RTW INC /MN/, 10-K405, 2000-03-30

RTW INC /MN/
10-K405, 2000-03-30
FIRE, MARINE & CASUALTY INSURANCE

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PART I
	ITEM 1. BUSINESS
	ITEM 2. PROPERTIES
	ITEM 3. LEGAL PROCEEDINGS
	ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
PART II
	ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
	ITEM 6. SELECTED FINANCIAL DATA
	ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
	ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
	ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
	ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
PART III
	ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
	ITEM 11. EXECUTIVE COMPENSATION
	ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
	ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
PART IV
	ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
	SIGNATURES

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, 1999

[ ] 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




(State or other jurisdiction of incorporation		(I.R.S. Employer Identification No.)




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

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 28, 2000, 10,893,685 shares of Common Stock, no par value, were outstanding. As of March 28, 2000, assuming as fair value the last sale price of $6.0625 per share on The Nasdaq Stock Market, the aggregate fair value of shares held by non-affiliates was approximately $56,400,000.

Documents incorporated by reference:

The Company’s Proxy Statement for its annual meeting of shareholders to be held in May 2000, a definitive copy of which will be filed with the Securities and Exchange Commission within 120 days of December 31, 1999, is incorporated by reference in Part III of this Report on Form 10-K.

TABLE OF CONTENTS

PART I


		PAGE
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


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	25




Item 8.	Financial Statements and Supplementary Data	25




Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	43

PART III


Item 10.	Directors and Executive Officers of the Registrant	43




Item 11.	Executive Compensation	43




Item 12.	Security Ownership of Certain Beneficial Owners and Management	43




Item 13.	Certain Relationships and Related Transactions	43

PART IV


Item 14.	Exhibits, Financial Statement Schedules, and Reports on Form 8-K	43




	Signatures	45

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 1999. The Company also had obtained licenses but was not yet operating in Pennsylvania, Tennessee, Maryland, Arkansas, Iowa, Florida, New Jersey, Georgia, North Carolina and Texas. 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 has developed two proprietary management systems: (i) the RTW SOLUTION(R), designed to lower employers’ workers’ compensation costs and return injured employees to work as soon as possible, and (ii) the ID15(R) system, designed to identify those injured employees who are likely to get stuck in the workers’ compensation system. The Company combines its management systems with insurance products underwritten by its insurance subsidiary to offer services to customers. 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 1998. Estimated insurance premiums totaled approximately $26.0 billion nationwide in 1997. This $26.0 billion includes: (i) the traditional, or private residual market, estimated at $23.2 billion, including commercial insurers and state operated assigned risk pools established for high risk employers; and (ii) state funds, estimated at $2.8 billion, operated in states in order to increase competition and stabilize the market.

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 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 five-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, and an assistant claims administrator / 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. As part of the insurance policy, 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 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 increased to $26,900 in 1999 from $21,000 in 1998 and $22,000 in 1997 due to focused aggressive re-underwriting in 1999. The Company’s ten largest customers accounted for approximately $6.5 million or 7.5% of the Company’s premiums in force in 1999 compared to $4.4 million or 5.3% of the Company’s premiums in force in 1998 and $5.3 million or 6.7% of premiums in force in 1997. No customer accounted for more than 5% of in force premiums in 1999, 1998 or 1997. The Company renewed approximately 65.8% of the policies scheduled to expire in 1999 whereas approximately 72.5% and 78% were renewed in 1998 and 1997, 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 these states, the Company is also currently licensed in Pennsylvania, Tennessee, Maryland, Arkansas, Iowa, Florida, New Jersey, Georgia, North Carolina and Texas. 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 or adopted 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 1999 compared to 8.0% of gross premiums earned in 1998 and 7.8% of gross premiums earned in 1997. The Company’s ten highest producing agencies accounted for approximately $19.9 million or 22.8% of premium in force in 1999 compared to $19.1 million or 23.2% of premiums in force in 1998 and $21.1 million or 26.9% of premiums in force in 1997. No agency accounted for more than 4.0% of premiums in force in 1999 compared to 3.4% of premiums in force in 1998 and 4.3% of premiums in force in 1997. 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 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 1999, 1998 and 1997, the Company selected per occurrence levels in Minnesota under the WCRA of $290,000, $280,000 and $1.1 million, respectively. In 2000, Minnesota excess of loss coverage under the WCRA begins at $310,000.

In 1999, 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 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, $265,000 in excess of $25,000 for 1999 and $275,000 in excess of $25,000 for 2000. This coverage reduces risk and volatility in the Company’s operating performance and is in effect through December 2000.

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 1999, 1998 and 1997, 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 April 1999. 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 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 1999, 1998 and 1997, 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. In 1999, the Company developed and implemented its own proprietary billing, cash receipts, collections and agency commission systems. These systems replaced third party software systems purchased by the Company. The Company continues to utilize third party software to maintain financial information, prepare accounting reports and financial statements and pay vendors. 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 249 full-time employees at December 31, 1999. Of the Company’s employees, approximately 105 work in the Company’s administrative and financial functions and 144 serve on, provide service to or manage approximately 23 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 at March 24, 2000:


Name	Age		Position

Carl B. Lehmann		45	President, Chief Executive Officer and Director




Jeffrey B. Murphy		38	Chief Financial Officer, Secretary and Treasurer




Anthony J. Rotondi		54	Chief Operations Officer




David J. LeBlanc		38	Chief Underwriting Officer




Tanna L. Moore		45	Chief Marketing Officer




Marguerite K. Downey		49	Chief Information Officer

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.

Jeffrey B. Murphy joined the Company in October 1994 as Controller and was promoted to Chief Financial Officer in February 2000. Mr. Murphy was the Corporate Controller and held other management positions for Midcontinent Media, Inc. from 1989 to 1994. Prior to that time, Mr. Murphy served in various financial audit positions with Grant Thornton LLP from 1983 to 1989.

David J. LeBlanc joined the Company in March 1997 as the Director of Marketing and Underwriting for the Company’s Massachusetts regional office. He held various other management positions within the Company before being promoted to Chief Underwriting Officer in October 1999. Prior to joining the Company, Mr. LeBlanc was a Regional Underwriting Manager from 1994 until 1997 for Liberty Mutual Insurance Company. Mr. LeBlanc also held several other leadership positions during his thirteen years with Liberty.

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 Financial Group from 1988 to 1996. Ms. Downey also served in other information system positions at Fortis Financial Group from 1972 to 1988.

ITEM 2. PROPERTIES

The following is a summary of properties leased by the Company at December 31, 1999:


	Area leased
Location and description	(in square feet)		Termination

Bloomington, Minnesota; Headquarters space		35,487	September 2002




Brainerd, Minnesota; Minnesota satellite office		4,274	October 2000




Denver, Colorado; Colorado office space		7,825	May 2005




St. Louis, Missouri; Missouri office space		8,476	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 2001




Boston, Massachusetts; Massachusetts office space		12,381	May 2002

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.

PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

QUARTERLY STOCK PRICE COMPARISON AND DIVIDENDS

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, 2000, the Company had approximately 2,000 shareholders.

First

Second

Third

Fourth

Fiscal Year:

Quarter

1999

High

7 7/8

6 5/8

6 9/16

6 1/4

Low

4 1/4

4 1/16

4 1/8

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

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.

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, 1999, and the consolidated balance sheet data at December 31, 1999 and 1998 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, 1996, and the consolidated balance sheet data at December 31, 1997, 1996 and 1995, 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.


	1995		1996		1997		1998			1999

			(In thousands, except per share data)
Total revenues	$	49,433	$	68,725	$	88,263	$	90,152		$	77,812




Income (loss) from operations		12,569		14,808		9,446		(10,485	)		8,357




Net income (loss)		7,058		8,982		5,799		(7,081	)		6,167




Basic income (loss) per share (1)		0.67		0.76		0.49		(0.59	)		0.50




Diluted income (loss) per share (1)		0.64		0.74		0.48		(0.59	)		0.50




Premiums in force at year end		51,700		69,500		78,400		82,100			87,200




Total assets		101,124		123,731		142,997		172,934			176,511




Notes payable		8,891		6,739		4,875		2,461			—




Total shareholders’ equity		41,438		51,311		58,357		52,618			55,565

(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.

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 have developed two proprietary management systems: (i) the RTW SOLUTION(R), designed to lower employers’ workers’ compensation costs and return injured employees to work as soon as possible, and (ii) the ID15(R) system, designed to identify those injured employees who are likely to get stuck in the workers’ compensation system. We combine our management systems 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. During 1999, we operated in Minnesota, Wisconsin, South Dakota, Colorado, Missouri, Illinois, Kansas, Michigan, Indiana, Massachusetts, Connecticut, New Hampshire and Rhode Island.

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):


	*Year Ended December 31,*
	1999		1998			1997

Gross premiums earned	$	89,226	$	89,881		$	81,385




Total revenues		77,812		90,152			88,263




Claim and claim settlement expenses		43,323		75,294			55,543




Net income (loss)		6,167		(7,081	)		5,799

RTW reported gross premiums earned of $89.2 million in 1999 compared to $89.9 million in 1998. Total revenues for 1999 were $77.8 million, a 13.7 percent decrease from total revenues of $90.2 million reported for 1998. Total revenues in 1999 and 1998 were significantly reduced by premiums ceded under an excess of loss reinsurance agreement, effective for claims occurring on or after July 1, 1998, which was entered into during the fourth quarter of 1998. Premiums ceded in 1999 include $13.3 million representing a full year of premiums ceded under this reinsurance agreement, compared to 1998, which included $6.6 million in premiums ceded for the period from July 1, 1998 to December 31, 1998. Additionally, premiums ceded were favorably affected by refunds from the Minnesota Workers’ Compensation Reinsurance Association (WCRA) of $2.3 million in 1998; no such refund was recorded in 1999. Excluding the effects of reinsurance and refunds, adjusted total revenues decreased 3.6 percent in 1999 versus the reported decrease of 13.7 percent, primarily the result of a $1.2 million decrease in investment income and a $1.0 million decrease in realized investment gains.

We reported net income of $6.2 million in 1999 compared to a net loss of $7.1 million in 1998, and basic and diluted net income per share of $0.50 in 1999 versus basic and diluted net loss per share of ($0.59) in 1998, due primarily to the following factors:

• We aggressively targeted selected policies for non-renewal or re-underwriting at more favorable rates during 1999 at policy expiration. For 1999, our aggressive re-underwriting resulted in $10.9 million of premiums renewed at higher prices as well as $10.8 million in premiums that were not renewed. We will continue to review business at policy expiration in 2000 and non-renew or re-underwrite at more favorable rates, any business not meeting our standards;

• Pricing pressure continued to affect premiums in force and decrease profit margins, especially in Minnesota. The pricing pressure is the result of increased competition in our markets; and

• Inflation continues to affect medical and wage costs.

While we expect to continue to operate in a competitive pricing environment in 2000, we are working to improve profitability in all of our offices by continuing to aggressively manage expenses, refining our sales and distribution channels and improving our underwriting, including reviewing policy profitability at renewal and canceling unprofitable accounts.

