<PAGE>
________________________________________________________________________________
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
___________________
FORM 10-K
(Mark One)
(X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934 (NO FEE REQUIRED).
For the fiscal year ended December 31, 1997
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 (NO FEE REQUIRED).
Commission file number 0-28214
_________________________
MEDICAL DEFENSE HOLDING CO.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
Missouri 43-1696112
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
1311 East Woodhurst, Springfield, Missouri 65804
(Address of principal executive offices) (Zip Code)
</TABLE>
(Registrant's telephone number, including area code): (417) 887-3120
__________________________________________
Securities registered pursuant to Section 12(b) of the Act: None.
Securities registered pursuant to Section 12(g) of the Act: None.
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.
X Yes No
----------- -----------
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K ((S)229.405 of this chapter) is not contained herein, and
will not be contained, to the best of 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)
The aggregate market value of the voting stock held by non-affiliates of
the Registrant is undeterminable since there is no market at this time for the
stock. See Part II Item 5, Market for the Registrant's Common Stock and Related
Stockholder Matters.
As of March 23, 1998 there were 7,426,010 shares outstanding of the
Registrant's Convertible Preferred Stock, $1.00 par value. In addition, there
were 999,998 shares of the Registrant's Class A Common Stock, $.50 par value
outstanding and there were 53,400 shares outstanding of the Registrant's Class B
Common Stock, $.50 par value.
DOCUMENTS INCORPORATED BY REFERENCE: None
________________________________________________________________________________
<PAGE>
PART I
Item 1. Business
-----------------
BUSINESS OF THE HOLDING COMPANY
Medical Defense Holding Co. (the "Company") was incorporated in Missouri on
November 28, 1994. The Company is the parent holding company of Medical Defense
Associates (the "MDA"), a Missouri stock casualty insurance company. MDA owns
all of the issued and outstanding stock of Medical Defense Services Corp.
("MDS"), a Missouri corporation. MDS, in turn, owns all of the issued and
outstanding stock of Medical Defense Insurance Company ("MDIC"), a Missouri
stock casualty insurance company. MDA and MDIC offer medical professional
liability insurance for physicians, surgeons, dentists and others engaged in the
delivery of health care services. The Company and its subsidiaries comprise an
insurance holding company system under Missouri law.
BUSINESS OF MEDICAL DEFENSE ASSOCIATES
Background
----------
MDA was formed in 1976 as an entity operating under Chapter 383 R.S.Mo. for
the purpose of providing medical malpractice insurance or indemnification upon
the assessment plan. On April 3, 1995, the members of MDA voted in favor of the
conversion of MDA to a stock insurance company operating under Chapter 379
R.S.Mo. The conversion was completed on June 26, 1995 and MDA became a wholly
owned subsidiary of the Company at that time. The Company issued approximately
12,000,000 shares of Preferred Stock to policyholders who were named insureds of
MDA under policies in force on April 4, 1994. Officers, directors or members of
management of the Company or its subsidiaries also purchased 999,992 shares of
Class A Common Stock for approximately $500,000.
Lines of Insurance
------------------
MDA currently writes medical malpractice insurance as its only line of
business. MDA insures physicians and surgeons with the degree of Doctor of
Medicine or Doctor of Osteopathy, dentists and oral surgeons and ancillary
health professionals. MDA has written only medical malpractice insurance since
its inception in 1976. MDA offered only an Occurrence Policy from its inception
through March 31, 1986. Excess coverage was offered from 1981 through 1985.
Effective April 1, 1986, new policyholders were offered a choice of a Claims
Made Policy or an Occurrence Policy. Effective July 1, 1986, MDA offered only
Claims Made Policies to new policyholders. Existing occurrence policyholders
were converted to Claims Made Policies as they renewed after January 1, 1987. At
this time, MDA only offers Claims Made Policies.
As of December 31, 1997, MDA had 1,165 policyholders including those with
corporate coverage. MDA writes limits ranging from $200,000 per occurrence and
$600,000 in the aggregate per year to $1,000,000 per occurrence and $3,000,000
in the aggregate per year. The policyholders represent a diverse range of
specialties and geographic locations within the State of Missouri.
General Aspects of MDA's Business
---------------------------------
UNDERWRITING
MDA exercises strict underwriting which is performed by an Underwriting
Committee of five (5) physicians licensed in the State of Missouri. The
Underwriting Committee is augmented by an experienced underwriting staff.
2
<PAGE>
CLAIMS
MDA's claims philosophy is to defend all non-meritorious claims. In
addition, MDA will not settle a claim without the prior consent of the insured.
In those claims in which the insured consents to settle and in which liability
exists, MDA moves promptly to settle the claim early in order to minimize
indemnity and loss adjustment expenses.
RESERVES FOR UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES
MDA is required to maintain loss reserves for anticipated losses and loss
adjustment expenses. The loss reserves represent the estimated probable cost of
settling of losses under MDA's policies of insurance. The loss adjustment
expense reserves represent the estimated probable cost of investigating all
losses and when necessary defending lawsuits in connection therewith. The loss
reserves are estimated based upon individual loss data and historical loss data
and include amounts determined on the basis of individual and actuarially
determined estimates of future losses. Therefore, MDA's ultimate liability could
deviate from the amounts currently reflected in the loss reserves.
MDA's claims department continually monitors and reviews circumstances
related to potential or actual claims and the methods utilized for making
reserve estimates. The reasonableness of statutory loss reserves under the terms
of MDA's policies and agreements, and under the requirements of the insurance
laws of the State of Missouri is subject to statement of actuarial opinion
requirements by a qualified actuary. The Missouri Department of Insurance (the
"Department") reviews the loss reserves of MDA as a part of an insurance company
financial examination. The latest examination done by the Department was in
1996. Any adjustments to loss reserves are reflected in operations.
MDA's loss reserves are estimated by an actuary on the basis of statistical
information regarding MDA's historical development pattern, industry averages,
and indices. A medical professional liability insurance company must accumulate
substantial loss reserves because policies provide for payments of substantial
amounts in the future for claims that have occurred in prior contract periods.
These loss reserves are established as balance sheet liabilities representing
estimates of future amounts needed to pay claims and related expenses with
respect to insured events which have occurred, including events that have not
yet been reported.
MDA employs an independent actuary to make recommendations in the
establishment of its reserves. However, the quantification of reserves is
complex and imprecise as a result of the time it takes to settle claims, the
complex nature of damage claims and the evolving nature of claims and remedies
sought by plaintiffs. In determining reserve levels, actuaries necessarily rely
primarily on historical loss experience, adjusted for changing circumstances as
deemed appropriate. This reliance is based on the assumption that historical
loss experience provides a good indication of future loss experience despite
uncertainties in loss cost trends and delays in reporting and settling claims.
These uncertainties are increased by changes in normal inflation, changing
propensities of individuals to file claims, and new causes of action. Despite
these uncertainties in the determination of reserve levels, management believes
that the methods used by MDA to establish its reserves are reasonable and
appropriate.
As additional information becomes available and is reviewed, the estimates
reflected in earlier reserves may be revised resulting in either increases or
decreases to reserves, including reserves for insured events of prior years. Any
such increases could have an adverse effect on results for the period in which
adjustments are made. The uncertainties inherent in estimating ultimate losses
on the basis of past experience have grown significantly in recent years as a
result of judicial expansion of liability standards and expansive
interpretations of insurance contracts.
3
<PAGE>
Reconciliation of Loss Reserves
-------------------------------
The following table sets forth an analysis of loss reserve liabilities and
loss adjustment expenses for the Company on a consolidated basis and provides a
reconciliation of beginning and ending liability balances for the years ended
December 31, 1997, 1996, and 1995:
Reconciliation of Loss Reserves (gross of reinsurance)
(in thousands)
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Unpaid losses and loss adjustment expenses,
beginning of year........................................ $63,205 $65,660 $65,803
------- ------- -------
Losses and loss adjustment expenses incurred
related to:
Current year........................................... 13,506 15,802 18,115
Prior years............................................ (783) 4,145 (2,478)
------- ------- -------
Total incurred......................................... 12,723 19,947 15,637
------- ------- -------
Losses and loss adjustment expenses payments,
excluding the change in outstanding claim
drafts, for claims incurred during:
Current year........................................... 266 749 1,333
Prior years............................................ 17,008 21,653 14,447
------- ------- -------
Total paid............................................. 17,274 22,402 15,780
------- ------- -------
Unpaid losses and loss adjustment expenses,
end of year.............................................. $58,654 $63,205 $65,660
======= ======= =======
</TABLE>
Loss Reserve Development Table
The following table sets forth the development of loss and loss adjustment
expense reserve liabilities of MDA for each of the years in the ten year period
prior to December 31, 1997. The top line of the table shows the estimated
liability for unpaid losses and loss adjustment expense recorded at the end of
each of the years indicated. These liabilities represent the estimated amount of
losses and loss adjustment expense reserves for claims arising in the current
year and all prior years that are unpaid as of the end of each year.
The "Cumulative Paid End of Year" portion of the table presents the
cumulative amounts paid with respect to the liability previously recorded as of
the end of each succeeding year. The portion of the table which shows the re-
estimated amount relating to the previously recorded liability is based upon
experience as of the end of each succeeding year. The estimate is either
increased or decreased as additional information about the frequency and
severity of claims for each individual year becomes available and is reviewed.
The section of the table entitled "Cumulative Redundancy (Deficiency)" is
based upon actual amounts recorded in MDA's financial records and represents the
aggregate change in the estimated loss and loss adjustment expenses incurred
over all prior years.
Information presented in the following table is cumulative and,
accordingly, each amount includes the effects of all changes in amounts for
prior years. For example, the amount of the increase related to losses settled
or provided for in 1996, but incurred in 1992, will be included in the
cumulative increase (decrease) in estimated losses and loss adjustment expenses
for all of the intervening years.
4
<PAGE>
Loss Reserve Development Table, continued
The most recent eight years, 1990 through 1997, are presented on a direct
basis consistent with Statement of Financial Accounting Standards #113. All
years prior to 1990 are presented on a net of reinsurance basis as it was not
practical to generate the table on a direct basis for those years due to
differences in financial reporting for periods prior to 1990.
Medical Defense Associates
Loss Reserve Development Table*
(in thousands)
<TABLE>
<CAPTION>
Net Net Net Direct Direct Direct Direct Direct Direct Direct Direct
1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997
-------- ------- ------- ------- ------- ------- ------- ------- -------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Reserve for unpaid....... $42,312 $49,965 $66,984 $79,456 $76,515 $70,223 $70,326 $65,785 $65,606 $62,970 $58,594
Cumulative Paid
End of Year:
1........................ 13,630 6,240 12,607 17,210 19,070 11,682 18,528 14,779 21,967 16,853 --
2........................ 19,111 17,291 26,719 32,208 28,142 29,017 31,097 31,823 35,921
3........................ 28,899 25,912 37,626 38,022 41,127 39,101 43,342 42,881
4........................ 33,769 30,907 40,093 47,882 49,277 46,472 48,245
5........................ 37,323 32,380 43,907 52,389 54,653 49,222
6........................ 38,456 34,816 47,579 57,189 56,163
7........................ 40,484 38,257 51,077 58,145
8........................ 43,050 41,415 51,813
9........................ 46,160 41,988
10....................... 46,633
Re-estimated Liability:
1........................ 52,721 53,801 66,511 72,994 71,098 66,291 68,666 63,695 70,101 62,249 --
2........................ 55,650 55,584 61,105 69,179 67,965 64,076 66,191 66,385 68,325
3........................ 56,810 51,579 59,313 66,734 66,781 62,601 67,699 63,438
4........................ 54,105 49,949 56,606 66,477 66,267 62,990 65,659
5........................ 52,481 45,762 56,715 66,428 67,541 61,628
6........................ 49,420 46,072 57,276 67,148 66,529
7........................ 49,928 46,544 58,003 66,239
8........................ 50,179 47,441 57,599
9........................ 51,075 46,981
10....................... 50,607
Cumulative Redundancy
(Deficiency).............
(8,295) 2,984 9,385 13,217 9,986 8,595 4,667 2,347 (2,719) 721 --
</TABLE>
NOTE: The figures presented on the Loss Reserve Development Table for
years 1990 through 1997 are gross of the effects of reinsurance in order to be
consistent with figures presented in those years' financial statements. However,
the figures for years 1987 through 1989 have not been restated and are net of
the effects of reinsurance. Restatement of the 1987 through 1989 amounts is not
practical because the information necessary is not contained in MDA's statutory
Annual Statement or records.
* Excludes MDIC, as MDIC's share of loss and loss adjustment expense
reserves compared to total reserves is less than one (1) percent.
5
<PAGE>
Discounting of Loss Reserves
The Company does not discount its loss reserves for generally accepted
accounting principles purposes. For statutory accounting purposes, for accident
years prior to 1995, MDA discounted its medical professional liability loss and
loss adjustment expense reserves on a non-tabular basis. During 1995, the
Missouri Department of Insurance instituted, for all Missouri domiciled property
and casualty companies, a policy which does not permit non-tabular discounting
of unpaid losses and loss adjustment expenses. In conjunction with this new
policy, MDA reached agreement with the Missouri Department of Insurance to
eliminate non-tabular reserve discounting in MDA's statutory financial
statements over a five-year period. Under this agreement all unpaid losses and
loss adjustment expenses related to accident years 1995 and subsequent will be
reflected gross of discounting. In addition, the total non-tabular discount of
$3,484,000 reflected in MDA's 1994 year-end reserves will be phased-out over
five years by a 20% adjustment per year directly to surplus as regards
policyholders. The effect of this phase-out adjustment on MDA's statutory
balance sheet at year end 1997 was to increase total reserves for loss and loss
adjustment expenses by $2,091,000, with a corresponding decrease to surplus as
regards policyholders. Discount factors and the discount taken for the five-year
period ended December 31, 1997 were as follows:
<TABLE>
<CAPTION>
Year Discount Factor Discount Taken
---- --------------- --------------
<S> <C> <C>
1993 3.0% $3,660,000
1994 3.0% $3,484,000
1995 Based on statutory agreement $2,787,000
noted above
1996 Based on statutory agreement $2,090,000
noted above
1997 Based on statutory agreement $1,393,000
noted above
</TABLE>
MDIC's loss and loss adjustment expense reserves are not discounted for
statutory accounting purposes.
REINSURANCE
MDA reinsured all Occurrence Policies issued after October 31, 1980 and all
Claims-Made Policies issued before November 1, 1987. The Company ceased
reinsuring Claims-Made Policies as of November 1, 1987. All claims related to
Occurrence Policies issued after October 31, 1980 and Claims-Made Policies
before November 1, 1987 are still reinsured.
A reserve for estimated retrospective premium due reinsurers has been
established for the excess of the anticipated reinsurance premium payable over
the amount paid to date for reinsurance treaty years 1980 through 1987. The
ultimate reinsurance premium to be paid is based on the ultimate loss
developments for claims arising during those treaty years. Changes in the
estimated amount due reinsurers are reflected in current operations. The
ultimate amount due reinsurers is estimated by MDA's independent actuary.
