996 (2,169) 803 (1,366)
1997 (7,483) (7,483)
-------- -------- -------- -------- -------- --------- ------------
Total $(10,979) $ 3,085 $ 8,075 $ 1,474 $ (98) $ (273) $ 1,284
-------- -------- -------- -------- -------- --------- ------------
-------- -------- -------- -------- -------- --------- -----------
</TABLE>
LIQUIDITY AND CAPITAL RESOURCES
Liquidity refers to our ability to generate sufficient cash flows to meet the
short- and long-term cash requirements of our operations. Capital resources
represent those funds deployed or available to be deployed to support our
business operations.
Our primary sources of cash from operations are premiums collected and
investment income. Our investment portfolio is also a source of liquidity,
through the sale of readily marketable fixed maturity investments, as well as
longer-term investments that have appreciated in value. Our primary cash
requirements consist of payments for (i) claim and claim settlement expenses,
(ii) policy acquisition costs, (iii) general and administrative expenses,
(iv)
20
<PAGE>
capital expenditures, (v) income taxes, and (vi) debt service or principal
repayment on our outstanding Senior Notes. We generate positive net cash from
operations due, in part, to timing differences between the receipt of
premiums and the payment of claim and claim settlement expenses. Cash
generated is either invested in short-term cash and cash equivalents or
longer-term available-for-sale securities pending future payments for such
expenses as indemnity, medical benefits and other operating expenses. Cash
and cash equivalents consist primarily of U. S. government 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 1998 was $9.8 million. This is
primarily a result of an increase of $36.2 million in unpaid claim and claim
settlement expenses which are non-cash accruals for future claims, offset by
an increase of $14.2 million in amounts due from reinsurers and our net loss
of $7.1 million. Net cash used in investing activities was $12.9 million,
primarily the result of purchases of $77.6 million of investments, $800,000
in purchases of furniture and equipment offset by proceeds from sales of
investments of $63.5 million and maturities of $2.0 million of investments.
Net cash used in financing activities was $2.0 million, primarily due to
payments totaling $2.5 million on outstanding Senior Notes in December 1998.
Our need for additional capital is primarily the result of regulations
that require certain ratios of capital to premiums written. In the future, we
expect that our need for additional capital will be primarily related to the
growth of our insurance subsidiary and the need to maintain appropriate
capital to premium ratios as defined by state regulatory bodies. As an
alternative to raising additional capital, we believe we could secure
quota-share or other additional reinsurance, which would have the effect of
reducing the ratio of premiums to capital, and could be used to satisfy state
regulatory requirements.
State insurance regulations limit distributions, including dividends,
from our insurance subsidiary to us. The maximum amount of dividends that can
be paid by ACIC to us in any year is equal to the greater 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 us in 1998, without regulatory approval, is
approximately $4.2 million. (See Note 9 of Notes to Consolidated Financial
Statements.) ACIC has never paid a dividend to us and we intend to retain
capital in the insurance subsidiary.
On September 15, 1998, our Board of Directors approved a share
repurchase program authorizing us to repurchase, from time to time, up to
$4,000,000 of RTW, Inc. common stock. We will repurchase the shares on the
open market or through private transactions depending upon market conditions
and availability. Through December 31, 1998 we had repurchased 19,500 shares
for approximately $87,000. The repurchased shares will be used for employee
stock option and purchase plans and other corporate purposes.
We believe that cash flow generated by our operations and our cash and
investment balances will be sufficient to fund continuing operations,
principal repayments and debt service on our outstanding Senior Notes,
including principal repayments of $2.5 million due in December 1999, and
capital expenditures for the next 12 months.
INTEREST RATE RISK
Our fixed maturity investments and notes payable are subject to interest rate
risk. Increases and decreases in prevailing interest rates generally
translate into decreases and increases in the fair value of these
instruments. Also, fair values of interest rate sensitive instruments may be
affected by the credit worthiness of the issuer, prepayment options, relative
values of alternative instruments, the liquidity of the instrument and other
general market conditions. We regularly evaluate interest rate risk in order
to evaluate the appropriateness of our investments.
An increase of 100 basis points in prevailing interest rates would
reduce the fair value of our interest rate sensitive instruments by
approximately $6.1 million.
The effect of interest rate risk on potential near-term fair value was
determined based on commonly used models. The models project the impact of
interest rate changes on factors such as duration, prepayments, put options
and call options. Fair value was determined based on the net present value of
cash flows or duration estimates, using a representative set of likely future
interest rate scenarios.
21
<PAGE>
IMPACT OF THE YEAR 2000 ON COMPUTER APPLICATIONS
The year 2000 is a critical year for computer applications. Historically,
many computer programs were written using two digits rather than four to
define the appropriate year. As a result, many computer programs that have
date sensitive fields may recognize a date using "00" as the year 1900 rather
than the year 2000. This could result in system failures or miscalculations
causing disruption of operations, including, among other things, a temporary
inability to process transactions, send invoices or engage in other critical
business activities.
Year 2000 readiness includes addressing information technology systems
(computer equipment, computer software, network hardware and software, etc.),
non-information technology systems (systems which include embedded technology
such as micro-controllers including telephone systems) and issues relating to
third parties with whom we have a material relationship (customers and
vendors).
INFORMATION TECHNOLOGY SYSTEMS: Our insurance subsidiary operations
began in 1992. After using third party software and services for several
years, we developed our own internal computer systems to manage our claims
and related claim settlement expenses (1996) and administer our policy
information (1995). These computer systems are year 2000 compliant.
Additionally, during the second quarter of 1998 we implemented third-party
provided general ledger and accounts payable software, which is year 2000
compliant. Also, we are in the process of internally developing a billing and
cash receipt system to be completed by the first quarter of 1999, which will
be year 2000 compliant. These system replacements and software developments
are occurring as a part of our ongoing operations and are not specifically
occurring as a result of the year 2000 issue. We anticipate that our critical
computer hardware and software systems will be fully year 2000 compliant in
early 1999 and non-critical hardware and software systems will be compliant
during the second quarter of 1999. The cost of any hardware and software
changes required to comply with the year 2000, other than those contemplated
as routine upgrades in our operations, are not expected to have a material
adverse effect on our results of operations.
NON-INFORMATION TECHNOLOGY SYSTEMS: We have reviewed our operationally
critical non-information technology systems (non-IT systems) which may have
embedded technology that is reliant on the year 2000. We have developed a
formal plan to address any non-IT system year 2000 issues. We expect that our
non-IT systems will be fully year 2000 compliant by the end of the second
quarter of 1999. We are currently unable to determine the ultimate costs
relating to non-information technology systems.
THIRD PARTY READINESS: We have taken steps to ensure that our
significant customers and vendors are year 2000 compliant through surveys and
further information requests. We have received preliminary information from
our critical vendors and anticipate follow-up based on information received
through mid-1999 until we are comfortable that our vendors are year 2000
compliant.
We are reviewing and updating our year 2000 business contingency plan
that will address any year 2000 risks we identify. We expect completion of
this plan during the second quarter of 1999.
NAIC RISK-BASED CAPITAL STANDARDS
The National Association of Insurance Commissioners (NAIC) has risk-based
capital standards to determine the capital requirements of a property and
casualty insurance carrier based upon the risks inherent in its operations.
These 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, our percent of total adjusted capital is substantially in excess
of authorized control level risk-based capital.
REGULATION
Our insurance subsidiary is subject to substantial regulation by governmental
agencies in the states in which we operate, and will be subject to such
regulation in any state in which we provide workers' compensation products
and services in the future. State regulatory agencies have broad
administrative power with respect to all aspects of our business, 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. At December
31, 1998, our insurance subsidiary was licensed to do business in Minnesota,
South Dakota, Wisconsin, Colorado, Missouri, Illinois, Kansas, Michigan,
22
<PAGE>
Indiana, Massachusetts, Connecticut, Rhode Island, Pennsylvania, Tennessee,
Maryland, Arkansas, Iowa and Florida.
In March 1998, the National Association of Insurance Commissioners
adopted the Codification of Statutory Accounting Principles (Codification).
The Codification, which is intended to standardize regulatory accounting and
reporting for the insurance industry, is proposed to be effective January 1,
2001. However, statutory accounting principles will continue to be
established by individual state laws and permitted practices and it is
uncertain when, or if, the state of Minnesota will require adoption of
Codification for preparing statutory financial statements. We have not
quantified the effect Codification may have on our statutory financial
statements.
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 our actual results and could cause our actual
financial performance to differ materially from that expressed in any
forward-looking statement: (i) our ability to manage both our existing claims
and our new claims in an effective manner, (ii) competition from traditional
workers' compensation insurance carriers, (iii) our ability to further
penetrate our existing markets, (iv) changes in workers' compensation
regulation by states, including changes in mandated benefits or insurance
company regulation, (v) our ability to retain our existing customers at
favorable beneficial premium rates when their policies renew (vi) our ability
to successfully introduce new products and services, and (vii) our ability to
ensure that our operations are not adversely affected by year 2000 compliance
including our dependence on outside vendors and customers and their ability
to become year 2000 compliant. This discussion of uncertainties is by no
means exhaustive but is designed to highlight important factors that may
impact our future performance.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Information with respect to Disclosures about Market Risk is contained in the
Section entitled "Management's Discussion and Analysis of Financial Condition
and Results of Operations" under Item 7 of this Report of Form 10-K and is
incorporated herein by reference.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
FINANCIAL STATEMENTS Page
<S> <C>
Independent Auditors' Report 24
Consolidated Balance Sheets - December 31, 1998 and 1997 25
Consolidated Statements of Operations - Years Ended December 31, 1998, 1997 and 1996 26
Consolidated Statements of Shareholders' Equity - Years Ended December 31, 1998, 1997 and 1996 27
Consolidated Statements of Cash Flows - Years Ended December 31, 1998, 1997 and 1996 28
Notes to Consolidated Financial Statements - Years Ended December 31, 1998, 1997 and 1996 29
</TABLE>
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, 1998 and 1997, and the
related consolidated statements of operations, shareholders' equity, and cash
flows for each of the three years in the period ended December 31, 1998.
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
consolidated 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, 1998 and 1997, and the results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1998, in conformity with generally accepted accounting
principles.
/s/ DELOITTE & TOUCHE LLP
Minneapolis, Minnesota
February 1, 1999
24
<PAGE>
RTW, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1998 AND 1997
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
ASSETS
Investments at fair value, amortized cost of $123,924 and $110,880 $ 126,631 $ 112,294
Cash and cash equivalents 700 5,798
Accrued investment income 1,761 1,836
Premiums receivable, less allowance of $417 and $182 6,554 5,763
Reinsurance recoverables:
On unpaid claim and claim settlement expenses 19,414 5,374
On paid claim and claim settlement expenses 867 743
Deferred policy acquisition costs 1,501 1,559
Furniture and equipment, net 4,565 4,927
Other assets 8,952 4,703
----------- -----------
Total assets $ 170,945 $ 142,997
----------- -----------
----------- -----------
LIABILITIES AND SHAREHOLDERS' EQUITY
Unpaid claim and claim settlement expenses $ 97,269 $ 61,069
Unearned premiums 13,027 13,580
Accrued expenses and other liabilities 5,570 5,116
Notes payable 2,461 4,875
----------- -----------
Total liabilities 118,327 84,640
Shareholders' equity:
Common stock, no par value; authorized 25,000,000 shares;
issued and outstanding 11,935,000 and 11,841,000 shares 29,451 28,976
Retained earnings 21,408 28,489
Accumulated other comprehensive income 1,759 892
----------- -----------
Total shareholders' equity 52,618 58,357
----------- -----------
Total liabilities and shareholders' equity $ 170,945 $ 142,997
----------- -----------
----------- -----------
</TABLE>
See notes to consolidated financial statements.
25
<PAGE>
RTW, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Revenues:
Gross premiums earned $ 89,881 $ 81,385 $ 63,755
Premiums ceded (8,489) (342) (697)
----------- ----------- -----------
Premiums earned 81,392 81,043 63,058
Investment income 7,714 6,821 5,667
Net realized investment gains 1,046 399 -
----------- ----------- -----------
Total revenues 90,152 88,263 68,725
Expenses:
Claim and claim settlement expenses 75,294 55,543 39,080
Policy acquisition costs 13,974 11,658 6,327
General and administrative expenses 11,369 11,616 8,510
----------- ----------- -----------
Total expenses 100,637 78,817 53,917
----------- ----------- -----------
Income (loss) from operations (10,485) 9,446 14,808
Interest expense 546 777 1,086
----------- ----------- -----------
Income (loss) before income taxes (11,031) 8,669 13,722
Income tax expense (benefit) (3,950) 2,870 4,740
----------- ----------- -----------
Net income (loss) $ (7,081) $ 5,799 $ 8,982
----------- ----------- -----------
----------- ----------- -----------
Income (loss) per share:
Basic income (loss) per share $ (0.59) $ 0.49 $ 0.76
----------- ----------- -----------
----------- ----------- -----------
Diluted income (loss) per share $ (0.59) $ 0.48 $ 0.74
----------- ----------- -----------
----------- ----------- -----------
Weighted average shares outstanding:
Basic shares outstanding 11,927,000 11,833,000 11,774,000
----------- ----------- -----------
----------- ----------- -----------
Diluted shares outstanding 11,927,000 12,079,000 12,137,000
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
See notes to consolidated financial statements.
26
<PAGE>
RTW, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(IN THOUSANDS)
<TABLE>
<CAPTION>
ACCUMULATED
OTHER TOTAL
COMMON COMPREHENSIVE RETAINED COMPREHENSIVE SHAREHOLDERS'
STOCK INCOME EARNINGS INCOME EQUITY
---------- ------------- ---------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Balance at January 1, 1996 $ 27,606 $ 13,708 $ 124 $ 41,438
Comprehensive income:
Net income - $ 8,982 8,982 - 8,982
Other comprehensive income, net of tax:
Unrealized investment losses - (113) (113) (113)
-------------
Comprehensive income $ 8,869
-------------
-------------
Non-qualified stock options exercised 608 - - 608
Incentive 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
Comprehensive income:
Net income - $ 5,799 5,799 - 5,799
Other comprehensive income, net of tax:
Unrealized investment gains - 881 - 881 881
-------------
Comprehensive income $ 6,680
-------------
-------------
Incentive stock options exercised 1 - - 1
Issuance of non-qualified options 96 - - 96
Issuance of shares to ESOP 115 - - 115
Issuance of shares under ESPP 154 - - 154
---------- ---------- ------------- -------------
Balance at December 31, 1997 28,976 28,489 892 58,357
Comprehensive loss:
Net loss - $ (7,081) (7,081) - (7,081)
Other comprehensive income, net of tax:
Unrealized investment gains - 867 - 867 867
-------------
Comprehensive loss $ (6,214)
-------------
-------------
Non-qualified stock options exercised 167 - - 167
Incentive stock options exercised 166 - - 166
Issuance of common shares 30 - - 30
Issuance of shares under ESPP 199 - - 199
Retirement of common stock (87) - - (87)
---------- ---------- ------------- -------------
Balance at December 31, 1998 $ 29,451 $ 21,408 $ 1,759 $ 52,618
---------- ---------- ------------- -------------
---------- ---------- ------------- -------------
</TABLE>
See notes to consolidated financial statements.
27
<PAGE>
RTW, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(IN THOUSANDS)
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- ---------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) $ (7,081) $ 5,799 $ 8,982
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Net realized investment gains (1,046) (399) -
Depreciation and amortization 1,341 1,237 1,071
Deferred income taxes (2,239) (715) (767)
Changes in assets and liabilities:
Amounts due from reinsurers (14,164) 2,621 1,143
Unpaid claim and claim settlement expenses 36,200 11,813 12,118
Unearned premiums, net of premiums receivable (1,344) (1,015) 2,129
Other, net (1,849) 1,032 (1,540)
-------- -------- ---------
Net cash provided by operating activities 9,818 20,373 23,136
Cash flows from investing activities:
Maturities of investments 2,000 2,500 3,500
Purchases of available-for-sale investments (77,594) (62,403) (25,273)
Proceeds from sales of available-for-sale investments 63,522 39,095 -
Purchases of furniture and equipment (819) (2,447) (2,047)
-------- -------- ---------
Net cash used in investing activities (12,891) (23,255) (23,820)
Cash flows from financing activities:
Payments on notes payable (2,500) (2,000) (2,362)
Stock options and warrants exercised 333 1 130
Issuance of common stock to ESOP - 115 236
Issuance of common stock under ESPP 199 154 129
Issuance of common stock 30 - -
Retirement of common stock (87) - (1)
-------- -------- ---------
Net cash used in financing activities (2,025) (1,730) (1,868)
-------- -------- ---------
Net decrease in cash and cash equivalents (5,098) (4,612) (2,552)
Cash and cash equivalents at beginning of year 5,798 10,410 12,962
-------- -------- ---------
Cash and cash equivalents at end of year $ 700 $ 5,798 $ 10,410
-------- -------- ---------
-------- -------- ---------
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest $ 546 $ 664 $ 898
-------- -------- ---------
-------- -------- ---------
Income taxes $ 488 $ 3,536 $ 6,338
-------- -------- ---------
-------- -------- ---------
</TABLE>
See notes to consolidated financial statements.
28
<PAGE>
RTW, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION - RTW, Inc. (RTW) provides workers' compensation insurance
coverage to employers through its wholly owned insurance subsidiary, American
Compensation Insurance Company (ACIC). Collectively, "we," "our" and "us"
will refer to these entities in these "Notes to Consolidated Financial
Statements."
We benefit from our ability to reduce workers' compensation costs and
provide employers the ability to control their workers' compensation
programs. We are domiciled in Minnesota and were licensed in Minnesota,
Colorado, Missouri, Michigan, Massachusetts, Illinois, Kansas, Connecticut,
Wisconsin, Rhode Island, Florida, Iowa, Indiana, Arkansas, Pennsylvania,
Tennessee, South Dakota and Maryland at December 31, 1998. We wrote policies
primarily in Minnesota, Colorado, Missouri, Illinois, Kansas, Michigan,
Massachusetts, Connecticut and Wisconsin during 1998. We also received our
license to write workers' compensation insurance coverage for companies
covered under the Longshoreman's Act in 1997.
The following explain the accounting policies we use to arrive at some
of the more significant amounts in our financial statements.
ACCOUNTING PRINCIPLES - We prepare our financial statements in accordance
with Generally Accepted Accounting Principles (GAAP).
CONSOLIDATION - Our consolidated financial statements include RTW and ACIC.
We eliminate all intercompany accounts and transactions in consolidation.
USE OF ESTIMATES - We make estimates and assumptions that affect the reported
amounts of assets and liabilities, the disclosure of contingent assets and
liabilities at the financial statement date and the recorded amounts of
revenues and expenses during the reporting period. Our most significant
estimates are those relating to our unpaid claim and claim settlement
expenses and accrual for premium adjustments. We continually review our
estimates and assumptions and make adjustments as necessary, but actual
results could vary significantly from what we envisioned when we made these
estimates.
INVESTMENTS - We invest entirely in fixed maturity investments and classify
our investments as available-for-sale in accordance with Statement of
Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain
Investments in Debt and Equity Securities."
AVAILABLE-FOR-SALE INVESTMENTS: We intend to hold our available-for-sale
investments to maturity, but may sell before maturity in response to changes
in interest rates, prepayment risk and funding sources or terms, or to
address liquidity needs. Our available-for-sale investments are carried at
fair value with unrealized gains or losses, net of deferred taxes, reported
as other comprehensive income. The fair values of our investments are
determined based upon quoted market prices as obtained through commercial
pricing services or brokers who provide estimated fair values. In December
1997, we reclassified our entire held-to-maturity portfolio, invested in U.S.
government securities with a historical cost, net of amortization of $53.8
million and a fair value of $54.7 million, to available-for-sale investments.
We reclassified these securities to enable us to more actively manage our
investment yield and overall portfolio risk.