In the following pages, we take a look at the 1999, 1998 and 1997 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):


					*Year Ended December 31,*
					1999			1998			1997

Gross premiums earned					$	89,226		$	89,881		$	81,385




Premiums ceded						(18,008	)		(8,489	)		(342	)

	Premiums earned					71,218			81,392			81,043




Investment income						6,510			7,714			6,821




Net realized investment gains (losses):




		Gains				108			1,591			479




		Losses				(24	)		(545	)		(80	)

			Net realized investment gains			84			1,046			399

				Total revenues	$	77,812		$	90,152		$	88,263


Premiums in force by regional office at year-end		1999		1998		1997

Minnesota		$	31,500	$	34,800	$	44,600




Colorado			14,000		12,300		12,900




Missouri			15,000		16,300		14,300




Michigan			11,500		9,700		5,200




Massachusetts			15,200		9,000		1,400

	Total premiums in force	$	87,200	$	82,100	$	78,400

Premiums In Force and 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 premiums in force grew 6.2% to $87.2 million at December 31, 1999 from $82.1 million at December 31, 1998 due to $9.7 million in growth in our Colorado, Michigan and Massachusetts markets offset by a $4.6 million

decrease in premiums in force in our Minnesota and Missouri markets. We aggressively targeted selected policies for non-renewal or re-underwriting at more favorable rates during 1999 at policy expiration when the profitability of the policy did not meet our underwriting profit margin standards. For 1999, our aggressive re-underwriting resulted in $10.9 million of premiums renewed at higher prices as well as $10.8 million in premiums that were not renewed. We will continue to review business at policy expiration in 2000 and non-renew or re-underwrite at more favorable rates any business not meeting our standards.

Our gross premiums earned decreased slightly to $89.2 million in 1999 from $89.9 million in 1998. This decrease resulted from a decrease in final audit premiums earned to $4.7 million in 1999 from $7.2 million in 1998, partially offset by premiums earned from our increase in premiums in force to $87.2 million in 1999 from $82.1 million in 1998. 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.

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.

The premium rate that we charge policyholders per payroll dollar has declined for several years; however, in 1999, we have seen indications that pricing may be firming. The historical decline in rates is due, in part, to 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 paid by 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, in turn, improves their claims history, lowering the premium that they have to pay for insurance. The improvement that we provide our customers also makes them more desirable to our competition, thus increasing price competition on these accounts.

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 to premiums ceded as a reduction to gross premiums earned. In Minnesota, we are required to purchase excess of loss coverage for our Minnesota policies from the Minnesota Workers’ Compensation Reinsurance Association (WCRA). We ceded Minnesota claims in excess of $290,000, $280,000 and $1.1 million per occurrence during 1999, 1998 and 1997, respectively, to the WCRA. In our non-Minnesota states, we decreased our per-incident exposure to $300,000 in 1999 from $500,000 in 1998 and 1997. We purchased this coverage from various reinsurers in 1998 and 1997 and limited the coverage to one insurer in 1999. Additionally, for claims occurring after June 30, 1998, we further limited our per incident exposure by purchasing excess of loss coverage for losses from $25,000 to the WCRA selected retention level in Minnesota and from $25,000 to $300,000 in other states from a single reinsurer. This agreement was finalized after its effective date and activity occurring from July 1, 1998 through September 30, 1998 was recorded on a retrospective basis resulting in the deferral of a gain totaling $2.0 million at December 31, 1998. We amortized $740,000 of the deferred gain as a reduction of claim and claim settlement expenses in 1999 resulting in an un-amortized deferred gain of $1.2 million at December 31, 1999. The deferred gain is being amortized into income using the effective interest rate inherent in the amounts paid to the reinsurer and the estimated timing and amounts of recoveries from the reinsurer. Activity occurring on or after October 1, 1998 is recorded prospectively.

The following table summarizes the components of premiums ceded (000’s):


			*Year Ended December 31,*
			1999			1998			1997

Premiums ceded, net:




	Non-WCRA excess of loss policies		$	(14,710	)	$	(7,805	)	$	(682	)




	WCRA			(3,298	)		(2,931	)		(18	)




	Refund from the WCRA on prior years’ activity			—			2,247			358

		Premiums ceded	$	(18,008	)	$	(8,489	)	$	(342	)

Premiums ceded to reinsurers increased to $18.0 million in 1999 from $8.5 million in 1998. This increased cost resulted from (i) premiums ceded under our new excess of loss reinsurance coverage for losses over $25,000 for all of 1999 compared to ceding only in the second half of 1998; (ii) increased effective excess of loss premium rates in Minnesota in 1999 from 1998 due to premium price changes within that state, (iii) increased excess of loss costs resulting from increased premiums earned in non-Minnesota states, and (iv) the recognition of a refund of $2.2 million from the WCRA recorded in the first quarter of 1998. No comparable refund was received in 1999.

Premiums ceded to reinsurers increased to $8.5 million in 1998 from $342,000 in 1997. This increased cost resulted from (i) increased excess of loss costs resulting from further limiting our exposure to $25,000, (ii) reducing our selected Minnesota excess of loss reinsurance coverage levels to $280,000 in 1998 from $1.1 million in 1997, (iii) increased excess of loss premium rates in Minnesota in 1998 from 1997, and (iv) increased excess of loss costs resulting from increased premiums earned in non-Minnesota states. 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.

2000 Outlook: The 2000 outlook for gross premiums earned and premiums ceded include the following factors:

• We expect that our aggressive targeting of policies for non-renewal or re-underwriting during 2000 will put downward pressure on premiums in force in our Minnesota and Missouri markets; however, we expect continued growth in premiums in force in our Colorado, Michigan and Massachusetts markets, as well as new business in our Minnesota and Missouri markets will lead to moderate growth in gross premiums earned for 2000. In Massachusetts, our premium growth rate will be tempered by an unexpected decision by the Massachusetts Department of Insurance to reduce premium rates effective September 1, 1999. We are encouraged by a favorable trend in premium rates. In 1998, our book of business saw a 10.2% decline in premium rates. This was followed by another 6.7% decline in 1999. In the fourth quarter of 1999, however, premium rates declined just one 0.5%. In January, 2000, we were able to achieve a 8.5% increase in rate in our January 2000 renewal business;

• We expect that premiums ceded in 2000 will be consistent with premiums ceded in 1999. Premiums ceded may decrease slightly in 2000 as a percent of gross premiums earned as the non-Minnesota markets, where we pay smaller reinsurance premiums, continue to grow relative to Minnesota;

• We believe the recent events within the workers’ compensation reinsurance market will have no impact on our reinsurance program for 2000.

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 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 decreased 15.6% to $6.5 million in 1999 from $7.7 million in 1998. Investment income decreased due to reduced funds available for investment as funds were used to pay reinsurance premiums on our $25,000 to $300,000 reinsurance policy. Additionally, tax-exempt municipal securities, which earn lower pre-tax rates than taxable securities but are comparable on a tax adjusted basis, increased to 56.3% of our investment

portfolio at year-end 1999 compared to 52.6% at year end 1998 and none at year end 1997. We first began purchasing tax-exempt securities in the second quarter of 1998. Funds available for investment decreased to $108.1 million at December 31, 1999 from $126.6 million at December 31, 1998, due to decreased net cash provided by operating activities, resulting primarily from (i) the difference in timing between the receipt of premiums, the payment of premiums ceded under our reinsurance agreements, the payment of claim and claim settlement expenses and the recovery of paid claim and claim settlement expenses under our reinsurance programs, and (ii) net cash provided by investment income. Tax-adjusted investment yields were 6.6% in 1999 and 1998. The investment yields realized in future periods will be affected by yields attained on new investments.

Net realized investment gains were $84,000 in 1999 compared to $1.0 million realized in 1998. The reduced investment activity in 1999 is mainly due to portfolio restructuring completed in the second and third quarters of 1998 that resulted in the significant net realized investment gains. No such restructuring has occurred in 1999.

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.

2000 Outlook: Barring significant changes in interest rates or operational cash flows, we expect the 2000 pre-tax yield from our investment portfolio to be affected by the following:

• Funds provided by our operating cash flows and investment cash flows have historically provided growth in our investment portfolio. Operating cash flows consist of the excess of premiums collected over claim and claim settlement expenses, reduced by payments for reinsurance premiums as well as other operating expenses paid. Investment cash flows consist of income on existing investments and proceeds from sales and maturities of investments. We have historically generated positive net cash flows from operations due, in part, to timing differences between the receipt of premiums and the payment of claim and claim settlement expenses. These net cash flows have decreased significantly as we have focused on closing older claims, paying earlier to close those claims. Combined with relatively flat premiums in force since December 1998, our cash flow from timing on claims payments has decreased. Additionally, as we lowered our reinsurance retention levels to $25,000 in mid-1998, we decreased our current period cash flows as a result of “pre-funding” quarterly premiums under that agreement. We expect this reduction in quarterly cash flow will continue until reimbursements for loss payments to claimants under these contracts equal disbursements for premium payments;

• Our recognition of realized gains and losses will depend on sales of our investments, if any, to meet our short-term cash requirements; and

• We will continue to include fixed maturity tax-exempt securities in our investment portfolio to increase after-tax yields. The mix of taxable and tax-exempt securities in our portfolio may change over time to accommodate our tax situation. 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.

Total expenses: Our expenses include claim and claim settlement expenses, policy acquisition costs, general and administrative expenses, interest expense and income taxes.

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 decreased to $43.3 million in 1999 from $75.3 million in 1998. As a percent of premiums earned, claim and claim settlement expenses decreased to 60.8% in 1999 compared to 92.5% for 1998. These changes are due to the following:

• In 1999, we recorded an estimate of ceded paid and unpaid claim and claim settlement expenses under our $25,000 to $300,000 excess of loss reinsurance agreement totaling $22.0 million including $740,000 amortized from a deferred retrospective reinsurance gain resulting in a corresponding reduction in 1999 claim and claim settlement expenses. Our 1998 results include an estimate of ceded paid and unpaid claim and claim settlement expenses totaling $8.6 million recorded in the fourth quarter of 1998.

• The 1999 results include an $8.1 million decrease in reserves for unpaid claim and claim settlement expenses to reflect favorable development of prior period claims compared to the 1998 results which include an $11.0 million increase in reserves for unpaid claim and claim settlement expenses, of which we recorded $3.0 million in the first quarter of 1998 and $8.0 million in the fourth quarter of 1998 to reflect adverse development of prior period claims. The favorable development in 1999 is primarily the result of a strong focus on claim closure. Our open claims decreased 9.7% to 5,252 at December 31, 1999 from 5,816 at December 31, 1998. Additionally, the 1998 results included a $400,000 Minnesota Special Compensation Fund (SCF) adjustment recorded in the second quarter of 1998. The SCF assesses us to cover the costs of second injuries that are substantially greater, because of a pre-existing physical impairment, than what would have resulted from the second injury alone.

• We aggressively targeted selected policies for non-renewal or re-underwriting at more favorable rates during 1999 at policy expiration if the profitability of the policy did not meet our underwriting profit margin standards. For 1999, our aggressive re-underwriting resulted in $10.9 million of premiums renewed at higher prices as well as $10.8 million in premiums that were not renewed. We will continue to review business at policy expiration in 2000 and non-renew or re-underwrite at more favorable rates, any business not meeting our standards;

• Reduced premiums due to legislative changes in estimated loss costs, increased competition and improving customer loss experience, have continued to place upward pressure on claim and claim settlement expenses as a percentage of premiums earned; and

• Claim costs continued to increase in 1999 compared to 1998 due to increasing medical and indemnity costs. This was offset somewhat by the effects of provider agreements that we negotiated during 1998.

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;

• 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.