INVESTMENT PROGRAM
The goal of the investment portfolio is to achieve maximum income
consistent with capital preservation. MDA employs Scudder Insurance Asset
Management ("SIAM") headquartered in Chicago, Illinois, to manage the Company's
investment funds. SIAM operates under guidelines which are adopted by the Board
of Directors. These guidelines are reviewed periodically to ensure that they are
compatible with MDA's philosophy and needs. Current guidelines for SIAM are:
1) All investments must meet the criteria established for
property/casualty insurance companies by (S)379.080 R.S.Mo.;
2) There shall be no minimum or maximum limit placed on investments
directly guaranteed by the full faith and credit of the United
States Government, such as U.S. Treasuries and Government National
Mortgage Association Bonds;
6
<PAGE>
INVESTMENT PROGRAM, continued
3) Investments in agencies of the U.S. Government, which are
implicitly guaranteed by the United States Government, such as
Federal National Mortgage Association and Federal Home Loan
Mortgage Association Bonds, shall be limited to no more than 50%
of the total portfolio. There shall be no minimum limitation;
4) Investments in specific securities, other than U.S. Treasuries,
shall be limited to no more than 2% of MDA's total portfolio,
without regard to the new investment. In addition, corporate
bonds shall be limited to no more than $1,000,000 par in any one
position, and a minimum quality rating for corporate bonds shall
continue to be AA or better. All corporate bonds cannot exceed
30% of the portfolio;
5) Investments in federally tax-exempt securities shall be permitted
as deemed appropriate from time to time, provided that tax-exempt
securities in the aggregate shall not exceed 15% of the total
portfolio. The acceptable quality rating for tax-exempt
securities shall be AA or better;
6) All investments must receive the National Association of
Insurance Commissioner's highest rating; and
7) Investments in corporate bonds and federally tax-exempt
securities combined may not exceed 30% of the total portfolio.
BUSINESS STRATEGY
MDA's primary mission is to provide professional liability insurance to
physicians, surgeons, dentists and other licensed health care professionals at
competitive prices consistent with sound actuarial principles. MDA's secondary
mission is to offer other insurance and financial services and products that
support the Company's primary mission.
FORWARD-LOOKING STATEMENTS
In addition to the historical information contained herein, this Annual
Report contains "forward-looking statements" within the meaning of the Private
Securities Litigation Act of 1995. These statements typically, but not
exclusively, are identified by the inclusion of phrases such as "the Company
anticipates," "the Company believes," "the Company expects," "the Company
plans," "the Company intends," and other phrases of similar meaning. Such
forward-looking statements involve known and unknown risks, uncertainties,
contingencies and other factors that may cause the company's actual results of
operations, financial condition or business performance to be materially
different from the results of operation, financial condition or business
performance expressed or implied by such forward-looking statements. Factors
that could cause or contribute to such differences include, but are not limited
to: market competition and consolidation, government regulation and health care
reform, changes in key management, the year 2000 issue, and other factors
discussed elsewhere in this report.
MARKET CONDITION AND COMPETITION
The current status of the professional liability market in Missouri is one
of intense competition. The business of medical malpractice is cyclical in
nature and is impacted by legislative changes, judicial interpretations, market
competition, inflation and other circumstances. There are several major
competitors and with the "soft" portion of the insurance cycle in full
operation, the market is rife with price cutting and discounting. MDA has not
responded in kind but has rather chosen to maintain its actuarially sound
pricing policy. Due to changes in the health care industry, the recent trend
has been for physicians, surgeons and dentists, who have been the Company's
primary clients, to become employees of hospitals or other health care networks
and cease to obtain their own medical professional liability insurance. Due to
this change, the Company's market share has continued to decline during the past
three years. During 1995 the policyholder count declined from 1,751 to 1,609,
while in 1996 the count declined to 1,459, and in 1997 the policyholder count
further declined to 1,165. However, the Company continues to intensify its
services to policyholders in an attempt to maintain or increase market share.
7
<PAGE>
MARKET CONDITION AND COMPETITION, continued
MDA has no independent agents, and relies on its employees for the sale of
medical professional liability insurance.
Other Aspects of MDA's Business
-------------------------------
EMPLOYEES
MDA has one employee. MDS, a wholly-owned subsidiary of MDA, performs
management services for MDA, MDIC, and the Company. See following section on
Business of MDS for further discussion of employees. The Company and MDIC at
this time have no employees.
GOVERNMENT REGULATION
The business and activities of MDA are generally subject to federal and
state laws and regulations which affect the conduct of its business. As an
insurance company, MDA is subject to regulation and supervision by the
Department. The Department has statutory authority and administrative power to
regulate such matters as licensing, investments, trade practices, loss reserves
and capital maintenance. MDA is required to file financial and other reports
with the Department and the National Association of Insurance Commissioners (the
"NAIC") on a quarterly and annual basis, and the operations and accounts of MDA
are subject to periodic financial and market conduct examination by the
Department. The Department conducted a routine periodic financial examination
of MDA and its subsidiaries during 1996. The examination covered the two years
ended December 31, 1995. The examination commenced on September 9, 1996 and the
final report became available to the public on March 21, 1997. The report
reflected no change to MDA's statutory surplus for the periods under
examination.
In recent years, the NAIC has promulgated new reporting requirements
relating to property and casualty insurance companies regarding risk based
capital ("RBC"). Under these new reporting rules, property and casualty
insurance companies are categorized according to the extent to which they meet
RBC thresholds, with increasing degrees of regulatory scrutiny or intervention
appropriate for companies in categories of less RBC compliance. The RBC
requirements were adopted in Missouri in 1996 for property and casualty
insurers. MDA and MDIC both significantly exceed the RBC thresholds, as
promulgated by the NAIC and adopted in Missouri. Management believes that the
RBC thresholds will not have any significant regulatory effect on MDA or MDIC.
BUSINESS OF MEDICAL DEFENSE SERVICES CORP.
MDS, a wholly-owned subsidiary of MDA, was formed in 1982 as a corporation
under the General Business and Corporation Law of Missouri, Chapter 351 R.S.Mo.
MDS performs management services for MDA and MDIC under the terms of management
contracts. As of December 31, 1997, MDS had 28 employees. The employees of MDS
are not represented by any union or collective bargaining organizations and MDS
believes its employee relations are good. Under the current management
contract, MDS provides services to MDA and MDIC at cost plus 10%. MDA and MDIC
each pay their share of those costs, currently at 95% and 5% respectively. All
inter-company balances are eliminated in the consolidated financial statements
of the Company.
BUSINESS OF MEDICAL DEFENSE INSURANCE COMPANY
MDIC, a wholly-owned subsidiary of MDS, was organized in 1982 as a Missouri
stock casualty insurance company under Chapter 379 R.S.Mo. MDIC was formed to
issue non-assessable medical malpractice insurance policies to persons or
entities who could not be insured by MDA under (S)383.010 R.S.Mo. MDIC is
licensed to operate in Missouri and in Kansas. From its inception in 1982 until
September 1, 1988, MDIC only wrote business in Kansas. In September of 1988,
MDIC voluntarily ceased writing business in Kansas. In June of 1994, MDIC again
began to write business in Kansas. For the year ended December 31, 1997, MDIC
had premiums written of less than $100,000 and fewer than twenty policyholders.
MDIC does not have any employees, and all persons conducting MDIC's
business are employees of MDS. See the paragraph above regarding Business of
MDS.
8
<PAGE>
YEAR 2000 COMPLIANCE
Many computer systems world-wide are not currently equipped to properly
handle the change in calendar years from 1999 to 2000. This problem is commonly
referred to as the Year 2000 Compliance issue. The Company has an active
program in place to address the Year 2000 Compliance issue as it relates to the
various computer systems which the Company either uses or is dependent upon. By
September 1996, the Company had migrated its application system software to a
hardware platform that could properly support dates after 1999. By November
1997, all application software had been converted to be Year 2000 compliant.
The Company's existing computer operating system will be upgraded during 1998
and at that time the Company's computer systems will be fully Year 2000
compliant. The total cost to the Company to become Year 2000 compliant is
projected to be approximately $275,000. Of this amount, approximately $10,000
has yet to be incurred and, with the exception of the cost of new system
hardware and software of approximately $130,000 which has been capitalized over
periods not to exceed five years, all costs have been expensed as incurred.
In addition, the Company has held discussions with various of its external
vendors with whom the Company is dependent upon and the Company believes that
these vendors will also be fully Year 2000 compliant in an appropriately timely
fashion.
Item 2. Properties
-------------------
MDS currently owns the executive offices used by the Company, MDA, MDS and
MDIC. The executive offices are in Springfield, Missouri, and consist of
approximately 16,000 square feet. Management believes such facility is adequate
to support its business plans, both now and in the foreseeable future.
Item 3. Legal Proceedings
--------------------------
While the Company and its subsidiaries are routinely involved in defending
claims against its insureds, none of these entities were defendants in material
legal or regulatory actions as of December 31, 1997.
Item 4. Submission of Matters to a Vote of Security Holders
------------------------------------------------------------
No matters were submitted to a vote of the shareholders of the Company
during the fourth quarter of the year ended December 31, 1997.
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
--------------------------------------------------------------------------
Matters
- -------
MARKET
None of the Preferred Stock, the Class A Common Stock or the Class B Common
Stock are listed on any securities exchange or with any automated quotation
system, such as NASDAQ. No brokers or dealers serve as market makers for any
securities of the Company.
HOLDERS OF RECORD
As of March 23, 1998, there were approximately one thousand one hundred
forty (1,140) holders of Preferred Stock, ten (10) holders of Class A Common
Stock and three (3) holders of Class B Common Stock.
DIVIDENDS
The Company did not pay or declare dividends during 1997. Pursuant to its
Articles of Incorporation, the Company is prohibited from paying any dividends
on its Class A Common Stock or Class B Common Stock while any Company Preferred
Stock is outstanding. The Company Preferred Stock is redeemable, at the
Company's option after three years from the date of conversion. Holders of
Preferred Stock may convert to Class B Common Stock, at their option, at any
time prior to redemption.
9
<PAGE>
Item 6. Selected Financial Data
--------------------------------
MEDICAL DEFENSE HOLDING CO. AND SUBSIDIARIES
The following Selected Consolidated Financial Data is derived from the
audited consolidated financial statements of the Company. The Company acquired
MDA on June 26, 1995, and the accompanying data which pertains to preacquisition
periods have been prepared as if the companies were combined throughout those
periods. This data should be read in conjunction with the Consolidated
Financial Statements and accompanying notes and management discussion and
analysis included elsewhere herein.
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
Net premiums written............................ $ 10,582 $12,722 $ 13,960 $ 14,257 $ 15,697
======= ======= ======== ======== ========
Net premiums earned............................. 12,092 13,200 15,183 13,508 15,654
Investment income............................... 5,279 5,584 5,810 5,583 5,850
Net realized capital gains and other income..... 107 95 219 247 2,110
------- ------- -------- -------- --------
Total revenues............................... 17,478 18,879 21,212 19,338 23,614
------- ------- -------- -------- --------
Losses and loss adjustment expenses............. 13,301 20,379 16,159 14,727 12,475
Other operating expenses........................ 2,812 3,206 2,989 3,128 2,255
------- ------- -------- -------- --------
Total expenses............................... 16,113 23,585 19,148 17,855 14,730
------- ------- -------- -------- --------
Income (Loss) before income taxes............... 1,365 (4,706) 2,065 1,482 8,884
Income tax expense.............................. 783 795 248 586 2,662
------- ------- -------- -------- --------
Net income(loss)............................. $ 582 $(5,501) $ 1,816 $ 896 $ 6,222
======= ======= ======== ======== ========
Per common share: (1)
Basic earnings per common share $ 0.56 $ (5.39) $ 1.18 n/a n/a
======= ======= ======== ======== ========
Diluted earnings per common share
and common share equivalent $ 0.03 n/a (2) $0.05 n/a n/a
======= ======= ======== ======== ========
Balance Sheet Data (at year end):
Investments..................................... $81,335 $83,299 $ 91,748 $ 78,371 $ 90,673
Total Assets.................................... 89,931 96,778 108,199 102,301 110,008
Unpaid losses and loss adjustment expenses...... 58,654 63,205 65,660 65,803 70,436
Unearned premiums............................... 6,059 7,572 8,055 9,210 8,457
Stockholders' equity............................ 22,355 21,835 29,557 22,932 27,090
</TABLE>
(1) For 1995 earnings per common share are reflected for earnings subsequent to
June 26, 1995, which is the date that Medical Defense Holding Co. completed
its acquisition of Medical Defense Associates and its subsidiaries. For
years prior to 1995 no earnings per share data is presented since all
earnings are related to Medical Defense Associates preacquisition
activities and, therefore, are not considered earnings per common share of
Medical Defense Holding Co.'s stockholders. See Note 12 of Notes to
Consolidated Financial Statements.
(2) Anti-dilutive.
10
<PAGE>
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Management's discussion and analysis of financial condition and results of
operations is intended to provide a review of significant factors affecting the
financial condition and results of operations of Medical Defense Holding Co.
(the "Company") and its subsidiaries as of December 31, 1997 and 1996 and for
each of the three years presented elsewhere herein. These financial statements
give retroactive effect to the acquisition of MDA and its subsidiaries by the
Company on June 26, 1995. The following discussion should be read in conjunction
with the consolidated financial statements and the related notes thereto of the
Company which appear elsewhere herein.
General
The Company is a Missouri general business corporation formed for the
purpose of facilitating the conversion of MDA from a mutual association to a
stock insurance company. On June 26, 1995, the conversion was completed with the
exchange of the policyholders' rights in MDA, the mutual insurance association,
for shares of convertible Preferred Stock in the Company, the parent holding
company. The Company owns one hundred percent (100%) of the outstanding shares
of MDA.
The accompanying consolidated financial statements and related discussion
include the accounts of the Company and its wholly-owned insurance subsidiary,
MDA, and have been consolidated with the Company in a manner similar to a
pooling of interests to reflect the conversion of MDA to a wholly-owned
subsidiary of the Company. Cash flow within the Company consists of investment
income and operating expenses. The Company does not have any significant revenue
producing operations of its own other than through its ownership of MDA. MDA is
licensed in Missouri to write medical professional liability insurance and MDA
is one of the leading writers of medical professional liability insurance in the
state of Missouri. Also included in the accompanying consolidated financial
statements are MDA's wholly-owned subsidiaries, Medical Defense Services Corp.
("MDS") and Medical Defense Insurance Company ("MDIC"). MDS is a wholly-owned
subsidiary of MDA and provides management services primarily to MDA. MDIC is a
wholly-owned subsidiary of MDS and is a stock insurance company organized under
Chapter 379 RSMo for the purpose of providing protection against loss from
medical professional liability claims. During the past 12 months, MDIC has
written a small amount of premium, less than $100,000, entirely in the state of
Kansas.
The professional medical liability market in Missouri continues to be one
of intense competition. There are several major competitors and with the "soft"
portion of the insurance cycle continuing, the market is abundant with price
cutting and discounting. The Company has refused to respond in kind but rather
has chosen to maintain its actuarially based pricing structure. Due to changes
in the health care industry, the recent trend has been for physicians, surgeons
and dentists, who have been the company's primary clients, to become employees
of hospitals or other health care networks and cease to obtain their own medical
professional liability insurance. Due to this change, the Company's market share
has continued to decline during the past three years. During 1995 the
policyholder count declined from 1,751 to 1,609, while in 1996 the count
declined to 1,459, and in 1997 the policyholder count further declined to 1,165.
However, the Company continues to intensify its services to policyholders in an
attempt to maintain or increase market share.
Results of Operations
The Company recorded a 7% or $1,401,058 decrease in total revenues during
1997 as compared to 1996. This decrease was primarily the result of a reduction
in premium income of approximately $1,100,000, a decline in investment income of
approximately $305,000 and, an increase in realized investment gains of $12,316.
The decline in premium income was primarily the result of an approximate 20%
decline in MDA's total policyholders and occurred despite a 15% rate increase
which was effective January 1, 1997 on all of MDA's new and renewal business.