REALIZED INVESTMENT GAINS AND LOSSES: Net realized investment gains are
identified separately in our Consolidated Statements of Operations. Cost of
investments sold is determined by the specific identification method.
We continually monitor the difference between investment cost and fair
value for each of our securities. If any security experienced a decline in
value that is determined to be other than temporary, we would reduce the
security's carrying value for the decline and record a realized loss in the
Consolidated Statements of Operations. No securities were reduced for
declines in fair value in 1998 or 1997.
CASH AND CASH EQUIVALENTS - We generally consider all highly liquid
investments with a maturity of three months or less when purchased to be cash
equivalents.
DEFERRED POLICY ACQUISITION COSTS - The costs directly related to writing an
insurance policy are referred to as policy acquisition costs and consist of
commissions, state premium taxes and other direct underwriting expenses.
29
<PAGE>
Although these costs arise when we issue a policy, we defer certain costs,
principally commissions and state premium taxes, and amortize these costs to
expense as premium revenue is recognized.
If deferred policy acquisition costs were to exceed the sum of unearned
premiums and related anticipated investment income less expected claim and
claim settlement expenses, we would immediately expense the excess costs.
DEPRECIATION - We depreciate furniture and equipment on a straight-line basis
over the estimated useful lives of the assets (five to ten years).
Accumulated depreciation in 1998 and 1997 was $2,951,000 and $2,309,000,
respectively.
UNPAID CLAIM AND CLAIM SETTLEMENT EXPENSES - Claim expenses refer to amounts
that we paid or expect to pay to claimants for events that have occurred. The
costs of investigating, resolving and processing these claims are referred to
as claim settlement expenses. We record these expenses, net of amounts
recoverable under reinsurance contracts, to "Claim and claim settlement
expenses" in the Consolidated Statements of Operations.
Our "Unpaid claim and claim settlement expenses" represent established,
undiscounted reserves for the estimated total unpaid cost of claim and claim
settlement expenses that cover events that occurred in 1998 and prior years.
These reserves reflect our estimates of the total costs of claims that were
reported, but not yet paid, and the cost of claims incurred but not yet
reported. Our estimates consider such variables as past loss experience,
current claim trends and prevailing social, economic and legal environments.
We have limited historical data to estimate our reserves for unpaid claim and
claim settlement expenses due to commencing operations in 1992 and supplement
our experience with external industry data, as adjusted to reflect
anticipated differences between our results and the industry. We reduce the
unpaid claim and claim settlement expenses for estimated amounts of
subrogation.
We believe our reserves for unpaid claim and claim settlement expenses
are adequate to cover the ultimate costs of claim and claim settlement
expenses. The ultimate cost of claim and claim settlement expenses may differ
from the established reserves, particularly when claims may not be settled
for many years. Reserves for unpaid claim and claim settlement expenses and
assumptions used in their development are continually reviewed. We record
adjustments to prior estimates of unpaid claim and claim settlement expenses
to operations in the year in which the adjustments are made.
DEBT ISSUE COSTS - We report debt issue costs associated with the Senior
Notes payable as a reduction in notes payable and amortize the cost over the
term of the Senior Notes.
PREMIUMS EARNED - Premiums on workers' compensation insurance policies are
our largest source of revenue. We record premiums written on an installment
basis matching billing to the policyholder and earn premiums on a daily basis
over the life of each insurance policy. Premiums earned include an estimate
for earned but unbilled audit premiums. We record the excess of premiums
billed over premiums earned for each policy as unearned premiums on our
balance sheet.
RECLASSIFICATIONS - Certain 1997 and 1996 amounts have been reclassified to
conform to the consolidated financial statement presentation in 1998.
NOTE 2 - INCOME (LOSS) PER SHARE
Effective December 1997, we adopted SFAS No. 128, "Earnings Per Share." SFAS
No. 128 requires dual presentation of a basic income (loss) per share (IPS),
which excludes dilution, and a diluted IPS, which reflects the potential
dilution that could occur if actions taken with respect to dilutive
securities resulted in the issuance of common stock. Dilutive securities
consist of stock options and warrants. Basic IPS is computed by dividing net
income (loss) by the weighted average number of common shares outstanding for
the period. Diluted IPS is computed by dividing net income (loss) by the
weighted average number of common shares and dilutive securities outstanding
for the period. Dilutive securities issued after April 1995 are considered
outstanding from the date of grant after applying the treasury stock method
for determining the dilutive effect. Dilutive securities issued prior to that
date are considered outstanding for all periods after applying the treasury
stock method for determining the dilutive effect.
30
<PAGE>
The following is a reconciliation of the numerators and denominators of basic
and diluted income (loss) per share:
<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Net income (loss) (000's) $ (7,081) $ 5,799 $ 8,982
------------ ------------ ------------
------------ ------------ ------------
Basic weighted average shares outstanding 11,927,000 11,833,000 11,774,000
Effect of dilutive securities
Warrants - - 4,000
Stock options - 246,000 359,000
------------ ------------ ------------
Diluted weighted average shares outstanding 11,927,000 12,079,000 12,137,000
------------ ------------ ------------
------------ ------------ ------------
Basic income (loss) per share $ (0.59) $ 0.49 $ 0.76
------------ ------------ ------------
------------ ------------ ------------
Diluted income (loss) per share $ (0.59) $ 0.48 $ 0.74
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
Options to purchase 1,894,811 shares of common stock at prices ranging from
$2.00 to $28.75 were outstanding during 1998 but were not included in the
computation of diluted IPS due to our net loss. Diluted weighted average
shares outstanding would have increased by 219,000 shares had these shares
not been antidilutive in the computation. These options were still
outstanding at the end of 1998.
NOTE 3 - INVESTMENTS
VALUATION OF INVESTMENTS - The following tables present amortized cost, gross
unrealized gains and losses and estimated fair values of investments (000's):
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
1998 Cost Gains Losses Value
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Available-for-sale securities:
U.S. government securities $ 14,141 $ 436 $ (2) $ 14,575
Tax-exempt municipal securities 65,273 1,369 (6) 66,636
Corporate securities 20,941 562 (9) 21,494
Asset-backed securities 4,499 104 - 4,603
Mortgage-backed securities 19,070 288 (35) 19,323
----------- ----------- ----------- -----------
Total investments $ 123,924 $ 2,759 $ (52) $ 126,631
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
</TABLE>
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
1997 Cost Gains Losses Value
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Available-for-sale securities:
U.S. government securities $ 66,916 $ 1,345 $ (18) $ 68,243
Corporate securities 22,582 355 (428) 22,509
Asset-backed securities 6,997 44 - 7,041
Mortgage-backed securities 14,385 120 (4) 14,501
----------- ----------- ----------- -----------
Total investments $ 110,880 $ 1,864 $ (450) $ 112,294
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
</TABLE>
STATUTORY DEPOSITS - Included in investments are U.S. government securities
on deposit with various regulatory authorities as required by law with a fair
value of $2,931,000 and $2,828,000 in 1998 and 1997, respectively.
FIXED MATURITIES BY MATURITY DATE - The following table presents the
amortized cost and fair value of investments by contractual maturity in 1998.
Actual maturities may differ from those stated as a result of calls and
prepayments (000's):
<TABLE>
<CAPTION>
ESTIMATED
AMORTIZED FAIR
MATURING: COST VALUE
- --------- ----------- -----------
<S> <C> <C>
One year or less $ 4,099 $ 4,119
Over one year through five years 18,724 19,169
Over five years through ten years 64,469 66,112
Over ten years 17,562 17,908
Mortgage-backed securities with various maturities 19,070 19,323
----------- -----------
Total investments $ 123,924 $ 126,631
----------- -----------
----------- -----------
</TABLE>
31
<PAGE>
INVESTMENT INCOME - Investment income includes income from the following
sources (000's):
<TABLE>
<CAPTION>
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Fixed maturity investments $ 6,995 $ 6,129 $ 5,004
Short-term investments 506 692 663
Other 213 - -
----------- ----------- -----------
Investment income $ 7,714 $ 6,821 $ 5,667
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
NET REALIZED INVESTMENT GAINS - Net realized investment gains includes gross
realized investment gains net of gross unrealized investment losses as
follows (000's):
<TABLE>
<CAPTION>
1998 1997 1996
----------- ----------- ---------
<S> <C> <C> <C>
Realized investment gains $ 1,591 $ 479 $ -
Realized investment losses (545) (80) -
----------- ----------- ---------
Net realized investment gains $ 1,046 $ 399 $ -
----------- ----------- ---------
----------- ----------- ---------
</TABLE>
NOTE 4 - REINSURANCE
Our financial statements reflect the effects of ceded reinsurance
transactions. The primary purpose of ceded reinsurance is to protect us from
potential losses in excess of the level that we are willing to accept.
We report reinsurance transactions on a "gross" basis on the balance
sheet, resulting in reinsurance recoverable amounts on paid and unpaid claim
and claim settlement expenses recorded as assets. We estimate amounts
recoverable from reinsurers in a manner consistent with the claim liability
associated with the reinsured policy.
We ceded Minnesota claims in excess of $280,000, $1,080,000 and
$1,040,000 per occurrence during 1998, 1997 and 1996, respectively, to the
Minnesota Workers' Compensation Reinsurance Association. Non-Minnesota state
claims in excess of $500,000 were ceded to various reinsurers in 1998, 1997
and 1996. Additionally, for claims occurring on or after July 1, 1998, we
further limited our per incident exposure by purchasing excess of loss
coverage for losses from $25,000 to $280,000 in Minnesota and from $25,000 to
$300,000 in other states from a single reinsurer. This agreement was
finalized after its effective date. As a result, activity occurring from July
1, 1998 through October 1, 1998 has been recorded on a retroactive basis
resulting in the deferral of a gain totaling $1,990,000. Activity occurring
on or after October 1, 1998 has been recorded prospectively. This gain will
be amortized into income in future years using the effective interest rate
inherent in the amounts paid to the reinsurer and the estimated timing and
amounts of recoveries from the reinsurer.
Reinsurance contracts do not relieve us from our obligations to
policyholders. We expect reinsurers to which we have ceded reinsurance to
honor their obligations. Failure of these reinsurers to honor their
obligations could result in losses to us. We do not anticipate any such
losses and accordingly, no provision for amounts deemed uncollectible are
included in our financial statements. We attempt to minimize our exposure to
significant losses from reinsurer insolvency by monitoring the financial
condition of our reinsurers. The reinsurance recoverable on unpaid claim and
claim settlement expenses associated with reinsurers are as follows (000's):
<TABLE>
<CAPTION>
1998 1997
--------- ----------
<S> <C> <C>
Excess of loss reinsurance through various reinsurers $ 18,788 $ 4,651
Quota-share reinsurance for 1992 to 1994 through a single reinsurer 626 723
--------- ----------
Reinsurance recoverable on unpaid claim and claim settlement expenses $ 19,414 $ 5,374
--------- ----------
--------- ----------
</TABLE>
The effect of ceded reinsurance on premiums written, premiums earned and
claim and claim settlement expenses are as follows (000's):
<TABLE>
<CAPTION>
1998 1997 1996
---------- --------- ----------
<S> <C> <C> <C>
Premiums written:
Direct $ 89,328 $ 81,657 $ 67,457
Ceded (8,489) (342) (697)
---------- --------- ----------
Net premiums written $ 80,839 $ 81,315 $ 66,760
---------- --------- ----------
---------- --------- ----------
</TABLE>
32
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C>
Claim and claim settlement expenses:
Direct $ 90,011 $ 55,825 $ 38,389
Ceded (14,717) (282) 691
---------- --------- ----------
Net claim and claim settlement expenses $ 75,294 $ 55,543 $ 39,080
---------- --------- ----------
---------- --------- ----------
</TABLE>
The reinsurance recoverable on paid claim and claim settlement expenses
consists solely of receivables from paid claim and claim settlement expenses
at December 31, 1998 and 1997.
Ceding commissions earned, which is based upon final settlement of claim
and claim settlement expenses, will range between 10% and 48% during accident
years 1994 and 1993 and between 15% and 25% during accident year 1992. Ceding
commissions earned of $1,871,000 for fiscal year 1996 is reported as a
reduction in policy acquisition costs in the Consolidated Statements of
Operations.
NOTE 5 - UNPAID CLAIM AND CLAIM SETTLEMENT EXPENSES
The following table represents a reconciliation of beginning and ending
unpaid claim and claim settlement expense reserves for each of the last three
years (000's):
<TABLE>
<CAPTION>
1998 1997 1996
---------- --------- ----------
<S> <C> <C> <C>
Balance at January 1 $ 61,069 $ 49,256 $ 37,138
Less reinsurance recoverables 5,374 6,183 8,312
---------- --------- ----------
Net balance at January 1 55,695 43,073 28,826
Incurred related to:
Current year 64,268 58,675 47,155
Prior years 10,979 (3,085) (8,075)
---------- --------- ----------
Total incurred 75,247 55,590 39,080
Paid related to:
Current year 25,350 23,529 16,238
Prior years 27,737 19,439 8,595
---------- --------- ----------
Total paid 53,087 42,968 24,833
---------- --------- ----------
Net balance at December 31 77,855 55,695 43,073
Plus reinsurance recoverables 19,414 5,374 6,183
---------- --------- ----------
Balance at December 31 $ 97,269 $ 61,069 $ 49,256
---------- --------- ----------
---------- --------- ----------
</TABLE>
Changes in estimates of unpaid claim and claim settlement expenses for
prior years increased the provision for claim and claim settlement expenses
by $10,979,000 in 1998 and decreased the provision for claim and claim
settlement expenses by $3,085,000 and $8,075,000 in 1997 and 1996,
respectively.
NOTE 6 - NOTES PAYABLE
Unsecured notes payable of RTW consist of Senior Notes payable with principal
maturities and monthly interest due as follows (000's):
<TABLE>
<CAPTION>
Maturity Interest Rate 1998 1997
- ---------------------- ------------- -------- ---------
<S> <C> <C> <C>
December 15, 1998 9.25% $ 2,500
December 15, 1999 9.50% $ 2,500 2,500
-------- ---------
Notes payable - Principal 2,500 5,000
Less: Unamortized debt issue cost (39) (125)
-------- ---------
Notes payable $ 2,461 $ 4,875
-------- ---------
-------- ---------
</TABLE>
We may 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 of 1%.
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 incurring additional
indebtedness or paying dividends or other distributions to shareholders. At
December 31, 1998, we were in compliance with these covenants.
33
<PAGE>
Based on borrowing rates currently available to us for loans with
similar terms and average maturities (prime at December 31, 1998 and 1997 was
7.75% and 8.50%, respectively), the fair value of notes payable was
approximately $2,556,000 and $5,116,000 at December 31, 1998 and 1997,
respectively.
NOTE 7 - INCOME TAXES
We compute income taxes under the liability method. This means deferred
income taxes reflect the estimated future tax effects of temporary
differences between the carrying value of assets and liabilities for
financial reporting purposes and the carrying value of assets and liabilities
for income tax purposes.
Income tax expense (benefit) consists of the following (000's):
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- ---------
<S> <C> <C> <C>
Current:
Federal $ (1,568) $ 3,714 $ 5,165
State (143) (129) 342
-------- -------- ---------
Total current tax expense (benefit) (1,711) 3,585 5,507
Deferred:
Federal (2,218) (721) (650)
State (21) 6 (117)
-------- -------- ---------
Total deferred tax benefit (2,239) (715) (767)
-------- -------- ---------
Income tax expense (benefit) $ (3,950) $ 2,870 $ 4,740
-------- -------- ---------
-------- -------- ---------
</TABLE>
Our income tax expense (benefit) differs from the federal statutory rate as
follows (000's):
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- ---------
<S> <C> <C> <C>
Federal income tax expense (benefit) at 35% $ (3,861) $ 3,034 $ 4,803
Increase (reduction) in income tax expense (benefit) resulting from:
State income taxes, net of federal income tax benefit 8 (64) 126
Tax-exempt investment income (486) - -
Prior year tax return adjustments 301 - -
Other 88 (100) (189)
-------- -------- ---------
Income tax expense (benefit) $ (3,950) $ 2,870 $ 4,740
-------- -------- ---------
-------- -------- ---------
</TABLE>
Differences between the tax basis of assets and liabilities and their
reported amounts in the Consolidated Financial Statements that will result in
taxable or deductible amounts in future years are called temporary
differences. The tax effects of temporary differences that gave rise to net
deferred tax asset balances, included within other assets, are as follows
(000's):
<TABLE>
<CAPTION>
1998 1997
-------- ---------
<S> <C> <C>
Unpaid claim and claim settlement expenses $ 4,709 $ 3,512
Unearned premiums 912 1,002
Accrued second injury funds 918 -
Other 383 202
-------- ---------
Deferred tax assets 6,922 4,716
Deferred policy acquisition costs (525) (575)
Unrealized gain on securities (948) (522)
Depreciation (464) (447)
-------- ---------
Deferred tax liabilities (1,937) (1,544)
-------- ---------
Net deferred tax assets $ 4,985 $ 3,172
-------- ---------
-------- ---------
</TABLE>
No valuation allowance was provided against the deferred tax assets
recorded in 1998 or 1997, as we expect to generate sufficient taxable income
in the future to offset reversing temporary differences.
Income taxes receivable at December 31, 1998 and 1997 were approximately
$3,289,000 and $1,011,000, respectively.
34
<PAGE>
NOTE 8 - EMPLOYEE BENEFITS AND PLANS
STOCK BASED COMPENSATION - We account for our stock-based compensation plans,
the RTW, Inc. 1995 Employee Stock Purchase Plan and Trust (ESPP) and the 1994
Stock Plan, using Accounting Principles Board Opinion No. 25 (APB 25),
"Accounting for Stock Issued to Employees," and related Interpretations.
Under APB 25, compensation cost for stock options is measured as the excess,
if any, of the quoted market price of our stock at the date of the grant over
the amount an employee must pay to acquire the stock.
1995 EMPLOYEE STOCK PURCHASE PLAN - The ESPP provides employees the
opportunity to purchase shares of our stock at 85% of the fair value based on
the lesser of the beginning or ending share price for each plan year as set
forth in the plan. In May 1998, the shares reserved for distribution under
the plan were increased from 75,000 to 200,000 shares. 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 of Directors. Any employee completing
two weeks of service prior to commencing a phase of the plan may participate.
Employees may elect to contribute from $10 to 10% of monthly salary to the
plan through payroll withholdings. The following summarizes shares purchased
and purchase prices for each phase completed through 1998:
<TABLE>
<CAPTION>
SHARES PURCHASE
PURCHASED PRICE
--------- --------
<S> <C> <C>
Phase:
Beginning April 1995, expiring April 1996 14,891 $8.67
Beginning April 1996, expiring April 1997 20,092 $7.65
Beginning April 1997, expiring April 1998 28,139 $7.07
</TABLE>
The fourth one-year phase began in April 1998 and expires in April 1999.
Our liability for employee contributions withheld at December 31, 1998 and
1997 for the purchase of shares in April 1999 and April 1998 under the ESPP
was $158,000 and $202,000, respectively.
1994 STOCK PLAN - The 1994 Stock Plan provides for awards of incentive and
non-qualified stock options. In January 1997 the shares reserved for
distribution under the plan were increased to 1,500,000. In July 1998, the
Board of Directors increased the shares reserved for distribution under the
plan to 2,000,000 subject to shareholder approval in May 1999. If shareholder
approval is not obtained, option grants will be revoked to the extent they
exceed shares currently available under the plan. Option price, option 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 exercise price for all options granted was the market price of
the common stock at the date of grant.