2000 Outlook: We expect that claim and claim settlement expenses will be affected by the following factors:

• Continued favorable effects of ceding paid and unpaid claim and claim settlement expenses under our $25,000 to $300,000 excess of loss reinsurance agreements resulting in a reduction of claim and claim settlement expenses;

• Claim costs will continue to 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;

• Continued pricing pressure due to legislative changes in estimated loss costs, increased competition and improving customer loss experience may result in reduced premiums, ultimately increasing claim and claim settlement expense as a percent of premium earned; and

• Continued application of our claims management technology and methods to all open claims.

The ultimate result of the above factors, combined with the change in premium rates, on 2000 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, and ceding commissions adjustments with 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 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):


		*Year Ended December 31,*
		1999		1998		1997

Commission expense		$	7,145	$	7,171	$	6,369




Premium tax expense			1,798		1,839		1,651




Other policy acquisition costs			4,847		4,964		3,637

	Direct policy acquisition costs		13,790		13,974		11,657




Ceding commissions resulting from unpaid claim and claim settlement liability adjustments from 1992 to 1994			321		—		1

	Policy acquisition costs	$	14,111	$	13,974	$	11,658

Policy acquisition costs increased to $14.1 million in 1999 from $14.0 million in 1998 and $11.7 million in 1997. As a percent of gross premiums earned, policy acquisition costs increased to 15.8% in 1999 from 15.5% in 1998 and 14.3% in 1997. These increases reflect the following:

• Commission expense increased to 8.0% of gross premiums earned in 1999 and 1998 from 7.8% in 1997. 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 1999, 1998 and 1997;

• Other policy acquisition costs decreased slightly to 5.4% of gross premiums earned in 1999 from 5.5% in 1998 and increased from 4.5% in 1997. Policy acquisition costs were consistent in 1999 and 1998, however, increased significantly from 1997 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

• We incurred ceding commission expense totaling $321,000 in 1999 compared to no cost in 1998 and a cost of $1,000 in 1997.

2000 Outlook: We expect that policy acquisition costs will stabilize or trend downward as a percent of gross premiums earned in 2000 due to the following:

• We expect commission expense as a percent of gross premiums earned to decrease slightly in 2000 as we manage our commission structures in our non-Minnesota states;

• We expect premium tax expense as a percent of gross premiums earned to remain consistent with 1999; and

• We expect that other policy acquisition costs will be consistent with 1999 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 2000 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.

Our general and administrative expenses increased to $12.0 million in 1999 from $11.4 million in 1998 and $11.6 million in 1997. As a percent of gross premiums earned, general and administrative expenses increased to 13.5% in 1999 from 12.6% in 1998 and decreased from 14.3% in 1997. General and administrative expenses continue to be managed aggressively and reduced where appropriate. General and administrative expenses for 1999 include one-time expenses totaling $1.3 million for corporate oversight expenses related to the efforts of the majority shareholders in seeking a buyer for their shares and expenses related to a reorganization effected in the fourth quarter of 1999. General and administrative expenses for 1998 and 1997 include benefits of $1.1 million recorded in the second quarter of 1998 and $842,000 recorded in the third quarter of 1997, resulting from the reversal of 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 1999, 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 payable in 2000. After adjusting for the accrual reversals, general and administrative expenses decreased to 12.0% in 1999 from 13.9% in 1998 and 14.0% in 1997 as a percent of gross premiums earned. These decreases reflect:

• General and administrative expenses continue to improve as a percent of premiums earned, after adjusting for MIGA accrual reversals and one-time charges. We have aggressively managed personnel and other operating costs and expenses to bring operating expenses more in line with revenues. All expenses continue to be managed aggressively and reduced where appropriate.

• The reorganization effected in the fourth quarter of 1999 began earlier in 1999 and resulted in a net reduction of thirty-three positions. This reorganization has reduced costs and centralized and strengthened certain processes.

2000 Outlook: We expect that general and administrative expenses will be affected by the following:

• We expect that the reorganization effected in the fourth quarter of 1999 will result in further personnel cost reductions in 2000.

• We will continue to aggressively manage all other operating costs and expenses in 2000;

• We have no plans to open additional state offices in 2000 and expect that growth in premiums in force will result in additional revenues to cover the fixed costs in all of our states; and

• We expect to realize additional operational efficiency during 2000 through enhancements to our internal processes and procedures, including changes to our operating structure as well as improvements to our internal proprietary computer systems.

Interest Expense: We incurred interest charges on our Senior Notes in 1999, 1998 and 1997. The Senior Notes were paid in full in December 1999. We paid interest at a rate of 9.50% on the outstanding balance on our Senior Notes

during 1999. Interest expense decreased to $266,000 in 1999 from $546,000 in 1998 and $777,000 in 1997 due to principal payments on the Senior Notes in December 1998, 1997 and 1996. The Senior Notes were paid in full in December 1999.

In February 2000, we entered into a $6.0 million, 90-day term loan with a bank in order to initiate the repurchase of shares from a group headed by our majority shareholder and Chairman, David C. Prosser. We expect to refinance this short-term term loan, obtain additional funding and close on the repurchase transaction in March 2000, by entering into an $8.0 million Term Loan agreement and a $2.0 million Revolving Credit Facility with a bank. These debt agreements are subject to interest, payable quarterly at an adjusted LIBOR rate (8.31% at February 29, 2000).

2000 Outlook: We expect to incur interest charges in 2000 on the Term Loan and Revolving Credit Facility totaling approximately $620,000, increasing from $266,000 in 1999.

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 tax expense was $1.9 million in 1999 compared to a benefit of $4.0 million in 1998 and an expense of $2.9 million in 1997. As a percent of income (loss) before income taxes, the income tax expense (benefit) was 23.8% of income before income taxes in 1999 compared to (35.8%) of the loss before income taxes in 1998 and 33.1% of income before income taxes in 1997. The income tax expense percent in 1999 has been affected by (i) our income from operations, (ii) decreased taxable net income from the service organization (RTW) which is subject to both federal and state income taxes, and (iii) the introduction of tax-exempt municipal income beginning in the second quarter of 1998.

2000 Outlook: Income tax expense (benefit) will vary based on (i) the income (loss) from operations we recognize for 2000, 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, 1999 included tax-exempt municipal securities (56.3%), U.S. government securities (14.0%), corporate securities (13.5%), mortgage-backed securities (14.4%), and asset-backed securities (1.8%). After several years of purchasing solely U.S. government securities, we engaged an investment manager in 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 by purchasing investment grade tax-exempt fixed maturity investments. We conservatively manage our fixed maturity portfolio, 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.

Funds provided by our operating cash flows and investment cash flows have historically provided growth in our investment portfolio. Operating cash flows consist of the excess of premiums collected over claim and claim settlement expenses reduced by payments for reinsurance premiums as well as other operating expenses paid. Investment cash flows consist of income on existing investments and proceeds from sales and maturities of investments. We have historically generated positive net cash flows from operations due, in part, to timing differences between the receipt of premiums and the payment of claim and claim settlement expenses. These net cash flows decreased significantly in 1999 as we have focused on closing old claims, paying earlier to close claims. Combined with relatively flat premiums in force since December 1998, our cash flows from timing on claims payments have decreased. Additionally, as we lowered our reinsurance retention levels to $25,000 in mid-1998, we decreased our current period cash flows as a result of “pre-funding” quarterly premiums under that agreement. We expect this reduction in quarterly cash flow will continue until reimbursements for loss payments to claimants under these contracts equal disbursements for premium payments. Our investment portfolio decreased 14.7% or $18.5

million to $108.1 million at December 31, 1999, from $126.6 million at December 31, 1998, 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. Prevailing market interest rates increased in 1999 resulting in a $4.3 million unrealized loss on investments compared to a $2.7 million unrealized gain in 1998.

UNPAID CLAIM AND CLAIM SETTLEMENT EXPENSES

Our unpaid claim and claim settlement expenses represent established, reserves for the estimated total unpaid cost of claim and claim settlement expenses, which cover events that occurred in 1999 and prior years. The reserves are primarily undiscounted, however, we discount reserves for selected claims that have fixed and determinable future payments at 8.0%. 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, we 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.

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):


				*Year Ended December 31,*
				1999			1998		1997

Gross Reserves for Claim and Claim Settlement Expenses:




	Gross reserves for claim and claim settlement expenses, beginning of year			$	97,269		$	61,069	$	49,256




	Provision increases (decreases) for claim and claim settlement expenses:




		Current year			79,333			78,520		60,265




		Prior years			(11,868	)		11,444		(4,394	)

			Total provision		67,465			89,964		55,871




	Payments for claim and claim settlement expenses:




		Current year			27,841			25,448		23,529




		Prior years			37,062			28,316		20,529

			Total payments		64,903			53,764		44,058

	Gross reserves for claim and claim settlement expenses, end of year			$	99,831		$	97,269	$	61,069

The following table sets forth reserves on a net (after reinsurance) basis (000’s):


					*Year Ended December 31,*
					1999			1998			1997

Net Reserves for Claim and Claim Settlement Expenses:




	Net reserves for claim and claim settlement expenses, beginning of year				$	75,866		$	55,695		$	43,073




	Plus: Deferred retrospective reinsurance gain, beginning of year					1,989			—			—




	Provision increases (decreases) for claim and claim settlement expenses:




			Current year			52,176			64,315			58,628




			Prior years			(8,113	)		10,979			(3,085	)




			Amortization of deferred retrospective reinsurance gain			(740	)		—			—

				Total provision		43,323			75,294			55,543




	Payments for claim and claim settlement expenses:




		Current year				26,897			25,397			23,482




		Prior years				34,380			27,737			19,439

				Total payments		61,277			53,134			42,921




	Less: Deferred retrospective reinsurance gain, end of year					(1,249	)		(1,989	)		—

Net reserves for claim and claim settlement expenses, end of year					$	58,652		$	75,866		$	55,695

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):

December 31,

1999 1998 1997 1996

Loss Reserve Development:

Gross reserves for unpaid claim and claim settlement expenses $ 99,831 $ 97,269 $ 61,069 $ 49,256

Deduct reinsurance recoveries 41,179 21,403 5,374 6,183

Net reserves for unpaid claim and claim settlement expenses $ 58,652 $ 75,866 $ 55,695 $ 43,073

Paid (cumulative) as of:

One year later $ 34,380 $ 27,737 $ 19,439

Two years later 42,046 28,173

Three years later 33,438

Four years later

Five years later

Six years later

Seven years later

Reserves re-estimated as of:

End of year $ 58,652 $ 75,866 $ 55,695 $ 43,073

One year later 67,753 66,674 39,988

Two years later 61,075 43,484

Three years later 41,451

Four years later

Five years later

Six years later

Seven years later

Initial reserves in excess of (less than) re-estimated reserves:

Amount $ 8,113 $ (5,380 ) $ 1,622

Percent 10.7 % (9.7 %) 3.8 %

[Additional columns below]

[Continued from above table, first column(s) repeated]

December 31,

1995 1994 1993 1992

Loss Reserve Development:

Gross reserves for unpaid claim and claim settlement expenses $ 37,138 $ 28,165 $ 13,279 $ 2,688

Deduct reinsurance recoveries 8,312 13,902 9,593 1,886

Net reserves for unpaid claim and claim settlement expenses $ 28,826 $ 14,263 $ 3,686 $ 802

Paid (cumulative) as of:

One year later $ 8,595 $ 4,639 $ 1,436 $ 583

Two years later 12,894 6,476 2,150 678

Three years later 15,521 7,863 2,348 815

Four years later 16,869 8,569 2,654 856

Five years later 9,046 2,816 925

Six years later 2,847 951

Seven years later 920

Reserves re-estimated as of:

End of year $ 28,826 $ 14,263 $ 3,686 $ 802

One year later 20,751 12,789 3,784 1,075

Two years later 18,469 9,318 3,416 1,008

Three years later 19,796 8,984 2,782 950

Four years later 19,389 9,669 2,861 912

Five years later 9,692 2,972 949

Six years later 2,927 964

Seven years later 926

Initial reserves in excess of (less than) re-estimated reserves:

Amount $ 9,437 $ 4,571 $ 759 $ (124 )

Percent 32.7 % 32.0 % 20.6 % (15.5 %)

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, 1999. 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):

Effect of Reserve re-estimates on Calendar Year Operations:

1999 1998 1997 1996

Accident Year:

1992 $ 38 $ (15 ) $ (37 ) $ 38

1993 7 (96 ) (42 ) 596

1994 (68 ) (574 ) 413 2,837

1995 430 (642 ) 1,948 4,604

1996 1,626 (2,169 ) 803

1997 3,566 (7,483 )

1998 2,514

Total $ 8,113 $ (10,979 ) $ 3,085 $ 8,075

[Additional columns below]

[Continued from above table, first column(s) repeated]

Cumulative

Re-estimates

for each

Effect of Reserve re-estimates on Calendar Year Operations: Accident

1995 1994 1993 Year

Accident Year:

1992 $ 58 $ 67 $ (273 ) $ (124 )

1993 310 (165 ) 610

1994 1,106 3,714

1995 6,340

1996 260

1997 (3,917 )

1998 2,514

Total $ 1,474 $ (98 ) $ (273 ) $ 9,397

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. Our primary cash requirements consist of payments for (i) reinsurance, (ii) claim and claim settlement expenses, (iii) policy acquisition costs, (iv) general and administrative expenses, (v) capital expenditures, (vi) income taxes, and (vii) debt service or principal repayment on our Senior Notes, Term Loan or Revolving Credit Facility. We have historically generated 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. As we lowered our reinsurance retention levels to $25,000 in mid-1998, we decreased our current period cash flows as a result of “pre-funding” quarterly premiums under that agreement. We expect this reduction in quarterly cash flow will continue until reimbursements for loss payments to claimants under these contracts equal disbursements for premium payments. 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 of U.S. government securities acquired under repurchase agreements, tax-exempt municipal securities and corporate securities all with maturities of 90 days or less, with the remaining balances in cash and a money market fund that invests primarily in short-term government securities.

Cash used in operating activities in 1999 was $10.3 million. This is primarily a result of an increase of $21.2 million in amounts due from reinsurers, a decrease of $3.1 million in premiums receivable, net of unearned premiums, offset by our net income of $6.2 million, an increase of $2.6 million in unpaid claim and claim settlement expenses, which are non-cash accruals for future claims, depreciation and amortization expense of $1.4 million and an increase in our deferred income tax asset of $764,000. Net cash provided by investing activities was $11.0 million, primarily the result of $20.9 million in proceeds from sales of securities and maturities of $1.9 million of investments offset by $11.2 million in purchases of securities and $573,000 in purchases of fixed assets. Net cash used in financing activities was $1.1 million due to payments on notes payable of $2.5 million offset by $1.3 million in proceeds from the exercise of stock options and $105,000 resulting from the issuance of common stock under our Employee Stock Purchase Plan.

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 that 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 2000, without regulatory approval, is approximately $4.6 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, 1999 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 and interest payments and capital expenditures for the next 12 months.

MARCH 2000 REPURCHASE OF SHARES

On November 2, 1999, we announced that a group consisting of David C. Prosser, Chairman, members of his family, and another of our directors retained an investment banker to explore a sale of the group’s shares to new strategic investors. The group held approximately 6,383,000 shares, representing 52% of all outstanding shares. In conjunction with the process, our Board of Directors appointed a Special Committee of independent directors to evaluate any proposed transaction.

On February 2, 2000, we entered into an agreement with participating members of the group (together, the “Prosser Selling Group”). Under the agreement, we agreed to repurchase from individual members of the Prosser Selling Group shares totaling approximately $7.8 million. On March 28, 2000, we repurchased 1,418,570 shares at $5.19 per share. At the closing, each member of the Prosser Selling Group signed a two year standstill and Voting Agreement under which each agreed, among other things, not to acquire additional Securities of RTW and not to initiate or support certain actions designed to effect fundamental changes in RTW policy or structure. In addition, David C. Prosser retired and resigned as Chairman and we paid him $225,000 as a termination benefit in conjunction with the closing. He is expected to remain as a member of our Board of Directors.

Under the terms of the agreement, we borrowed $6.0 million under a 90-day term loan agreement with a bank and advanced the proceeds to the Prosser Selling Group for a security interest in the shares owned by the group. This term loan is subject to interest at a LIBOR adjusted rate (8.31% at February 29, 2000). We expect to replace the 90-day term loan with an $8.0 million term loan agreement and $2.0 million revolving credit facility to be used for general corporate purposes. We expect the term loan will accrue interest, payable quarterly, at an adjusted LIBOR rate and expect principal maturities due as follows (000’s):


December 31,

2000	$	1,000




2001		1,500




2002		1,500




2003		2,000




2004		2,000

We expect the revolving credit facility will accrue interest, payable quarterly, at an adjusted LIBOR rate and mature in March 2001, but will be renewable annually at the discretion of the bank.

INTEREST RATE RISK

Our fixed maturity investments 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 $5.4 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.

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.

We have had no instances of system failure or interrupted operations resulting from system failures of our significant vendors in 2000 and expect no problems as we continue into the new millennium.

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, 1999, our insurance subsidiary was licensed to do business in Minnesota, South Dakota, Wisconsin, Colorado, Missouri, Illinois, Kansas, Michigan, Indiana, Massachusetts, Connecticut, Rhode Island, Pennsylvania, Tennessee, Maryland, Arkansas, Iowa, Florida, Georgia, New Jersey, North Carolina and Texas.

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, and (vi) our ability to successfully introduce new products and services. 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


FINANCIAL STATEMENTS	Page

Independent Auditors’ Report		26




Consolidated Balance Sheets — December 31, 1999 and 1998		27




Consolidated Statements of Operations — Years Ended December 31, 1999, 1998 and 1997		28




Consolidated Statements of Other Comprehensive Income (Loss) and




Shareholders’ Equity — Years Ended December 31, 1999, 1998 and 1997		29




Consolidated Statements of Cash Flows — Years Ended December 31, 1999, 1998 and 1997		30




Notes to Consolidated Financial Statements — Years Ended December 31, 1999, 1998 and 1997		31

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, 1999 and 1998, and the related consolidated statements of operations, other comprehensive income (loss) and shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 1999. 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, 1999 and 1998, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1999, in conformity with generally accepted accounting principles.

/s/ DELOITTE & TOUCHE LLP

Minneapolis, Minnesota
February 3, 2000
(February 29, 2000 as to Note 13)

RTW, INC.
Consolidated Balance Sheets
December 31, 1999 and 1998
(IN THOUSANDS, EXCEPT SHARE DATA)


		1999			1998

ASSETS
Investments at fair value, amortized cost of $112,334 and $123,924			$	108,064	$	126,631




Cash and cash equivalents				302		700




Accrued investment income				1,475		1,761




Premiums receivable, less allowance of $519 and $417				9,435		6,554




Reinsurance recoverables:




	On unpaid claim and claim settlement expenses			41,179		21,403




	On paid claim and claim settlement expenses			2,323		867




Deferred policy acquisition costs				1,487		1,501




Furniture and equipment, net				3,881		4,565




Other assets				8,365		8,952

Total assets			$	176,511	$	172,934

LIABILITIES AND SHAREHOLDERS’ EQUITY


Unpaid claim and claim settlement expenses				$	99,831		$	97,269




Unearned premiums					12,766			13,027




Accrued expenses and other liabilities					8,349			7,559




Notes payable					—			2,461

		Total liabilities			120,946			120,316




Shareholders’ equity:




	Undesignated stock, no par value; authorized 4,750,000 shares;




			none issued or outstanding		—			—




	Series A Junior Participating Preferred Stock, no par value;




			authorized 250,000 shares; none issued or outstanding		—			—




	Common stock, no par value; authorized 25,000,000 shares;




			issued and outstanding 12,312,000 and 11,935,000 shares		30,808			29,451




	Retained earnings				27,575			21,408




	Accumulated other comprehensive (loss) income				(2,818	)		1,759

		Total shareholders’ equity			55,565			52,618

		Total liabilities and shareholders’ equity		$	176,511		$	172,934

See notes to consolidated financial statements.

RTW, INC.
Consolidated Statements of Operations
Years Ended December 31, 1999, 1998 and 1997
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)


				1999			1998			1997

Revenues:




	Gross premiums earned			$	89,226		$	89,881		$	81,385




	Premiums ceded				(18,008	)		(8,489	)		(342	)

		Premiums earned			71,218			81,392			81,043




	Investment income				6,510			7,714			6,821




	Net realized investment gains				84			1,046			399

		Total revenues			77,812			90,152			88,263




Expenses:




	Claim and claim settlement expenses				43,323			75,294			55,543




	Policy acquisition costs				14,111			13,974			11,658




	General and administrative expenses				12,021			11,369			11,616

		Total expenses			69,455			100,637			78,817

			Income (loss) from operations		8,357			(10,485	)		9,446




	Interest expense				266			546			777

			Income (loss) before income taxes		8,091			(11,031	)		8,669




	Income tax expense (benefit)				1,924			(3,950	)		2,870

Net income (loss)				$	6,167		$	(7,081	)	$	5,799

Income (loss) per share:




	Basic income (loss) per share			$	0.50		$	(0.59	)	$	0.49

	Diluted income (loss) per share			$	0.50		$	(0.59	)	$	0.48

Weighted average shares outstanding:




	Basic shares outstanding				12,291,000			11,927,000			11,833,000

	Diluted shares outstanding				12,360,000			11,927,000			12,079,000

See notes to consolidated financial statements.

RTW, INC.
Consolidated Statements of Other Comprehensive Income (Loss) and Shareholders’ Equity
Years Ended December 31, 1999, 1998 and 1997
(IN THOUSANDS)


														Accumulated
														Other
								Comprehensive						Comprehensive			Total
					Common			Income			Retained			Income			Shareholders'
					Stock			(Loss)			Earnings			(Loss)			Equity

Balance at January 1, 1997					$	28,610					$	22,690		$	11		$	51,311




	Comprehensive income:




		Net income				—		$	5,799			5,799			—			5,799




		Other comprehensive income, net of tax:




			Change in 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:




			Change in 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




	Comprehensive income:




		Net income				—		$	6,167			6,167			—			6,167




		Other comprehensive losses, net of tax:




			Change in unrealized investment losses			—			(4,577	)					(4,577	)		(4,577	)

				Comprehensive income				$	1,590

		Non-qualified stock options exercised				1,172						—			—			1,172




		Incentive stock options exercised				80						—			—			80




		Issuance of shares under ESPP				105						—			—			105

Balance at December 31, 1999					$	30,808					$	27,575		$	(2,818	)	$	55,565

See notes to consolidated financial statements.