The decrease in the Company's investment income was primarily the result of a
decline in fixed maturity investments during 1997 as compared to 1996. These
fixed maturity investments normally generate a higher rate of return than short-
term investments. In addition, interest rate yields in 1997 were slightly lower
then the previous year. Realized investment gains increased $12,316, when
compared to 1996, as fixed-income investment prices were somewhat higher in 1997
and therefore the opportunity to realize investment gains was more prevalent
than in 1996.
11
<PAGE>
Results of Operations, continued
The Company recorded an 11% or $2,332,960 decrease in total revenues during
1996 as compared to 1995. This decrease was primarily the result of a reduction
in premium income of approximately $1,983,000, a decline in investment income of
approximately $226,000 and, a decrease in realized investment gains of $123,697.
The decline in premium income was primarily the result of an approximate 9%
decline in MDA's total policyholders and occurred despite a 14% rate increase
which was effective January 1, 1996 on all of MDA's new and renewal business.
The decrease in the Company's investment income was primarily the result of a
decline in invested assets during 1996 as compared to 1995. This decline in
invested assets, which was approximately $8,450,000 at December 31, 1996
compared to the previous year-end, was the result of an increase in claim
payments in 1996 compared to 1995. See "Business of Medical Defense Associates -
Reserves for Unpaid Losses and Loss Adjustment Expenses." Realized investment
gains declined $123,697, when compared to 1995, as fixed-income investment
prices were generally higher in 1996 and therefore the opportunity to realize
investment gains was not as prevalent as in 1995.
During 1997, total expenses decreased $7,471,717 or 31.7% compared to 1996.
This decrease was almost entirely the result of a decrease in claim losses and
claim loss adjustment expenses which decreased approximately $7.1 million
compared to these same expenses in 1996. During 1996 the Company experienced a
significant increase in claim expense payments, and following actuarial
analysis, the Company strengthened its loss and loss adjustment expense reserves
for accident years prior to 1996 by approximately $4.6 million. The Company will
continue to monitor the level of claim severity, and to seek input from
actuaries as appropriate. The balance of the decrease in total expenses during
1997 compared to 1996 was primarily the result of a decrease in amortization of
deferred acquisition costs of approximately $220,000, which is entirely related
to Missouri premium taxes, and a decrease in other underwriting and insurance
expenses of approximately $190,000, which was the result of a reduction in
general operating expenses of approximately 7.9%.
See "Business of Medical Defense Associates - Reserves for Unpaid Losses
and Loss Adjustment Expenses."
During 1996, total expenses increased $4,437,310 or 23.2% compared to 1995.
This increase was almost entirely the result of an increase in claim losses and
claim loss adjustment expenses which increased approximately $4.2 million
compared to these same expenses in 1995. Due to an increase in the amount of
claim loss and loss adjustment expense payments during 1996, Company management
retained its actuary to perform additional actuarial analysis and as a result of
actuarial analysis, the Company strengthened its loss and loss adjustment
expense reserves for accident years prior to 1996 by approximately $4.6 million.
The Company will continue to monitor the level of claim severity, and to seek
input from actuaries as appropriate. The balance of the increase in total
expenses during 1996 compared to 1995 was primarily the result of an increase in
amortization of deferred acquisition costs of approximately $315,000, which is
entirely related to Missouri premium taxes. The Company was not subject to
Missouri premium taxes prior to the completion of MDA's demutualization on June
26, 1995 and therefore, no deferred acquisition costs were recorded or amortized
prior to that date.
For the year ended December 31, 1997, the Company had net income (before
provision for income taxes) of $1,365,030, compared to a net loss (before
provision for income taxes) of $4,705,629 in 1996. Although the Company's net
income increased approximately $6 million from the prior year's net loss the
total tax provision was virtually unchanged at approximately $790,000. This was
primarily due to a decrease in the deferred tax provision of approximately $2
million, when compared to the prior year. This decrease in the deferred tax
provision was due to the change in the deferred tax asset valuation allowance
and the deferred tax asset. The deferred tax asset valuation allowance relates
entirely to loss reserve discounting and represents the difference between the
total deferred tax asset related to loss reserve discounting required by the
Internal Revenue Service and the amount that is more likely than not to be
realized by the Company. Due to a change in the tax law effective January 1,
1998, the Company may only carry back net operating losses two years and as no
taxes were paid in 1997 or 1996 the Company does not have any tax benefit to
recover from prior years taxes. Furthermore, the Company does not believe it can
reasonably determine the amount of loss reserve deferred tax benefit which can
be recovered from future taxable income using a more likely than not standard.
Therefore, as of December 31, 1997, the Company's total deferred tax asset was
included in the deferred tax asset valuation allowance. As a result, the
Company's net income for 1997 was $582,319 compared to a net loss of $5,501,042
for 1996.
12
<PAGE>
Results of Operations, continued
For the year ended December 31, 1996, the Company experienced a loss
(before provision for income taxes) of $4,705,629, compared to income (before
provision for income taxes) of $2,064,641 in 1995. The Company's total tax
provision increased $547,150 to $795,413 which was primarily the result of an
increase in the deferred tax provision of approximately $3.7 million. This
increase in the deferred tax provision was due to an increase in the deferred
tax asset valuation allowance of approximately $2.4 million, which relates
entirely to loss reserve discounting and represents the difference between the
total deferred tax asset related to loss reserve discounting required by the
Internal Revenue Service and the amount that is more likely than not to be
realized. As a result, the Company's net loss for 1996 was $5,501,042 compared
to net income of $1,816,378 for 1995.
Financial Condition
Total consolidated assets of the Company at December 31, 1997 were
$89,930,625 which was a decrease of approximately $6.8 million or 7.1% as
compared to December 31, 1996. This decrease was primarily due to the payment of
loss and loss adjustment expenses in excess of incurred loss and loss adjustment
expenses by approximately $4.5 million and a decrease in premiums written during
1997 compared to the previous year of approximately $2.8 million which was the
result of the decline in policyholders discussed earlier. In addition, the
Company utilized a portion of its cash to conduct a tender offer during 1997 to
purchase outstanding shares of preferred stock. This tender offer resulted in
the purchase of approximately $1.8 million shares of the Company's preferred
stock for approximately $700,000. Over 93% of the Company's total assets at
December 31, 1997 are comprised of cash, cash equivalents, or investments and,
in addition, the Company's investment portfolio is conservatively invested in
high-quality investments as approximately 80% of total assets at December 31,
1997 consisted of either cash or cash equivalents, U.S. Treasury bonds or notes,
or U.S. government agency bonds. In addition, the Company does not hold, either
directly or indirectly, any real estate owned for investment purposes, any fixed
maturity investments rated below AA by nationally recognized rating agencies, or
any equities other than stock in affiliates. The composition of the Company's
total investments is not anticipated to change substantially in the near future.
Total consolidated liabilities of the Company at December 31, 1997 were
$67,575,817 a decrease of $7,367,187 from the previous year end. This decrease
was the result of the increase in claim payments of approximately $4.5 million
discussed earlier, a decline of approximately $1.5 million in the unearned
premium reserve which was primarily due to the decrease in policyholders, a
decrease in amounts payable to reinsurers on retrospectively rated reinsurance
contracts of $857,000, and a decrease in claims drafts outstanding of
approximately $420,000 which is included in the decrease in other liabilities of
$426,125. Over 86% of the Company's total liabilities at December 31, 1997
relate to reserves for unpaid losses and loss adjustment expenses, which
declined approximately $4.5 million from the prior year end. These unpaid loss
and loss adjustment expense reserves are established based on actuarially
determined estimates and are reviewed regularly by management and the Company's
independent actuary.
Stockholders' equity as of December 31, 1997, increased $519,318 or 2.4%
from December 31, 1996. This increase was due to the net income in 1997 of
$582,319, the purchase of the Company's preferred stock for $706,377, and the
net increase in the unrealized gains and losses on fixed maturity investments of
$643,376.
Liquidity and Capital Resources
Future cash flow for the Company will be primarily dependent on the ability
of its subsidiary, MDA, to pay cash dividends. MDA's cash flow is generated from
its insurance operations and investment portfolio. MDA is subject to annual
statutory dividend limitations as to the amount of any dividend which may be
paid without prior approval of the Director of the Missouri Department of
Insurance. For 1997 the maximum dividend payable to the Company from MDA,
without prior approval of the Missouri Department of Insurance, is $1,979,766.
13
<PAGE>
Liquidity and Capital Resources, continued
The Company's consolidated net cash flow used by operating activities for
the year ended December 31, 1997 was $2,997,262 which was an increase in net
cash provided by operation of $4,113,584 when compared to the previous year.
This increase was primarily the result of an increase in net income for 1997
compared to the net loss in 1996 of $6,083,361, coupled with an increase in paid
loss and loss adjustment expenses over incurred loss and loss adjustment
expenses of $1,949,676 in 1997 compared to 1996. For the year ended December 31,
1996, compared to the previous year, the Company's consolidated net cash flow
provided by operating activities decreased by $12,750,632. This decrease was
primarily the result of several factors including a decrease in net income for
1996 compared to 1995 of $7,317,420, a decrease in unpaid loss and loss
adjustment expenses during 1996 compared to 1995 of $2,455,000, and the
collection in 1995 of amounts recorded as receivable from reinsurers which
accounted for $2,307,494 million of the variation from 1995.
During 1997, as a result of the cash flow used by operating activities, the
Company's net cash flow provided from investing activities was $3,143,946, as
fewer fixed maturity investments were purchased to replace those investments
sold or matured. Also, during 1996, due to cash flow used by operating
activities, the Company's net cash flow provided from investing activities was
$6,785,490, again as fewer fixed maturity investments were purchased to replace
those investments sold or matured. Due to the positive cash flow provided by
operations during 1995, the Company was able to increase net cash flow in
investing activities for the year ended December 31, 1995 by $6,812,854.
During 1997 the Company conducted a second tender offer for its shares of
preferred stock which resulted in the Company acquiring 1,765,943 preferred
shares at a cost of $0.40 per share. On November 15, 1996 the Company completed
the acquisition of 2,781,338 shares of its preferred stock at $0.40 per share in
a tender offer dated September 12, 1996. On June 26, 1995 the Company received
$499,996 in cash for the sale of shares of Class A Common Stock to Company
principals in conjunction with the consummation of the conversion of MDA to a
wholly-owned stock subsidiary of the Company.
The Company's cash flow from operations and its investment portfolio are
utilized to meet its obligations related to payment of losses and loss
adjustment expenses, payment of operating expenses, and other needs as deemed
necessary from time to time. Under employment agreements with certain officers
and directors, payments totaling approximately $500,000 are to be made if the
number of insureds fall below 913. Such payments are forfeited in whole or in
part if the individual does not remain employed for a period of 36 months
following the payment date.
The Company does not anticipate in the immediate future any major capital
expenditures outside the normal course of operations.
The Company anticipates that its future cash flow will be sufficient to
meet its ongoing obligations for the foreseeable future.
14
<PAGE>
Item 8. Financial Statements and Supplementary Data
----------------------------------------------------
MEDICAL DEFENSE HOLDING CO. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
<TABLE>
<CAPTION>
Page
------------
<S> <C>
Report of Independent Accountants........................................................................... 16
Consolidated Balance Sheets as of December 31, 1997 and 1996................................................ 17
Consolidated Statements of Operations for the years ended December 31, 1997, 1996 and 1995.............. 19
Consolidated Statements of Changes in Stockholders' Equity for the years ended December 31, 1997,
1996 and 1995............................................................................................. 20
Consolidated Statements of Cash Flow for the years ended December 31, 1997, 1996 and 1995................ 21
Notes to Consolidated Financial Statements.................................................................. 22
Schedules:
</TABLE>
<TABLE>
<CAPTION>
<S> <C> <C>
Report of Independent Accountants on Supplemental Schedules........................................ S-1
I - Summary of Investments as of December 31, 1997, 1996 and 1995...................................... S-2
II - Condensed Financial Information of Registrant (Parent Company Only) for the
year ended December 31, 1997 and 1996............................................................ S-3
IV - Reinsurance Schedule for the years ended December 31, 1997, 1996 and 1995.......................... S-6
V - Valuation and Qualifying Accounts Gross of Reinsurance for the years ended
December 31, 1997, 1996 and 1995................................................................. S-7
VI - Supplemental Information Concerning Property/Casualty Insurance Operations
as of December 31, 1997, 1996 and 1995 and for the years then ended............................. S-8
</TABLE>
15
<PAGE>
Report of Independent Accountants
To the Board of Directors
Medical Defense Holding Co.:
We have audited the accompanying consolidated balance sheets of Medical Defense
Holding Co. and Subsidiaries (the "Company") as of December 31, 1997 and 1996,
and the related consolidated statements of operations, changes in stockholders'
equity and cash flows for each of the three years in the period ended December
31, 1997. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of the Medical
Defense Holding Co. and Subsidiaries as of December 31, 1997 and 1996 and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1997, in conformity with generally
accepted accounting principles.
As discussed more fully in Note 12, to the financial statements, the Company
adopted Statement of Financial Accounting Standard No. 128, Earnings Per Share.
COOPERS & LYBRAND L.L.P.
St. Louis, Missouri
February 13, 1998
16
<PAGE>
Medical Defense Holding Co.
Consolidated Balance Sheets
December 31, 1997 and 1996
<TABLE>
<CAPTION>
ASSETS 1997 1996
<S> <C> <C>
Investments:
Fixed maturity investments, at market
value (amortized cost of $73,477,904
and $79,151,698, respectively) $74,091,837 $78,789,906
Short-term investments, at market 7,242,682 4,508,740
----------- -----------
Total investments 81,334,519 83,298,646
Other assets:
Cash and cash equivalents 2,955,161 3,514,854
Accrued investment income 998,833 1,054,327
Premium receivable 1,521,050 1,895,965
Reinsurance recoverable on loss and
loss expenses:
Paid claims 2,798
Unpaid claims 1,373,000 1,951,000
Property and equipment, net of
accumulated depreciation of
$1,250,772 and $1,163,536, respectively 1,028,089 1,117,542
Federal income tax:
Current - refundable 383,879 2,401,224
Deferred 1,204,000
Other assets 336,094 338,138
----------- -----------
Total assets $89,930,625 $96,778,494
=========== ===========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
17
<PAGE>
<TABLE>
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY 1997 1996
<S> <C> <C>
Liabilities:
Claims and policy liabilities:
Unpaid losses and loss adjustment expenses $58,654,324 $63,205,000
Unearned premiums 6,059,398 7,571,534
----------- -----------
Total claims and policy liabilities 64,713,722 70,776,534
Other liabilities:
Retrospective premium due reinsurers 1,113,047 1,970,047
Amounts withheld or retained by Company
for account of others 252,429 273,679
Other liabilities 1,496,619 1,922,744
----------- -----------
Total liabilities 67,575,817 74,943,004
----------- -----------
Stockholders' equity:
Preferred stock, par value $1.00 per share;
12,000,000 shares authorized:
7,436,095 and 9,208,851 shares issued and
outstanding, respectively (Note 3) 7,436,095 9,208,851
Class A common stock, $0.50 per share;
2,000,000 shares authorized:
999,998 issued and outstanding 499,999 499,999
Class B common stock, $0.50 per share;
48,000,000 shares authorized:
33,230 and 19,604 shares issued and,
outstanding, respectively 16,615 9,802
Additional Paid in Capital (Note 3) 2,728,369 1,668,803
Unrealized gains (losses) on investments
(net of deferred income taxes (provision)
benefit of $(208,872) and $122,565,
respectively) 405,456 (237,920)
Retained earnings 11,268,274 10,685,955
----------- -----------
Total stockholders' equity/surplus as
regards policyholders 22,354,808 21,835,490
----------- -----------
Total liabilities and stockholders' equity $89,930,625 $96,778,494
=========== ===========
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
18
<PAGE>
Medical Defense Holding Co.