Options granted, exercised, canceled and outstanding under the 1994 Stock
Plan are as follows:
<TABLE>
<CAPTION>
QUALIFIED NON-QUALIFIED
---------------------- ---------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
OPTION EXERCISE OPTION EXERCISE
SHARES PRICE SHARES PRICE
--------- -------- ------- --------
<S> <C> <C> <C> <C>
Balance, January 1, 1996: 160,575 $8.06 3,750 $2.67
Granted 60,000 21.13 - -
Exercised (2,400) 8.67 - -
Canceled (300) 8.67 - -
--------- -------- ------- --------
Balance, December 31, 1996 217,875 8.34 3,750 2.67
Granted 112,500 10.68 510,000 6.93
Exercised (150) 8.67 - -
Canceled (10,975) 18.10 - -
--------- -------- ------- --------
Balance, December 31, 1997 319,250 10.21 513,750 6.90
Granted 974,122 6.53 - -
Exercised (37,650) 2.69 - -
Canceled (151,806) 12.22 (42,855) 6.75
--------- -------- ------- --------
Balance, December 31, 1998 1,103,916 $6.94 470,895 $6.91
--------- -------- ------- --------
--------- -------- ------- --------
</TABLE>
35
<PAGE>
Each of the qualified options expire ten years from the date of grant,
subject to continued employment with us. Each of the non-qualified options
expire ten years from the date of grant. Certain of the options are subject
to vesting provisions that restrict exercise of the option.
The following table summarizes the options outstanding and exercisable in
1999:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------- ---------------------
WEIGHTED AVERAGE WEIGHTED
NUMBER ----------------------- NUMBER AVERAGE
OF CONTRACTUAL EXERCISE OF EXERCISE
EXERCISE PRICE RANGE OPTIONS LIFE PRICE OPTIONS PRICE
- -------------------------- --------- ----------- -------- ------- --------
<S> <C> <C> <C> <C> <C>
Qualified options:
$ 2.67 - $ 9.00 1,036,166 9.2 years $6.49 95,785 $6.99
10.75 - 19.33 57,750 8.0 years 11.65 12,900 12.33
22.88 - 28.75 10,000 7.6 years 26.14 4,000 26.14
------------------ --------- ----------- -------- ------- -----
$ 2.67 - $ 28.75 1,103,916 9.1 years $6.94 112,685 $8.28
------------------ --------- ----------- -------- ------- -----
------------------ --------- ----------- -------- ------- -----
Non-qualified options:
$ 2.67 3,750 5.8 years $2.67 3,750 $2.67
$ 6.75 - 15.88 467,145 8.9 years 6.95 245,715 8.87
------------------ --------- ----------- -------- ------- -----
$ 2.67 - $ 15.88 470,895 8.9 years $6.91 249,465 $8.82
------------------ --------- ----------- -------- ------- -----
------------------ --------- ----------- -------- ------- -----
</TABLE>
NON-QUALIFIED COMMON STOCK OPTIONS - Certain non-qualified options were
issued prior to the onset of the 1994 Stock Plan. These non-qualified options
are all exercisable. Non-qualified options granted, exercised and outstanding
are as follows:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
OPTION EXERCISE EXERCISE
SHARES PRICE PRICE
------- -------- --------
<S> <C> <C> <C>
Balance, January 1, 1996 412,500 2.00 2.00
Exercised in 1996 (49,000) 2.00 2.00
------- -------- --------
Balance, December 31, 1996 and 1997 363,500 2.00 2.00
Exercised in 1998 (43,500) 2.00 2.00
------- -------- --------
Balance, December 31, 1998 320,000 $2.00 $2.00
------- -------- --------
------- -------- --------
</TABLE>
These options were exercised in January 1999. We are 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 1999, we will record
a reduction of income taxes payable and will increase common stock by
$532,000 to reflect the January exercise. In 1998 and 1996, we recorded
reductions in income taxes payable and increased common stock by $80,000 and
$510,000, respectively, to reflect exercises during the year. No exercises
occurred in 1997.
PRO FORMA INFORMATION - Had we calculated compensation expense for our option
grants under the 1994 Stock Plan and stock purchases under the ESPP based on
the fair value method described in SFAS No. 123, "Accounting for Stock-Based
Compensation," our net income (loss), basic net income (loss) per share and
dilutive net income (loss) per share would approximate the following pro
forma amounts (in 000's, except per share data):
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Net income (loss):
As reported $ (7,081) $ 5,799 $ 8,982
Pro forma $ (7,995) $ 5,238 $ 8,788
Basic net income (loss) per share:
As reported $ (0.59) $ 0.49 $ 0.76
Pro forma $ (0.67) $ 0.44 $ 0.74
Dilutive net income (loss) per share:
As reported $ (0.59) $ 0.48 $ 0.74
Pro forma $ (0.67) $ 0.43 $ 0.72
</TABLE>
36
<PAGE>
The pro forma effect on net income (loss) for 1998, 1997 and 1996 is not
representative of the pro forma effect on net income (loss) in future years
because it does not include pro forma compensation expense related to
pre-1995 option grants.
The weighted average fair value of options granted under the ESPP and
1994 Stock Plan during 1998, 1997 and 1996 is estimated at $3.14, $4.06 and
$12.11, respectively, on the date of grant using the Black-Scholes
option-pricing model with the following assumptions: no dividend yield;
volatility of 71.0% in 1998, 76.1% in 1997 and 65.3% in 1996; risk-free
interest rates ranging from 4.51% to 7.70%; and an expected life of 1 to 5
years.
EMPLOYEE CONTRACT - We entered into a three-year employment agreement with
our new President and Chief Executive Officer beginning January 15, 1998.
Under this agreement, he receives a base salary of $400,000, subject to
review annually for increase by our Board of Directors. In addition to base
salary, he is eligible for bonuses, reimbursements and fringe benefits
including a $1,000,000 term life insurance policy and an additional payment
sufficient to reimburse him for a long-term disability policy paying monthly
benefits of $5,000. We also provide him with health, dental, life and
disability insurance consistent with that provided other officers. Under this
agreement, we have agreed to indemnify him for his actions on behalf of us.
In the event of termination without cause or resignation for good reason, we
are obligated to continue to pay his then-current base salary and bonuses for
the remaining term of the agreement or twelve months, whichever is greater.
COMBINED RETIREMENT PLAN - In January 1998, we combined our 401(K) Retirement
Plan and ESOP into a single retirement plan, the KSOP. The KSOP retains the
features of each separate plan except for eligibility and vesting provisions.
Under the plan, employees become eligible to participate in the plan on the
first day of the month after beginning employment and attaining age 21.
401(K) RETIREMENT PLAN - We sponsor a defined contribution retirement plan
under Section 401(K) of the Internal Revenue Code for eligible employees. Our
contributions to the plan are discretionary and are based on contributions
made by employees to the plan. Expense recognized under the plan for 1998,
1997 and 1996 was $140,000, $94,000 and $52,000, respectively.
EMPLOYEE STOCK OWNERSHIP PLAN - We maintain an Employee Stock Ownership Plan
(ESOP) for our qualified employees. Our contributions to the plan are
discretionary. We may contribute cash or shares of our common stock.
In March 1997, we contributed 13,205 shares to the plan for fiscal 1996
at a fair value of $8.75 per share. In January 1996, we 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 was $116,000. No
expense was recorded in 1998 or 1997.
OTHER EMPLOYEE BENEFIT PLANS - We maintained bonus plans in 1998, 1997 and
1996 under which all employees, including officers, were eligible for a bonus
based on our operating results. These bonuses aggregated $267,000, $643,000
and $498,000 in 1998, 1997 and 1996, respectively.
NOTE 9 - SHAREHOLDERS' EQUITY
On April 25, 1996, our 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. All share and per share amounts have been adjusted to
reflect the effect of the stock splits.
On September 15, 1998, our Board of Directors approved a share repurchase
program authorizing us to repurchase, from time to time, up to $4,000,000 of
RTW, Inc. common stock. We will repurchase the shares on the open market or
through private transactions depending upon market conditions and
availability. Through December 31, 1998 we had repurchased 19,500 shares for
approximately $87,000. The repurchased shares will be used for employee stock
option and purchase plans and other corporate purposes.
SHAREHOLDER RIGHTS PLAN - In April 1997, we adopted a shareholder rights plan
and declared a dividend of one right for each outstanding share of common
stock to shareholders of record at the close of business on June 30, 1997.
The rights become exercisable only after any person or group (the "Acquiring
Person") becomes the beneficial owner of 15% or more of the voting power of
our common stock. Certain shares held by our Chairman and his wife are
excluded from the computation for determining whether a person is an
Acquiring Person. Each right entitles its registered holder to purchase from
us one one-hundredth share of a new Series A Junior Participating Preferred
Stock, no par value, at a price of $85 per one one-hundredth share, subject
to adjustment. If any Acquiring Person acquires beneficial ownership of 15%
or more of our voting power, each right will entitle its holder (other than
such Acquiring Person) to purchase, at the then current purchase price of the
right, that number of shares of our common
37
<PAGE>
stock having a market value of two times the purchase price of the right,
subject to certain possible adjustments. In addition, if we are acquired in a
merger or other business combination transaction, each right will entitle its
holder to purchase, at the then current purchase price of the right, that
number of common shares of the acquiring company having a market value of two
times the purchase price of the right. Following the acquisition of a
beneficial ownership of 15% or more of our outstanding common stock by any
Acquiring Person and prior to an acquisition by any Acquiring Person of 50%
or more of our outstanding common stock, our Board of Directors may exchange
the outstanding rights (other than rights owned by such Acquiring Person), in
whole or in part, at an exchange ratio of one share of common stock, or one
one-hundredth share of Preferred Stock (or equivalent securities) per right,
subject to adjustment. We may redeem the rights, in whole, at $.001 per
right, at any time prior to an acquisition by any Acquiring Person of 15% or
more of our outstanding common stock and prior to the expiration of the
rights. The rights expire on April 17, 2007, unless extended or earlier
redeemed by us.
DIVIDEND RESTRICTIONS - Dividends are paid as determined by our Board of
Directors. No dividends have ever been paid by us.
Our ability to pay cash dividends to shareholders may depend upon the
amount of dividends received from our insurance subsidiary. 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, any such payments must be an amount deemed prudent by ACIC's Board of
Directors and, unless otherwise approved by the Commissioner of the Minnesota
Department of Commerce (Commissioner), must be paid solely from the adjusted
earned surplus of ACIC. Adjusted earned surplus means the 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, without approval of the Commissioner,
ACIC may not pay a dividend in any calendar year which, when combined with
dividends paid in the preceding twelve months, exceeds the greater of (i) 10%
of ACIC's statutory capital and surplus at the prior year end or (ii) 100% of
ACIC's statutory net gain from operations (not including realized capital
gains) for the prior calendar year. For 1999, dividends in excess of
$4,188,000 would require prior consent of the Commissioner.
STATUTORY SURPLUS AND STATUTORY NET INCOME (LOSS) - Our insurance subsidiary
is required to file financial statements with state regulatory agencies. The
accounting principles used to prepare the statutory financial statements
follow prescribed accounting practices that differ from GAAP. Statutory
policyholders' surplus in 1998 and 1997, and statutory net income (loss) for
1998, 1997 and 1996 are as follows (000's):
<TABLE>
<CAPTION>
STATUTORY
STATUTORY NET
POLICYHOLDERS' INCOME
SURPLUS (LOSS)
-------------- ----------
<S> <C> <C>
December 31, 1998 $ 41,884 $ (6,767)
December 31, 1997 45,367 5,871
December 31, 1996 6,658
</TABLE>
NOTE 10 - COMMITMENTS AND CONTINGENCIES
OPERATING LEASES - We conduct our operations in leased office facilities
under 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, 1998, are as follows (000's):
<TABLE>
<CAPTION>
<S> <C>
1999 $ 1,848
2000 1,782
2001 1,565
2002 919
--------
$ 6,114
--------
--------
</TABLE>
Rent expense, including contingent rentals, was $2,181,000, $1,776,000 and
$1,063,000 for 1998, 1997 and 1996, respectively.
38
<PAGE>
NOTE 11 - ACCUMULATED OTHER COMPREHENSIVE INCOME
We adopted Statement of Financial Accounting Standards No. 130 (SFAS 130),
"Reporting Comprehensive Income," effective January 1, 1998. Our
comprehensive income includes only unrealized gains and losses on investments
classified as available-for-sale. Changes in accumulated other comprehensive
income and other comprehensive income (loss) were as follows (000's):
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- ---------
<S> <C> <C> <C>
Accumulated other comprehensive income, beginning of year $ 892 $ 11 $ 124
Changes in comprehensive income (loss) arising during the year:
Unrealized investment gains (losses) 2,339 1,795 (176)
Less: Adjustment for net realized investment gains (1,046) (399) -
-------- -------- ---------
Increase in net unrealized investment gains 1,293 1,396 (176)
Income tax expense (benefit) 426 515 (63)
-------- -------- ---------
Other comprehensive income (loss) for the year 867 881 (113)
-------- -------- ---------
Accumulated other comprehensive income, end of year $ 1,759 $ 892 $ 11
-------- -------- ---------
-------- -------- ---------
</TABLE>
NOTE 12 - QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following tables present unaudited quarterly results of operations for
the eight quarters ended December 31, 1998:
<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
1998 (IN THOUSANDS, EXCEPT PER SHARE DATA)
Premiums in force $ 78,900 $ 80,500 $ 84,400 $ 82,100
--------- --------- --------- ---------
--------- --------- --------- ---------
Revenues:
Gross premiums earned $ 21,333 $ 22,241 $ 22,885 $ 23,422
Premiums (ceded) recovered 1,211 (1,056) (1,029) (7,615)
--------- --------- --------- ---------
Premiums earned 22,544 21,185 21,856 15,807
Investment income 2,037 2,018 1,854 1,805
Net realized investment gains (losses) 3 716 330 (3)
--------- --------- --------- ---------
Total revenues 24,584 23,919 24,040 17,609
Expenses:
Claim and claim settlement expenses 19,273 17,938 17,571 20,512
Policy acquisition costs 3,280 3,310 3,657 3,727
General and administrative expenses 3,647 1,884 3,150 2,688
--------- --------- --------- ---------
Total expenses 26,200 23,132 24,378 26,927
--------- --------- --------- ---------
Income (loss) from operations $ (1,616) $ 787 $ (338) $ (9,318)
--------- --------- --------- ---------
--------- --------- --------- ---------
Net income (loss) $ (1,117) $ 491 $ (138) $ (6,317)
--------- --------- --------- ---------
--------- --------- --------- ---------
Basic income (loss) per share $ (0.09) $ 0.04 $ (0.01) $ (0.53)
--------- --------- --------- ---------
--------- --------- --------- ---------
Diluted income (loss) per share $ (0.09) $ 0.04 $ (0.01) $ (0.53)
--------- --------- --------- ---------
--------- --------- --------- ---------
39
<PAGE>
1997
Premiums in force $ 72,600 $ 72,700 $ 75,500 $ 78,400
--------- --------- --------- ---------
--------- --------- --------- ---------
Revenues:
Gross premiums earned $ 19,308 $ 19,814 $ 20,279 $ 21,984
Premiums (ceded) recovered (105) (162) 144 (219)
--------- --------- --------- ---------
Premiums earned 19,203 19,652 20,423 21,765
Investment income 1,567 1,626 1,759 1,869
Net realized investment gains (losses) - (16) 147 268
--------- --------- --------- ---------
Total revenues 20,770 21,262 22,329 23,902
Expenses:
Claim and claim settlement expenses 12,980 12,886 14,250 15,427
Policy acquisition costs 2,614 2,992 2,876 3,176
General and administrative expenses 2,848 2,872 2,329 3,567
--------- --------- --------- ---------
Total expenses 18,442 18,750 19,455 22,170
--------- --------- --------- ---------
Income from operations $ 2,328 $ 2,512 $ 2,874 $ 1,732
--------- --------- --------- ---------
--------- --------- --------- ---------
Net income $ 1,340 $ 1,466 $ 1,705 $ 1,288
--------- --------- --------- ---------
--------- --------- --------- ---------
Basic income per share $ 0.11 $ 0.12 $ 0.14 $ 0.11
--------- --------- --------- ---------
--------- --------- --------- ---------
Diluted income per share $ 0.11 $ 0.12 $ 0.14 $ 0.11
--------- --------- --------- ---------
--------- --------- --------- ---------
</TABLE>
Quarterly revenues are affected by (i) premiums in force at the beginning of
the quarter, (ii) new policies written in the quarter, (iii) final audit
premiums recognized during the quarter and (iv) our policy renewal rate in
the quarter. Historically, a majority of new policies written and policy
renewals have occurred in the first, second and fourth quarters.
Additionally, our quarterly results for 1998 and 1997 were affected by
refunds from the Minnesota Workers' Compensation Reinsurance Corporation
(included in premiums earned), adjustments to the liability for unpaid claim
and claim settlement expenses for prior years and adjustments to reverse
liabilities accrued for the Minnesota Insurance Guarantee Association
(included in general and administrative expenses) as follows (000's):
<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
1998
Premiums earned $ 2,247 $ - $ - $ -
Claim and claim settlement expenses (3,000) (400) - (7,579)
General and administrative expenses - 1,076 - 695
--------- --------- --------- ---------
Quarterly effect on income (loss) from operations $ (753) $ 676 $ - $ (6,884)
--------- --------- --------- ---------
--------- --------- --------- ---------
1997
Premiums earned $ - $ - $ 358 $ -
Claim and claim settlement expenses 675 850 850 710
General and administrative expenses - - 842 -
--------- --------- --------- ---------
Quarterly effect on income from operations $ 675 $ 850 $ 2,050 $ 710
--------- --------- --------- ---------
--------- --------- --------- ---------
</TABLE>
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 1999 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.
40
<PAGE>
ITEM 11. EXECUTIVE COMPENSATION
Information required under this item is contained in the Section entitled
"Executive Compensation and Other Information" in the Company's 1999 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 1999 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 1999 Proxy Statement and is
incorporated herein by reference.
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 24 through
40 of Part II, Item 8 of this Report.
Independent Auditors' Report
Consolidated Balance Sheets - December 31, 1998 and 1997
Consolidated Statements of Operations - Years Ended December
31, 1998, 1997 and 1996
Consolidated Statements of Shareholders' Equity - Years Ended
December 31, 1998, 1997 and 1996
Consolidated Statements of Cash Flows - Years Ended December
31, 1998, 1997 and 1996
Notes to Consolidated Financial Statements - Years Ended
December 31, 1998, 1997 and 1996
(2) FINANCIAL STATEMENT SCHEDULES FOR THE THREE YEARS ENDED
DECEMBER 31, 1998
<TABLE>
<CAPTION>
Page
----
<S> <C>
Independent Auditors' Report on Schedules for the Years Ended
December 31, 1998, 1997 and 1996.......................................................S-1
Schedule I - Summary of Investments......................................................S-2
Schedule II - Condensed Financial Information (Parent Company)...........................S-3
Schedule III - Supplemental Information Concerning Insurance Operations..................S-7
Schedule IV - Reinsurance................................................................S-8
Schedule V - Valuation and Qualifying Accounts...........................................S-9
</TABLE>
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)
<TABLE>
<CAPTION>
<S> <C>
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)
41
<PAGE>
4.2 Registration Rights Agreement (2)
10.1* Employment Agreement Letter dated November 24, 1997 between RTW and Carl B. Lehmann
10.2* Non-Qualified Stock Option Agreement dated November 24, 1997 between
RTW and Carl B. Lehmann
10.3* Letter Agreement dated January 15, 1998 Amending the Non-Qualified
Stock Option Agreement between RTW and Carl B. Lehmann
10.4* Incentive Stock Option Agreement dated January 15, 1998 between RTW and
Carl B. Lehmann
10.5* Employment Agreement Letter dated January 22, 1999 between RTW and
David C. Prosser
10.6* RTW, Inc. Employee Stock Ownership Plan (2)
10.7* Amended RTW, Inc. 1994 Stock Plan (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 the 1999 Gain Sharing Program
10.11* 401(k) Plan Adoption Agreement (1)
10.12 Reinsurance contract between ACIC and First Excess and Reinsurance
Corporation effective July 1, 1998
10.13 Endorsement No. 2 to the reinsurance contract between ACIC and General
Reinsurance Corporation
10.14 Minnesota Workers' Compensation Reinsurance Association reinsurance
agreement
10.15 Election form for Minnesota Workers' Compensation Reinsurance
Association reinsurance agreement for 1999
11 Statement re; Computation of Income (Loss) 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 - Year ended December 31, 1998
</TABLE>
- ----------------------
(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.