RTW, INC.
Consolidated Statements of Cash Flows
Years Ended December 31, 1999, 1998 and 1997
(IN THOUSANDS)


				1999			1998			1997

Cash flows from operating activities:




	Net income (loss)			$	6,167		$	(7,081	)	$	5,799




	Adjustments to reconcile net income (loss) to net cash provided by operating activities:




		Net realized investment gains			(84	)		(1,046	)		(399	)




		Depreciation and amortization			1,382			1,341			1,237




		Deferred income taxes			764			(2,239	)		(715	)




		Changes in assets and liabilities:




			Amounts due from reinsurers		(21,232	)		(14,164	)		2,621




			Unpaid claim and claim settlement expenses		2,562			36,200			11,813




			Unearned premiums, net of premiums receivable		(3,142	)		(1,344	)		(1,015	)




			Other, net		3,313			(1,849	)		1,032

			Net cash (used in) provided by operating activities		(10,270	)		9,818			20,373




Cash flows from investing activities:




	Maturities of investments				1,915			2,000			2,500




	Purchases of available-for-sale investments				(11,239	)		(77,594	)		(62,403	)




	Proceeds from sales of available-for-sale investments				20,912			63,522			39,095




	Purchases of furniture and equipment				(573	)		(819	)		(2,447	)

			Net cash provided by (used in) investing activities		11,015			(12,891	)		(23,255	)




Cash flows from financing activities:




	Payments on notes payable				(2,500	)		(2,500	)		(2,000	)




	Stock options and warrants exercised				1,252			333			1




	Issuance of common stock under ESPP				105			199			154




	Issuance of common stock to ESOP				—			—			115




	Issuance of common stock				—			30			—




	Retirement of common stock				—			(87	)		—

			Net cash used in financing activities		(1,143	)		(2,025	)		(1,730	)

Net decrease in cash and cash equivalents					(398	)		(5,098	)		(4,612	)




Cash and cash equivalents at beginning of year					700			5,798			10,410

Cash and cash equivalents at end of year				$	302		$	700		$	5,798

Supplemental disclosure of cash flow information: Cash paid (received) during the year for:




		Interest		$	238		$	546		$	664

		Income tax (refunds) payments		$	(1,312	)	$	488		$	3,536

See notes to consolidated financial statements.

RTW, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1999, 1998, AND 1997

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, Maryland, Georgia, New Jersey, North Carolina and Texas at December 31, 1999. We are also licensed to write workers’ compensation insurance coverage for companies covered under the Longshoreman’s Act. We wrote policies primarily in Minnesota, Colorado, Missouri, Illinois, Kansas, Michigan, Massachusetts, Connecticut and Wisconsin during 1999.

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 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 changes in unrealized gains or losses, net of deferred taxes, reported as other comprehensive (loss) 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.

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 1999, 1998 or 1997.

Cash and Cash Equivalents — We consider all highly liquid investments with maturities 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. 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 1999 and 1998 was $3,879,000 and $2,951,000, 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, as “Claim and claim settlement expenses” in the Consolidated Statements of Operations.

Our “Unpaid claim and claim settlement expenses” represent established, reserves for the estimated total unpaid cost of claim and claim settlement expenses that cover events that occurred in 1999 and prior years. The reserves are primarily undiscounted, however, we discounted selected claims that have fixed or determinable future payments by $2,873,000 after applying an 8% discount factor. 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.

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. 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.

Reclassifications — Certain 1998 and 1997 amounts have been reclassified to conform to the consolidated financial statement presentation in 1999.

NOTE 2 — INCOME (LOSS) PER SHARE

We apply SFAS No. 128, “Earnings Per Share”, which 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. 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 are considered outstanding from the date of grant, after applying the treasury stock method for determining the dilutive effect.

The following is a reconciliation of the numerators and denominators of basic and diluted income (loss) per share:


		1999		1998			1997

Net income (loss) (000’s)		$	6,167	$	(7,081	)	$	5,799

Basic weighted average shares outstanding			12,291,000		11,927,000			11,833,000




	Effect of dilutive stock options		69,000		—			246,000

Diluted weighted average shares outstanding			12,360,000		11,927,000			12,079,000

Basic income (loss) per share		$	0.50	$	(0.59	)	$	0.49

Diluted income (loss) per share		$	0.50	$	(0.59	)	$	0.48

Options to purchase 1,894,811 shares of common stock at prices ranging from $2.00 to $28.75 were outstanding during 1998 but excluded from the computation of diluted IPS due to our 1998 net loss. Diluted weighted average

shares outstanding would have increased by 219,000 shares had these shares not been anti-dilutive in the computation.

NOTE 3 — INVESTMENTS

Valuation of Investments — The following tables present amortized cost, gross unrealized gains and losses and estimated fair values of our available-for-sale securities (000’s):


				Gross		Gross			Estimated
		Amortized		Unrealized		Unrealized			Fair
1999		Cost		Gains		Losses			Value

Tax-exempt municipal securities		$	63,104	$	17	$	(2,267	)	$	60,854




U.S. government securities			15,665		19		(578	)		15,106




Corporate securities			15,462		3		(845	)		14,620




Asset-backed securities			2,000		—		(20	)		1,980




Mortgage-backed securities			16,103		—		(599	)		15,504

	Total investments	$	112,334	$	39	$	(4,309	)	$	108,064


				Gross		Gross			Estimated
		Amortized		Unrealized		Unrealized			Fair
1998		Cost		Gains		Losses			Value

Tax-exempt municipal securities		$	65,273	$	1,369	$	(6	)	$	66,636




U.S. government securities			14,141		436		(2	)		14,575




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

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 $3,452,000 and $2,931,000 in 1999 and 1998, respectively.

Fixed Maturities by Maturity Date — The following table presents the amortized cost and fair value of investments by contractual maturity at December 31, 1999. Actual maturities may differ from those stated as a result of calls and prepayments (000’s):


				Estimated
		Amortized		Fair
Maturing:		Cost		Value

One year or less		$	505	$	499




Over one year through five years			22,635		22,283




Over five years through ten years			53,467		51,635




Over ten years			19,624		18,143




Mortgage-backed securities with various maturities			16,103		15,504

	Total investments	$	112,334	$	108,064

Investment Income — Investment income includes income from the following sources (000’s):


		1999		1998		1997

Fixed maturity investments		$	6,318	$	6,995	$	6,129




Short-term investments			133		506		692




Other			59		213		—

	Investment income	$	6,510	$	7,714	$	6,821

Net Realized Investment Gains — Net realized investment gains includes gross realized investment gains net of gross realized investment losses as follows (000’s):


		1999			1998			1997

Realized investment gains		$	108		$	1,591		$	479




Realized investment losses			(24	)		(545	)		(80	)

	Net realized investment gains	$	84		$	1,046		$	399

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 $290,000, $280,000 and $1,080,000 per occurrence during 1999, 1998 and 1997, respectively, to the Minnesota Workers’ Compensation Reinsurance Association (WCRA). In our non-Minnesota states, we decreased our per-incident exposure to $300,000 in 1999 from $500,000 in 1998 and 1997. We purchased this coverage from various reinsurers in 1998 and 1997 and limited the coverage to one reinsurer in 1999. Additionally, for claims occurring after June 30, 1998, we further limited our per incident exposure by purchasing excess of loss coverage for losses from $25,000 to the WCRA selected retention level in Minnesota and from $25,000 to $300,000 in other states from a single reinsurer. This agreement was finalized after its effective date and activity occurring from July 1, 1998 through September 30, 1998 was recorded on a retrospective basis resulting in the deferral of a gain totaling $1,989,000 at December 31, 1998. We amortized $740,000 of the deferred gain as a reduction of claim and claim settlement expenses in 1999 resulting in an un-amortized deferred gain of $1,249,000 at December 31, 1999. The deferred gain is being amortized into income using the effective interest rate inherent in the amounts paid to the reinsurer and the estimated timing and amounts of recoveries from the reinsurer. Activity occurring on or after October 1, 1998 is recorded prospectively.

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):


			1999		1998

	Excess of loss reinsurance through various reinsurers		$	40,830	$	20,777




	Quota-share reinsurance for 1992 to 1994 through a single reinsurer			349		626

		Reinsurance recoverable on unpaid claim and claim settlement expenses	$	41,179	$	21,403

The effect of ceded reinsurance on premiums written and claim and claim settlement expenses are as follows (000’s):


			1999			1998			1997

Premiums written:




	Direct		$	88,966		$	89,328		$	81,657




	Ceded			(18,008	)		(8,489	)		(342	)

		Net premiums written	$	70,958		$	80,839		$	81,315

Claim and claim settlement expenses:




	Direct		$	67,465		$	90,011		$	55,825




	Ceded			(24,142	)		(14,717	)		(282	)

		Net claim and claim settlement expenses	$	43,323		$	75,294		$	55,543

The reinsurance recoverable on paid claim and claim settlement expenses consists solely of receivables from paid claim and claim settlement expenses at December 31, 1999 and 1998.

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):


			1999			1998			1997

Balance at January 1			$	97,269		$	61,069		$	49,256




	Less reinsurance recoverables			(21,403	)		(5,374	)		(6,183	)




	Plus deferred gain on retrospective reinsurance			1,989			—			—

Net balance at January 1				77,855			55,695			43,073




Incurred related to:




	Current year			52,176			64,315			58,628




	Prior years			(8,113	)		10,979			(3,085	)




	Amortization of deferred retrospective reinsurance gain			(740	)		—			—

		Total incurred		43,323			75,294			55,543




Paid related to:




	Current year			26,897			25,397			23,482




	Prior years			34,380			27,737			19,439

		Total paid		61,277			53,134			42,921

Net balance at December 31				59,901			77,855			55,695




	Plus reinsurance recoverables			41,179			21,403			5,374




	Plus deferred gain on retrospective reinsurance			(1,249	)		(1,989	)		—

Balance at December 31			$	99,831		$	97,269		$	61,069

Changes in estimates of unpaid claim and claim settlement expenses for prior years decreased the provision for claim and claim settlement expenses by $8,113,000 in 1999, 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 in 1997.

NOTE 6 — NOTES PAYABLE

We paid our unsecured Senior Notes in full in December 1999. Interest was paid monthly at 9.5% in 1999 and at rates ranging from 9.25% to 9.5% in 1998. Debt issue costs associated with the Senior Notes totaling $39,000 at December 31, 1998 was recorded as a reduction in notes payable and amortized over the term of the Senior Notes.

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 basis of assets and liabilities for income tax purposes.

Income tax expense (benefit) consists of the following (000’s):


			1999			1998			1997

Current:




	Federal		$	1,056		$	(1,568	)	$	3,714




	State			104			(143	)		(129	)

		Total current tax expense (benefit)		1,160			(1,711	)		3,585




Deferred:




	Federal			1,031			(2,218	)		(721	)




	State			(267	)		(21	)		6

		Total deferred tax expense (benefit)		764			(2,239	)		(715	)

		Income tax expense (benefit)	$	1,924		$	(3,950	)	$	2,870

Our income tax expense (benefit) differs from the federal statutory rate as follows (000’s):


			1999			1998			1997

Federal income tax expense (benefit) at 35%			$	2,832		$	(3,861	)	$	3,034




Increase (reduction) in income tax expense (benefit) resulting from:




	State income taxes, net of federal income tax benefit			23			8			(64	)




	Tax-exempt investment income			(930	)		(486	)		—




	Prior year tax return adjustments			—			301			—




	Other			(1	)		88			(100	)

		Income tax expense (benefit)	$	1,924		$	(3,950	)	$	2,870

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):


		1999			1998

Unpaid claim and claim settlement expenses		$	3,739		$	4,709




Unrealized loss on securities			1,452			—




Accrued second injury funds			1,165			918




Unearned premiums			894			912




Retrospective reinsurance			437			676




AMT credit carry-forward			280			—




Other			305			383

	Deferred tax assets		8,272			7,598




Unrealized gain on securities			—			(948	)




Deferred policy acquisition costs			(521	)		(525	)




Depreciation			(454	)		(464	)

	Deferred tax liabilities		(975	)		(1,937	)

	Net deferred tax assets	$	7,297		$	5,661

No valuation allowance was provided against the deferred tax assets recorded in 1999 or 1998, as we expect to generate sufficient taxable income in the future to offset reversing temporary differences.