Consolidated Statements of Operations
for the years ended December 31, 1997, 1996 and 1995
<TABLE>
<CAPTION>
1997 1996 1995
<S> <C> <C> <C>
Revenues:
Premiums earned, including retrospective premium
adjustments of $857,000, $196,034, and $70,000,
respectively $ 12,091,778 $ 13,200,021 $ 15,183,259
Investment income 5,278,764 5,583,656 5,810,039
Net realized investment gains 107,234 94,918 218,615
Other income 586 825 467
------------ ------------ ------------
Total revenues 17,478,362 18,879,420 21,212,380
------------ ------------ ------------
Expenses:
Losses and loss adjustment expenses, net of change in
reinsurance recoverables of ($578,000), ($432,000),
and ($522,000), respectively 13,300,937 20,379,346 16,158,522
Amortization of policy acquisition costs 154,784 374,546 59,921
Other underwriting and insurance expenses 2,207,116 2,396,302 2,585,322
Investment expenses 267,947 286,894 286,762
Other operating expenses 182,548 147,961 57,212
------------ ------------ ------------
Total expenses 16,113,332 23,585,049 19,147,739
------------ ------------ ------------
Income (loss) before provision for
federal income taxes 1,365,030 (4,705,629) 2,064,641
------------ ------------ ------------
Provision for federal income taxes:
Current (89,852) (2,084,000) 1,088,686
Deferred 872,563 2,879,413 (840,423)
------------ ------------ ------------
Total tax provision 782,711 795,413 248,263
------------ ------------ ------------
Net income (loss) $ 582,319 $ (5,501,042) $ 1,816,378
============ ============ ============
Earnings per common share and common
share equivalent (Note 12):
Basic earnings per common share $ 0.56 $ (5.39) $ 1.18
============ ============ ============
Diluted earnings per common share and
common share $ 0.03 $ n/a(1) $ 0.05
============ ============ ============
</TABLE>
(1) Anti-dilutive
The accompanying notes are an integral part of the
consolidated financial statements.
19
<PAGE>
Medical Defense Holding Co.
Consolidated Statements of Changes in
Stockholders' Equity
for the years ended December 31, 1997, 1996 and 1995
<TABLE>
<CAPTION>
1997 1996 1995
<S> <C> <C> <C>
Stockholders' equity, January 1 $ 21,835,490 $ 29,557,098
Surplus as regards policyholders, January 1 $ 22,931,598
Changes in surplus/stockholders' equity:
Net income (loss) 582,319 (5,501,042) 1,816,378
Issuance of 999,998 shares common stock Class A 499,996
Purchase of 2,781,338 shares of preferred stock (1,112,535)
Purchase of 1,765,943 shares of preferred stock (706,377)
Change in unrealized gains and losses on fixed
maturity investments (net of related deferred
tax (provision) credits of $(331,437),
$570,804 and $(2,219,853), respectively) 643,376 (1,108,031) 4,309,126
--------------- --------------- ---------------
Stockholders' equity, December 31 $ 22,354,808 $ 21,835,490 $ 29,557,098
=============== =============== ===============
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
20
<PAGE>
Medical Defense Holding Co.
Consolidated Statements of Cash Flow
for the years ended December 31, 1997, 1996 and 1995
<TABLE>
<CAPTION>
1997 1996 1995
<S> <C> <C> <C>
Operating activities:
Net income (loss) $ 582,319 $(5,501,042) $ 1,816,378
Adjustments to reconcile net income to net cash (used)
provided by operating activities:
Realized investment gains (107,234) (94,918) (218,615)
Depreciation and amortization of deferred policy acquisition costs 266,590 480,341 150,739
Provision (benefit) for deferred income tax 872,563 2,879,413 (840,423)
Change in assets and liabilities:
Accrual and amortization of investment income (64,631) 43,980 197,536
Premiums receivable from policyholders 374,915 656,928 2,110,509
Policy acquisition costs deferred (154,784) (254,019) (180,448)
Reinsurance recoverable on loss and loss expenses:
Paid claims 2,798 (2,798) 2,304,696
Unpaid claims 578,000 432,000 522,000
Unpaid losses and loss adjustment expenses (4,550,676) (2,455,000) (143,000)
Unearned premiums (1,512,136) (483,303) (1,154,845)
Retrospective premium due reinsurers (857,000) (225,449) (390,956)
Amounts withheld or retained by Company on account of others (21,250) (92,958) 78,321
Income tax refundable 2,017,345 (3,019,698) 1,328,686
Other assets 2,044 349,601 (205,653)
Other liabilities (426,125) 176,076 264,861
----------- ----------- -----------
Net cash (used) provided by operating activities (2,997,262) (7,110,846) 5,639,786
----------- ----------- -----------
Investing activities:
Proceeds from:
Fixed maturity investments :
Sales 10,277,261 5,599,375 10,006,129
Maturities 8,152,884 7,466,549 5,551,096
Short-term investments - Maturities 17,750,000 26,519,421 4,340,000
Purchase of investments:
Fixed maturity investments (12,845,507) (9,428,393) (17,869,313)
Short-term investments (20,168,339) (23,231,664) (8,795,496)
Purchases of property and equipment (22,353) (139,798) (45,270)
----------- ----------- -----------
Net cash provided used) by investing activities 3,143,946 6,785,490 (6,812,854)
----------- ----------- -----------
Financing activities:
Proceeds from sale of common stock 499,996
Purchase of preferred stock (Note 3) (706,377) (1,112,535)
----------- ----------- -----------
Net cash (used) provided by financing activities (706,377) (1,112,535) 499,996
----------- ----------- -----------
Net (decrease) in cash and cash equivalents (559,693) (1,437,891) (673,072)
Cash and cash equivalents, beginning of period 3,514,854 4,952,745 5,625,817
----------- ----------- -----------
Cash and cash equivalents, end of period $ 2,955,161 $ 3,514,854 $ 4,952,745
=========== =========== ===========
Federal income taxes (recovered) paid $(2,107,197) $ 935,698 $ (231,000)
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of the consolidated
financial statements.
21
<PAGE>
Medical Defense Holding Co.
Notes to Consolidated Financial Statements
1. Organization and Related Matters:
Medical Defense Holding Co. (the "Company") is a Missouri general business
corporation formed on November 28, 1994, for the purpose of facilitating
the consummation of a series of transactions whereby Medical Defense
Associates ("MDA") converted from a mutual assessment insurance
organization under Chapter 383 RSMo to a wholly-owned stock insurance
company subsidiary of the Company. MDA's conversion was completed on June
26, 1995 in accordance with an agreement and plan of conversion dated
November 29, 1994. The agreement and plan of conversion was approved by
eligible policyholders at a special meeting on April 3, 1995.
MDA was organized in 1976 as a mutual assessment insurance organization for
the purpose of providing protection against loss from medical professional
liability claims for Missouri health care professionals. MDA's wholly-owned
subsidiary, Medical Defense Services Corp.("MDS") provides management
services primarily to MDA. MDS's wholly-owned subsidiary, Medical Defense
Insurance Company ("MDIC"), is a stock insurance company organized under
Chapter 379 RSMo for the purpose of providing protection against loss from
medical professional liability claims. MDIC is licensed to operate in
Missouri and Kansas but only wrote business in Kansas from its inception in
1982 until September 1, 1988 when it ceased writing business. In 1994, MDIC
again began writing policies in Kansas.
2. Summary of Significant Accounting Policies:
The following is a description of the significant accounting policies under
generally accepted accounting principles followed by the Company in the
preparation of the accompanying consolidated financial statements:
A. Pervasiveness of Estimates: The preparation of consolidated financial
statements in conformity with generally accepted accounting principles
requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities at the date of the
consolidated financial statements and the reported amounts of revenues
and expenses during the reporting period. Actual results could differ
from those estimates.
B. Principles of Consolidation: The consolidated financial statements of
the Company include Medical Defense Holding Co. and its wholly-owned
subsidiaries, MDA, MDS and MDIC. As described in Note 1, the Company
acquired MDA on June 26, 1995. The accompanying statements which pertain
to preacquisition periods have been prepared as if the companies were
combined throughout those periods. All significant intercompany
transactions have been eliminated.
C. MDA Statutory Net Income and Surplus: The accompanying financial
statements have been prepared in conformity with generally accepted
accounting principles which vary in certain respects from accounting
practices prescribed or permitted by the Missouri Department of
Insurance statutory accounting practices.
22
<PAGE>
Medical Defense Holding Co.
Notes to Consolidated Financial Statements, Continued
2. Summary of Significant Accounting Policies, continued:
C. MDA Statutory Net Income and Surplus, continued: A reconciliation of
net income for the years 1997, 1996 and 1995 and surplus as regards
policyholders at December 31, 1997, 1996 and 1995 reported by MDA on a
generally accepted accounting principles (GAAP) basis which includes
its wholly-owned subsidiaries MDS and MDIC, to the amounts reported by
MDA on a statutory basis which includes equity in MDS and MDIC is as
follows:
<TABLE>
<CAPTION>
Net (Loss) Income
Year ended December 31 1997 1996 1995
<S> <C> <C> <C>
GAAP net income (loss) $ 341,567 $(5,649,894) $ 1,570,789
Change in deferred
acquisition costs 120,528 (120,528)
Deferred income taxes 872,563 2,879,413 (840,423)
----------- ----------- -----------
Statutory net income (loss) $ 1,214,130 $(2,649,953) $ 609,838
=========== =========== ===========
Surplus as Regards Policyholders
Year ended December 31 1997 1996 1995
GAAP basis $19,007,534 $19,829,961 $26,427,657
Nonadmitted assets for
statutory reporting (25,886) (23,422)
Unrealized losses (gains) (602,879) 370,151 (1,304,624)
Deferred acquisition costs (120,528)
Discount of reserves 1,393,000 2,090,000 2,787,000
Deferred income taxes 0 (1,204,000) (3,512,609)
----------- ----------- -----------
Statutory surplus as regards
policyholders $19,797,655 $21,060,226 $24,253,474
=========== =========== ===========
</TABLE>
The maximum amount of dividends which can be paid by Missouri
insurance companies without prior approval of the Insurance
Commissioner is subject to statutory provisions. Dividends paid by MDA
to the Company during 1997 and 1996 were $2,100,000 and $0,
respectively. The maximum dividend payout which may be made in 1998,
without prior approval of the Missouri Department of Insurance, is
$1,979,766.
23
<PAGE>
Medical Defense Holding Co.
Notes to Consolidated Financial Statements, Continued
2. Summary of Significant Accounting Policies, continued:
D. Premium Revenues and Related Expenses: Premiums are recognized as
income over the terms of the related insurance policies. The unearned
premium reserve represents the portion of the premiums written that
relate to the unexpired terms of policies in force. Such reserves are
computed on a pro rata method.
The Company operates as a direct writer of professional liability
insurance and thus does not incur sales commissions or other variable
sales costs directly related to premium production which are normally
associated with deferred acquisition costs. Subsequent to completion
of MDA's conversion to a stock insurance company, as discussed in Note
1, all MDA premiums written are subject to Missouri premium taxes.
Deferred acquisition costs recorded during 1997 and 1996 relate
entirely to Missouri premium taxes. Such deferred costs are amortized
over the terms of the underlying policies, written off when policies
are canceled and tested for recoverability out of the unearned premium
reserve annually.
E. Unpaid Losses and Loss Adjustment Expenses: As more fully described in
Note 10, the reserves for losses and loss adjustment expenses include
amounts determined on the basis of individual claims and actuarially
determined estimates of future losses. The methods of making such
estimates and for establishing the resulting liabilities are
continually reviewed and updated based upon current circumstances and
any adjustments resulting therefrom are reflected in current
operations.
Losses and loss adjustment expenses incurred, and the liabilities for
unpaid losses and loss adjustment expenses are shown gross of any
reinsurance recoveries from other companies. In the event that any
reinsuring company was unable or unwilling to meet its obligations
under existing agreements, MDA would become liable.
F. Investments: Statement of Financial Accounting Standards No. 115,
Accounting for Certain Investments in Debt and Equity Securities
("SFAS"), requires companies to classify securities into three
categories. Held-to-maturity debt securities that the Company has the
positive intent and ability to hold to maturity, are to be reported at
amortized cost. Debt and equity securities that are bought and held
principally for the purpose of selling them in the near term are
classified as trading securities and are to be reported at fair value,
with unrealized gains and losses included in earnings. Debt and equity
securities not classified in the other two categories are classified
as available-for-sale securities and reported at fair value, with
unrealized gains and losses excluded from earnings, and reported as a
separate component of surplus as regards policyholders.
24
<PAGE>
Medical Defense Holding Co.
Notes to Consolidated Financial Statements, Continued
2. Summary of Significant Accounting Policies, continued:
F. Investments, continued: The Company has classified all investments in
fixed maturities as available for sale and carries such investments at
market value as a result of the Company's willingness to sell
investments based on market conditions and interest rate changes.
Should the Company experience declines in market value that are other
than temporary, the difference between amortized cost and market would
be recognized through current earnings.
Fair value is defined as market value based on third-party quoted
market prices of the securities or when unavailable, on similar
securities.
Investment income includes amortization of premium and accretion of
discount relating to fixed maturities acquired at other than par
value.
At December 31, 1997 and 1996, short-term investments consist of
certificates of deposit which mature between three months and one
year, a repurchase agreement investing exclusively in securities
issued and guaranteed by the U.S. Treasury, and U.S. Treasury Bills
with original maturities between three months and one year. The
carrying amounts reported in the balance sheet for these instruments
is their estimated fair values.
Gains or losses on sales of investments are determined on a specific
cost identification basis.
G. Property and Equipment: Property and equipment are carried at cost
less accumulated depreciation. Depreciation is computed over the
estimated useful lives of the assets using the modified accelerated
cost recovery method. Maintenance, repairs and minor renewals are
charged to expense as incurred while renewals and betterments are
capitalized.
The cost and related allowance for depreciation of assets sold or
retired are removed from the related accounts and the resulting gains
or losses are reflected in operations.
H. Federal Income Taxes: The Company employs the provisions of Statement
of Financial Accounting Standards No. 109, Accounting for Income Taxes
("SFAS 109"). SFAS 109 requires recognition of deferred tax assets and
liabilities for the expected future tax consequences of events that
have been included in the financial statements or tax returns. Under
this method, deferred tax assets and liabilities are determined based
upon the differences between the financial statement and tax bases of
assets and liabilities using enacted tax rates in effect for the year
in which the differences are expected to reverse.
I. Cash Equivalents: Cash equivalents represent bank repurchase
agreements or certificates of deposit with original maturity dates
within 90 days.
25
<PAGE>
Medical Defense Holding Co.
Notes to Consolidated Financial Statements, Continued
3. Capital Stock:
During 1995 the Company issued 11,999,991 shares of $1.00 par value
redeemable convertible preferred stock, with limited voting rights, to the
eligible policyholders of MDA in exchange for their mutual policyholders'
rights in MDA. Each share of preferred stock is convertible into two shares
of Medical Defense Holding Co. Class B Common Stock, at the holder's
option, and may be converted at any time prior to redemption. Holders of
preferred stock have limited voting rights as set forth in the Company's
Articles of Incorporation. Such voting rights primarily deal with a change
in control or a sale of a major portion of the Company's assets. Each share
of preferred stock is redeemable, at the Company's option, after three
years from the date of issuance, at a price per share of $1.00. The
preferred stock does not provide a stated dividend; however, no dividends
may be paid on any Company common stock while there are preferred stock
shares outstanding. In 1997, 6,813 shares of preferred stock were converted
to 13,626 shares of Class B common stock. In 1995, 9,802 shares of
preferred stock were converted to 19,604 shares of Class B common stock.