(5) Incorporated by reference to the Company's 1996 Report on Form 10-K.
42
<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 19, 1999 By /s/ Carl B. Lehmann
-------------------------------------
Carl B. Lehmann
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 Carl B. Lehmann and Tim C.
Chan 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.
<TABLE>
<CAPTION>
Date Signature and Title
---- -------------------
<S> <C>
March 19, 1999 By /s/ Carl B. Lehmann
----------------------------------------------
Carl B. Lehmann
President, Chief Executive Officer and Director
(Principal Executive Officer)
March 19, 1999 By /s/ Tim C. Chan
----------------------------------------------
Tim C. Chan
Secretary, Treasurer and Chief Financial Officer
(Principal Financial and Accounting Officer)
March 19, 1999 By /s/ David C. Prosser
----------------------------------------------
David C. Prosser
Chairman of the Board
March 19, 1999 By /s/ J. Alexander Fjelstad, III
----------------------------------------------
J. Alexander Fjelstad, III
Director
March 19, 1999 By /s/ David R. Hubers
----------------------------------------------
David R. Hubers
Director
March 19, 1999 By /s/ Mark E. Hegman
----------------------------------------------
Mark E. Hegman
Director
March 19, 1999 By /s/ Steven M. Rothschild
----------------------------------------------
Steven M. Rothschild
Director
</TABLE>
43
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders
RTW, Inc.
Minneapolis, Minnesota
We have audited the consolidated financial statements of RTW, Inc. and
subsidiary (the Company) as of December 31, 1998 and 1997 and for each of the
three years in the period ended December 31, 1998, and have issued our report
thereon dated February 1, 1999. 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 the Company'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.
/s/ DELOITTE & TOUCHE LLP
Minneapolis, Minnesota
February 1, 1999
S-1
<PAGE>
SCHEDULE I
RTW, INC.
SUMMARY OF INVESTMENTS
DECEMBER 31, 1998
(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:
Available-for-sale:
Tax-exempt municipal securities $ 65,273 $ 66,636 $ 66,636
Corporate securities 20,941 21,494 21,494
Mortgage-backed securities 19,070 19,323 19,323
United States government, government agencies and authorities 14,141 14,575 $ 14,575
Asset-backed securities 4,499 4,603 4,603
-------------- -------------- -----------------
Total Investments $ 123,924 $ 126,631 $ 126,631
-------------- -------------- -----------------
-------------- -------------- -----------------
</TABLE>
S-2
<PAGE>
SCHEDULE II
RTW, INC.
CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
BALANCE SHEETS
DECEMBER 31, 1998 AND 1997
(IN THOUSANDS)
<TABLE>
<CAPTION>
1998 1997
----------- -------------
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 213 $ 936
Furniture and equipment, net 4,565 4,927
Investment in and advances to subsidiary 52,067 57,783
Income tax receivable 117 720
Other assets 631 520
----------- -------------
$ 57,593 $ 64,886
----------- -------------
----------- -------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Accrued expenses and other liabilities $ 1,770 $ 1,342
Deferred income taxes 346 312
Notes payable 2,461 4,875
----------- -------------
Total liabilities 4,577 6,529
Shareholders' equity 53,016 58,357
----------- -------------
$ 57,593 $ 64,886
----------- -------------
----------- -------------
</TABLE>
See notes to condensed financial statements.
S-3
<PAGE>
SCHEDULE II
RTW, INC.
CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(IN THOUSANDS)
<TABLE>
<CAPTION>
1998 1997 1996
------------ ---------- -----------
<S> <C> <C> <C>
Revenues:
Intercompany fee income $ 25,262 $ 22,364 $ 17,699
Investment income 28 249 408
------------ ---------- -----------
Total revenues 25,290 22,613 18,107
Expenses:
General and administrative expenses 25,526 23,097 15,555
------------ ---------- -----------
Income (loss) from operations (236) (484) 2,552
Interest expense 546 777 1,086
------------ ---------- -----------
Income (loss) before income taxes and equity in
undistributed net income (loss) of subsidiary (782) (1,261) 1,466
Provision for income taxes (263) (429) 614
------------ ---------- -----------
Income (loss) before equity in undistributed net
income (loss) of subsidiary (519) (832) 852
Equity in undistributed net income (loss) of subsidiary (6,562) 6,631 8,130
------------ ---------- -----------
Net income (loss) $ (7,081) $ 5,799 $ 8,982
------------ ---------- -----------
------------ ---------- -----------
</TABLE>
See notes to condensed financial statements.
S-4
<PAGE>
SCHEDULE II
RTW, INC.
CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(IN THOUSANDS)
<TABLE>
<CAPTION>
1998 1997 1996
---------- ---------- ------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Reconciliation of net income (loss) to net cash provided
by operating activities:
Net income (loss) $ (7,081) $ 5,799 $ 8,982
Adjustments to reconcile net income (loss)
to net cash provided by operating activities:
Depreciation and amortization 1,267 1,079 793
Equity in net loss (income) from subsidiary 6,562 (6,631) (8,130)
Deferred income taxes 34 131 122
Changes in assets and liabilities:
Accrued expenses and other liabilities 428 257 263
Other, net 1,359 351 345
---------- ---------- ------------
Net cash provided by operating
activities 2,569 986 2,375
CASH FLOWS FROM INVESTING ACTIVITIES:
Investment in and advances to subsidiary (448) (2,761) (988)
Purchases of furniture and equipment (819) (2,447) (2,047)
---------- ---------- ------------
Net cash used in investing activities (1,267) (5,208) (3,035)
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on notes payable (2,500) (2,000) (2,362)
Stock options and warrants exercised 333 1 130
Issuance of common stock to ESOP - 115 236
Issuance of common stock under ESPP 199 154 129
Proceeds from sales of common stock 30 - -
Retirement of common stock (87) - (1)
---------- ---------- ------------
Net cash used in financing activities (2,025) (1,730) (1,868)
---------- ---------- ------------
NET DECREASE IN CASH AND CASH EQUIVALENTS (723) (5,952) (2,528)
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 936 6,888 9,416
---------- ---------- ------------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 213 $ 936 $ 6,888
---------- ---------- ------------
---------- ---------- ------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for:
Interest $ 546 $ 664 $ 898
---------- ---------- ------------
---------- ---------- ------------
Income taxes $ 16 $ 61 $ 45
---------- ---------- ------------
---------- ---------- ------------
</TABLE>
See notes to condensed financial statements.
S-5
<PAGE>
SCHEDULE II
RTW, INC.
CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
NOTES TO CONDENSED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
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. 1998 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 $8,908,000,
$8,057,000 and $6,327,000 for the years ended December 31, 1998, 1997 and
1996, 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 $16,289,000, $14,307,000 and $11,372,000 for the years ended
December 31, 1998, 1997 and 1996, 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 (to) from ACIC related to the above transactions are included in
the balance sheet account caption "Investment in and advances to subsidiary"
and totaled approximately $7,104,000 and $6,208,000 at December 31, 1998 and
1997, respectively.
S-6
<PAGE>
SCHEDULE III
RTW, INC.
SUPPLEMENTAL INFORMATION CONCERNING INSURANCE OPERATIONS
(IN THOUSANDS)
<TABLE>
<CAPTION>
(COLUMN C)
RESERVES FOR INVESTMENT
DEFERRED UNPAID CLAIM DISCOUNT, INCOME AND
POLICY AND CLAIM IF ANY, NET REALIZED
ACQUISITION SETTLEMENT DEDUCTED IN UNEARNED EARNED INVESTMENT
YEAR COSTS EXPENSES COLUMN C PREMIUMS PREMIUMS GAINS
- ---------- ------------- ----------- ------------- ---------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
1998 $ 1,501 $ 97,269 - $ 13,027 $ 81,392 $ 8,732
1997 $ 1,559 $ 61,069 - $ 13,580 $ 81,043 $ 6,971
1996 $ 1,624 $ 49,256 - $ 13,308 $ 63,058 $ 5,259
<CAPTION>
CLAIM AND CLAIM
SETTLEMENT EXPENSES AMORTIZATION
INCURRED RELATED TO: OF DEFERRED PAID CLAIM
------------------- POLICY AND CLAIM
CURRENT PRIOR ACQUISITION SETTLEMENT PREMIUMS
YEAR YEAR YEARS COSTS EXPENSES WRITTEN
- ----------- --------- ---------- ----------------- --------------- -------------
<S> <C> <C> <C> <C> <C>
1998 $ 64,268 $ 10,979 $ 13,974 $ 53,087 $ 80,839
1997 $ 58,675 $ (3,085) $ 11,658 $ 42,968 $ 81,315
1996 $ 47,155 $ (8,075) $ 6,327 $ 24,833 $ 66,760
</TABLE>
S-7
<PAGE>
SCHEDULE IV
RTW, INC.
REINSURANCE
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(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>
1998
PREMIUMS - Wokers' Compensation $ 89,881 $ 8,489 $ - $ 81,392 0.00%
1997
PREMIUMS - Workers' Compensation $ 81,385 $ 342 $ - $ 81,043 0.00%
1996
PREMIUMS - Workers' Compensation $ 63,755 $ 697 $ - $ 63,058 0.00%
</TABLE>
S-8
<PAGE>
SCHEDULE V
RTW, INC.
VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(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>
1998
Allowance for Doubtful Accounts $ 182 $ 379 $ - $ 144 $ 417
1997
Allowance for Doubtful Accounts $ 105 $ 250 $ - $ 173 $ 182
1996
Allowance for Doubtful Accounts $ 73 $ 128 $ - $ 96 $ 105
</TABLE>
S-9
<PAGE>
[LETTERHEAD]
January 22, 1999
Mr. David C. Prosser
RTW, Inc.
P.O. Box 39327
8500 Normandale Lake Boulevard
Minneapolis, MN 55439
Dear Dave:
This letter will serve to confirm our arrangement regarding your
continued employment by RTW for a period of up to 12 months after December
31, 1998.
1. RESPONSIBILITIES. Your role, responsibilities, and goals will be
defined by the Company from time to time. We will periodically review the
status and progress of the various projects for which you are responsible.
One such review will occur between mid-June and mid-July.
At this time, we anticipate that your services may include activities in
the following:
a. assistance in consideration and integration into RTW of
potential merger or acquisition opportunities;
b. acquisition or implementation of self-insured opportunities;
c. representing RTW as its founder within or outside the Company;
d. helping me personally with the transition to a new management
team, especially in operations;
e. completion of the operations portability project, including
process charting and training;
f. guidance and development of the brand and internal
communication of the RTW vision;
g. providing services as a listener and a coach to me personally on
critical issues;
h. assistance in product restructuring and product development; and
<PAGE>
Prosser Page 2
January 22, 1999
i. providing historical perspective and resident knowledge to Team
S as needed.
2. SALARY AND BENEFITS. While you are employed under the terms of this
Letter Agreement, you will receive a monthly salary of $25,000, will be
eligible to participate in the standard health, life, medical insurance, and
other fringe benefit programs available to all RTW employees. You will not be
eligible for continued reimbursement of your automobile expenses.
3. AT-WILL EMPLOYMENT. Your employment will be "at-will" and may be
terminated by either you or by RTW at any time and for any reason whatsoever
upon fourteen (14) days notice. Your employment will automatically terminate
in the event of your death or if you are unable to substantially perform your
responsibilities by reason of physical or mental disability for more than
thirty (30) days.
4. ENTIRE AGREEMENT. This Letter Agreement, together with the
Agreement regarding Confidential Information, Inventions, and Non-Competition
which you previously executed, contain the entire understanding and agreement
with respect to your continued employment by RTW and supercede all previous
agreements, discussions, or understandings, whether written or oral, between
you and RTW on the same subject.
5. AMENDMENT. This Agreement may be amended or modified only by a
written agreement signed by both of us.
If this letter accurately sets forth our understanding on this matter,
please sign and return one copy to me for RTW's files. The other copy is for
your records.
Sincerely,
/s/ Carl B. Lehmann
Carl B. Lehmann
Chief Executive Officer
READ AND AGREED
/s/ David C. Prosser
- ------------------------------------
David C. Prosser
<PAGE>
1999 GAIN SHARING BONUS PLAN
All employees of the company are eligible to receive annual cash bonuses based
on annual results. The components used to determine the ultimate bonus payment
are as follows:
IN FORCE PREMIUM In force premium is the annualized total premiums in
effect at any one point in time.
NET INCOME Pre-tax, pre-bonus operating profit.
Targets were established for each of the identified components above based on
the 1999 business plan goals. The amount of the bonus payment is determined
based on actual performance compared to the established Gain Sharing Bonus Plan
targets.
<PAGE>
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WORKERS' COMPENSATION FIRST EXCESS OF LOSS
REINSURANCE CONTRACT
EFFECTIVE: JULY 1, 1998
issued to
American Compensation Insurance Company
Minneapolis, Minnesota
and any and all insurance companies which are now or hereafter
come under the same ownership or management as
American Compensation Insurance Company
E.W. Blanch Co.
Reinsurance Services
3500 West 80th Street
Minneapolis, Minnesota 55431
- -----------------------------------------------------------------------------
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<PAGE>
- -----------------------------------------------------------------------------
- -----------------------------------------------------------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
ARTICLE PAGE
<S> <C>
I Classes of Business Reinsured 1
II Commencement and Termination 1
III Territory (BRMA 51A) 2
IV Exclusions 2
V Retention and Limit 4
VI Definitions 5
VII Claims 6
VIII Subrogation 7
IX Reinsurance Premium 7
X Reports and Remittances 8
XI Offset 8
XII Late Payments 8
XIII Access to Records (BRMA 1D) 9
XIV Liability of the Reinsurer 10
XV Net Retained Lines (BRMA 32B) 10
XVI Errors and Omissions 10
XVII Currency (BRMA 12A) 10
XVIII Taxes (BRMA 50B) 11
XIX Federal Excise Tax (BRMA 17A) 11
XX Unauthorized Reinsurers 11
XXI Insolvency 12
XXII Arbitration (BRMA 6J) 13
XXIII Service of Suit (BRMA 49C) 14
XXIV Governing Law 15
XXV Other Provisions 15
XXVI Agency Agreement 15
XXVII Intermediary (BRMA 23A) 16
Attachments:
Nuclear Incident Exclusion Clause - Liability - Reinsurance (USA)
Nuclear Incident Exclusion Clause - Liability - Reinsurance (Canada)
</TABLE>
E.W. BLANCH CO.
- -----------------------------------------------------------------------------
- -----------------------------------------------------------------------------
REINSURANCE SERVICES
<PAGE>
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- -----------------------------------------------------------------------------
WORKERS' COMPENSATION FIRST EXCESS OF LOSS
REINSURANCE CONTRACT
EFFECTIVE: JULY 1, 1998
issued to
American Compensation Insurance Company
Minneapolis, Minnesota
and any and all insurance companies which are now or hereafter
come under the same ownership or management as
American Compensation Insurance Company
(HEREINAFTER REFERRED TO COLLECTIVELY AS THE "Company")
by
The Subscribing Reinsurer(s) Executing the
Interests and Liabilities Agreement(s)
Attached Hereto
(HEREINAFTER REFERRED TO AS THE "Reinsurer")
ARTICLE I - CLASSES OF BUSINESS REINSURED
By this Contract the Reinsurer agrees to reinsure the excess liability which
may accrue to the Company under its policies, contracts and binders of
insurance or reinsurance (hereinafter called "policies") in force at the
effective date hereof or issued or renewed on or after that date,
and classified by the Company as Workers' Compensation and/or Employers
Liability business, subject to the terms, conditions and limitations
hereinafter set forth.
ARTICLE II - COMMENCEMENT AND TERMINATION
A. This Contract shall become effective on July 1, 1998, with respect
to losses arising out of occurrences commencing on or after that date,
and shall continue in force thereafter until terminated.
B. Either party may terminate this Contract on December 31, 2000 or any
December 31 thereafter by giving the other party not less than 90 days
prior notice by certified mail.
C. The Company may terminate a Subscribing Reinsurer's share under this
Contract by giving the Subscribing Reinsurer not less than 10 days notice
by certified mail in the event a Subscribing Reinsurer loses at least
50.0% of its statutory surplus existing at inception, or is deemed impaired
or insolvent by applicable regulatory or judicial authorities.
E.W. BLANCH CO.
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REINSURANCE SERVICES
PAGE 1
<PAGE>
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D. Unless the Company elects that the Reinsurer have no liability for losses
arising out of occurrences commencing after the effective date of
termination, and so notifies the Reinsurer prior or as promptly as possible
after the effective date of termination, reinsurance hereunder on business
in force on the effective date of termination shall remain in full force
and effect until expiration, cancellation or next premium anniversary of
such business, whichever first occurs, but in no event beyond 12 months
plus odd time (not exceeding 15 months in all) following the effective date
of termination.
E. In an occurrence covered hereunder is in progress at the end of any
contract year, the Reinsurer's liability hereunder shall, subject to the
other terms and conditions of this Contract, be determined as if the
entire occurrence had occurred prior to the end of that contract year,
provided that no part of such occurrence is claimed against any other
contract year or any renewal or replacement of this Contract.
ARTICLE III - TERRITORY (BRMA 51A)
The territorial limits of this Contract shall be identical with those of the
Company's policies.
ARTICLE IV - EXCLUSIONS
A. This Contract shall not apply to:
1. Reinsurance assumed by the Company, except inter-company reinsurance
or reinsurance assumed by the Company from other issuing companies
because of regulatory and/or practical reasons while in all other
aspects acting as the insurance carrier.
2. "Self-insurance" or "self-insured obligations," howsoever styled, of
the Company, its affiliates or subsidiaries, or any insurance wherein
the Company, its affiliates or subsidiaries, are named as the insured
party, either alone or jointly with some other party, notwithstanding
that no legal liability may arise in respect thereof by reason of the
fact that the Company, its affiliates or subsidiaries, may not be
obligated by law to pay a claim to itself, its affiliates or
subsidiaries.
3. Any loss or liability accruing to the Company directly or indirectly
from any insurance written by or through any pool or association
including pools or associations in which membership by the Company is
required under any statutes or regulations; however, this exclusion
shall not apply to the Company's involuntary participation in assigned
risk plans in so far as the class of business is one written by the
Company.
4. Any liability of the Company arising from its participation or
membership in any insolvency fund.
E.W. BLANCH CO.
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REINSURANCE SERVICES
PAGE 2
<PAGE>
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5. Nuclear risks as defined in the "Nuclear Incident Exclusion Clause -
Liability - Reinsurance (U.S.A.)" and the "Nuclear Incident Exclusion
Clause - Liability - Reinsurance (Canada)" attached to and forming
part of this Contract.
6. As regards interests which at time of loss or damage are on shore,
no liability shall attach hereto in respect of any loss or damage which
is occasioned by war, invasion, hostilities, acts of foreign enemies,
civil war, rebellion, insurrection, military or usurped power, or
martial law or confiscation by order of any government or public
authority. This War Exclusion Clause shall not, however, apply to
interests which at time of loss or damage are within the territorial
limits of the United States of America (comprising the Fifty States of
the Union, the District of Columbia, and including bridges between the
United States of America and Mexico provided they are under United
States ownership), Canada, St. Pierre and Miquelon, provided such
interests are insured under policies containing a standard war or
hostilities or warlike operations exclusion clause.