Income taxes receivable at December 31, 1999 and 1998 were approximately $674,000 and $3,289,000, respectively.

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 1999:


	Shares		Purchase
Phase:	Purchased			Price

Beginning April 1996, expiring April 1997		20,092		$	7.65




Beginning April 1997, expiring April 1998		28,139		$	7.07




Beginning April 1998, expiring April 1999		27,143		$	3.88

The fourth one-year phase began in April 1999 and expires in April 2000.

Our liability for employee contributions withheld at December 31, 1999 and 1998 for the purchase of shares in April 2000 and April 1999 under the ESPP was $145,000 and $158,000, respectively.

1994 Stock Plan — The 1994 Stock Plan provides for awards of qualified 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. 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:


		Qualified					Non-Qualified

					Weighted					Weighted
					Average					Average
		Option			Exercise		Option			Exercise
		Shares			Price		Shares			Price

Balance, January 1, 1997			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




	Granted		187,672			6.28		55,556			4.50




	Exercised		(30,000	)		2.67		—			—




	Canceled		(238,052	)		8.08		—			—

Balance, December 31, 1999			1,023,536		$	6.68		526,451		$	6.66

Each of the qualified stock options expires ten years from the date of grant and substantially all are subject to continued employment with us. Each of the non-qualified options expires 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 at December 31, 1999:


		Options Outstanding						Options Exercisable

				Weighted Average						Weighted
		Number						Number		Average
		of		Contractual		Exercise		of		Exercise
Exercise Price Range		Options		Life		Price		Options		Price

Qualified stock options:




	$ 4.38 - $ 5.81		493,944	8.9 years		$	5.19		109,833	$	5.10




	7.00 - 9.00		489,342	8.1 years			7.60		141,964		7.86




	10.75 - 25.00		40,250	6.9 years			13.81		18,450		14.73

	$ 4.38 - $25.00		1,023,536	8.4 years		$	6.68		270,247	$	7.21

Non-qualified stock options:




	$ 2.67 - $ 4.50		59,306	9.0 years		$	4.38		3,750	$	2.67




	6.75 - 15.88		467,145	7.9 years			6.95		370,715		7.00

	$ 2.67 - $15.88		526,451		8.0 years	$	6.66		374,465	$	6.95

Non-Qualified Common Stock Options — Certain non-qualified options were issued prior to the onset of the 1994 Stock Plan. Non-qualified options exercised and outstanding are as follows:


							Weighted
							Average
		Option			Exercise		Exercise
		Shares			Price		Price

Balance, January 1, 1997 and December 31, 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




	Exercised in 1999		(320,000	)		2.00		2.00

Balance, December 31, 1999			—		$	—	$	—

We are permitted a tax deduction equal to the difference between the non-qualified 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 and 1998, we recorded reductions of income taxes payable and increased common stock by $532,000 and $80,000, respectively, to reflect the exercises.

Pro Forma Information — Had we calculated compensation expense for our option grants under the 1994 Stock Plan and stock issuances under the ESPP based on the fair value method described in SFAS No. 123, “Accounting for Stock-Based Compensation,” our net income (loss) and basic and dilutive net income (loss) per share would approximate the following pro forma amounts (in 000’s, except per share data):


		1999		1998			1997

Net income (loss):




	As reported	$	6,167	$	(7,081	)	$	5,799




	Pro forma	$	5,060	$	(7,995	)	$	5,238




Basic net income (loss) per share:




	As reported	$	0.50	$	(0.59	)	$	0.49




	Pro forma	$	0.41	$	(0.67	)	$	0.44




Dilutive net income (loss) per share:




	As reported	$	0.50	$	(0.59	)	$	0.48




	Pro forma	$	0.41	$	(0.67	)	$	0.43

The pro forma effect on net income (loss) for 1999, 1998 and 1997 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 1999, 1998 and 1997 is estimated at $2.53, $3.14 and $4.06, respectively, on the date of grant using the Black-Scholes option-pricing model with the following assumptions: no dividend yield; volatility of 64.3% in 1999, 71.0% in 1998 and 76.1% in 1997; 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 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 to other officers and employees. 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 Employee Stock Ownership Plan (ESOP) into a single retirement plan, the KSOP. The KSOP retains the features of each separate component 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 Component — We sponsor a defined contribution retirement component under Section 401(K) of the Internal Revenue Code for eligible employees. Our contributions are discretionary and are based on

contributions made by employees. Expense recognized for 1999, 1998 and 1997 was $151,000, $140,000 and $94,000, respectively.

Employee Stock Ownership Component — We maintain an ESOP for our qualified employees. Our contributions are discretionary. We may contribute cash or shares of our common stock. No expense was recorded in 1999, 1998 or 1997.

Other Employee Benefit Plans — We maintained bonus plans in 1999, 1998 and 1997 under which all employees, including officers, were eligible for a bonus based on our operating results. These bonuses aggregated $544,000, $267,000 and $643,000 in 1999, 1998 and 1997, respectively.

NOTE 9 — SHAREHOLDERS’ EQUITY

On September 15, 1998, our Board of Directors approved a share repurchase program authorizing the repurchase of up to $4,000,000 of RTW, Inc. common stock. We may repurchase shares on the open market or through private transactions depending upon market conditions and availability. Through December 31, 1999 we had repurchased 19,500 shares for $87,000. We will use the repurchased shares 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 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 that 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 2000, dividends in excess of $4,605,000 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 1999 and 1998, and statutory net income (loss) for 1999, 1998 and 1997 are as follows (000’s):


	*Statutory*		*Statutory Net*
	*Policyholders'*		*Income*
	*Surplus*		*(Loss)*

December 31, 1999	$	46,048	$	5,544




December 31, 1998		41,884		(6,767	)




December 31, 1997				5,871

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, 1999, are as follows (000’s):


	2000	$	1,418




	2001		1,274




	2002		860




	2003		155




	2004		155




Thereafter			65

		$	3,927

Rent expense, including contingent rentals, was $2,124,000, $2,181,000 and $1,776,000 for 1999, 1998 and 1997, respectively.

In the ordinary course of administering our workers’ compensation management program, we are routinely involved in the adjudication of claims resulting from workplace injuries. We are not involved in any legal or administrative claims that we believe are likely to have a material adverse effect our financial condition or results of operations.

NOTE 11 — ACCUMULATED OTHER COMPREHENSIVE (LOSS) INCOME

Our comprehensive (loss) income includes only unrealized gains and losses on investments classified as available-for-sale. Changes in accumulated other comprehensive (loss) income and other comprehensive (loss) income were as follows (000’s):


				1999			1998			1997

Accumulated other comprehensive income, beginning of year				$	1,759		$	892		$	11




Changes in comprehensive (loss) income arising during the year:




	Unrealized investment (losses) gains				(6,893	)		2,339			1,795




	Less: Adjustment for net realized investment gains				(84	)		(1,046	)		(399	)

		Change in net unrealized investment (losses) gains			(6,977	)		1,293			1,396




		Income tax (benefit) expense			(2,400	)		426			515

			Other comprehensive (loss) income for the year		(4,577	)		867			881

Accumulated other comprehensive (loss) income, end of year				$	(2,818	)	$	1,759		$	892

NOTE 12 — QUARTERLY RESULTS OF OPERATIONS (Unaudited)

The following tables present unaudited quarterly results of operations for the eight quarters ended December 31, 1999:


			*First*			*Second*			*Third*			*Fourth*
			*Quarter*			*Quarter*			*Quarter*			*Quarter*

1999			*(In thousands, except per share data)*
Premiums in force			$	81,900		$	85,900		$	85,700		$	87,200

Revenues:




	Gross premiums earned		$	21,314		$	21,798		$	22,254		$	23,860




	Premiums ceded			(4,160	)		(4,609	)		(4,682	)		(4,557	)

		Premiums earned		17,154			17,189			17,572			19,303




	Investment income			1,686			1,640			1,588			1,596




	Net realized investment gains (losses)			37			65			(18	)		—

		Total revenues		18,877			18,894			19,142			20,899




Expenses:




	Claim and claim settlement expenses			10,804			10,448			11,082			10,989




	Policy acquisition costs			3,486			3,523			3,016			4,086




	General and administrative expenses			2,987			2,931			2,879			3,224

		Total expenses		17,277			16,902			16,977			18,299

Income from operations			$	1,600		$	1,992		$	2,165		$	2,600

Net income			$	1,233		$	1,487		$	1,611		$	1,836

Basic income per share			$	0.10		$	0.12		$	0.13		$	0.15

Diluted income per share			$	0.10		$	0.12		$	0.13		$	0.15


			*First*			*Second*			*Third*			*Fourth*
			*Quarter*			*Quarter*			*Quarter*			*Quarter*

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	)

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 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):


	*First*			*Second*			*Third*		*Fourth*
1998	*Quarter*			*Quarter*			Quarter		Quarter

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	)

NOTE 13 — SUBSEQUENT EVENTS

On November 2, 1999, we announced that a group consisting of David C. Prosser, Chairman, members of his family, and another of our directors retained an investment banker to explore a sale of the group’s shares to new strategic investors. The group held approximately 6,383,000 shares representing 52% of all outstanding shares. In conjunction with the process, our Board of Directors appointed a Special Committee of independent directors to evaluate any proposed transaction.

On February 2, 2000, we entered into an agreement with participating members of the group (together, the “Prosser Selling Group”). Under the agreement, we agreed to repurchase from individual members of the Prosser Selling Group shares totaling approximately $7.8 million. Based on the market formula contained in the agreement, we expect to repurchase approximately 1,493,000 shares at $5.19 per share. This transaction is expected to close in March 2000. In addition, we expect David C. Prosser to retire and resign as Chairman and expect to pay him $225,000 as a termination benefit in conjunction with the closing. He is expected to remain as a member of our Board of Directors.

In connection with the closing, each member of the Prosser Selling Group is required to enter into a standstill and voting agreement under which each agrees, for a period of two years following the transaction, not to: (i) acquire additional securities of RTW; (ii) initiate, solicit or propose any corporate transaction such as a merger, reorganization, liquidation, sale or transfer of assets of RTW; (iii) initiate, solicit, support or propose a change in the composition of our Board of Directors or management; (iv) propose any material change in our business or corporate structure, our articles of incorporation or bylaws and make, participate or solicit any proxy to vote or seek to influence any other RTW shareholders with respect to RTW voting securities. Each member of the Prosser Selling Group will also agree to (i) vote his or her shares as recommended by our Board of Directors or in the same proportion as other RTW shareholders vote, and (ii) grant to the Chair of the Special Committee or his designee or successor, a conditional proxy with respect to such member’s shares.