On August 8, 1997, MDHC initiated a tender offer for up to 5,000,000 shares
of the Company's $1.00 par value redeemable preferred stock at a price
ranging from $0.30 to $0.40 per share, utilizing a method commonly referred
to as a Dutch auction. This offer closed on October 3, 1997, with the
Company accepting 1,721,445 tendered shares at a price of $0.40 per share.
The tender offer was completed on October 16, 1997, with the Company's
payment of $688,578 for all preferred shares accepted for purchase. In
addition, during December 1997, the Company purchased 44,498 shares of its
convertible preferred stock, at a total purchase price of $17,799, from a
small number of shareholders, at their request, at a price of $0.40 per
share. The difference between the payment and the par value of the stock
has been credited to additional paid-in capital.
On September 12, 1996, MDHC initiated a tender offer for up to 5,000,000
shares of the Company's $1.00 par value redeemable preferred stock at a
price ranging from $0.30 to $0.40 per share, utilizing a method commonly
referred to as a Dutch auction. This offer closed on November 1, 1996, with
the Company accepting 2,781,338 tendered shares at a price of $0.40 per
share. The tender offer was completed on November 15, 1996, with the
Company's payment of $1,112,535 for all preferred shares accepted for
purchase. The difference between the payment and the par value of the stock
has been credited to additional paid-in capital.
The Company has issued shares of $0.50 par value Class A common stock, in
accordance with an agreement and plan of conversion dated November 29,
1994, in exchange for cash. Class A common stock is not redeemable and is
entitled to fifty votes per share on all matters.
The Company has issued shares of $0.50 par value Class B common stock in
accordance with the conversion rights of the convertible preferred stock.
Class B common stock is not redeemable and is entitled to one vote per
share on all matters.
26
<PAGE>
Medical Defense Holding Co.
Notes to Consolidated Financial Statements, Continued
4. Investments:
The following information summarizes the difference between amortized cost
and market value of fixed maturities investments:
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Market
December 31, 1997 Cost Gains Losses Value
<S> <C> <C> <C> <C>
U.S. Treasury debt securities and
obligations of U.S.
Government corporations and
agencies $36,435,311 $417,449 $ 85,125 $36,767,635
Corporate debt securities 5,126,604 81,809 2,942 5,205,471
Mortgage-backed securities 27,129,137 270,152 92,807 27,306,482
Other debt securities 4,786,852 40,073 14,676 4,812,249
----------- -------- -------- -----------
$73,477,904 $809,483 $195,550 $74,091,837
=========== ======== ======== ===========
</TABLE>
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Market
December 31, 1996 Cost Gains Losses Value
<S> <C> <C> <C> <C>
U.S. Treasury debt securities and
obligations of U.S.
Government corporations and
agencies $40,130,465 $207,149 $336,604 $40,001,010
Corporate debt securities 6,371,525 78,063 37,161 6,412,427
Mortgage-backed securities 29,829,606 188,864 434,881 29,583,589
Other debt securities 2,820,102 13,306 40,528 2,792,880
----------- -------- -------- -----------
$79,151,698 $487,382 $849,174 $78,789,906
=========== ======== ======== ===========
</TABLE>
The change in net unrealized holding gain or loss on available for sale
securities, net of deferred taxes, for the years ended December 31, 1997,
1996 and 1995 are as follows:
<TABLE>
<CAPTION>
1997 1996 1995
<S> <C> <C> <C>
$ 643,376 $ (1,108,031) $ 4,309,126
========= ============ ===========
</TABLE>
27
<PAGE>
Medical Defense Holding Co.
Notes to Consolidated Financial Statements, Continued
4. Investments, continued:
The amortized cost and estimated market value of debt securities by
estimated and contractual maturity are shown as follows:
<TABLE>
<CAPTION>
Estimated
Amortized Market
December 31, 1997 Cost Value
<S> <C> <C>
Due in one year or less $ 9,302,759 $ 9,322,741
Due after one year through five years 33,333,631 33,490,968
Due after five years through ten years 23,737,086 24,122,023
Due after ten years 7,104,428 7,156,105
----------- -----------
$73,477,904 $74,091,837
=========== ===========
</TABLE>
For purposes of the above, bonds without prepayment characteristics have
been included at their stated maturity date. Bonds with prepayment features
are included at their estimated maturity date as supplied by the Company's
investment adviser. Accordingly, actual maturities may differ from
estimates.
Accrued investment income at December 31, is as follows:
<TABLE>
<CAPTION>
1997 1996
<S> <C> <C>
U.S. Treasury securities $705,909 $ 726,630
Corporate bonds 114,506 140,595
Mortgage-backed securities 159,026 174,860
Other debt securities 19,392 12,242
-------- ----------
$998,833 $1,054,327
======== ==========
</TABLE>
Securities on Deposit With Statutory Authorities: MDA had a U.S. Treasury
Note with a par value of $1,400,000 at December 31, 1997, on deposit with
the state of Missouri. In addition, MDA had on deposit U.S. Treasury Notes
with a par value totaling $5,000,000 at December 31, 1997, on deposit with
the state of Missouri in compliance with a joint custody agreement with the
Missouri Department of Insurance. This joint custody agreement relates to
the release of MDA's former members' assessment liabilities relative to
assessable insurance policies issued by MDA prior to the conversion date
(Note 1).
To comply with the Missouri Department of Insurance, MDIC had a U.S.
Treasury Note with a par value of $850,000 as of December 31, 1997 and
1996, on deposit with the state of Missouri.
28
<PAGE>
Medical Defense Holding Co.
Notes to Consolidated Financial Statements, Continued
4. Investments, continued:
Escrow Funds: Pursuant to the settlement agreement for a specific claim,
MDA has deposited $400,000 in escrow to guarantee future annuity payments.
MDA receives all earnings on the escrowed funds. At December 31, 1997 and
1996, the escrowed funds were invested in a $400,000 par value U.S.
Treasury Note with a fair value of $406,248 and $400,876, respectively,
which is included with investments on the balance sheet. This U.S. Treasury
note matures April 30, 2001.
Net investment income by source for each of the three years ended December
31, was as follows:
<TABLE>
<CAPTION>
1997 1996 1995
<S> <C> <C> <C>
Investment income:
Fixed maturity investments $4,834,942 $5,111,510 $5,285,665
Short-term investments 443,822 472,146 524,374
---------- ---------- ----------
Total investment income 5,278,764 5,583,656 5,810,039
Less investment expenses 267,947 286,894 286,762
---------- ---------- ----------
Net investment income $5,010,817 $5,296,762 $5,523,277
========== ========== ==========
</TABLE>
Realized gains on investments reflected in the results of operations for
each of the three years ended December 31, are as follows:
<TABLE>
<CAPTION>
1997 1996 1995
<S> <C> <C> <C>
Sale of fixed maturity
investments:
Realized gains $ 117,871 $ 103,817 $ 220,862
Realized losses (10,637) (8,899) (2,247)
---------- ---------- ----------
Net realized gains $ 107,234 $ 94,918 $ 218,615
========== ========== ==========
</TABLE>
29
<PAGE>
Medical Defense Holding Co.
Notes to Consolidated Financial Statements, Continued
5. Concentrations of Credit Risk:
The Company maintains the following assets, at amortized cost, issued by
single entities in excess of 10% of stockholders' equity at December 31:
<TABLE>
<CAPTION>
1997 1996
<S> <C> <C>
Commerce Bank of Springfield -
Collateralized repurchase agreement $ 2,295,000 $ 3,315,000
=========== ===========
</TABLE>
All premiums are receivable from physicians, surgeons, dentists, and
related health care providers, primarily concentrated in Missouri.
See Note 8 regarding reinsurance.
6. Management Contract:
MDA and MDIC entered into contracts in 1983 with MDS whereby MDS performs
management and administrative services on behalf of the insurance
companies.
MDS has a noncontributory defined contribution pension plan covering
substantially all employees of the affiliated group. As a matter of policy,
pension costs are funded as they accrue. Pension expense was $210,602,
$175,968 and $203,710 in 1997, 1996 and 1995, respectively. MDS also has a
401(k) savings plan covering substantially all employees of the affiliated
group which the Company provides a 100% matching contribution up to 6% of
compensation subject to current IRS limitations. The 401(k) savings plan
expense for 1997, 1996 and 1995 totaled $82,323, $85,042 and $79,985,
respectively.
7. Deferred Policy Acquisition Costs:
Changes in deferred policy acquisition costs at December 31, are summarized
as follows:
<TABLE>
<CAPTION>
1997 1996
<S> <C> <C>
Deferred, January 1 $ 0 $ 120,527
Additions - Premium tax 154,784 254,019
Less - Amortization and write-off
to expense 154,784 374,546
--------- ---------
Deferred, December 31 $ 0 $ 0
========= =========
</TABLE>
30
<PAGE>
Medical Defense Holding Co.
Notes to Consolidated Financial Statements, Continued
8. Reinsurance:
MDA reinsured all occurrence basis policies issued after October 31, 1980
and all claims-made policies issued before November 1, 1987. MDA ceased
reinsuring claims-made policies as of November 1, 1987. All claims related
to occurrence policies issued after October 31, 1980 and claims-made
policies before November 1, 1987 are still reinsured. The Company is liable
for reinsured amounts in the event a reinsurer is unable to pay its portion
of the losses. The recoverable related to the policies is an asset on the
balance sheet.
A reserve for estimated retrospective premium due reinsurers has been
established for the excess of the anticipated reinsurance premium payable
over the amount paid to date for reinsurance treaty years 1980 through
1987. The ultimate reinsurance premium to be paid is based on an actuarial
evaluation of the ultimate loss developments for claims arising during
those treaty years. Changes in the estimated amount due reinsurers is
reflected in current operations.
All reinsurance contracts are with Lloyd's Underwriters and related
syndicates.
MDIC reinsured all claims-made policies from February 14, 1983 through
August 14, 1987. As of December 31, 1996, MDIC had no outstanding claims
that were anticipated to involve reinsurers.
31
<PAGE>
Medical Defense Holding Co.
Notes to Consolidated Financial Statements, Continued
9. Federal Income Tax:
The Company files a consolidated federal income tax return. The following
table accounts for the differences between the actual tax provision and the
amounts obtained by applying the statutory U.S. federal income tax rate to
income before income taxes:
<TABLE>
<CAPTION>
1997 1996 1995
------------------------ --------------------------- -------------------------
Income Effective Income Effective Income Effective
Taxes Tax Rate Taxes Tax Rate Taxes Tax Rate
<S> <C> <C> <C> <C> <C> <C>
Pre-tax income (loss)
calculated at
statutory tax
rates $464,110 34.00% $(1,599,914) 34.00% $701,978 34.00%
Nondeductible
reorganization
costs 98,036 4.75
Other permanent
differences 47,367 3.47 20,623 (0.44) (32,047) (1.56)
Change in valuation
allowance 271,234 19.87 2,374,704 (50.47) (519,704) (25.17)
-------- ----- ---------- ------ --------- ------
Provision for income
taxes $782,711 57.34% $ 795,413 (16.91)% $ 248,263 12.02%
======== ===== ========== ======= ========= ======
</TABLE>
32
<PAGE>
Medical Defense Holding Co.
Notes to Consolidated Financial Statements, Continued
9. Federal Income Tax, continued:
The components of the net deferred tax asset at December 31, 1997 and 1996
are as follows:
<TABLE>
<CAPTIONS>
1997 1996
--------------------------------- ----------------------------------
<S> <C> <C> <C> <C>
Deferred Deferred Deferred Deferred
Tax Tax Tax Tax
Asset Liability Asset Liability
Tax discounting of loss
reserves $ 3,571,217 $ 4,069,721
Tax acceleration of
unearned premium 412,039 514,864
Unrealized gain/loss 208,872 122,565
-------------- --------------- -------------- -------------
$ 3,983,256 $ 208,872 $ 4,707,150 $
============== =============== ============== =============
Net deferred federal
income tax asset $ 3,774,384 $ 4,707,150
Valuation allowance (3,774,384) (3,503,150)
-------------- --------------
Net realized deferred
asset $ 0 $ 1,204,000
============== ==============
</TABLE>
The valuation allowance represents the difference between the total
deferred tax asset related to loss reserve discounting required by the
Internal Revenue Service and the amount that is more likely than not to be
realized. Medical malpractice is a long tail line of business. The
Company's payout pattern as well as the industry payout pattern for this
line of business is expected to be 15 years or longer.
Management evaluates the payout pattern based on advice from its outside
actuary concerning trends in claim frequencies and severities and needed
changes in future premium rates, industry trends and experience of direct
Missouri competitors in these matters.
33
<PAGE>
Medical Defense Holding co.
Notes to Consolidated Financial Statements, Continued
9. Federal Income Tax, continued:
Projection of future income is inherently uncertain and the achievability
of any projection is made more difficult by the length of the discount
period. Historical losses cannot be adjusted precisely to future cost
levels and the impacts of future emergence of new classes of losses or
types of losses which may not be represented sufficiently in the Company's
data base or which are not yet quantifiable, cannot be precisely
anticipated. Utilizing an outside actuary, management believes that it can
reasonably estimate the amount of the loss reserves which will likely
settle in future years. Based on this estimate, management can determine
how much of the discount will likely reverse and could be recovered, if
necessary, from taxes paid in the carryback period. The 1997 Tax Act
changed the carryback period for net operating losses from three years to
two years effective for tax years beginning after August 5, 1997. This
change impacted the amount of taxes recoverable from carrybacks as no taxes
were paid in 1996 and 1997.
Management does not believe it can reasonably determine the amount of loss
reserve deferred tax benefit which can be recovered from future taxable
income arising more than two years beyond the carryback period using a more
likely than not standard.
The change in the valuation allowance is as follows:
<TABLE>
<CAPTION>
1997 1996 1995
<S> <C> <C>
$ 271,234 $ 2,374,704 $ (519,704)
============ =============== =================
</TABLE>
10. Unpaid Losses and Loss Adjustment Expenses:
The Company's reserves for loss and loss adjustment expenses represent the
estimated ultimate cost of all losses and loss adjustment expenses which
are unpaid at the balance sheet date.
The reserves include estimates of future trends in claim frequency,
severity and cash flow, which could vary as the losses are ultimately
settled; thus, the ultimate liability may be in excess of, or less than,
the amounts provided in the accompanying financial statement.
Company management and their independent actuary believe the reserves are
reasonably stated to cover the ultimate net cost of losses and related loss
adjustment expenses which are unpaid at December 31, 1997 and 1996,
respectively; however, as the reserves are based on estimates, there can be
no assurance that the ultimate liability will not differ from such
estimates. Developments on 1995 and prior years are due primarily to
increases in claim severity that have been considered in ultimate loss
projections at December 31, 1997 and 1996.
MDIC's reserves for loss and loss adjustment expenses have not been
actuarially reviewed due to the few number of claims outstanding. MDIC's
reserves represent less than 1% of total reserves for the periods
represented by the financial statements.
34
<PAGE>
Medical Defense Holding Co.