7. Insurance with respect to operations involving:
a. Aircraft flight operations or operations in which the flying
hazard is a major part of the insured's operation;
b. Manufacturing, packing, handling, shipping, or storage of
substances intended for use as an explosive, ammunitions, fuses,
arms, magnesium, propellant charges, detonating devices, fireworks,
nitroglycerine, celluloid or pyroxylin; however, this exclusion
shall not apply to the incidental packing, handling or storage of
same in connection with the sale of such substances. Firearm
manufacturing shall not be excluded;
c. Gas companies, dealers or distributors, except those in the
gasoline service station business; oil or gas operators, lease
operators or contractors; oil or gas pipeline construction or
operations; oil rig and derrick work; onshore or offshore gas or
oil drilling operations. Gasoline hauling shall not be excluded
if the insured's primary operation is retail gasoline distribution
and the tankers are used to distribute to the risk's own locations
only;
d. Production, refining, handling, shipping or storage of "flammable
liquids" or "flammable gasses" as defined by the National Fire
Protection Association; however, this exclusion shall not apply
to the incidental handling or storage of same in connection with
the sale of such substances;
e. Railroad operation or construction of railroads;
f. Maritime or federal employments; steamship lines, agencies, or
stevedoring, navigation or operation of vessels; operation of
drydocks, marine wrecking; and including all United States
Longshore and Harbor Workers' exposures except as incidental and
necessary to the primary operation;
g. Sewer and subway construction, shaft sinking or tunnelling;
E.W. BLANCH CO.
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REINSURANCE SERVICES
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<PAGE>
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h. Wrecking or demolition;
i. Underground mining, strip mining, or quarrying;
j. Off-shore or subaqueous work;
k. Caisson of coffer dam work; dam, dike, lock or revetment
construction;
l. Nuclear Regulatory Commission projects or operations conducted
under license from the Nuclear Regulatory Commission;
m. Asbestos removal;
n. Firefighters and police officers.
B. If the Company provides insurance for an insured with respect to any
operations listed in subparagraph 5 of paragraph A above, and if such
operations constitute only a minor and incidental part of the total
operations of the insured, such exclusion(s) shall not apply. "Minor
and incidental" as used herein is defined as 10.0% or less of the
total premium for the account.
C. If the Company is bound, without the knowledge of and contrary to the
instructions of the Company's supervisory underwriting personnel, on
any business falling within the scope of one or more of the exclusions
set forth in this Article, these exclusions, except subparagraphs 1,
2, 3 and 4 of paragraph A, shall be suspended with respect to such
business until 30 days after an underwriting supervisor of the Company
acquires knowledge of such business.
ARTICLE V - RETENTION AND LIMIT
The Company shall retain and be liable for the first $25,000 of ultimate net
loss (whether involving any one or any combination of the classes of
business covered hereunder, regardless of the number of policies under which
such loss is payable or the number of different interests insured) arising
out of each occurrence. The Reinsurer shall then be liable for the amount by
which such ultimate net loss exceeds the Company's retention, but the
liability of the Reinsurer shall not exceed $275,000 as respects any one
occurrence. However, as respects an occurrence where a claim is filed by any
insured involved in the occurrence in accordance with Minnesota Workers'
Compensation Law, the liability of the Reinsurer shall not exceed the
following:
1. As respects occurrences commencing during the 1998 contract year,
$255,000;
2. As respects occurrences commencing during the 1999 contract year,
$265,000;
3. As respects occurrences commencing during the 2000 contract year
and each subsequent contract year, $275,000;
E.W. BLANCH CO.
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REINSURANCE SERVICES
PAGE 4
<PAGE>
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ARTICLE VI - DEFINITIONS
A. "Ultimate net loss" as used herein is defined as the sums or sums
(including loss in excess of policy limits, extra contractual obligations
and any loss adjustment expense, as hereinafter defined) which shall
constitute one loss, paid or payable by the Company in settlement of
claims and in satisfaction of judgments rendered on account of such
claims, after deduction of all salvage, all recoveries and all claims on
inuring insurance or reinsurance, whether collectible or not. Nothing
herein shall be construed to mean that losses under this Contract are not
recoverable until the Company's ultimate net loss has been ascertained.
B. "Loss in excess of policy limits" and "extra contractual obligations"
as used herein shall be defined as follows:
1. "Loss in excess of policy limits" shall mean 95.0% of any amount
of loss, together with any legal costs and expenses incurred in
connection therewith, paid or payable by the Company in excess of its
policy limits, but otherwise within the coverage terms of its policy,
as a result of an action against it by its insured or its insured's
assignee to recover damages the insured is legally obligated to pay
to a third party claimant because of the alleged fraud or alleged or
actual negligence or bad faith of the Company or the Company's
parent, R.T.W., Inc., Bloomington, Minnesota, in rejecting a
settlement within policy limits, or in discharging its duty to defend
or prepare the defense in the trial of an action against its insured,
or in discharging its duty to prepare or prosecute an appeal
consequent upon such an action.
2. "Extra contractual obligations" shall mean 95.0% of any punitive,
exemplary, compensatory or consequential damages, other than loss in
excess of policy limits, together with any legal costs and expenses
incurred in connection therewith, paid of payable by the Company as a
result of an action against it by its insured, its insured's assignee
or a third party claimant, which action alleges negligence, fraud or
bad faith on the part of the Company or R.T.W., Inc., Bloomington,
Minnesota, in handling a claim under a policy subject to this
Contract. An extra contractual obligation shall be deemed to have
occurred on the same date as the loss covered or alleged to be
covered under the policy.
Notwithstanding anything stated herein, this Contract shall not apply to
any loss in excess of policy limits or any extra contractual obligation
incurred by the Company as a result of any fraudulent and/or criminal act
directed against the Company by any officer or director of the Company or
R.T.W., Inc., Bloomington, Minnesota, acting individually or collectively
or in collusion with any individual or corporation or any other
organization or party involved in the presentation, defense or settlement
of any claim under a policy subject to this Contract.
C. "Loss adjustment expense" as used herein shall mean expenses
assignable to the investigation, appraisal, adjustment, settlement,
litigation, defense and/or appeal of specific claims, regardless of how
such expenses are classified for statutory reporting purposes. Loss
adjustment expense shall include, but not be limited to, interest on
judgments and declaratory judgment expenses or other legal expenses and
costs incurred in connection with
E.W. BLANCH CO.
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REINSURANCE SERVICES
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<PAGE>
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coverage questions and legal actions connected thereto. Loss adjustment
expense shall not include office expenses, salaries of the Company's regular
employees or payments made by the Company to R.T.W., Inc., Bloomington,
Minnesota.
D. "Occurrence" as used herein shall mean each accident or occurrence or
series of accidents or occurrences arising out of one event regardless of
the number of employees or employers involved, except as modified below.
As respects an occupational or other disease or cumulative injury under
Workers' Compensation or Employers Liability policies for which the
employer is liable:
1. Which arises from a specific sudden and accidental event limited
in time and place, such occupational or other disease suffered by one
or more employees of one or more employers shall be deemed to be an
occurrence within the meaning of this contract, and the date of
occurrence shall be deemed to be the date of the sudden and
accidental event.
2. Which does not arise from a specific sudden and accidental event
limited in time and place, such occupational disease as defined by
the Workers' Compensation Laws of the states in which the Company
writes Workers' Compensation business shall mean an occupational
disease of one specific type suffered by one or more employees of one
employer. The date of occurrence shall be deemed to be the date on
which the occupational disease suffered by an employee is first
reported by the Company to the Reinsurer and any case of occupational
disease of the same specific type suffered by any other employee of
the same employer shall be deemed to have arisen out of the same
occurrence.
E. "Contract year" as used herein shall mean the periods from July 1, 1998
to December 31, 1998, both days inclusive, January 1, 1999 to December
31, 1999, both days inclusive, January 1, 2000 to December 31, 2000, both
days inclusive, and each respective period beginning January 1 and ending
December 31 thereafter that this Contract continues in force. However, if
this Contract is terminated, the period from the beginning of the then
current contract year through the effective date of termination shall be
considered a contract year, and the "runoff" period (if any) shall be
considered a separate contract year and referred to as the "runoff
contract year."
ARTICLE VII - CLAIMS
A. The Company shall notify the Reinsurer of claims in a monthly
bordereau report as provided in paragraph B below. The Reinsurer shall
have the right to participate, at its own expense, in the defense of any
claim or suit or proceeding involving this reinsurance.
B. On the last day of each calendar month, the Company shall provide a
bordereau report to the Reinsurer setting forth all losses for which the
paid plus outstanding ultimate net loss is greater than $12,500. Such
report shall specifically identify all claims involving loss in excess of
policy limits, extra contractual obligations, Employers Liability
business,
E.W. BLANCH CO.
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REINSURANCE SERVICES
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<PAGE>
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occupational disease and/or cumulative injury. The Company shall also
provide a summary of the Reinsurer's share of all losses and loss
adjustment expense paid during the calendar month.
C. All claim settlements made by the Company, provided they are within
the terms of this Contract, shall be binding upon the Reinsurer, and the
Reinsurer agrees to pay all amounts for which it may be liable within 15
days of receipt of the Company's monthly bordereau report.
ARTICLE VIII - SUBROGATION
The Reinsurer shall be credited with recoveries from subrogation (i.e.,
reimbursement obtained or recovery made by the Company or by R.T.W., Inc.,
Bloomington, Minnesota, on behalf of the Company, less the actual cost,
excluding salaries of officials and employees of the Company or R.T.W., Inc.,
Bloomington, Minnesota, of obtaining such reimbursement or making such
recovery) on account of claims and settlements involving reinsurance
hereunder. Recoveries therefrom shall always be used to reimburse the excess
carriers in the reverse order of their priority according to their
participation before being used in any way to reimburse the Company for its
primary loss. The Company hereby agrees to enforce its rights to subrogation
relating to any loss, a part of which loss was sustained by the Reinsurer,
and to prosecute all claims arising out of such rights.
E.W. BLANCH CO.
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ARTICLE X - REPORTS AND REMITTANCES
Annually, if requested by the Reinsurer in writing, the Company shall furnish
the Reinsurer with such information as the Reinsurer may require to complete
its Annual Convention Statement.
ARTICLE XI - OFFSET
The Company and the Reinsurer shall have the right to offset any balance or
amounts due from one party to the other under the terms of this Contract
only. The party asserting the right of offset may exercise such right any time
whether the balances due are on account of premiums or losses or otherwise.
ARTICLE XII - LATE PAYMENTS
A. The provisions of this Article shall not be implemented unless
specifically invoked, in writing, by one of the parties to this Contract.
B. In the event any premium, loss or other payment due either party is not
received by the intermediary named in Article XXVI (hereinafter referred to
as the "Intermediary") by the payment due date, the party to whom payment
is due may, by notifying the Intermediary in writing, require the debtor
party to pay, and the debtor party agrees to pay, an interest
E.W. BLANCH CO.
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penalty on the amount past due calculated for each such payment on the last
business day of each month as follows:
1. The number of full days which have expired since the due date or the
last monthly calculation, whichever the lesser; times
2. 1/365th of the 6-month United States Treasury Bill rate, as quoted in
THE WALL STREET JOURNAL on the first business day of the month for which
the calculation is made; times
3. The amount past due, including accrued interest.
It is agreed that interest shall accumulate until payment of the original
amount due plus interest penalties have been received by the Intermediary.
C. As respects any routine payment, adjustment or return due either party,
the due date, for purposes of this Article, shall be as provided for in the
applicable section of this Contract. In the event a due date is not
specifically stated for a given payment, it shall be deemed due 30 days
after the date of transmittal by the Intermediary of the initial billing
for each such payment. For purposes of interest calculations only,
amounts due hereunder shall be deemed paid upon receipt by the
Intermediary.
D. Nothing herein shall be construed as limiting or prohibiting a
Subscribing Reinsurer from contesting the validity of any claim, or from
participating in the defense or control of any claim or suit, or
prohibiting either party from contesting the validity of any payment or
from initiating any arbitration or other proceeding in accordance with
the provisions of this Contract. If the debtor party prevails in an
arbitration or other proceeding, then any interest penalties due
hereunder on the amount in dispute shall be null and void. If the debtor
party loses in such proceeding, then the interest penalty on the amount
determined to be due hereunder shall be calculated in accordance with the
provisions set forth above unless otherwise determined by such
proceedings. If a debtor party advances payment of any amount it is
contesting, and proves to be correct in its contestation, either in whole
or in part, the other party shall reimburse the debtor party for any such
excess payment made plus interest on the excess amount calculated in
accordance with this Article.
E. Interest penalties arising out of the application of this Article that
are $100 or less from any party shall be waived unless there is a pattern of
late payments consisting of three or more items over the course of any
12-month period.
ARTICLE XIII - ACCESS TO RECORDS (BRMA 1D)
The Reinsurer or its designated representatives shall have access at any
reasonable time to all records of the Company which pertain in any way to
this reinsurance.
E.W. BLANCH CO.
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ARTICLE XIV - LIABILITY OF THE REINSURER
A. The liability of the Reinsurer shall follow that of the Company in every
case and be subject in all respects to all the general and specific
stipulations, clauses, waivers and modifications of the Company's
policies and any endorsements thereon. However, in no event shall this be
construed in any way to provide coverage outside the terms and conditions
set forth in this Contract.
B. Nothing herein shall in any manner create any obligations or establish
any rights against the Reinsurer in favor of any third party or any persons
not parties to this Contract.
ARTICLE XV - NET RETAINED LINES (BRMA 32B)
A. This Contract applies only to that portion of any policy which the
Company retains net for its own account, and in calculating the amount of
any loss hereunder and also in computing the amount or amounts in excess
of which this Contract attaches, only loss or losses in respect of that
portion of any policy which the Company retains net for its own account
shall be included.
B. The amount of the Reinsurer's liability hereunder in respect of any
loss or losses shall not be increased by reason of the inability of the
Company to collect from any other reinsurer(s), whether specific or
general, any amounts which may have become due from such reinsurer(s),
whether such inability arises from the insolvency of such other
reinsurer(s) or otherwise.
ARTICLE XVI - ERRORS AND OMISSIONS
The Company and the Reinsurer shall not be prejudiced in any way by any
delays, errors or omissions through mistake, accident or failure to cede any
reinsurance under the terms of this Contract or by erroneous cancellation,
either partial or total, of any cession, or by omitting to report or by
erroneously reporting any claim or loss settlement or any other transaction
hereunder, provided that such delays, errors or omissions are sought to be
rectified after discovery. Delays, errors or omissions made in connection
with this Contract or any transaction hereunder shall not relieve either
party from any liability which would have attached had such delay, error or
omission not occurred.
ARTICLE XVII - CURRENCY (BRMA 12A)
A. Whenever the word "Dollars" or the "$" sign appears in this Contract,
they shall be construed to mean United States Dollars and all transactions
under this Contract shall be in United States Dollars.
E.W. BLANCH CO.
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B. Amounts paid or received by the Company in any other currency shall be
converted to United States Dollars at the rate of exchange at the date
such transaction is entered on the books of the Company.
ARTICLE XVIII - TAXES (BRMA 50B)
In consideration of the terms under which this Contract is issued, the
Company will not claim a deduction in respect of the premium hereon when
making tax returns, other than income or profits tax returns, to any state or
territory of the United States of America or the District of Columbia.
ARTICLE XIX - FEDERAL EXCISE TAX (BRMA 17A)
(Applicable to those reinsurers, excepting Underwriters at Lloyd's London and
other reinsurers exempt from Federal Excise Tax, who are domiciled outside
the United States of America.)
A. The Reinsurer has agreed to allow for the purpose of paying the Federal
Excise Tax the applicable percentage of the premium payable hereon (as
imposed under Section 4371 of the Internal Revenue Code) to the extent such
premium is subject to the Federal Excise Tax.
B. In the event of any return of premium becoming due hereunder the Reinsurer
will deduct the applicable percentage from the return premium payable
hereon and the Company or its agent should take steps to recover the tax
from the United States Government.
ARTICLE XX - UNAUTHORIZED REINSURERS
A. If the Reinsurer is unauthorized in any state of the United States of
America or the District of Columbia, the Reinsurer agrees to fund its
share of the Company's ceded outstanding loss and loss adjustment
expense reserves (including incurred but not reported loss reserves) by:
1. Clean, irrevocable and unconditional letters of credit issued and
confirmed, if confirmation is required by the insurance regulatory
authorities involved, by a bank or banks meeting the NAIC
Securities Valuation Office credit standards for issuers of letters
of credit and acceptable to said insurance regulatory authorities;
and/or
2. Escrow accounts for the benefit of the Company; and/or
3. Cash advances;
if, without such funding, a penalty would accrue to the Company on any
financial statement it is required to file with the insurance regulatory
authorities involved. The Reinsurer, at its sole option, may fund in
other than cash if its method and form of funding are acceptable to the
insurance regulatory authorities involved.
E. W. BLANCH CO.
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B. With regard to funding in whole or in part by letters of credit, it is
agreed that each letter of credit will be in a form acceptable to
insurance regulatory authorities involved, will be issued for a term of
at least one year and will include an "evergreen clause," which
automatically extends the term for at least one additional year at each
expiration date unless written notice of non-renewal is given to the
Company not less than 30 days prior to said expiration date. The Company
and the Reinsurer further agree, notwithstanding anything to the
contrary in this Contract, that said letters of credit may be drawn upon
by the Company or its successors in interest at any time, without
diminution because of the insolvency of the Company or the Reinsurer,
but only for one or more of the following purposes:
1. To reimburse itself for the Reinsurer's share of losses and/or loss
adjustment expense paid under the terms of policies reinsured
hereunder, unless paid in cash by the Reinsurer;
2. To reimburse itself for the Reinsurer's share of any other amounts
claimed to be due hereunder, unless paid in cash by the Reinsurer;
3. To fund a cash account in an amount equal to the Reinsurer's share
of any ceded outstanding loss and loss adjustment expense reserves
(including incurred but not reported loss reserves) funded by means
of a letter of credit which is under non-renewal notice, if said
letter of credit has not been renewed or replaced by the Reinsurer
10 days prior to its expiration date;
4. To refund to the Reinsurer any sum in excess of the actual amount
required to fund the Reinsurer's share of the Company's ceded
outstanding loss and loss adjustment expense reserves (including
incurred but not reported loss reserves), if so requested by the
Reinsurer.
In the event the amount drawn by the Company on any letter of credit is
in excess of the actual amount required for B(1) or B(3), or in the case
of B(2), the actual amount determined to be due, the Company shall
promptly return to the Reinsurer the excess amount so drawn.
ARTICLE XXI - INSOLVENCY
A. In the event of the insolvency of one or more of the reinsured
companies, this reinsurance shall be payable directly to the company or
to its liquidator, receiver, conservator or statutory successor, on the
basis of the liability of the company without diminution because of the
insolvency of the company or because the liquidator, receiver,
conservator or statutory successor of the company has failed to pay all
or a portion of any claim. It is agreed, however, that the liquidator,
receiver, conservator or statutory successor of the company shall give
written notice to the Reinsurer of the pendency of a claim against the
company indicating the policy or bond reinsured which claim would
involve a possible liability on the part of the Reinsurer within a
reasonable time after such claim is filed in the conservation or
liquidation proceeding or in the receivership, and that during the
pendency of such claim, the Reinsurer may investigate such claim and
interpose, at its own expense, in the
E. W. BLANCH CO.
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proceeding where such claim is to be adjudicated, any defense or defenses
that may deem available to the company or its liquidator, receiver,
conservator or statutory successor. The expense thus incurred by the
Reinsurer shall be chargeable, subject to the approval of the Court,
against the company as part of the expense of conservation or
liquidation to the extent of a pro rata share of the benefit which may
accrue to the company solely as a result of the defense undertaken by
the Reinsurer.
B. Where two or more reinsurers are involved in the same claim and a
majority in interest elect to interpose defense to such claim, the
expense shall be apportioned in accordance with the terms of this
Contract as though such expense had been incurred by the company.