Under the terms of the agreement, we borrowed $6.0 million under a 90-day term loan agreement with a bank and advanced the proceeds to the Prosser Selling Group for a security interest in the shares owned by the group. This term loan is subject to interest at a LIBOR adjusted rate (8.31% at February 29, 2000). We expect to replace the 90-day term loan and fund the remaining repurchase price of the shares in March 2000 with an $8.0 million term loan agreement and $2.0 million revolving credit facility to be used for general corporate purposes. We expect the term loan will accrue interest, payable quarterly, at an adjusted LIBOR rate and expect principal maturities due as follows (000’s):


December 31,
2000	$	1,000




2001		1,500




2002		1,500




2003		2,000




2004		2,000

We expect the revolving credit facility will accrue interest, payable quarterly, at an adjusted LIBOR rate and mature in March 2001. We expect that the revolving credit facility will be renewable annually at the discretion of the bank.

We expect to collateralize the term loan by stock of ACIC and expect that we will be subject to restrictive financial covenants that require maintaining minimum financial ratios, including (i) debt coverage, (ii) net worth, (iii) statutory surplus, (iv) net earnings, (v) risk based capital, (vii) A.M. Best Rating, and (viii) investment grade ratios. We expect the agreement to also restrict dividends, purchases, redemptions or retirements of stock.

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 2000 Proxy Statement and is incorporated herein by reference.

Information with respect to Executive Officers of the Company is included in PART I of this Report on Form 10-K.

ITEM 11. EXECUTIVE COMPENSATION

Information required under this item is contained in the Section entitled “Executive Compensation and Other Information” in the Company’s 2000 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 2000 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 2000 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 25 through 42 of Part II, Item 8 of this Report.

      Independent Auditors’ Report
      Consolidated Balance Sheets — December 31, 1999 and 1998

      Consolidated Statements of Operations — Years Ended December 31, 1999, 1998 and 1997

      Consolidated Statements of Other Comprehensive Income (Loss) and

      Shareholders’ Equity — Years Ended December 31, 1999, 1998 and 1997

      Consolidated Statements of Cash Flows — Years Ended December 31, 1999, 1998 and 1997

      Notes to Consolidated Financial Statements — Years Ended December 31, 1999, 1998 and 1997

      (2) Financial Statement Schedules for the Three Years Ended December 31, 1999


		Page

Independent Auditors’ Report on Schedules for the Years Ended




December 31, 1999, 1998 and 1997.		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

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.


3.1		Amended Articles of Incorporation (1)




3.2		Amended Bylaws (1)




4.1		Registration Rights Agreement (2)




10.1*		Employment Agreement Letter dated November 24, 1997 between RTW and Carl B. Lehmann (4)




10.2*		Non-Qualified Stock Option Agreement dated November 24, 1997 between RTW and Carl B. Lehmann (4)




10.3*		Letter Agreement dated January 15, 1998 Amending the Non-Qualified Stock Option Agreement between RTW and Carl B. Lehmann (4)




10.4*		Incentive Stock Option Agreement dated January 15, 1998 between RTW and Carl B. Lehmann (4)




10.5*		Employment Agreement Letter dated January 22, 1999 between RTW and David C. Prosser (4)




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 2000 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 (4)




10.13		Endorsement No. 2 to the reinsurance contract between ACIC and General Reinsurance Corporation (4)




10.14		Minnesota Workers’ Compensation Reinsurance ssociation reinsurance agreement (4)




10.15		Election form for Minnesota Workers’ Compensation Reinsurance Association reinsurance agreement for 2000




10.16		Standstill and Voting Agreement




10.17		Letter Agreement dated March 3, 2000 between US Bank and RTW, Inc. regarding Term Note and Revolving Credit Facilities




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, 1999




99.1		Press Release Dated March 27, 2000 Announcing Repurchase of Shares

(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 1998 Report on Form 10-K.

SIGNATURES

Pursuant to the requirements of Section 13 or 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 28, 2000	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 Jeffrey B. Murphy as his true and lawful attorney-in-fact and agents, each acting alone, with full power of substitutions and resubstitution, for him and in his name, place, and stead, in any and all capacities, to sign any or all amendments to this Annual Report on Form 10-K and to file the same, with the exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission.


Date		Signature and Title

March 28, 2000		By /s/ Carl B. Lehmann

		Carl B. Lehmann President, Chief Executive Officer and Director (Principal Executive Officer)

March 28, 2000		By /s/ Jeffrey B. Murphy

		Jeffrey B. Murphy Secretary, Treasurer and Chief Financial Officer (Principal Financial and Accounting Officer)

March 28, 2000		By /s/ David C. Prosser

		David C. Prosser Director

March 28, 2000		By /s/ J. Alexander Fjelstad, III

		J. Alexander Fjelstad, III Director

March 28, 2000		By /s/ David R. Hubers

		David R. Hubers Director

March 28, 2000		By /s/ Mark E. Hegman

		Mark E. Hegman Director

March 28, 2000		By /s/ Steven M. Rothschild

		Steven M. Rothschild Director

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, 1999 and 1998 and for each of the three years in the period ended December 31, 1999, and have issued our report thereon dated February 3, 2000. 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 financial statements taken as a whole, present fairly in all material respects the information set forth therein.

/s/ Deloitte & Touche LLP

Minneapolis, Minnesota
February 3, 2000

S-1

SCHEDULE I

RTW, INC.
SUMMARY OF INVESTMENTS
December 31, 1999
(In thousands)


								Amount at
								which shown
				Amortized		Fair		in the balance
Type of investment				Cost		Value		sheet

Fixed maturities:




	Available-for-sale:




		Tax-exempt municipal securities		$	63,104	$	60,854	$	60,854




		Corporate securities			15,462		14,620		14,620




		Mortgage / asset-backed securities			18,103		17,484		17,484




		United States government, government agencies and authorities			15,665		15,106		15,106

			Total Investments	$	112,334	$	108,064	$	108,064

S-2

SCHEDULE II

RTW, INC.
Condensed Financial Information of the Registrant
Balance Sheets
December 31, 1999 and 1998
(In thousands)


				1999		1998

			ASSETS




	Cash and cash equivalents			$	2	$	213




	Furniture and equipment, net				3,881		4,565




	Investment in and advances to subsidiary				53,279		51,669




	Income tax receivable				22		117




	Other assets				339		631

				$	57,523	$	57,195

LIABILITIES AND SHAREHOLDERS’ EQUITY




	Accrued expenses and other liabilities			$	1,628	$	1,770




	Deferred income taxes				330		346




	Notes payable				—		2,461

		Total liabilities			1,958		4,577




	Shareholders’ equity				55,565		52,618

				$	57,523	$	57,195

See notes to condensed financial statements.

S-3

SCHEDULE II

RTW, INC.
Condensed Financial Information of the Registrant
Statements of Operations
Years Ended December 31, 1999, 1998 and 1997
(In thousands)


			1999		1998			1997

Revenues:




	Intercompany fee income		$	25,762	$	25,262		$	22,364




	Investment income			15		28			249

		Total revenues		25,777		25,290			22,613




Expenses:




	General and administrative expenses			25,044		25,526			23,097

		Income (loss) from operations		733		(236	)		(484	)




Interest expense				266		546			777

Income (loss) before income taxes and equity in undistributed net income (loss) of subsidiary				467		(782	)		(1,261	)




	Provision for income taxes			246		(263	)		(429	)

Income (loss) before equity in undistributed net income (loss) of subsidiary				713		(519	)		(832	)




	Equity in undistributed net income (loss) of subsidiary			5,454		(6,562	)		6,631

Net income (loss)			$	6,167	$	(7,081	)	$	5,799

See notes to condensed financial statements.

S-4

SCHEDULE II

RTW, INC.
Condensed Financial Information of the Registrant
Statements of Cash Flows
Years Ended December 31, 1999, 1998 and 1997
(In thousands)


					1999			1998			1997

Cash Flows from Operating Activities:




	Reconciliation of net income (loss) to net cash provided by operating activities:




		Net income (loss)			$	6,167		$	(7,081	)	$	5,799




		Adjustments to reconcile net income (loss) to net cash provided by operating activities:




			Depreciation and amortization			1,296			1,267			1,079




			Equity in net loss (income) from subsidiary			(5,454	)		6,562			(6,631	)




			Deferred income taxes			(16	)		34			131




			Changes in assets and liabilities:




				Accrued expenses and other liabilities		(142	)		428			257




				Other, net		(4,190	)		1,359			351

				Net cash (used in) provided by operating activities		(2,339	)		2,569			986




Cash Flows from Investing Activities:




	Investment in and advances to subsidiary					3,844			(448	)		(2,761	)




	Purchases of furniture and equipment					(573	)		(819	)		(2,447	)

				Net cash provided by (used in) investing activities		3,271			(1,267	)		(5,208	)




Cash Flows from Financing Activities:




	Payments on notes payable					(2,500	)		(2,500	)		(2,000	)




	Stock options and warrants exercised					1,252			333			1




	Issuance of common stock to ESOP					—			—			115




	Issuance of common stock under ESPP					105			199			154




	Proceeds from sales of common stock					—			30			—




	Retirement of common stock					—			(87	)		—

				Net cash used in financing activities		(1,143	)		(2,025	)		(1,730	)

Net decrease in Cash and Cash Equivalents						(211	)		(723	)		(5,952	)




Cash and Cash Equivalents at Beginning of Year						213			936			6,888

Cash and Cash Equivalents at End of Year					$	2		$	213		$	936

Supplemental Disclosure of Cash Flow Information:




	Cash paid (received) during the year for:




		Interest			$	238		$	546		$	664

		Income tax (refunds) payments			$	(97	)	$	16		$	61

See notes to condensed financial statements.

S-5

SCHEDULE II

RTW, INC.
Condensed Financial Information of the Registrant
Notes to Condensed Financial Statements
Years Ended December 31, 1999, 1998 and 1997

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. 1999 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 $8,933,000, $8,908,000 and $8,057,000 for the years ended December 31, 1999, 1998 and 1997, 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 $16,771,000, $16,289,000 and $14,307,000 for the years ended December 31, 1999, 1998 and 1997, 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 ($1,259,000) and $7,104,000 at December 31, 1999 and 1998, respectively.

S-6

SCHEDULE III

RTW, INC.
SUPPLEMENTAL INFORMATION CONCERNING INSURANCE OPERATIONS
(in thousands)

(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

1999 $ 1,487 $ 99,831 $ 2,873 $ 12,766 $ 71,218 $ 6,521

1998 $ 1,501 $ 97,269 — $ 13,027 $ 81,392 $ 8,732

1997 $ 1,559 $ 61,069 — $ 13,580 $ 81,043 $ 6,971

[Additional columns below]

[Continued from above table, first column(s) repeated]

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

1999 $ 51,436 $ (8,113 ) $ 14,111 $ 61,277 $ 70,958

1998 $ 64,315 $ 10,979 $ 13,974 $ 53,134 $ 80,839

1997 $ 58,628 $ (3,085 ) $ 11,658 $ 42,921 $ 81,315

S-7

SCHEDULE IV

RTW, INC.
REINSURANCE
Years ended December 31, 1999, 1998 and 1997
(In thousands)


		Premiums earned
										Percentage
				Ceded to		Assumed				of amount
				other		from other				assumed
Description		Direct		companies		companies		Net		to net

1999




	PREMIUMS - Workers' Compensation	$	89,226	$	18,008	$	—	$	71,218		0.00	%




1998




	PREMIUMS - Workers' Compensation	$	89,881	$	8,489	$	—	$	81,392		0.00	%




1997




	PREMIUMS - Workers' Compensation	$	81,385	$	342	$	—	$	81,043		0.00	%

S-8

SCHEDULE V

RTW, INC.
VALUATION AND QUALIFYING ACCOUNTS
Years ended December 31, 1999, 1998 and 1997
(In thousands)


				Additions

		Balance at		Charged to		Charged to				Balance at
		beginning		costs and		other				end
Description		of period		expenses		accounts		Write-offs		of period

1999




	Allowance for Doubtful Accounts	$	417	$	163	$	—	$	61	$	519




1998




	Allowance for Doubtful Accounts	$	182	$	379	$	—	$	144	$	417




1997




	Allowance for Doubtful Accounts	$	105	$	250	$	—	$	173	$	182

S-9

	•		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.