Notes to Consolidated Financial Statements, Continued
10. Unpaid Losses and Loss Adjustment Expenses, continued:
Activity in the liability for unpaid claims and claim adjustment expenses
is summarized as follows:
<TABLE>
<CAPTION>
1997 1996
<S> <C> <C>
Balance at January 1 $ 63,205,000 $ 65,660,000
Less reinsurance recoverables 1,951,000 2,383,000
--------------- ---------------
Net balance at January 1 61,254,000 63,277,000
--------------- ---------------
Incurred related to:
Current year 13,505,569 15,802,388
Prior years (204,632) 4,576,958
--------------- ---------------
Total incurred 13,300,937 20,379,346
--------------- ---------------
Paid related to:
Current year 265,569 749,388
Prior years 17,008,044 21,652,958
--------------- ---------------
Total paid 17,273,613 22,402,346
--------------- ---------------
Net balance at December 31 57,281,324 61,254,000
Plus reinsurance recoverables 1,373,000 1,951,000
--------------- ---------------
Balance at December 31 $ 58,654,324 $ 63,205,000
=============== ===============
</TABLE>
11. Commitments and Contingencies:
The Company is party to a number of insurance claims arising in the normal
course of business. While the results of litigation cannot be predicted
with certainty, management, based upon the advice of Company's counsel,
believes that the final outcome of such litigation will not have a material
adverse effect on the consolidated financial position or results of
operations of the Company.
Under employment agreements with certain officers and directors, payments
totaling approximately $500,000 are to be made if the number of insureds
fall below 913. Such payments are forfeited in whole or part if the
individual does not remain employed for a period of 36 months following the
payment date.
35
<PAGE>
Medical Defense Holding Co.
Notes to Consolidated Financial Statements, Continued
12. Net Income Per Common Share:
In February of 1997, the Financial Accounting Standards Board published
Statement of Financial Accounting Standard No. 128, Earnings Per Share
("SFAS 128"), which requires certain changes in the reporting of earnings
per share. The Company was required to adopt SFAS 128 at December 31, 1997.
Additionally, the Company was required to restate 1996 and 1995 earnings
per share data as previously presented.
SFAS 128 requires the computation of basic earnings per share ("EPS") and
diluted EPS. Basic EPS is computed by dividing income (loss) available to
common shareholders by the weighted-average number of common shares
outstanding for the period. Diluted EPS is computed by dividing income
(loss) available to shareholders by the weighted-average number of common
shares plus the weighted-average number of common share equivalents
outstanding for the period. Anti-dilutive amounts are not shown which was
the case for the year ended December 31, 1996.
All of the Company's preferred stock are convertible to common stock at a
ratio of two shares of common stock to one share of preferred stock, and
therefore, are considered common stock equivalents. The Company's preferred
stock has no stated dividend rate, and therefore, these securities have no
effect on computing basic EPS.
As discussed in Note 3, on October 16, 1997 and November 15, 1996, the
Company purchased 1,721,445 and 2,781,338 shares of its convertible
preferred stock. In addition, during December 1997, the Company purchased
44,498 shares of its convertible preferred stock from a small number of
shareholders.
On June 26, 1995, MDA was converted to a stock insurance company and became
a wholly owned subsidiary of MDHC. Therefore the net income of $617,713
recorded by MDA as of June 30, 1995, is virtually entirely attributable to
preconversion results and, therefore, is excluded for 1995 earnings per
share presentation purposes.
36
<PAGE>
Medical Defense Holding Co.
Notes to Consolidated Financial Statements, Continued
12. Net Income Per Common Share, continued:
Basic and diluted earnings per share for the three years ended December 31,
is as follows:
<TABLE>
<CAPTION>
1997 1996 1995
<S> <C> <C> <C>
Net income (loss) $ 582,319 $ (5,501,042) $ 1,816,378
Less net income of subsidiary through
June 30, 1995 (617,713)
---------- ------------ -----------
Adjusted net income $ 582,319 $ (5,501,042) $ 1,198,665
========== ============ ===========
Weighted average common shares
outstanding 1,031,025 1,019,602 1,019,602
Weighted average common stock options
expressed as common stock equivalents 17,688,120 23,281,244 23,980,378
---------- ------------ -----------
Weighted average common and equivalent
shares outstanding 18,719,145 24,300,846 24,999,980
========== ============ ===========
Basic earnings per share $ 0.56 $ (5.39) $ 1.18
========== ============ ===========
Diluted earnings per share $ 0.03 $ n/a(1) $ 0.05
========== ============ ===========
</TABLE>
(1) Anti-dilutive
13. Retained Earnings:
Retained earnings at December 31, is derived as follows:
<TABLE>
<CAPTION>
1997 1996
<S> <C> <C>
Unassigned surplus/retained earnings at January 1 $ 10,685,955 $16,186,997
Net income 582,319 (5,501,042)
------------ -----------
Retained earnings at December 31 $ 11,268,274 $10,685,955
============ ===========
</TABLE>
37
<PAGE>
Item 9. Changes in and Disagreements with Accountants on Accounting and
------------------------------------------------------------------------
Disclosures
-----------
There have been no changes in nor any disagreements with accountants on
accounting and financial disclosure within the three year period ended December
31, 1997.
PART III
Item 10. Directors and Executive Officers of the Registrant
-----------------------------------------------------------
IDENTIFICATION OF DIRECTORS AND EXECUTIVE OFFICERS
The board of directors of the Company consists of six (6) persons, all of
whom are currently directors, executive officers, or both, of the Company,
MDA, MDS and MDIC.
The directors and executive officers of the Company are currently as
follows:
<TABLE>
<CAPTION>
Period as a
Director of the
Name Age Principal Occupation Position Company
---- --- -------------------- -------- ---------------
<S> <C> <C> <C> <C>
Ronald G. Benson 57 Obstetrician/ Chairman of the Board, 1994 to date
Gynecologist President and Chief
Executive Officer
Gary L. Robinson 61 Obstetrician/ Vice President 1994 to date
Gynecologist
John J. Stamatis 56 Thoracic and Cardio- Vice President 1994 to date
vascular Surgeon
David W. Brown 59 Orthopedic Surgeon Treasurer 1994 to date
Arlen D. Winsky 60 Plastic Surgeon Secretary 1994 to date
Geri H. Morrison 42 Chief Operating Officer Assistant Secretary 1994 to date
and Chief Operating
Officer
Samuel J. Pippin 42 Director of Accounting Principal Financial
Officer and Principal
Accounting Officer
</TABLE>
The officers of the Company are to be elected annually and hold office
until their respective successors have been elected and qualified or until
death, resignation or removal by the board of directors of the company.
FAMILY RELATIONSHIPS
Geri H. Morrison and Robert E. Morrison are married to each other. In
addition to being a Director and Chief Operating Officer of the Company, Ms.
Morrison is a Director of MDA and MDIC and Chief Operating Officer of MDA, MDS
and MDIC. Mr. Morrison is a Director of MDA and MDIC.
38
<PAGE>
BUSINESS EXPERIENCE
Ronald G. Benson, M.D., age 57, has been a member of the Board of Directors
of the Company since 1994, MDA since 1976 and of MDS and MDIC since 1982. He
has served as Chairman of the Board of Directors of the Company since 1994, MDA
since 1983 and of MDS and MDIC since 1982. He has served as President and Chief
Executive Officer of the Company since 1994. Since 1976, he has served as
President of MDA and as Chief Executive Officer of MDA since 1989. He has
served as the Chairman of the Board of Directors since 1982, President since
1992, and Chief Executive Officer of MDS since 1989. He has served as Chairman
of the Board of Directors of MDIC since 1982, Chief Executive Officer of MDIC
since 1989, and President of MDIC since 1992. Dr. Benson is an
obstetrician/gynecologist practicing in Springfield, Missouri.
Gary L. Robinson, M.D., age 61, has been a member of the Board of Directors
of the Company since 1994, MDA since 1976 and of MDS and MDIC since 1982. He
has served as Vice President of the Company since 1994, MDA since 1976 and as
Vice President of MDS and MDIC since 1982. Dr. Robinson is an
obstetrician/gynecologist practicing in Springfield, Missouri, and is affiliated
with the Family Residency Program at Cox Health Systems in Springfield,
Missouri.
John J. Stamatis, M.D., age 56, has been a member of the Board of Directors
of the Company since 1994, MDA since 1976 and of MDS and MDIC since 1982. He
has served as Vice President of the Company since 1994, MDA since 1979 and of
MDS and MDIC since 1982. Dr. Stamatis is a thoracic and cardiovascular surgeon
practicing in Springfield, Missouri.
David W. Brown, M.D., age 59, has been a member of the Board of Directors
of the Company since 1994, MDA since 1976 and of MDS and MDIC since 1982. He
has served as Treasurer of the Company since 1994, MDA since 1979 and of MDS and
MDIC since 1982. Dr. Brown is an orthopedic surgeon practicing in Springfield,
Missouri.
Arlen D. Winsky, M.D., age 60, has been a member of the Board of Directors
of the Company since 1994, MDA since 1976 and of MDS and MDIC since 1982. He
has served as Secretary of the Company since 1994, MDA since 1976 and of MDS and
MDIC since 1982. He was also Treasurer of MDA from 1976 to 1979. Dr. Winsky is
a plastic surgeon practicing in Springfield, Missouri.
Geri H. Morrison, CPA, MBA, age 42, has been a member of the Board of
Directors, Assistant Secretary and Chief Operating Officer of the Company since
1994. She has been Chief Operating Officer of MDA, MDS and MDIC since 1989.
She has been Assistant Treasurer of MDA since 1988 and Assistant Secretary of
MDS and MDIC since 1992. She has been a director of MDA since 1995 and of MDIC
since 1991. Ms. Morrison received a B.S. in Accounting from Southwest Missouri
State University in 1980 and an M.B.A. from Drury College in 1993. Ms. Morrison
was Comptroller from 1987 to 1988, and Chief Financial Officer from 1988 to
1989, for MDA, MDS and MDIC. Prior to that time, Ms. Morrison was with Baird,
Kurtz & Dobson in Springfield, Missouri.
Samuel J. Pippin, CPA, MBA, age 42, has been Principal Financial Officer
and Principal Accounting Officer of the Company since 1994. Mr. Pippin has been
Director of Accounting and Finance of MDA, MDS and MDIC since 1989. He has been
Assistant Secretary of MDA since 1993 and Assistant Treasurer of MDIC since
1992. He has been a director of MDA since 1995 and of MDIC since 1991. Mr.
Pippin received a B.S. in Accounting from Southwest Missouri State University in
1985 and an M.B.A. from Drury College in 1995. Prior to that time, Mr. Pippin
was employed with Baird, Kurtz & Dobson in Springfield, Missouri.
39
<PAGE>
Item 11. Executive Compensation
--------------------------------
Cash Compensation
The following table sets forth information concerning compensation paid for
each of the three years ended December 31, 1997 with respect to the Company's
chief executive officer and each other executive officer whose aggregate annual
salary and bonus exceed $100,000.
<TABLE>
<CAPTION>
Annual Compensation
---------------------------
All Other
Name and Principal Position Year Salary Bonus Compensation
- --------------------------- ---- ------ ----- ------------
<S> <C> <C> <C> <C>
Ronald G. Benson, M.D., 1997 $132,959 $75,000 (1) $37,625 (2)
Chairman of the Board, 1996 $129,387 $75,000 (1) $36,850 (2)
President and Chief Executive Officer 1995 $125,867 $75,000 (1) $32,703 (3)
Geri H. Morrison, CPA, MBA, 1997 $149,877 $80,381 (4) $37,615 (2)
Chief Operating Officer 1996 $151,449 $80,387 (4) $31,106 (2)
1995 $131,123 $80,378 (4) $23,676 (5)
</TABLE>
(1) Reflects contribution to the five-year compensation plan instituted
in 1993. See "Executive Compensation Plan" below for additional
detail.
(2) Includes $8,400 in Company director's fees, $3,600 in MDA director's
fees and contributions to the two MDS qualified defined contribution
plans.
(3) Includes $4,200 in Company director's fees, $3,600 in MDA director's
fees and contributions to the two MDS qualified defined contribution
plans.
(4) Includes $65,000 contribution to the five-year
executive compensation plan instituted in 1993.
See "Executive Compensation Plan" below for
additional detail.
(5) Includes $4,200 in Company director's fees, $1,800 in MDA director's
fees and contributions to the two MDS qualified defined contribution
plans.
The six Directors of the Company each receives $700 per month compensation
for their service in that capacity. The nine Directors of MDA each receive $300
per month compensation for their service in that capacity.
Pension Plan
In 1984, MDS adopted the "Medical Defense Services Corp. Integrated Money
Purchase Pension Plan And Trust Agreement" (the "Pension Plan"), which was
amended and restated in 1990. MDS makes contributions for each participant in an
amount equal to 10% of all compensation paid to the participant during the plan
year. The Pension Plan provides "integration level" contributions of an
additional 4.3% for all compensation above the integration level (currently set
at $35,000). Except for qualified "rollover contributions", the Pension Plan
does not permit or require participants to make voluntary contributions. All
employees who are 21 years of age and have attained 200 hours of service with
MDS are eligible to participate in the Pension Plan. Both MDA and MDIC are
participating employers in the Pension Plan.
401(k) Plan
Effective January 1, 1991, MDS adopted the "Medical Defense Services Corp.
401(k) Plan" (the "401(k) Plan"). Under the 401(k) Plan, employees may make
deferred salary contributions in an amount up to the limit allowed by applicable
law for the plan year. MDS makes a matching contribution of 100% of the amount
contributed by the employee, up to 6% of each employee's compensation for the
year. All employees who are 21 years of age and have two months of service with
MDS are eligible to participate in the 401(k) Plan. Both MDA and MDIC are
participating employers in the Pension Plan.
40
<PAGE>
Executive Compensation Plan and Executive Compensation Plan II
In order to secure the continued employment of certain key employees, MDS
in 1993 adopted the "Medical Defense Services Corp. Executive Compensation Plan"
and related "Executive Compensation Trust Agreement" (collectively, the "Secular
Trust"). The Secular Trust terminated on December 31, 1997. In order to
continue to secure the employment of certain key employees, MDS in December,
1997, adopted the "Medical Defense Services Corp. Executive Compensation Plan
II" and related "Executive Compensation Trust Agreement" (collectively, the
"Secular Trust II"). The Secular Trust II was effective January 1, 1998 and
terminates December 31, 2002. The benefits and provisions of the Secular Trust
II are essentially the same as the Secular Trust. The Board of Directors of MDS
designates by resolution those employees of MDS who may participate in the
Secular Trust and Secular Trust II. An employee is entitled to participate only
if the employee is employed on December 31 of a Plan Year as that term is
defined in the Secular Trust/Secular Trust II. Those employees who are entitled
to participate may receive a cash benefit or elect to have MDS pay such benefit
directly to a Trust maintained pursuant to the Secular Trust/Secular Trust II.
The employee designates the beneficiary of the Trust maintained pursuant to the
Secular Trust/Secular Trust II. An employee's participation in the Secular
Trust/Secular Trust II terminates upon the employee's termination of employment
with MDS.
Item 12. Security Ownership of Certain Beneficial Owners and Management
-----------------------------------------------------------------------
PREFERRED STOCK CLASS A COMMON STOCK
--------------- --------------------
<TABLE>
<CAPTION>
# OF % OF ALL # OF % OF ALL
SHARES SHARES SHARES SHARES
------ -------- ------ --------
<S> <C> <C> <C> <C>
RONALD G. BENSON 38,399 0.516% 142,857 14.286%
GARY L. ROBINSON 15,474 0.208% 142,857 14.286%
JOHN J. STAMATIS 30,574 0.411% 142,857 14.286%
DAVID W. BROWN 30,429 0.409% 142,857 14.286%
ARLEN D. WINSKY 20,765 0.280% 142,857 14.286%
GERI H. MORRISON 0 0.000% 142,857 14.286%
ROBERT E. MORRISON 0 0.000% 35,714 3.571%
SAMUEL J. PIPPIN 0 0.000% 35,714 3.571%
DAVID W. JACKSON 0 0.000% 35,714 3.571%
WILLIAM H. PENNINGER, JR 0 0.000% 35,714 3.571%
------- ----- ------- -------
135,641 1.824% 999,998 100.000%
======= ===== ======= =======
</TABLE>
None of the persons listed above owns any Class B Common Stock. The
Company is not aware of any person or entity which owns or has beneficial
ownership of more than 5% of the Preferred Stock. All of the holders of Class A
Common Stock are set forth above.