C. It is further understood and agreed that, in the event of the insolvency
of one or more of the reinsured companies, the reinsurance under this
Contract shall be payable directly by the Reinsurer to the company or to
its liquidator, receiver or statutory successor, except as provided by
Section 4118(a) of the New York Insurance Law or except (1) where this
Contract specifically provides another payee of such reinsurance in the
event of the insolvency of the company or (2) where the Reinsurer with
the consent of the direct insured or insureds has assumed such policy
obligations of the company as direct obligations of the Reinsurer to the
payees under such policies and in substitution for the obligations of
the company to such payees.
D. Prior to the implementation of a novation, any certificate of assumption
on New York risks must be approved in advance by the Superintendent of
Insurance for New York.
ARTICLE XXII - ARBITRATION (BRMA 6J)
A. As a condition precedent to any right of action hereunder, in the event
of any dispute or difference of opinion hereafter arising with respect
to this Contract, it is hereby mutually agreed that such dispute or
difference of opinion shall be submitted to arbitration. One Arbiter
shall be chosen by the Company, the other by the Reinsurer, and an
Umpire shall be chosen by the two Arbiters before they enter upon
arbitration, all of whom shall be active or retired disinterested
executive officers of insurance or reinsurance companies or Lloyd's
London Underwriters. In the event that either party should fail to
choose an Arbiter within 30 days following a written request by the other
party to do so, the requesting party may choose two Arbiters who shall in
turn choose an Umpire before entering upon arbitration. If the two
Arbiters fail to agree upon the selection of an Umpire within 30 days
following their appointment, each Arbiter shall nominate three
candidates within 10 days thereafter, two of whom the other shall
decline, and the decision shall be made by drawing lots.
B. Each party shall present its case to the Arbiters within 30 days
following the date of appointment of the Umpire. The Arbiters shall
consider this Contract as an honorable engagement rather than merely as
a legal obligation and they are relieved of all judicial formalities and
may abstain from following the strict rules of law. The decision of the
Arbiters shall be final and binding on both parties; but failing to
agree, they shall call in the Umpire and the decision of the majority
shall be final and binding upon both parties.
E. W. BLANCH CO.
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Judgment upon the final decision of the Arbiters may be entered in any
court of competent jurisdiction.
C. If more than one reinsurer is involved in the same dispute, all such
reinsurers shall constitute and act as one party for purposes of this
Article and communications shall be made by the Company to each of the
reinsurers constituting one party, provided, however, that nothing
herein shall impair the rights of such reinsurers to assert several,
rather than joint, defenses or claims, not be construed as changing the
liability of the reinsurers participating under the terms of this
Contract from several to joint.
D. Each party shall bear the expense of its own Arbiter, and shall jointly
and equally bear with the other the expense of the Umpire and of the
arbitration. In the event that the two Arbiters are chosen by one party,
as above provided, the expense of the Arbiters, the Umpire and the
arbitration shall be equally divided between the two parties.
E. Any arbitration proceedings shall take place at a location mutually
agreed upon by the parties to this Contract, but notwithstanding the
location of the arbitration, all proceedings pursuant hereto shall be
governed by the law of the state in which the Company has its principal
office.
ARTICLE XXIII -- SERVICE OF SUIT (BRMA 49C)
(Applicable if the Reinsurer is not domiciled in the United States of
America, and/or is not authorized in any State, Territory or District of the
United States where authorization is required by insurance regulatory
authorities)
A. It is agreed that in the event the Reinsurer fails to pay any amount
claimed to be due hereunder, the Reinsurer, at the request of the
Company, will submit to the jurisdiction of a court of competent
jurisdiction within the United States. Nothing in this Article
constitutes or should be understood to constitute a waiver of the
Reinsurer's rights to commence an action in any court of competent
jurisdiction in the United States, to remove an action to a United States
District Court, or to seek a transfer of a case to another court as
permitted by the laws of the United States or of any state in the United
States.
B. Further, pursuant to any statute of any state, territory or district of
the United States which makes provision therefor, to the Reinsurer hereby
designates the party named in its Interests and Liabilities Agreement,
or if no party is named therein, the Superintendent, Commissioner or
Director of Insurance or other officer specified for that purpose in the
statute, or his successor or successors in office, at its true and
lawful attorney upon whom may be served any lawful process in any
action, suit or proceeding instituted by or on behalf of the Company or
any beneficiary hereunder arising out of this Contract.
E. W. BLANCH CO.
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ARTICLE XXIV -- GOVERNING LAW
This Contract shall be governed as to performance, administration and
interpretation by the laws of the State of Minnesota, exclusive of its rules
with respect to conflicts of law, except as to state rules with respect to
credit for reinsurance in which case the rules of all applicable states
shall apply.
ARTICLE XXV -- OTHER PROVISIONS
A. Waiver. The failure of the Company or the Reinsurer to insist on strict
compliance with this Contract, or to exercise any right or remedy
hereunder, shall not constitute a waiver of any rights herein nor stop
the parties from thereafter demanding full and complete compliance nor
prevent the parties from exercising such a remedy in the future.
B. Conflict with Law and Severability. If any provision of this Contract
should be invalid under applicable laws, the latter shall control but
only to the extent of the conflict without affecting the remaining
provisions of this Contract.
C. Headings. The headings preceding the text of the Articles and paragraphs
of this Contract are intended and inserted solely for convenience of
reference and shall not affect the meaning, interpretation, construction
or effect of this Contract.
D. Assignment. This Contract shall be binding upon and inure to the benefit
of the Company and the Reinsurer and their respective successors and
assigns provided, however, that this Contract may not be assigned by the
Reinsurer without the prior written consent of the Company which consent
may be withheld by the Company in its sole discretion.
E. Entire Agreement. This Contract constitutes the full and complete
agreement between the parties with respect to the reinsurance
arrangement between them. This Contract may be amended by mutual consent
of the parties hereto expressed in an addendum or endorsement, and such
addendum or endorsement, when executed by the parties hereto, shall be
deemed to be an integral part of this Contract and binding on the
parties hereto.
F. Third Party Beneficiary. Except as provided under Article XXI --
Insolvency, in no event shall anyone other than the Reinsurer or the
Company have any rights under this Contract.
ARTICLE XXVI -- AGENCY AGREEMENT
If more than one reinsured company is named as a party to this Contract, the
first named company shall be deemed the agent of the other reinsured
companies for purposes of sending or receiving notices required by the terms
and conditions of this Contract, and for purposes of remitting or receiving
any monies due any party.
E. W. BLANCH CO.
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ARTICLE XXVII -- INTERMEDIARY (BRMA 23A)
E. W. Blanch Co. is hereby recognized as the Intermediary negotiating this
Contract for all business hereunder. All communications (including but not
limited to notices, statements, premium, return premium, commissions, taxes,
losses, loss adjustment expense, salvages and loss settlements) relating
thereto shall be transmitted to the Company or the Reinsurer through E. W.
Blanch Co., Reinsurance Services, 3500 West 80th Street, Minneapolis,
Minnesota 55431. Payments by the Company to the Intermediary shall be deemed
to constitute payment to the Reinsurer. Payments by the Reinsurer to the
Intermediary shall be deemed to constitute payment to the Company only to the
extent that such payments are actually received by the Company.
IN WITNESS WHEREOF, the Company by its duly authorized representative has
executed this Contract as of the date undermentioned at:
Minneapolis, Minnesota, this 16th day of March 1999.
/s/ Tim C. Chan
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American Compensation Insurance Company (for and on behalf of
the Company)
E. W. BLANCH CO.
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INTERESTS AND LIABILITIES AGREEMENT
of
First Excess and Reinsurance Corporation
Overland Park, Kansas
through
CORE Managers, Inc.
Stamford Connecticut
(HEREIN REFERRED TO AS THE "SUBSCRIBING REINSURER")
with respect to the
WORKERS' COMPENSATION FIRST EXCESS OF LOSS
REINSURANCE CONTRACT
EFFECTIVE: JULY 1, 1998
issued to and duly executed by
American Compensation Insurance Company
Minneapolis, Minnesota
and any and all insurance companies which are now or hereafter
come under the same ownership or management as
American Compensation Insurance Company
The SUBSCRIBING REINSURER hereby accepts a 100% share in the interests and
liabilities of the "Reinsurer" as set forth in the attached Contract captioned
above.
This Agreement shall become effective on July 1, 1998, and shall continue in
force until terminated in accordance with the provisions of the attached
Contract.
The SUBSCRIBING REINSURER'S share in the attached Contract shall be separate
and apart from the shares of the other reinsurers, and shall not be joint
with the shares of the other reinsurers, it being understood that the
SUBSCRIBING REINSURER shall in no event participate in the interests and
liabilities of the other reinsurers.
IN WITNESS WHEREOF, the SUBSCRIBING REINSURER by its duly authorized
representative has executed this Agreement as of the date undermentioned at:
Stamford, Connecticut this 15th day of March 1999.
/s/ Peter S. Zaffinel
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CORE Managers Inc. (as Reinsurance Manager for and on behalf
of First Excess and Reinsurance Corporation)
E.W. BLANCH CO.
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NUCLEAR INCIDENT EXCLUSION CLAUSE -- LIABILITY - REINSURANCE
CANADA
1. This Agreement does not cover any loss or liability accruing to the
Reinsured as a member of, or subscriber to, any association of insurers
formed for the purpose of covering nuclear energy risks or as a direct or
indirect reinsurer of any such member, subscriber, or association.
2. Without in any way restricting the operation of paragraph 1 of this clause
it is agreed that for all purposes of this Agreement all the original
liability contracts of the Reinsured, whether new, renewal or replacement, of
the following classes, namely,
Personal Liability,
Farmers Liability,
Storekeepers Liability,
which become effective on or after 31st December 1984, shall be deemed to
include, from their inception dates and thereafter, the following provision:
LIMITED EXCLUSION PROVISION
This Policy does not apply to bodily injury or property damage with
respect to which the Insured is also insured under a contract of nuclear
energy liability insurance (whether the Insured is named in such
contract or not and whether or not it is legally enforceable by the
Insured) issued by the Nuclear Insurance Association of Canada or any
other group or pool of insurers or would be an Insured under any such
policy but for its termination upon exhaustion of its limit of liability.
With respect to property, loss of use of such property shall be deemed
to be property damage.
3. Without in any way restricting the operation of paragraph 1 of this
clause it is agreed that for all purposes of this Agreement all the original
liability contracts of the Reinsured, whether new, renewal or replacement, of
any class whatsoever (other than Personal Liability, Farmers Liability,
Storekeepers Liability or Automobile Liability contracts), which become
effective on or after 31st December 1984, shall be deemed to include, from
their inception dates and thereafter, the following provision:
BROAD EXCLUSION PROVISION
It is agreed that this Policy does not apply:
(a) to liability imposed by or arising under the Nuclear Liability Act;
or
(b) to bodily injury or property damage with respect to which an
Insured under this Policy is also insured under a contract of
nuclear energy liability insurance (whether the Insured is named in
such contract or not and whether or not it is legally enforceable
by the Insured) issued by the Nuclear Insurance Association of
Canada or any other insurer or group or pool of insurers or would
be an Insured under any such policy but for its termination upon
exhaustion of its limit of liability; or
(c) to bodily injury or property damage resulting directly or indirectly
from the nuclear energy hazard arising from:
<PAGE>
(1) the ownership, maintenance, operation or use of a nuclear
facility by or on behalf of an Insured;
(2) the furnishing by an Insured of services, materials, parts or
equipment in connection with the planning, construction,
maintenance, operation or use of any nuclear facility; and
(3) The possession, consumption, use, handling, disposal or
transportation of fissionable substances or of other radioactive
material (except radioactive isotopes, away from a nuclear
facility, which have reached the final stage of fabrication so
as to be useable for any scientific, medical, agricultural,
commercial or industrial purpose) used, distributed, handled or
sold by an Insured.
As used in this Policy:
(I) The term "nuclear energy hazard" means the radioactive,
toxic, explosive or other hazardous properties of radioactive
material;
(II) The term "radioactive material" means uranium, thorium,
plutonium, neptunium, their respective derivatives and
compounds, radioactive isotopes of other elements and any other
substances that the Atomic Energy Control Board may, by
regulation, designate as being prescribed substances
capable of releasing atomic energy, or as being requisite for
the production, use or application of atomic energy;
(III) The term "nuclear facility" means:
(a) any apparatus designed or used to sustain nuclear fission
in a self-supporting chain reaction or to contain a
critical mass of plutonium, thorium and uranium or any one
or more of them;
(b) any equipment or device designed or used for (i)
separating the isotopes of plutonium, thorium and uranium
or any one or more of them, (ii) processing or utilizing
spent fuel, or (iii) handling, processing or packaging
waste;
(c) any equipment or device used for the processing,
fabricating or alloying of plutonium, thorium or uranium
enriched in the isotope uranium 233 or in the isotope
uranium 235, or any one or more of them if at any time the
total amount of such material in the custody of the Insured
at the premises where such equipment or device is located
consists of or contains more than 25 grams of plutonium or
uranium 233 or any combination thereof, or more than 250
grams of uranium 235;
(d) any structure, basin, excavation, premises or place
prepared or used for the storage or disposal of waste
radioactive material;
and includes the site on which any of the foregoing is
located, together with all operations conducted thereon and all
premises used for such operations.
(IV) The term "fissionable substance" means any prescribed
substance that is, or from which can be obtained, a substance
capable of releasing atomic energy by nuclear fission.
(V) With respect to property, loss of use of such property shall
be deemed to be property damage.
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U.S.A.
NUCLEAR INCIDENT EXCLUSION CLAUSE - LIABILITY - REINSURANCE
(APPROVED BY LLOYD'S UNDERWRITERS' FIRE AND NON-MARINE ASSOCIATION)
(1) This reinsurance does not cover any loss or liability accruing to
the Reassured as a member of, or subscriber to, any association of insurers
or reinsurers formed for the purpose of covering nuclear energy risks or as
a direct or indirect reinsurer of any such member, subscriber or association.
(2) Without in any way restricting the operation of paragraph (1) of
this Clause it is understood and agreed that for all purposes of this
reinsurance all the original policies of the Reassured (new, renewal and
replacement) of the classes specified in Clause II of this paragraph (2) from
the time specified in Clause III in this paragraph (2) shall be deemed to
include the following provision (specified as the Limited Exclusion
Provision):
LIMITED EXCLUSION PROVISION.*
I. It is agreed that the policy does not apply under any liability
coverage,
to (INJURY, SICKNESS, DISEASE, DEATH OR DESTRUCTION
(bodily injury or property damage
with respect to which an insured under the policy is also an
insured under a nuclear energy liability policy issued by
Nuclear Energy Liability Insurance Association, Mutual
Atomic Energy Liability Underwriters or Nuclear Insurance
Association of Canada, or would be an insured under any such
policy but for its termination upon exhaustion of its limit of
liability.
II. Family Automobile Policies (liability only), Special Automobile
Policies (private passenger automobiles, liability only), Farmers
Comprehensive Personal Liability Policies (liability only),
Comprehensive Personal Liability Policies (liability only) or
policies of a similar nature; and the liability portion of
combination forms related to the four classes of policies stated
above, such as the Comprehensive Dwelling Policy and the applicable
types of Homeowners Policies.
III. The inception dates and thereafter of all original policies as
described in II above, whether new, renewal or replacement,
being policies which either
(a) become effective on or after 1st May, 1960 or
(b) become effective before that date and contain the Limited
Exclusion Provision set out above;
provided this paragraph (2) shall not be applicable to Family
Automobile Policies, Special Automobile Policies or policies or
combination policies of a similar nature, issued by the Reassured
on New York risks, until 90 days following approval of the
limited Exclusion Provision by the Governmental Authority having
jurisdiction thereof.
(3) Except for those classes of policies specified in Clause II of
paragraph (2) and without in any way restricting the operation of paragraph (1)
of this Clause, it is understood and agreed that for all purposes of this
reinsurance the original liability policies of the Reassured (new, renewal
and replacement) affording the following coverages:
Owners, Landlords and Tenants Liability, Contractual Liability,
Elevator Liability, Owners or Contractors (including railroad)
Protective Liability, Manufacturers and Contractors Liability,
Product Liability, Professional and Malpractice Liability,
Storekeepers Liability, Garage Liability, Automobile Liability
(including Massachusetts Motor Vehicle or Garage Liability)
shall be deemed to include, with respect to such coverages, from the time
specified in Clause V of this paragraph (3), the following provision
(specified as the Broad Exclusion Provision):
BROAD EXCLUSION PROVISION.*
It is agreed that the policy does not apply:
I. Under any Liability Coverage to (INJURY, SICKNESS, DISEASE, DEATH OR
DESTRUCTION
(bodily injury or property damage
<PAGE>
(a) with respect to which an insured under the policy is also an
insured under a nuclear energy liability policy issued by Nuclear
Energy Liability Insurance Association, Mutual Atomic Energy
Liability Underwriter or Nuclear Insurance Association of Canada,
or would be an insured under any such policy but for its termination
upon exhaustion of its limit of liability; or
(b) resulting from the hazardous properties of nuclear material and
with respect to which (1) any person or organization is required to
maintain financial protection pursuant to the Atomic Energy Act of
1954, or any law amendatory thereof, or (2) the insured is, or had
this policy not been issued would be, entitled to indemnity from
the United States of America, or any agency thereof, under any
agreement entered into by the United States of America, or any
agency thereof, with any person or organization.
II. Under any Medical Payments Coverage, or under any Supplementary Payments
Provision relating to (IMMEDIATE MEDICAL OR SURGICAL RELIEF
(first aid,
to expenses incurred with respect
to (BODILY INJURY, SICKNESS, DISEASE OR DEATH
(bodily injury
resulting from the hazardous properties of nuclear material and
arising out of the operation of a nuclear facility
by any person or organization.
III. Under any Liability Coverage to (INJURY, SICKNESS, DISEASE, DEATH OR
DESTRUCTION
(bodily injury or property damage
resulting from the hazardous properties of nuclear material, if
(a) the nuclear material (1) is at any nuclear facility owned by, or
operated by or on behalf of, an insured or (2) has been discharged
or dispersed therefrom;
(b) the nuclear material is contained in spent fuel or waste at any
time possessed, handled, used, processed, stored, transported or
disposed of by or on behalf of an insured; or
(c) the (INJURY, SICKNESS, DISEASE, DEATH OR DESTRUCTION
(bodily injury or property damage
arises out of the furnishing by an insured of services,
materials, parts or equipment in connection with the
planning, construction, maintenance, operation or use of any
nuclear facility, but if such facility is located within the United
States of America, its territories, or possessions or Canada, this
exclusion (c) applies
only to (INJURY TO OR DESTRUCTION OF PROPERTY AT SUCH NUCLEAR
FACILITY
(property damage to such nuclear facility and any
property thereat.
IV. As used in this endorsement:
"hazardous properties" include radioactive, toxic or explosive
properties; "nuclear material" means source material, special nuclear
material or byproduct material; "source material", "special nuclear
material", and "byproduct material" have the meanings given them in the
Atomic Energy Act of 1954 or in any law amendatory thereof; "spent fuel"
means any fuel element or fuel component, solid or liquid, which has
been used or exposed to radiation in a nuclear reactor; "waste" means
any waste material (1) containing byproduct material and (2) resulting
from the operation by any person or organization of any nuclear facility
included within the definition of nuclear facility under paragraph (a)
or (b) thereof; "nuclear facility" means
(a) any nuclear reactor,
(b) any equipment or device designed or used for (1) separating the
isotopes of uranium or plutonium, (2) processing or utilizing spent
fuel, or (3) handling processing or packaging waste,
(c) any equipment or device used for the processing, fabricating or
alloying of special nuclear material if at any time the total
amount of such material in the custody of the insured at the
premises where such equipment or device is located consists of or
contains more than 25 grams of plutonium or uranium 233 or any
combination thereof, or more than 250 grams of uranium 235,
(d) any structure, basin, excavation, premises or place prepared or
used for the storage or disposal of waste, and includes the site on
which any of the foregoing is located, all operations conducted on such
site and all premises used for such operations; "nuclear reactor" means
any apparatus designed or used to sustain nuclear fission in a
self-supporting chain reaction or to contain a critical mass of
fissionable material;
( WITH RESPECT TO INJURY TO OR DESTRUCTION OF PROPERTY, THE WORD "INJURY"
OR "DESTRUCTION"
( "property damage" includes all forms of radioactive contamination of
property.