	•		In 1999, we recorded an estimate of ceded paid and unpaid claim and claim settlement expenses under our $25,000 to $300,000 excess of loss reinsurance agreement totaling $22.0 million including $740,000 amortized from a deferred retrospective reinsurance gain resulting in a corresponding reduction in 1999 claim and claim settlement expenses. Our 1998 results include an estimate of ceded paid and unpaid claim and claim settlement expenses totaling $8.6 million recorded in the fourth quarter of 1998.

	•		The 1999 results include an $8.1 million decrease in reserves for unpaid claim and claim settlement expenses to reflect favorable development of prior period claims compared to the 1998 results which include an $11.0 million increase in reserves for unpaid claim and claim settlement expenses, of which we recorded $3.0 million in the first quarter of 1998 and $8.0 million in the fourth quarter of 1998 to reflect adverse development of prior period claims. Additionally, the 1998 results included a $400,000 Minnesota Special Compensation Fund (SCF) adjustment recorded in the second quarter of 1998. The SCF assesses us to cover the costs of second injuries that are substantially greater, because of a pre-existing physical impairment, than what would have resulted from the second injury alone.

	•		We aggressively targeted selected policies for non-renewal or re-underwriting at more favorable rates during 1999 at policy expiration. For 1999, our aggressive re-underwriting resulted in $10.9 million of premiums renewed at higher prices as well as $10.8 million in premiums that were not renewed. We will continue to review business at policy expiration in 2000 and non-renew or re-underwrite at more favorable rates, any business not meeting our standards;

	•		Pricing pressure continued to affect premiums in force and decrease profit margins, especially in Minnesota. The pricing pressure is the result of increased competition in our markets; and

	•		Inflation continues to affect medical and wage costs.

	•		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 paid by 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, in turn, improves their claims history, lowering the premium that they have to pay for insurance. The improvement that we provide our customers also makes them more desirable to our competition, thus increasing price competition on these accounts.

	•		We expect that our aggressive targeting of policies for non-renewal or re-underwriting during 2000 will put downward pressure on premiums in force in our Minnesota and Missouri markets; however, we expect continued growth in premiums in force in our Colorado, Michigan and Massachusetts markets, as well as new business in our Minnesota and Missouri markets will lead to moderate growth in gross premiums earned for 2000. In Massachusetts, our premium growth rate will be tempered by an unexpected decision by the Massachusetts Department of Insurance to reduce premium rates effective September 1, 1999. We are encouraged by a favorable trend in premium rates. In 1998, our book of business saw a 10.2% decline in premium rates. This was followed by another 6.7% decline in 1999. In the fourth quarter of 1999, however, premium rates declined just one 0.5%. In January, 2000, we were able to achieve a 8.5% increase in rate in our January 2000 renewal business;

	•		We expect that premiums ceded in 2000 will be consistent with premiums ceded in 1999. Premiums ceded may decrease slightly in 2000 as a percent of gross premiums earned as the non-Minnesota markets, where we pay smaller reinsurance premiums, continue to grow relative to Minnesota;

	•		We believe the recent events within the workers’ compensation reinsurance market will have no impact on our reinsurance program for 2000.

	•		Funds provided by our operating cash flows and investment cash flows have historically provided growth in our investment portfolio. Operating cash flows consist of the excess of premiums collected over claim and claim settlement expenses, reduced by payments for reinsurance premiums as well as other operating expenses paid. Investment cash flows consist of income on existing investments and proceeds from sales and maturities of investments. We have historically generated positive net cash flows from operations due, in part, to timing differences between the receipt of premiums and the payment of claim and claim settlement expenses. These net cash flows have decreased significantly as we have focused on closing older claims, paying earlier to close those claims. Combined with relatively flat premiums in force since December 1998, our cash flow from timing on claims payments has decreased. Additionally, as we lowered our reinsurance retention levels to $25,000 in mid-1998, we decreased our current period cash flows as a result of “pre-funding” quarterly premiums under that agreement. We expect this reduction in quarterly cash flow will continue until reimbursements for loss payments to claimants under these contracts equal disbursements for premium payments;

	•		Our recognition of realized gains and losses will depend on sales of our investments, if any, to meet our short-term cash requirements; and

	•		We will continue to include fixed maturity tax-exempt securities in our investment portfolio to increase after-tax yields. The mix of taxable and tax-exempt securities in our portfolio may change over time to accommodate our tax situation. 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.

	•		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;

	•		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.

	•		Continued favorable effects of ceding paid and unpaid claim and claim settlement expenses under our $25,000 to $300,000 excess of loss reinsurance agreements resulting in a reduction of claim and claim settlement expenses;

	•		Claim costs will continue to 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;

	•		Continued pricing pressure due to legislative changes in estimated loss costs, increased competition and improving customer loss experience may result in reduced premiums, ultimately increasing claim and claim settlement expense as a percent of premium earned; and

	•		Continued application of our claims management technology and methods to all open claims.

	•		Commission expense increased to 8.0% of gross premiums earned in 1999 and 1998 from 7.8% in 1997. 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 1999, 1998 and 1997;

	•		Other policy acquisition costs decreased slightly to 5.4% of gross premiums earned in 1999 from 5.5% in 1998 and increased from 4.5% in 1997. Policy acquisition costs were consistent in 1999 and 1998, however, increased significantly from 1997 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

	•		We expect commission expense as a percent of gross premiums earned to decrease slightly in 2000 as we manage our commission structures in our non-Minnesota states;

	•		We expect premium tax expense as a percent of gross premiums earned to remain consistent with 1999; and

	•		We expect that other policy acquisition costs will be consistent with 1999 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 2000 realized through enhancements to our internal processes and procedures, including changes to our proprietary computer systems.

	•		General and administrative expenses continue to improve as a percent of premiums earned, after adjusting for MIGA accrual reversals and one-time charges. We have aggressively managed personnel and other operating costs and expenses to bring operating expenses more in line with revenues. All expenses continue to be managed aggressively and reduced where appropriate.

	•		The reorganization effected in the fourth quarter of 1999 began earlier in 1999 and resulted in a net reduction of thirty-three positions. This reorganization has reduced costs and centralized and strengthened certain processes.

	•		We expect that the reorganization effected in the fourth quarter of 1999 will result in further personnel cost reductions in 2000.

	•		We will continue to aggressively manage all other operating costs and expenses in 2000;

	•		We have no plans to open additional state offices in 2000 and expect that growth in premiums in force will result in additional revenues to cover the fixed costs in all of our states; and

	•		We expect to realize additional operational efficiency during 2000 through enhancements to our internal processes and procedures, including changes to our operating structure as well as improvements to our internal proprietary computer systems.


			*December 31,*
			1999		1998			1997			1996

Loss Reserve Development:
	Gross reserves for unpaid claim and claim settlement expenses		$	99,831	$	97,269		$	61,069		$	49,256
	Deduct reinsurance recoveries			41,179		21,403			5,374			6,183

	Net reserves for unpaid claim and claim settlement expenses		$	58,652	$	75,866		$	55,695		$	43,073

	Paid (cumulative) as of:
		One year later			$	34,380		$	27,737		$	19,439
		Two years later							42,046			28,173
		Three years later										33,438
		Four years later
		Five years later
		Six years later
		Seven years later
	Reserves re-estimated as of:




		End of year	$	58,652	$	75,866		$	55,695		$	43,073
		One year later				67,753			66,674			39,988
		Two years later							61,075			43,484
		Three years later										41,451
		Four years later
		Five years later
		Six years later
		Seven years later
	Initial reserves in excess of (less than) re-estimated reserves:
		Amount			$	8,113		$	(5,380	)	$	1,622
		Percent				10.7	%		(9.7	%)		3.8	%


			*December 31,*
			1995			1994			1993			1992

Loss Reserve Development:
	Gross reserves for unpaid claim and claim settlement expenses		$	37,138		$	28,165		$	13,279		$	2,688
	Deduct reinsurance recoveries			8,312			13,902			9,593			1,886

	Net reserves for unpaid claim and claim settlement expenses		$	28,826		$	14,263		$	3,686		$	802

	Paid (cumulative) as of:
		One year later	$	8,595		$	4,639		$	1,436		$	583
		Two years later		12,894			6,476			2,150			678
		Three years later		15,521			7,863			2,348			815
		Four years later		16,869			8,569			2,654			856
		Five years later					9,046			2,816			925
		Six years later								2,847			951
		Seven years later											920
	Reserves re-estimated as of:
		End of year	$	28,826		$	14,263		$	3,686		$	802
		One year later		20,751			12,789			3,784			1,075
		Two years later		18,469			9,318			3,416			1,008
		Three years later		19,796			8,984			2,782			950
		Four years later		19,389			9,669			2,861			912
		Five years later					9,692			2,972			949
		Six years later								2,927			964
		Seven years later											926
	Initial reserves in excess of (less than) re-estimated reserves:
		Amount	$	9,437		$	4,571		$	759		$	(124	)
		Percent		32.7	%		32.0	%		20.6	%		(15.5	%)


		*Effect of Reserve re-estimates on Calendar Year Operations:*
		1999			1998			1997			1996

Accident Year:




	1992	$	38		$	(15	)	$	(37	)	$	38




	1993		7			(96	)		(42	)		596




	1994		(68	)		(574	)		413			2,837




	1995		430			(642	)		1,948			4,604




	1996		1,626			(2,169	)		803




	1997		3,566			(7,483	)




	1998		2,514

	Total	$	8,113		$	(10,979	)	$	3,085		$	8,075


										*Cumulative*
										*Re-estimates*
										*for each*
		*Effect of Reserve re-estimates on Calendar Year Operations:*								*Accident*
		1995		1994			1993			*Year*

Accident Year:




	1992	$	58	$	67		$	(273	)	$	(124	)




	1993		310		(165	)					610




	1994		1,106								3,714




	1995										6,340




	1996										260




	1997										(3,917	)




	1998										2,514

	Total	$	1,474	$	(98	)	$	(273	)	$	9,397


			(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

1999	$	1,487	$	99,831	$	2,873	$	12,766	$	71,218	$	6,521




1998	$	1,501	$	97,269		—	$	13,027	$	81,392	$	8,732




1997	$	1,559	$	61,069		—	$	13,580	$	81,043	$	6,971


		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

	1999	$	51,436	$	(8,113	)	$	14,111	$	61,277	$	70,958




	1998	$	64,315	$	10,979		$	13,974	$	53,134	$	80,839




	1997	$	58,628	$	(3,085	)	$	11,658	$	42,921	$	81,315