As of March 9, 1998, three shareholders had converted a total of 26,700 shares
of Preferred Stock to 53,400 shares of Class B Common Stock. As of March 9,
1998, that constituted all of the shares of Class B Common Stock issued and
outstanding.
41
<PAGE>
Item 13. Certain Transactions and Relationships
-----------------------------------------------
During all or some portion of 1997, 1996, and 1995, each of Ronald G.
Benson, Gary L. Robinson, John J. Stamatis, David W. Brown and Arlen D. Winsky
are or were named insureds under a policy or contract of professional liability
insurance issued by MDA for which premiums attributable to such individual were
earned by MDA. All policies on which such persons were a named insured were
made in the ordinary course of business, did not involve more than the normal
underwriting risks or present other unfavorable features and were made on
substantially the same terms as those prevailing at the same time for comparable
policies issued to unaffiliated persons.
Other than as stated above, none of the Directors or Executive Officers of
the Company, MDA, MDS or MDIC, or the corporations and firms with which such
persons are associated, currently maintains or has maintained since the
beginning of the last fiscal year, any significant business or personal
relationship with the Company or MDA other than such as may arise by virtue of
his or her position or positions with the Company, MDA, MDS or MDIC.
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
-------------------------------------------------------------------------
(a) Financial Statements and Exhibits
1. Financial Statements
See accompanying Index to Consolidated Financial Statements
in Item 8.
2. Financial Statement Schedules
See accompanying Index to Consolidated Financial Statements
in Item 8. Schedules not in the accompanying index have been
omitted because they are not applicable.
3. Exhibits
Exhibits required to be filed by Item 601 of Regulation S-K
are listed in the Exhibit Index attached hereto, which is
incorporated herein by reference. Set forth below is a list
of management contracts and compensatory plans and
arrangements required to be filed as exhibits to this form
by Item 14 (c).
10.3 -- Amended and Restated Employment Agreement between
Ronald G. Benson and Medical Defense Services Corp.,
dated January 1, 1993.
10.4 -- Amended and Restated Employment Agreement between
Geraldine Hatfield (Morrison) and Medical Defense
Services Corp., dated January 1, 1993
10.5 -- Amended and Restated Employment Agreement between
Arlen D. Winsky and Medical Defense Services Corp.,
dated January 1, 1993.
10.6 -- Amended and Restated Employment Agreement between
David W. Brown and Medical Defense Services Corp.,
dated January 1, 1993.
10.7 -- Amended and Restated Employment Agreement between
Gary L. Robinson and Medical Defense Services Corp.,
dated January 1, 1993.
42
<PAGE>
Item 14. Exhibits, Financial Statement Schedules and Reports on form 8-K,
-------------------------------------------------------------------------
continued:
10.8 -- Amended and Restated Employment Agreement between
John J. Stamatis and Medical Defense Services
Corp., dated January 1, 1993.
10.9 -- Medical Defense Services Corp. Integrated Money
Purchase Pension and Trust Agreement, between,
Medical Defense Services Corp. and Boatmen's Trust
Company, as amended, dated December 31, 1990.
10.10 -- Carnahan, Evans, Cantwell & Brown, P.C. Defined
Contribution Prototype Plan and Trust Agreement,
adopted December 31, 1990.
10.11 -- Medical Defense Services Corp. Executive
Compensation Plan, dated October 15, 1993.
10.13 -- Form of Employment Guaranty Agreement by Medical
Defense Holding Co. guaranteeing existing Medical
Defense Services Corp.'s employment agreements.
10.14 -- Medical Defense Services Corp. Executive
Compensation Plan II.
See Accompanying Exhibit Index for additional
Exhibits incorporated by reference.
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the last quarter of
1997.
(c) Exhibits
See Item 14 (a) 3 above.
43
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of 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.
Dated: March 23, 1998 MEDICAL DEFENSE HOLDING CO.
By: /s/ RONALD G. BENSON
-----------------------------
Ronald G. Benson
President, Director and
Chairman of the Board
(Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
- --------- ----- ----
<S> <C> <C>
/s/ RONALD G. BENSON President, Director and Chairman March 23, 1998
- ------------------------------ of the Board (Principal Executive
Ronald G. Benson Officer)
/s/ ARLEN D. WINSKY Secretary and Director March 23, 1998
- ------------------------------
Arlen D. Winsky
Vice President and Director March __, 1998
- ------------------------------
Gary L. Robinson
/s/ JOHN J. STAMATIS Vice President and Director March 23, 1998
- ------------------------------
John J. Stamatis
/s/ DAVID W. BROWN Treasurer and Director March 23, 1998
- ------------------------------
David W. Brown
/s/ GERI H. MORRISON Assistant Secretary, Chief Operating March 23, 1998
- ------------------------------ Officer and Director
Geri H. Morrison
/s/ SAMUEL J. PIPPIN Director of Accounting and Finance March 26, 1998
- ------------------------------ (Principal Financial Officer and
Samuel J. Pippin Principal Accounting Officer)
</TABLE>
44
<PAGE>
Supplemental Information to be Furnished with Reports Filed Pursuant to Section
15(d) of the Act by Registrants Which Have Not Registered Securities Pursuant to
Section 12 of the Act.
The Registrant currently plans to mail an Annual Report for 1997 to security
holders in April, 1998. At that time, four copies will be furnished to the
Securities and Exchange Commission. No proxy statement, form of proxy, or other
proxy soliciting material has been sent to the Registrant's security holders
with respect to any annual or other meeting of security holders.
45
<PAGE>
Report of Independent Accountants
To the Board of Directors
Medical Defense Holding Co. and
Subsidiaries:
Our report on the consolidated financial statements of Medical Defense Holding
Co. and Subsidiaries is included on page 15 of this Form 10-K. In connection
with our audits of such financial statements, we have also audited the related
financial statement schedules listed in the index on page 14 of this Form 10-K.
In our opinion, the financial statement schedules referred to above, when
considered in relation to the basic financial statements taken as a whole,
present fairly, in all material respects, the information required to be
included therein.
COOPERS & LYBRAND L.L.P.
St. Louis, Missouri
February 13, 1998
S-1
<PAGE>
SCHEDULE I
MEDICAL DEFENSE HOLDING CO. AND SUBSIDIARIES
SUMMARY OF INVESTMENTS
As of December 31, 1997, 1996 and 1995
(Dollars in Thousands)
---------
<TABLE>
<CAPTION>
1997 1996
------------------------------- ------------------------------
Balance Balance
Amortized Market Sheet Amortized Market Sheet
Cost Value Amount Cost Value Amount
---- ----- ------ ---- ----- ------
<S> <C> <C> <C> <C> <C> <C>
Fixed Maturities:
Bonds:
United States Government
and Government Agencies
and Authorities $ 63,564 $ 64,074 $ 64,074 $ 69,960 $ 69,585 $ 69,585
Corporate Securities 5,127 5,206 5,206 6,372 6,412 6,412
Other debt securities 4,787 4,812 4,812 2,820 2,793 2,793
-------- ------- -------- -------- -------- --------
Total fixed maturities 73,478 74,092 74,092 79,152 78,790 78,790
Short-term investments 7,242 7,243 7,243 4,507 4,509 4,509
-------- ------- -------- -------- -------- --------
Total investments $ 80,720 $81,335 $ 81,335 $ 83,659 $ 83,299 $ 83,299
======== ======= ======== ======== ======== ========
</TABLE>
S-2
<PAGE>
SCHEDULE II
MEDICAL DEFENSE HOLDING CO. AND SUBSIDIARIES
Condensed Financial Information of Registrant
Balance Sheet
(Parent Company Only)
December 31, 1997 and 1996
(dollars in thousands)
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Assets:
Cash and cash equivalents.................... $ 271 $ 316
Investment in subsidiaries................... 19,690 17,644
Federal income tax recoverable............... 384 2,379
Other Assets................................. 3,110 1,501
------- -------
Total assets............................... $23,455 $21,840
======= =======
Liabilities:
Accrued Liabilities.......................... $ 8 $ 5
------- -------
Total liabilities.......................... 8 5
------- -------
Stockholder's equity:
Preferred Stock.............................. 7,436 9,209
Common Stock................................. 517 510
Additional paid-in capital................... 2,728 1,669
Retained earnings............................ 12,766 10,447
------- -------
Total stockholder's equity................. 23,447 21,835
------- -------
Total liabilities and stockholders' equity..... $23,455 $21,840
======= =======
</TABLE>
See Notes to Condensed Financial Information of Registrant.
S-3
<PAGE>
SCHEDULE II
MEDICAL DEFENSE HOLDING CO. AND SUBSIDIARIES
Condensed Financial Information of Registrant - (Continued)
Statement of Operations
(Parent Company Only)
For the Years Ended December 31, 1997, 1996 and 1995
(dollars in thousands, except per share data)
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Revenues:
Earnings of subsidiaries............................ $ 1,706 $ (5,494) $ 1,825
Investment Income................................... 136 142 27
--------------- --------------- ---------------
Total revenues................................. 1,842 (5,352) 1,852
Total expenses........................................... 160 125 36
--------------- --------------- ---------------
Income (loss) before taxes............................... 1,682 (5,477) 1,816
Federal income tax....................................... 8 24 0
--------------- --------------- ---------------
Net income............................................... $ 1,674 $ (5,501) $ 1,816
=============== =============== ===============
Basic earnings per share................................. $ 1.65 $ (5.39) $ 1.18
=============== =============== ===============
Diluted earnings per share............................... $ 0.09 $ n/a $ 0.05
=============== =============== ===============
</TABLE>
See Notes to Condensed Financial Information of Registrant.
S-4
<PAGE>
SCHEDULE II
MEDICAL DEFENSE HOLDING CO. AND SUBSIDIARIES
Condensed Financial Information of Registrant - (Continued)
Statement of Cash Flows
(Parent Company Only)
For the Years Ended December 31, 1997, 1996 and 1995
(dollars in thousands)
<TABLE>
<CAPTION>
Cash flows from operating activities: 1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Net income (loss)..................................................... $ 1,674 $ (5,501) $ 1,816
Adjustments to reconcile net income to net cash provided by
operating activities:
Dividends received from subsidiaries over subsidiaries' earnings...... 394 5,494 778
Changes in other assets and accrued liabilities....................... 70 (274) (36)
------- -------- -------
Net cash provided by operating activities......................... 2,138 (281) 2,558
------- -------- -------
Cash flows from investing activities:
Proceeds from short-term investments.................................. 6,900 13,300 0
Purchase of short-term investments.................................... (8,377) (11,937) (2,711)
------- -------- -------
Net cash used by investing activities............................. (1,477) 1,363 (2,711)
------- -------- -------
Cash flows from financing activities:
Purchase of preferred stock........................................... (706) (1,113) 0
Proceeds from common stock issued..................................... 0 0 500
------- -------- -------
Net cash (used) provided by financing activities.................. (706) (1,113) 500
------- -------- -------
Total cash provided............................................... (45) (31) 347
Cash and cash equivalents, beginning of period.......................... 316 347 0
------- -------- -------
Cash and cash equivalents, end of period................................ $ 271 $ 316 $ 347
======= ======== =======
</TABLE>
Notes to Condensed Financial Information of Registrant.
(1) The condensed financial information of registrant should be read in
conjunction with the Consolidated Financial Statements and Notes to
Consolidated Financial Statements included elsewhere herein.
S-5
<PAGE>
SCHEDULE IV
MEDICAL DEFENSE HOLDING CO. AND SUBSIDIARIES
REINSURANCE
For the Years Ended December 31, 1997, 1996 and 1995
(Dollars in Thousands)
---------
<TABLE>
<CAPTION>
Percentage
Gross Ceded to Assumed Net of Amount
Premiums Other From Other Premiums Assumed
Written Companies Companies Written to Net
-------- --------- ---------- --------- ----------
<S> <C> <C> <C> <C> <C>
1997
Medical Malpractice $ 9,725 $(857) $-0- $10,582 0%
======= ====== ==== ======= ===
1996
Medical Malpractice $12,526 $(196) $-0- $12,722 0%
======= ====== ==== ======= ===
1995
Medical Malpractice $13,890 $ (70) $-0- $13,960 0%
======= ====== ==== ======= ===
</TABLE>
Footnote:
Medical Defense Holding Co. amounts ceded to other companies reflect current
year adjustments in retrospectively rated reinsurance contracts which remain
in effect for policies from November 1, 1980 through October 31, 1987.
S-6
<PAGE>
SCHEDULE V
MEDICAL DEFENSE HOLDING CO. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
GROSS OF REINSURANCE
For the Years Ended December 31, 1997, 1996 and 1995
(Dollars in Thousands)
---------
<TABLE>
<CAPTION>
Additions Deductions
---------------------- ------------------------------
Balance, Charged to Charged to Losses and Retrospective Balance,
December 31, Costs and Other Loss Adjustment Premiums Paid December 31,
Description 1996 Expenses Accounts Expenses Paid to Reinsurers 1997
- ----------- ------------ ---------- ---------- --------------- ------------- ------------
<S> <C> <C> <C> <C> <C> <C>
Unpaid losses and loss
adjustment expenses $63,205 $12,723 $17,274 $58,654
Retrospective premiums
payable to reinsurers $ 1,970 $ (857) $ 1,113
<CAPTION>
Additions Deductions
---------------------- ------------------------------
Balance, Charged to Charged to Losses and Retrospective Balance,
December 31, Costs and Other Loss Adjustment Premiums Paid December 31,
Description 1995 Expenses Accounts Expenses Paid to Reinsurers 1996
- ----------- ------------ ---------- ---------- --------------- ------------- ------------
Unpaid losses and loss
adjustment expenses $65,660 $19,947 $22,402 $63,205
Retrospective premiums
payable to reinsurers $ 2,195 $ (196) $ (29) $ 1,970
<CAPTION>
Additions Deductions
---------------------- ------------------------------
Balance, Charged to Charged to Losses and Retrospective Balance,
December 31, Costs and Other Loss Adjustment Premiums Paid December 31,
Description 1994 Expenses Accounts Expenses Paid to Reinsurers 1995
- ----------- ------------ ---------- ---------- --------------- ------------- ------------
Unpaid losses and loss
adjustment expenses $65,803 $15,637 $15,780 $65,660
Retrospective premiums
payable to reinsurers $ 2,586 $ (70) $ 321 $ 2,195
</TABLE>
S-7
<PAGE>
SCHEDULE VI
MEDICAL DEFENSE HOLDING CO. AND SUBSIDIARIES
SUPPLEMENTAL INFORMATION CONCERNING
PROPERTY & CASUALTY INSURANCE OPERATIONS
For the Years Ended December 31, 1997, 1996 and 1995
(Dollars in Thousands)
---------
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Deferred policy acquisition costs $ 155 $ 375 $ 60
Reserve for unpaid losses
and loss adjustment expenses 58,654 63,205 65,660
Unearned premiums 6,059 7,572 8,055
Earned premiums (gross of reinsurance) 11,235 13,004 15,113
Net investment income 5,011 5,297 5,523
Amortization of deferred acquisition costs 155 375 60
Losses and loss adjustment
expenses (gross of reinsurance)
incurred related to:
Current years 13,506 15,802 18,115
Prior years (783) 4,145 (2,478)
Paid losses and loss adjustment expenses 17,274 22,402 15,780
Gross premiums written 9,725 12,526 13,890
</TABLE>
S-8
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit Page
No. Description No.