( INCLUDES ALL FORMS OF RADIOACTIVE CONTAMINATION OF PROPERTY.
<PAGE>
V. The inception dates and thereafter of all original policies
affording coverages specified in this paragraph (3), whether
new, renewal or replacement, being policies which become
effective on or after 1st May, 1960, provided this paragraph
(3) shall not be applicable to
(i) Garage and Automobile Policies issued by the
Reassured on New York risks, or
(ii) statutory liability insurance required under
Chapter 90, General Laws of Massachusetts, until 90 days
following approval of the Broad Exclusion Provision by the
Governmental Authority having jurisdiction thereof.
(4) Without in any way restricting the operation of paragraph (1) of
this Clause, it is understood and agreed that paragraphs (2) and (3) above are
not applicable to original liability policies of the Reassured in Canada and
that with respect to such policies this Clause shall be deemed to include
the Nuclear Energy Liability Exclusion Provisions adopted by the Canadian
Underwriters' Association of the Independent Insurance Conference of Canada.
* NOTE: THE WORDS PRINTED IN ITALICS IN THE LIMITED EXCLUSION PROVISION AND
IN THE BROAD EXCLUSION PROVISION SHALL APPLY ONLY IN RELATION TO ORIGINAL
LIABILITY POLICIES WHICH INCLUDE A LIMITED EXCLUSION PROVISION OR A BROAD
EXCLUSION PROVISION CONTAINING THOSE WORDS.
<PAGE>
ENDORSEMENT NO. 2
Attached to and made a part of
AGREEMENT OF REINSURANCE
NO. 8295
between
GENERAL REINSURANCE CORPORATION
and
AMERICAN COMPENSATION INSURANCE COMPANY
IT IS MUTUALLY AGREED that, retroactive to the inception of this Agreement,
the first paragraph of ARTICLE XIII - CONTINGENT COMMISSION is amended to read:
IT IS FURTHER AGREED that, effective 12:01 A.M., January 1, 1999, this
Agreement is amended as follows:
I - As respects losses resulting from occurrences taking place at and after
such time and date, ARTICLE IV is amended to read:
"ARTICLE IV - LIABILITY OF THE REINSURER
(a) Under Cover A, the Reinsurer shall pay to the Company, with respect to
worker's compensation and employers' liability business of the Company,
the amount of net loss each occurrence, other than non-sudden and
accidental occupational disease, in excess of the Company Retention but
not exceeding the Limits of Liability of the Reinsurer as follows:
The Company Retention shall be $300,000.
The Limits of Liability of the Reinsurer shall be for the:
(1) First Excess Cover, $700,000 excess of $300,000;
(2) Second Excess Cover, $9,000,000 excess of $1,000,000;
<PAGE>
(3) Third Excess Cover, the difference between statutory limits and
$10,000,000. However, under this Third Excess Cover, the
Reinsurer's liability as respects each earthquake occurrence shall
not exceed $20,000,000.
For purposes of this provision, the term "earthquake occurrence"
shall be deemed to mean an occurrence or series of occurrences
arising out of one earthquake, including fire following directly
occasioned by the earthquake, provided that only the claims and
losses sustained by the Company during the continuous period of
168 hours selected by the Company shall be used in the
determination of the net loss; and only one such continuous period
of 168 hours shall apply with respect to one earthquake.
(b) Under Cover B, the Reinsurer shall pay to the Company, with respect to
non-sudden and accidental occupational disease, the amount of net loss
each occurrence which is first reported by the Company to the Reinsurer
while this Agreement remains in effect in excess of the Company
Retention of $300,000, but not exceeding the Limit of Liability of
the Reinsurer $19,700,000. Further, the liability of the Reinsurer
shall not exceed $19,700,000 with respect to all occurrences first
reported by the Company to the Reinsurer during any one calendar year
that this Agreement remains in effect.
II - As respects losses resulting from occurrences taking place at and
after such time and date, the first paragraph of ARTICLE V - LOSS IN
EXCESS OF POLICY LIMITS is amended to read:
"Notwithstanding the provisions of the article entitled MANAGEMENT OF CLAIMS
AND LOSSES, if a third party claimant is awarded an amount in excess of the
Company's policy limit and, as a result of the Company's or RTW's failure to
settle within the policy limit or of the Company's or RTW's alleged or actual
negligence or bad faith in rejecting an offer of settlement or in the
preparation of the defense or in the trial of any action against its insured or
in the preparation or prosecution of an appeal consequent upon such action, an
action is taken by the insured or assignee which could impose legal liability on
the Company for an amount in excess of the Company's policy limit, 95% of that
portion of the award made to the third party claimant which is in excess of the
Company's policy limit shall be added to the Company's net loss from the
occurrence and the total shall be allocated in accordance with the
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<PAGE>
article entitled LIABILITY OF THE REINSURER. However, in no event shall the
Reinsurer's liability for any loss in excess of the Company's policy limit
exceed 95% of $10,000,000."
III - As respects losses resulting from occurrences taking place at and
after such time and date, the first paragraph of ARTICLE VI - EXTRA
CONTRACTUAL OBLIGATIONS is amended to read:
"Notwithstanding the provisions of the article entitled MANAGEMENT OF CLAIMS
AND LOSSES, if the Company incurs an extra contractual obligation, 95% of the
extra contractual obligation shall be added to the Company's net loss from the
occurrence and the total shall be allocated in accordance with the article
entitled LIABILITY OF THE REINSURER. However, in no event shall the Reinsurer's
liability for any extra contractual obligation exceed 95% of $10,000,000."
IV - The third paragraph of ARTICLE VII - COMMENCEMENT AND TERMINATION
OBLIGATIONS is amended to read:
"Either party may terminate this Agreement at December 31, 2000 or any
subsequent December 31st, by sending to the other, by registered mail to its
principal office, not less than 90 days prior written notice."
V - As respects losses resulting from occurrences taking place at and
after such time and date, ARTICLE VIII is amended to read:
"ARTICLE VIII - COMPANY POLICY AMOUNTS
For the purposes of determining the Company Retention and the Limits of
Liability of the Reinsurer, the limits of liability of the Company with respect
to any one policy shall be deemed not to exceed:
(a) Workers' Compensation Statutory
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<PAGE>
(b) Employers' Liability
(1) Bodily Injury by Accident $5,000,000 each accident
(2) Bodily Injury by Disease $5,000,000 policy limit
(3) Bodily Injury by Disease $5,000,000 each employee"
VI - As respects losses resulting from occurrences taking place at and
after such time and date, the second paragraph of paragraph (d) of
ARTICLE IX - DEFINITIONS is amended to read:
"This term shall include declaratory judgment expense incurred by the
Company in contesting insurance coverage on the policies covered
hereunder. However, in no event shall the Reinsurer's liability for
any declaratory judgment expense exceed $5,000,000."
VII - As respects losses resulting from occurrences taking place at and
after such time and date, ARTICLE X is amended to read:
"ARTICLE X - EXCLUSIONS
This Agreement shall not apply to:
(a) Business accepted by the Company as reinsurance from other insurers
other than its affiliates and through a Specific Retrocessional
Agreement No. 2073 between the Company and the Reinsurer;
(b) "Self-insurance" or "self-insured obligations", howsoever styled, of
the Company, its affiliates or subsidiaries, or any insurance wherein
the Company, its affiliates or subsidiaries, are named as the insured
party, either alone or jointly with some other party, notwithstanding
that no legal liability may arise in respect thereof by reason of the
fact that the Company, its affiliates or subsidiaries, may not be
obligated by law to pay a claim to itself, its affiliates or
subsidiaries;
(c) Any loss or liability accruing to the Company directly or indirectly
from any insurance written by or through any pool or association
including pools or associations in which membership by the Company is
required under any statutes or regulations; however, this exclusion
shall not apply to the Company's involuntary participation in assigned
risk plans in so far as the class of business is one written by the
Company;
(d) Any liability of the Company arising from its participation or
membership in any insolvency fund;
(e) Insurance with respect to operations involving:
- 4 -
<PAGE>
(1) Aircraft flight operations or operations in which the flying
hazard is a major part of the insured's operations;
(2) Manufacturing, packing, handling, shipping, or storage of
explosives, substances intended for use as an explosive,
ammunitions, fuses, arms, magnesium, propellant charges,
detonating devices, fireworks, nitroglycerine, celluloid, or
pyroxylin; however, this exclusion shall not apply to the
incidental packing, handling or storage of same in connection
with the sale of such substances. Firearm manufacturing shall
not be excluded;
(3) Gas companies, dealers, or distributors, except those in the
gasoline service station business; oil or gas operators, lease
operators or contractors; oil or gas well works; oil or gas
pipeline construction or operations; oil rig and derrick work;
onshore or offshore gas or oil drilling operations. Gasoline
hauling shall not be excluded if the insured's primary operation
is retail gasoline distribution and the tankers are used to
distribute to the risk's own locations only;
(4) Production, refining, handling, shipping or storage of "flammable
liquids" or "flammable gases" as defined by the National Fire
Protection Association; however, this exclusion shall not apply to
the incidental handling or storage of same in connection with the
sale of such substances;
(5) Railroad operation or construction of railroads;
(6) Maritime or federal employments; steamship lines, agencies, or
stevedoring, navigation or operation of vessels; operation of
drydocks; marine wrecking; and including all United States
Longshoremen's and Harbor Workers' exposures except as incidental
and necessary to the primary operation;
(7) Sewer and subway construction, shaft sinking, or tunnelling;
(8) Wrecking or demolition;
(9) Underground mining, strip mining, or quarrying;
(10) Off-shore or subaqueous work;
(11) Caisson or coffer dam work; dam, dike, lock or revetment
construction;
(12) Chemical manufacturing, which includes the following class codes
promulgated by NCCI. In the event the NCCI class
- 5 -
<PAGE>
codes don't apply, the corresponding state specific code is
excluded. Any new codes developed by combining or subdividing
these codes are also excluded:
4536 Acid Mfg.
4585 Ammonia Mfg.
4586 Ammonium Nitrate Mfg.
4741 Asphalt or Tar Distilling or Refining
4828 Chemical Blending or Mixing
4829 Chemical Mfg. NOC
4703 Dextrine Mfg.
1472 Distillation - Wood
1474 Distillation - Wood - Destructive Process & Drivers
2130 Distillery - Spiritous Liquor
4771 Explosives or Ammunition Mfg. NOC
4583 Fertilizer Mfg.
4653 Glue Mfg.
4557 Ink Mfg.
4439 Lacquer or Spirit Varnish Mfg.
4740 Oil Refining - Petroleum
4558 Paint Mfg.
Pulp Mfg. - Chemical Process
4758 Rocket Engine Ignitor Mfg. & Drivers
4759 Rocket Engine Mfg. - Solid Propellant & Drivers
4720 Soap Mfg.
4751 Synthetic Rubber Mfg.
1473 Turpentine or Resin Mfg.
4561 Varnish Mfg.
2416 Yarn Dyeing or Finishing;
(13) Nuclear Regulatory Commission projects or operations conducted
under license from the Nuclear Regulatory Commission;
(14) Asbestos removal;
(15) Firefighters and police officers including armed security guards.
If the Company provides insurance for an insured with respect to any
operations listed in exclusion (e), except exclusions (e)(2) and (e)(4), and if
such operations constitute only a minor and incidental part of the total
operations of the insured, such exclusion(s) shall not apply. Minor and
incidental is defined as 10% or less of the total premium for the account.
If the Company is bound, without the knowledge of and contrary to the
instructions of the Company's supervisory underwriting personnel, on any
business falling within the scope of
- 6 -
<PAGE>
one or more of the exclusions set forth in this Article these exclusions, except
(a) through (d), (e)(2) and (e)(3) shall be suspended with respect to such
business until 30 days after an underwriting supervisor of the Company acquires
knowledge of such business."
VIII - As respects new and renewal policies of the Company becoming effective
at and after such time and date and policies of the Company in force
at such time and date, ARTICLE XII is amended to read:
IN WITNESS WHEREOF, the parties hereto have caused this Endorsement to be
- 7 -
<PAGE>
executed in duplicate,
this 6th day of JANUARY , 1997,
GENERAL REINSURANCE CORPORATION
/s/ Tom Collett
-----------------------------
Vice President
Attest: /s/ E.A. Collins
-----------------------------
and this 15th day of January, 1999.
AMERICAN COMPENSATION INSURANCE
COMPANY
/s/ Tim C. Chan
-----------------------------
Attest: /s/ Jeffrey B. Murphy
-----------------------------
- 8 -
<PAGE>
WORKERS' COMPENSATION
REINSURANCE ASSOCIATION
REINSURANCE AGREEMENT
EFFECTIVE JANUARY 1, 1999
<PAGE>
I. NATURE AND SCOPE OF AGREEMENT
A. PURPOSE. The purpose of this Reinsurance Agreement is to set forth
the basic conditions of the reinsuring agreement between the
Workers' Compensation Reinsurance Association ("Association") and
the Member. This Agreement is based on the Association's Enabling
Act (Minn. Stat. Section 79.34, et seq.), its Plan of Operation
("Plan"), and its Operating Rules. The provisions of the Enabling
Act, Plan, and Operating Rules shall be controlling over the
provisions of this Agreement. This Agreement is not intended to
independently establish any rights, liabilities, or obligations for
either the Association or the Member.
Reference: Plan, Article VI.K.
B. PARTIES. This Agreement is solely between the Member and the
Association. All affiliated insurers or self-insurers within a
holding company system shall be considered a single entity for
purposes of the exercise of all rights and duties of membership in
the Association. Nothing in this Agreement shall establish any
rights in favor of any third party. Nothing in this Agreement shall
create any liability or responsibility on the part of the
Association for actions of the Member or other members. Nothing in
this Agreement shall limit the Member's liability to employers,
employees and others under Minn. Stat. chs. 79 and 176 and other
Minnesota law.
References: Minn. Stat. Section 79.34. subd. 1.
Plan, Article VI. E.I., and VI. M.
C. DEFINITIONS. To the extent defined in the Plan or in Operating
Rules, the words used in this Agreement shall have the meanings
given them by the Plan and Operating Rules.
Reference: Plan, Article I.
D. TERMS OF AGREEMENT CONFORMED TO ENABLING ACT, PLAN, AND OPERATING
RULES. The terms of this Agreement which are in conflict with the
Enabling Act, other provisions of Minnesota Law, the Plan, or
Operating Rules are hereby amended to conform thereto. This
Agreement shall be deemed to be automatically amended to conform to
any amendment to the Enabling Act, other provisions of Minnesota
law, the Plan, or the Operating Rules, or to the adoption of other
Minnesota law or Operating Rules after the effective date of this
Agreement. Such automatic amendment to this Agreement shall be
effective on the effective date of the amendment to the Enabling
Act, other provisions of Minnesota law, Plan, or Operating Rules, or
the adoption of other Minnesota law or Operating Rules.
Reference: Plan, Article IX. E.
WCRA 1
<PAGE>
II. REINSURING AGREEMENTS
A. LIABILITY OF ASSOCIATION. The Association shall reinsure the
Member's Minnesota workers' compensation liability and shall
indemnify the Member for 100 percent of the amount of ultimate loss
arising out of each occurrence compensable under Minn. Stat. Ch. 176
to the extent that the ultimate loss exceeds the Member's retention
limit in effect at the time of the loss occurrence and subject to
the terms and conditions of the Enabling Act, Plan, and Operating
Rules.
References: Minn. Stat Section 79.34, subd.2.
Plan, Article VI. A.
B. MEMBER'S DUTIES. The Member shall comply with all requirements of
the Enabling Act, Plan, and Operating Rules. These requirements
include, but are not limited to, the following: The Member shall
reinsure its Minnesota workers' compensation liability with the
Association, pay all benefits for losses reinsured by the Association,
belong to the Association, accept indemnification from the Association,
and report to the Association claims which may involve liability to the
Association.
References: Minn. Stat. Section 79.34, subds. 1 and 2.
Plan, Article III. and Article VI.A.
III. RETENTION LIMITS
The Member shall select the low, high or super retention limit for each
calendar year. The retention limits may be changed annually on January
1. The Member shall notify the Association by certified mail of any
change of its retention limit selection by December 1 of the year
preceding the coverage year. All affiliated insurers or self-insurers
within a holding company system shall select the same retention limit.
If the Association is not notified of the Member's change of retention
limit for the next coverage year by December 1, the Member shall be
deemed to have chosen for the next coverage year the same retention
limit (low, high, or super retention limit) which was in effect on
December 1.
References: Minn. Stat. Section 79.34, subds. 1 and 2.
Plan, Article VI.A.
IV. REINSURANCE PROVIDED BY ASSOCIATION EXCLUSIVE
A Member selecting the high or super retention limit shall not purchase
reinsurance for losses below its retention limit except in certain
circumstances specified by statute. A
WCRA 2
<PAGE>
Member selecting the low retention limit may purchase reinsurance from
other organizations to provide indemnification for losses below its
retention limit. A Member shall not issue large deductible policies in
Minnesota for deductible amounts in excess of its selected retention
limit.
References: Minn. Stat. Section 79.34, subd. 2.
Minn. Department of Commerce, Bulletin 91-5
V. COVERAGE
A. GENERAL SCOPE. The reinsurance provided by the Association shall
cover only benefits under Minn. Stat. Ch. 176 which are paid by the
Member, provided that for losses incurred on or after January 1,
1984, the reinsurance provided shall cover benefits paid by the
Member under the workers' compensation law of another state when the
injured worker is eligible for benefits under Minn. Stat. Section
176.041, subds. 2 or 3, but elects to receive benefits under the
workers' compensation statute of such other state, as provided in
Minn. Stat. Section 79.34 subd. 7. Any amounts paid by a Member
pursuant to Minn. Stat. Sections 176.183, 176.221, 176.225 and
176.82 shall not be included in ultimate loss and shall not be
indemnified by the Association. Employers' liability coverage is not
provided by the Association. The Association does not cover claims
under the Federal Employers' Liability Act, the Jones Act, the
Longshoremen's and Harbor Workers' Compensation Act, or any other
federal law.
References: Minn. Stat. Section 79.34, subds. 2 and 7.
Minn. Stat. Section 176.041, subds. 2 and 3
Plan, Article VI.
B. PER OCCURRENCE BASIS. Coverage shall be provided on a per
occurrence basis, as determined by the Association, except in the
case of occupational disease, where coverage is provided on a per
person per occurrence basis.
References: Minn. Stat. Section 79.34, subd. 2.
Plan, Article I. N. and Article VI.
C. CLAIMS EXPENSES. Claims expenses, assessments, damages and penalties
shall not be indemnified by the Association. Claims expenses include
investigation and legal expenses, court costs, interest and
penalties. Expenses subject to indemnification include expenditures
incurred in the preparation and development of a rehabilitation plan
submitted to the Department of Labor and Industry and in the
provision of rehabilitation services rendered in accordance with
such a rehabilitation plan.
References: Minn. Stat. Section 79.34, subd. 2.
WCRA 3
<PAGE>
Plan, Article I., Section H.
Operating Rule for Clarification of the Definition of
Claim Expenses.
D. ASSESSMENTS. Assessments, including Special Compensation Fund
assessments under Minn. Stat. Sections 176.129 and 176.131 (repealed
effective July 1, 1992), shall not be reimbursed by the Association.
References: Minn. Stat. Sections 176.129 and 79.34, subd. 2.
Plan, Article VI. V.
E. EFFECTIVE DATE. Coverage shall be effective on the date the Member
joins the Association. In no case shall the Association be liable
for benefits for occurrences taking place prior to October 1, 1979.
The Association shall have no liability for death benefits where an
injury prior to October 1, 1979, causes death on or after October 1,
1979. Effective January 1, 1984, certain benefits paid pursuant to
the workers' compensation laws of other states will be covered, as
provided in Article V. A. of this Agreement.
References: Minn. Stat. Section 79.34, subds. 2 and 7.
VI. PREMIUMS
A. ANNUAL PREMIUM. The Member shall pay an annual premium for the
reinsurance coverage provided by the Association at the rate
determined by the Board of Directors of the Association ("Board of
Directors") and approved by the Minnesota Commissioner of Labor and
Industry ("Commissioner"). Estimated premium shall be calculated in
accordance with procedures established in the Operating Rule for
Determination of Exposure Base. The estimated exposure base for a
Member may be revised after six months of the coverage year if the
member verifies that its current annualized six month exposure base
is at least fifteen percent higher or lower than its estimated
exposure base. When the actual exposure base figures for the
billing year become available, the actual premium shall be
calculated. A premium adjustment shall be made as provided in
Article VI. of this Agreement.
References: Minn. Stat. Section 79.35(d).
Plan, Article VI. D.
Operating Rule for Determination of Exposure Base.
B. BILLING OF PREMIUM. The estimated premium shall be billed on a
quarterly basis, and shall be payable within 30 days of the date of
the premium notice, with late payments subject to interest charges
established by the Board of Directors.
WCRA 4
<PAGE>
Reference: Plan, Article VI. D.3.
C. OFFSET. The Association may offset indemnification payable to the
Member against premium payable by the Member. Premiums payable shall
not be offset against indemnification claimed by the Member.
References: Plan, Article VI. D.3.c.
D. ANNUAL ADJUSTMENT OF PREMIUM. The Association shall annually provide
to the Member a statement indicating adjustments for previous years'
premium. Amounts due the Association as a result of the adjustment
shall be paid by the Member within 30 days of the billing date, with
late payments subject to interest charges established by the Board
of Directors. Amounts due the Member shall be credited to the
Member's premium account with the Association, and any credit
premium balance shall be refunded to the Member within 30 days.
References: Plan, Article VI. D.2.b.
Operating Rule for Determination of Exposure Base.
Operating Rule for Annual and Audit Premium Adjustment
Refunds
E. INTERIM ADJUSTMENT OF PREMIUM. A Member who ceases doing business in
Minnesota or a self-insurer Member who ceases to be an approved
self-insurer may request an interim adjustment of estimated annual
premium.
Reference: Operating Rule for Interim Adjustment of Estimated Annual
Premium.
F. SURPLUS DISTRIBUTIONS AND DEFICIENCY ASSESSMENTS. The Board of
Directors may declare a distribution of surplus or assessment of
deficiencies in the form of member excess or deficient premiums or
policyholder excess surplus or deficiencies as required by the
Operating Rule for the Determination of Surplus. Such distributions
or assessments may result from statutory changes, changes in the
exposure base, or a profit or loss. Distributions of surplus and
deficiency assessments shall be made as required by the Board of
Directors in accordance with the Enabling Act, Plan and Operating
Rule for the Determination of Surplus as they have been interpreted
by the courts.
References: Minn. Stat. Section 79.34, et seq.
Plan, Article VI. D. 1.d. and VI. N.
Operating Rule for the Determination of Surplus
G. CATASTROPHIC PREMIUMS. In the event that benefits paid or expected to
be paid on a claim in a calendar year exceed the prefunded limit in
effect at the time the loss was
WCRA 5
<PAGE>
incurred, the Association shall calculate and charge to all Members
an additional premium for that year sufficient to cover the payments
in excess of the prefunded limit. The premium shall be charged and
collected in the same manner as the annual premium.
References: Minn. Stat. Section 79.35(d).
H. PREMIUM AUDITS. The Association may inspect and audit any Member's
records to determine the accuracy of the premium calculation. The
Member shall timely provide all information requested and shall in
all respects cooperate fully in providing information during the
course of an audit.
References: Plan, Article VI.D.2.f.
VII. REIMBURSEMENT PROCEDURE
Requests for reimbursement shall be submitted in a form approved by the
Association. The first request shall be submitted within six months
after the Member's payments on a loss exceed the Member's Retention
Limit. Thereafter the Member, if entitled to indemnification by the
Association, shall file a reimbursement request form semi-annually
until the claim is closed. The request shall be submitted to the
Association during the month of the anniversary and half-year
anniversary of the loss occurrence date provided that, if the initial
reimbursement request for a claim was submitted prior to December 1,
1983, the Member may, at its option, continue to submit reimbursement
requests in January and July. The Member and the Association may, in
the alternative, agree upon a semi-annual reimbursement cycle, whereby
all of the Member's reimbursement requests, regardless of loss
occurrence date, are filed on the same cycle. If a claim settles on a
full, final and complete basis, or the claim file is closed, a
reimbursement request may be filed at anytime. If payments for which
reimbursement is due exceed $30,000 in the three months following a
regularly scheduled reimbursement date, a reimbursement request may be
filed in the following month. The reimbursement request shall itemize
all payments since submission of the last reimbursement request.
Proper and complete reimbursement requests shall be promptly paid by
the Association.
References: Plan, Article VI.
Operating Rule for Reimbursement Procedures.
VIII. MANAGEMENT OF CLAIMS AND LOSSES
A. CLAIMS. The Member shall have the primary responsibility for the
investigation, management, and defense of all claims and losses
WCRA 6
<PAGE>
If the Association determines that the claims procedures or
practices of a Member are inadequate to properly limit the
liabilities of the Association, or may, in any way, jeopardize the
interests of the Association, the Association may withhold
reimbursements from the Member until it determines that the
deficiencies in the claims procedures have been resolved, or the
Association may, with the approval of the Board of Directors and at
the Member's expense, undertake directly or contract with another
person, including another Member, to adjust or assist in the
adjustment of a Claim or Claims which create a potential liability
to the Association. The Association may charge the costs and
expenses of these activities, including legal expenses, to the
Member, and the Member shall cooperate fully with the Association in
such claims management. If the Board of Directors determines that
the claims procedures or practices of a Member are inadequate to
properly service the liabilities of the Association, or may, in any
way, jeopardize the interests of the Association, the Association
may also recommend to the Commissioner and the Commissioner of
Commerce that an Insurer Member's license to transact workers'
compensation insurance, or a Self-insurer Member's authorization to
self-insure workers' compensation liability, pursuant to Minn. Stat.
Section 176.181, be revoked.
References: Minn. Stat. Section 79.35(g).
Plan, Article VI.F.4.
Operating Rule for the Adjustment of Claims.
B. CLAIMS AUDITS. The Association may inspect and audit the Member's
records relating to all claims or related matters. The Member shall
timely provide all information requested and shall in all respects
cooperate fully in providing information during the course of an
audit.
References: Minn. Stat. Section 79.35(g).
Plan, Article VI.F.3.
C. REPORTING REQUIREMENTS. The Member shall promptly report to the
Association any claim meeting either of the following reporting
criteria:
1. CLAIM COST CRITERIA. When a Member estimates that the total
incurred cost (payments and reserves for future payments) of a
claim exceeds 50 percent of the retention limit which was in
effect during the year when the loss was incurred, or
2. CLAIM INJURY CRITERIA. When a claimant has suffered a serious
injury as described in the following list:
a. Central Nervous System Injury.
WCRA 7
<PAGE>
(1) Spinal cord injury resulting in paraplegia or quadriplegia.
(2) Brain damage affecting cognition and/or such conditions as
permanent disorientation, behavior disorder, personality
change, seizure disorder, sensorimotor deficits, aphasia, or
coma.
b. Fatality, except for a no dependent exposure.
c. Third degree burns covering 10 percent of the body, or second
degree burns covering 30 percent of the body, or if
significant medical costs can be anticipated.
d. Amputations of a significant portion of one extremity or
multiple amputations.
e. Impairment of total vision by 50 percent or more.
f. Peripheral nerve damage causing major muscle dysfunction or
paralysis in an upper or lower extremity.
g. Serious internal injuries resulting from blunt, penetrating, or
crushing injuries to the chest or abdomen.
h. Multiple fractures, or significant degloving injuries, involving
more than one arm, hand, or leg, malunion, or significant
shortening of the limbs.
i. Fracture of both heel bones (bilateral os calcis).
j. Occupational disease allegedly caused by working conditions or
other job-related factors, including asbestosis, or chronic
pulmonary disease or other occupational disease which results
in disability expected to last two years or more.
References: Plan, Article VI. B.1.
Operating Rule for Claim Reporting Procedure.
D. LEGAL PROCEEDINGS. The Association may intervene in legal
proceedings under Minnesota Statutes Chapter 176 where the result of
the proceeding is considered likely to affect the interests of the
Association. The Association shall notify the affected Member prior
to intervening.
References: Minn. Stat. Section 79.36(f).
WCRA 8
<PAGE>
Plan, Article VI.H.2.
Operating Rule for Intervention in Claim Proceedings.
IX. SUBROGATION, SALVAGE, AND THIRD PARTY RECOVERIES
The Member shall, to the extent permitted by law, prosecute or intervene
in any and all claims against third parties arising out of any covered
loss occurrence and all recoveries therefrom shall be applied to reduce
the loss which the Association is required to reimburse to the Member.
Should the Member fail or neglect to enforce any such claims, the
Association may be subrogated to the Member's interest in the claim. The
net proceeds recovered shall be distributed first to the Association to
the extent of amounts paid or payable in the future by the Association
for the claim. Any excess recovered by the Association shall be paid to
the Member or other person entitled to the proceeds, as determined by the
Board of Directors.
If the Member desires to waive subrogation, it must promptly notify the
WCRA and must secure advance approval by the WCRA staff before agreeing
to waive subrogation. If the Member waives its subrogation rights after a
claim has occurred without first obtaining the agreement of the
Association, and the Association determines that it was not in its best
interests to waive subrogation, the Association may refuse to indemnify
the Member for that claim to the extent of amounts which the Association
determines would have been recoverable through subrogation. The
Association may withhold reimbursements to the Member for other claims to
recover reimbursements already made on the claim where subrogation was
waived.
References: Minn. Stat. Section 79.36(g).
Plan, Article VI.E.3. and VI.G.
Operating Rule for the Adjustment of Claims.
Operating Rule for Approval of Waivers of Subrogation
X. RESOLUTION OF DISPUTES
Any member or other interested party aggrieved by any action or
decision of the Board of Directors or the Association, or any agent of
the Association, may, in addition to any other recourse available at law,
including judicial review, file a written complaint with the Association
concerning such action or decision within 30 days. The complaint will be
resolved either through binding arbitration or by the Member Appeals
Committee in accordance with the following procedures.
WCRA 9
<PAGE>
Any dispute between a Member (or Former Member or successor in interest
of a Member) and the Association with respect to Article VI. of the Plan
or any provisions in the Reinsurance Agreement or Operating Rules adopted
by the Board of Directors relating to coverage, claim, or premium issues,
as determined by the Association, shall be decided through binding
arbitration in accordance with procedures established in Article X of the
Plan.
Any other unresolved complaint filed by a Member (or Former Member or
successor in interest of a member) shall be decided by a Member Appeals
Committee appointed in accordance with Article X. C. of the Plan. Any
Member aggrieved by a determination by the Member Appeals Committee may
appeal such determination to the Commissioner within 30 days, provided
that, in addition, such Member shall have any other recourse available at
law, including judicial review.
References: Minn Stat. Section 79.36 (h).
Plan, Article X.
XI. INSOLVENCY
If the Member becomes insolvent, indemnification for losses payable by
the Association shall be payable by the Association directly to the
Member or its liquidator, receiver, or statutory successor.
If the Member or any other member becomes insolvent, any liability of the
insolvent member to the Association shall be apportioned among the
remaining members on the same basis as reinsurance premiums are charged.
The Association shall have, on behalf of all of the remaining members,
all rights allowed by law against the estate or funds of the insolvent
member for sums due the Association, and any amounts received by the
Association as a result thereof shall be credited to the members on the
same basis as reinsurance premiums are charged.
References: Minn Stat. Section 79.34, subd. 4.
Plan, Article III. A.2.
XII. TERMINATION
The Commissioner or Commissioner of Commerce may, upon notice to a
Member, take any appropriate action against a Member pursuant to procedures
available to the Commissioner or Commissioner of Commerce, including
revocation of the license of an Insurer to transact workers' compensation
insurance or revocation of authorization of a
WCRA 10
<PAGE>
Self-insurer to self-insure workers' compensation liability as authorized
by law, for failure to pay Premiums to the Association when due, failure
to comply with the Plan, Reinsurance Agreement, or Operating Rules, or
failure to comply with Minnesota law. Revocation of authority to write
workers' compensation insurance by an Insurer or to self-insure
automatically terminates membership in the Association. An Insurer may
voluntarily withdraw from membership in the Association only upon ceasing
to be authorized by the Commissioner of Commerce to transact workers'
compensation insurance in Minnesota. A Self-insurer may voluntarily
withdraw from membership in the Association only when it stops
self-insuring its workers' compensation liability, which voluntary
withdrawal is effective on the date determined by the Commissioner of
Commerce. Any unpaid Premiums which have been charged to a withdrawing or
terminated Member shall be due and payable as of the effective date of
withdrawal or termination, as determined by the Commissioner of Commerce.
A Former Member shall continue to be bound by the Act, Plan, and any
Reinsurance Agreement or Operating Rules with respect to the performance
and completion of any unsatisfied liabilities and obligations to the
Association.
References: Minn. Stat. Section 79.34, subd. 3.
Plan, Article III. A.1.
Adopted by action of the Board of Directors of the Workers' Compensation
Reinsurance Association at its meeting duly called on the 10th day of
December, 1998; and approved by the Minnesota Commissioner of Labor and
Industry on the 4th day of January, 1999.
WORKERS' COMPENSATION
REINSURANCE ASSOCIATION
By /s/ Jay Y. Benanav
----------------------------------------
Jay Y. Benanav
Its President
ATTEST
By /s/ Carl W. Cummins III
----------------------------------------
Carl W. Cummins III
Its Secretary
WCRA 11
<PAGE>
STATE OF MINNESOTA
DEPARTMENT OF LABOR AND INDUSTRY
BEFORE THE COMMISSIONER OF LABOR AND INDUSTRY
In the matter of the Amended Plan of ORDER APPROVING AMENDMENTS
Operation and Reinsurance Agreement TO THE PLAN OF OPERATION
of the Workers' Compensation AND REINSURANCE AGREEMENT
Reinsurance Association OF THE WORKERS' COMPENSATION
REINSURANCE ASSOCIATION
ORDER
In accordance with Minn. Stat. Section 79.38, subd.3 (1996) and
Articles I.AA and IX of the WCRA Plan of Operation, IT IS HEREBY ORDERED that
the Amendments to the WCRA Plan of Operation and Reinsurance Agreement, as
approved by the WCRA Board of Directors on December 10, 1998, are approved.
Dated: 1-4-99, 9:45 am /s/ Gretchen Maglich
-------------------- -------------------------
GRETCHEN MAGLICH
Commissioner of Labor and Industry
<PAGE>
1999
CERTIFICATE OF REINSURANCE
FOR THE
AGREEMENT OF REINSURANCE
BETWEEN THE
WORKERS' COMPENSATION REINSURANCE ASSOCIATION
AND
AMERICAN COMPENSATION INSURANCE COMPANY
JANUARY 1, 1999 - DECEMBER 31, 1999 RETENTION LIMIT: $290,000
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 Y. Benanav
--------------------------------------
Jay Y. Benanav
President and Chief Executive Officer
Dated: February 1, 1999
445 Minnesota Street, Suite 600, St. Paul, MN 55101-2125 Phone: (651) 293-0999
Fax: (651) 293-0719
<PAGE>
EXHIBIT 11
RTW, INC. AND SUBSIDIARY
STATEMENT REGARDING COMPUTATION OF BASIC AND DILUTED INCOME (LOSS) PER SHARE
<TABLE>
<CAPTION>
1996 1997 1998
------------ ------------ -------------
<S> <C> <C> <C>
BASIC WEIGHTED AVERAGE SHARES OUTSTANDING 11,774,147 11,832,720 11,926,819
STOCK WARRANTS 4,325 - -
STOCK OPTIONS
Options at $25.00 57 - -
Options at $19.33 7,013 - -
Options at $16.67 1,446 - -
Options at $12.50 3,424 - -
Options at $10.75 - 919 -
Options at $ 8.67 44,254 4,955 -
Options at $ 7.13 - 95 -
Options at $ 6.75 - 357 -
Options at $ 2.67 69,619 54,065 -
Options at $ 2.00 232,333 186,018 -
Options at $ 0.53 - - -
------------ ------------ -------------
WEIGHTED AVERAGE COMMON AND COMMON
SHARE EQUIVALENTS OUTSTANDING 12,136,618 12,079,129 11,926,891
------------ ------------ -------------
------------ ------------ -------------
NET INCOME (LOSS) ($000'S) $8,982 $5,799 ($7,018)
------------ ------------ -------------
------------ ------------ -------------
INCOME (LOSS) PER SHARE:
BASIC INCOME (LOSS) PER SHARE $0.76 $0.49 ($0.59)
------------ ------------ -------------
------------ ------------ -------------
DILUTED INCOME (LOSS) PER SHARE $0.74 $0.48 ($0.59)
------------ ------------ -------------
------------ ------------ -------------
</TABLE>
<PAGE>
INDEPENDENT AUDITORS' REPORT
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, Registration Statement No. 33-98966 of RTW, Inc. on
Form S-8, and Registration Statement No. 333-28585 of RTW, Inc. on Form S-8
of our reports dated February 1, 1999, appearing in this Annual Report on
Form 10-K of RTW, Inc. for the year ended December 31, 1998.
/s/ DELOITTE & TOUCHE LLP
Minneapolis, Minnesota
March 29, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 7
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> YEAR YEAR
<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1997
<PERIOD-START> JAN-01-1998 JAN-01-1997
<PERIOD-END> DEC-31-1998 DEC-31-1997
<DEBT-HELD-FOR-SALE> 126,631 112,294
<DEBT-CARRYING-VALUE> 0 0
<DEBT-MARKET-VALUE> 0 0
<EQUITIES> 0 0
<MORTGAGE> 0 0
<REAL-ESTATE> 0 0
<TOTAL-INVEST> 126,631 112,294
<CASH> 700 5,798
<RECOVER-REINSURE> 867 743
<DEFERRED-ACQUISITION> 1,501 1,559
<TOTAL-ASSETS> 170,945 142,997
<POLICY-LOSSES> 97,269 61,069
<UNEARNED-PREMIUMS> 13,027 13,580
<POLICY-OTHER> 5,570 5,116
<POLICY-HOLDER-FUNDS> 0 0
<NOTES-PAYABLE> 2,461 4,875
0 0
0 0
<COMMON> 29,451 28,976
<OTHER-SE> 23,167 29,381
<TOTAL-LIABILITY-AND-EQUITY> 170,945 142,997
81,392 81,043
<INVESTMENT-INCOME> 7,714 6,821
<INVESTMENT-GAINS> 1,046 399
<OTHER-INCOME> 0 0
<BENEFITS> 75,294 55,543
<UNDERWRITING-AMORTIZATION> 13,974 11,658
<UNDERWRITING-OTHER> 11,369 11,616
<INCOME-PRETAX> (11,031) 8,669
<INCOME-TAX> (3,950) 2,870
<INCOME-CONTINUING> (7,081) 5,799
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (7,081) 5,799
<EPS-PRIMARY> (0.59) 0.49
<EPS-DILUTED> (0.59) 0.48
<RESERVE-OPEN> 61,069 49,256
<PROVISION-CURRENT> 78,520 60,265
<PROVISION-PRIOR> 11,444 (4,394)
<PAYMENTS-CURRENT> 25,448 23,529
<PAYMENTS-PRIOR> 28,316 20,529
<RESERVE-CLOSE> 97,269 61,069
<CUMULATIVE-DEFICIENCY> 0 0
</TABLE>