--- ----------- ---
<S> <C> <C>
3.1 --- Articles of Incorporation of Medical Defense Holding Co. (Filed as Exhibit 3.1 to the
Registrant's Registration Statement on Form S-1 (file #33-87444) and hereby incorporated
by reference.)............................................................................
3.2 --- Bylaws of Medical Defense Holding Co. (Filed as Exhibit 3.2 to the Registrant's
Registration Statement on Form S-1 (file #33-87444) and hereby incorporated by reference.)
.........................................................................................
4.1 --- Right of First Refusal Agreement (Filed as Exhibit 4.1 to the Registrant's Registration
Statement on Form S-1 (file #33-87444) and hereby incorporated by reference.).............
4.2 --- Specimen Stock Certificate for Preferred Stock (Filed as Exhibit 4.2 to the Registrant's
Registration Statement on Form S-1 (file #33-87444) and hereby incorporated by reference.)
.........................................................................................
4.3 --- Specimen Stock Certificate for Class A Common Stock (Filed as Exhibit 4.3 to the
Registrant's Registration Statement on Form S-1 (file #33-87444) and hereby incorporated
by reference.)............................................................................
4.4 --- Specimen Stock Certificate for Class B Common Stock (Filed as Exhibit 4.4 to the
Registrant's Registration Statement on Form S-1 (file #33-87444) and hereby incorporated
by reference.)............................................................................
10.1 --- 1983 Management Agreement between Medical Defense Associates and Medical Defense Services
Corp., as amended (Filed as Exhibit 10.1 to the Registrant's Registration Statement on
Form S-1 (file #33-87444) and hereby incorporated by reference.)..........................
10.2 --- 1983 Management Agreement between Medical Defense Insurance Company and Medical Defense
Services Corp., as amended (Filed as Exhibit 10.2 to the Registrant's Registration
Statement on Form S-1 (file #33-87444) and hereby incorporated by reference.).............
10.3 --- Amended and Restated Employment Agreement between Ronald G. Benson and Medical Defense
Services Corp., dated January 1, 1993 (Filed as Exhibit 10.3 to the Registrant's
Registration Statement on Form S-1 (file #33-87444) and hereby incorporated by reference.)
..........................................................................................
10.4 --- Amended and Restated Employment Agreement between Geraldine Hatfield (Morrison) and
Medical Defense Services Corp., dated January 1, 1993 (Filed as Exhibit 10.4 to the
Registrant's Registration Statement on Form S-1 (file #33-87444) and hereby incorporated
by reference.)............................................................................
10.5 --- Amended and Restated Employment Agreement between Arlen D. Winsky and Medical Defense
Services Corp., dated January 1, 1993 (Filed as Exhibit 10.5 to the Registrant's
Registration Statement on Form S-1 (file #33-87444) and hereby incorporated by reference.)
..........................................................................................
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Exhibit Page
No. Description No.
--- ------------ ---
<S> <C> <C>
10.6 --- Amended and Restated Employment Agreement between David W. Brown and Medical Defense
Services Corp., dated January 1, 1993 (Filed as Exhibit 10.6 to the Registrant's
Registration Statement on Form S-1 (file #33-87444) and hereby incorporated by reference.)
10.7 --- Amended and Restated Employment Agreement between Gary L. Robinson and Medical Defense
Services Corp., dated January 1, 1993 (Filed as Exhibit 10.7 to the Registrant's
Registration Statement on Form S-1 (file #33-87444) and hereby incorporated by reference.)
10.8 --- Amended and Restated Employment Agreement between John J. Stamatis and Medical Defense
Services Corp., dated January 1, 1993 (Filed as Exhibit 10.8 to the Registrant's
Registration Statement on Form S-1 (file #33-87444) and hereby incorporated by reference.)
10.9 --- Medical Defense Services Corp. Integrated Money Purchase Pension and Trust Agreement,
between, Medical Defense Services Corp. and Boatmen's Trust Company, as amended, dated
December 31, 1990 (Filed as Exhibit 10.9 to the Registrant's Registration Statement on
Form S-1 (file #33-87444) and hereby incorporated by reference.)..........................
10.10 --- Carnahan, Evans, Cantwell & Brown, P.C. Defined Contribution Prototype Plan and Trust
Agreement, adopted December 31, 1990 (Filed as Exhibit 10.10 to the Registrant's
Registration Statement on Form S-1 (file #33-87444) and hereby incorporated by reference.)
10.11 --- Medical Defense Services Corp. Executive Compensation Plan, dated October 15, 1993 (Filed
as Exhibit 10.11 to the Registrant's Registration Statement on Form S-1 (file #33-87444)
and hereby incorporated by reference.)....................................................
10.12 --- Form of Deposit Agreement between Medical Defense Associates and Central Bank, Jefferson
City, Missouri (Filed as Exhibit 10.12 to the Registrant's Registration Statement on Form
S-1 (file #33-87444) and hereby incorporated by reference.)...............................
10.13 --- Form of Employment Guaranty Agreement by Medical Defense Holding Co. guaranteeing
existing Medical Defense Services Corp.'s employment agreements (Filed as Exhibit 10.13
to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1995 and
hereby incorporated by reference.)........................................................
10.14 --- Medical Defense Services Corp. Executive Compensation Plan II.............................
11.1 --- Statement re computation of per share earnings............................................
21.1 --- Subsidiaries of the registrant............................................................
27 --- Financial Data Schedule...................................................................
</TABLE>
<PAGE>
Exhibit 10.14
MEDICAL DEFENSE SERVICES CORP.
EXECUTIVE COMPENSATION PLAN II
This Executive Compensation Plan is established this 15th day of December,
1997, by Medical Defense Services Corp.
WITNESSETH:
WHEREAS, Medical Defense Services Corp. desires to make executive
compensation benefits available to certain of its employees to compensate them
for their loyalty to Medical Defense Services Corp. and it desires to establish
this Plan to implement and carry out said compensation benefits.
NOW, THEREFORE, in consideration of the premises, Medical Defense Services
Corp. agrees as follows:
ARTICLE I
DEFINITIONS
1.01 "Plan" means the executive compensation plan established by the Employer
designated as the Medical Defense Services Corp. Executive Compensation
Plan II.
1.02 "Employer" means Medical Defense Services Corp.
1.03 "Employee" means any employee of the Employer.
1.04 "Participant" is an Employee who is eligible to be and becomes a
Participant in accordance with the provisions of Section 2.01.
1.05 "Beneficiary" is a person designated by a Participant who is or may become
entitled to Benefits under the Plan. A Beneficiary who becomes entitled to
Benefits under the Plan remains a Beneficiary under the Plan until the
Employer has fully distributed Benefits to him. A Beneficiary's right to
(and the Employer's duty to provide to the Beneficiary) information or
data concerning the Plan does not arise until he first becomes entitled to
receive Benefits under the Plan.
1.06 "Nonforfeitable" means a Participant's or Beneficiary's unconditional
claim, legally
<PAGE>
enforceable against the Plan, to a Participant's Benefit under the Plan.
1.07 "Plan Year" means the fiscal year of the Plan, a 12 consecutive month
period ending every December 31.
1.08 "Effective Date" of the Plan shall be January 1, 1998.
1.09 "Accounting Date" is the last day of the Plan Year.
1.10 "Trust" means each separate trust maintained by each Participant under the
Plan.
1.11 "Trustee" means the trustee of each separate Trust, which shall be
Commerce Bank, N.A.
1.12 "Code" means the Internal Revenue Code of 1986, as amended.
1.13 A related group is a controlled group of corporations (as defined in Code
(S)414(b)), trades or businesses (whether or not incorporated) which are
under common control (as defined in Code (S)414(c)) or an affiliated
service group (as defined in Code (S)414(m) or in Code (S)414(o)). If the
Employer is a member of a related group, the term "Employer" includes the
related group members for purposes of the definition of Employee, for
purposes of Section 1.15 of this Plan and for any other purpose required
by a Plan provision.
1.14 "Benefits" mean the executive compensation benefits, if any, which are
available to each Participant under this Plan in each Plan Year.
1.15 "Change in Control" means control of the Employer is transferred, there is
a transfer of any kind of more than twenty-five percent (25%) of the
assets or liabilities of the Employer, Medical Defense Associates, a stock
Missouri insurance company is downsized for any reason (determined by
either the decrease in number of insureds measured in any twelve (12)
month period of more than twenty-five percent (25%) from the initial
measuring date of January 1, 1998, or the decrease in number of insureds
in existence as of January 1, 1998, measured by report form "Count of
Insureds Per Class/Limits", by more than fifty percent (50%) during the
term of this Plan) or a majority of the members of any Employer's Board of
Directors are replaced during any twenty-five (25) month period beginning
after January 1, 1998, by directors whose appointment or election is not
endorsed by a majority of the members of such Employer's Board of
Directors prior to the date of said appointment or election.
ARTICLE II
EMPLOYEE PARTICIPATION
<PAGE>
2.01 Each Employee designated by the Employer by resolutions of its Board of
Directors shall immediately become a Participant in the Plan.
2.02 A Participant shall cease being a Participant in the Plan on the date that
he terminates employment with the Employer.
ARTICLE III
EXECUTIVE COMPENSATION BENEFITS
3.01 For the Plan Years ending December 31, 1998 1999, 2000, 2001 and 2002, the
Employer shall make Benefits available to each Participant who has
satisfied the accrual of benefit requirements in Section 3.05.
3.02 The Employer by resolutions of its Board of Directors shall determine the
amount of Benefits to be made available for each Participant.
3.03 The Employer shall notify each Participant of his Benefit available for
each Plan Year on or before the next following January 10.
3.04 The Employer will not make any forfeiture allocation under this Plan.
3.05 A Participant shall not be entitled to receive any Benefit for a Plan Year
unless he is employed by the Employer on the Accounting Date of the Plan
Year.
3.06 The Employer shall provide for accelerated Benefits to be available for
Participants who are employed by the Employer on the day before the
effective date of a Change in Control. The Employer shall notify such
Participant of the proposed acceleration of Benefits at least 20 days
before the effective date of the Change in Control, if date is known.
ARTICLE IV
PARTICIPANT ELECTION
4.01 A Participant who is entitled to receive Benefits for a Plan Year may
elect for each Plan Year to receive all or any portion of the Benefit in
cash or to defer all or any portion of the receipt of such Benefit by
directing the Employer to pay all or any portion of such Benefit in cash
directly to the Trustee of the Trust maintained between the Participant
and the Trustee pursuant to the terms of this Plan. The Participant shall
make this election for each Plan Year by notifying the Employer, on forms
prescribed by the Employer, of such election on or before the next
following January 20. The payment of the Benefit either to the Participant
or to the Trustee shall be made as soon as administratively possible after
Participant's election.
<PAGE>
4.02 A Participant who is entitled to receive Benefits due to acceleration
because of a Change in Control shall not be entitled to any election to
receive cash or to defer such receipt. The Employer will pay such Benefit
(due to acceleration because of a Change in Control) in cash directly to
the Participant on the day before such Change in Control.
4.03 The Employer, regardless if the Benefits are paid to the Participant or to
the Trustee, shall withhold from the Benefit any taxes required by law to
be withheld.
ARTICLE V
VOLUNTARY/ROLLOVER CONTRIBUTIONS
5.01 The Plan does not permit any voluntary contributions other than as
provided in Article IV.
5.02 A Participant, with the Employer's and the Trustee's written consent, may
contribute as a "Rollover Contribution" to the Participant's Trust all or
any portion of the cash or property received by the Participant from the
Participant's Executive Compensation Trust dated October 15, 1993 with
Commerce Bank, N.A., as trustee. This Rollover Contribution shall become a
portion of the Participant's Benefit.
ARTICLE VI
PARTICIPANT VESTING
6.01 A Participant's Benefit which becomes payable is 100% Nonforfeitable at
all times.
ARTICLE VII
PARTICIPANT'S TRUST
7.01 A Participant's right to Benefits held by the Participant's Trust shall be
paid to the Participant or Beneficiary upon the terms and conditions as
set forth in the Participant's Trust.
7.02 The Participant's Trust shall be in the form attached hereto, marked as
Exhibit A and incorporated herein by this reference.
7.03 The Employer will not be a party to Participant's Trust and will have no
right or interest in the Participant's Trust.
7.04 The Employer must supply current information to the Trustee as to the
name, date of employment, and date of termination of each Participant,
together with any other information which the Trustee deems necessary for
the administration of the Trusts.
<PAGE>
7.05 The Employer assumes no obligations or responsibility to any of the
Participants for any act of, or failure to act, on the part of the
Trustee.
7.06 The Employer shall pay all fees and expenses of each Trust in accordance
with the Trustee's regular published fee and expense schedule.
ARTICLE VIII
PARTICIPANT ADMINISTRATIVE PROVISIONS
8.01 Any Participant may from time to time designate, in writing, any person or
persons, to whom the Employer will pay his Benefit payable in the event of
his death. The Employer will provide the form for the written designation
of Beneficiary.
8.02 If a Participant fails to name a Beneficiary in accordance with Section
8.01, or if the Beneficiary named by a Participant predeceases him, then
the Employer will pay the Benefit payable to the Participant's estate.
8.03 Neither a Participant nor a Beneficiary may anticipate, assign or alienate
(either at law or in equity) any Benefit payable under the Plan.
Furthermore, a Benefit payable under the Plan is not subject to
attachment, garnishment, levy, execution or other legal or equitable
process.
ARTICLE IX
MISCELLANEOUS
9.01 Any person entitled to notice under the Plan may waive the notice.
9.02 The Plan is binding upon all persons entitled to Benefits under the Plan,
their respective heirs and legal representatives and upon the Employer,
its successors and assigns.
9.03 Words used in the masculine also apply to the feminine where applicable,
and wherever the context of the Plan dictates, the plural includes the
singular and the singular includes the plural.
9.04 Missouri law will determine all questions arising with respect to the
provisions of this Plan.
9.05 Nothing contained in this Plan, or with respect to the establishment of
the Trusts, or any modification or amendments to the Plan, or the payment
of any Benefit gives any Employee, Employee-Participant or any Beneficiary
any right to continue employment, or any legal or equitable right against
the Employer or its agents or Employee of the Employer, except as
expressly provided by the Plan.
<PAGE>
9.06 The Employer has the right at any time and from time to time to amend this
Plan in any manner or to terminate this Plan.
IN WITNESS WHEREOF, the Employer has executed this Plan the day and year
first above written.
MEDICAL DEFENSE SERVICES CORP.
(SEAL)
By: /s/ Ronald G. Benson
--------------------------------
Ronald G. Benson
Chief Executive Officer
ATTEST:
/s/ Samuel J. Pippin
- ----------------------------------------
Samuel J. Pippin
Assistant Treasurer
<PAGE>
Exhibit A
EXECUTIVE COMPENSATION TRUST AGREEMENT
THIS TRUST AGREEMENT, made this _____ day of ____________________________,
________, by and between _____________________________________________________
("Participant") and Commerce Bank, N.A. ("Trustee");
WITNESSETH:
WHEREAS, Participant is an employee of Medical Defense Services Corp. (the
"Employer");
WHEREAS, the Employer has adopted the Medical Defense Services Corp.
Executive Compensation Plan II (the "Plan") for the benefit of certain
employees, one of which is Participant;
WHEREAS, the Plan provides for rollover contributions and for discretionary
compensation benefits to be made available to Participant and further allows
Participant an election to receive the benefit in cash or to direct Employer to
pay such benefit directly to Trustee;
WHEREAS, it is the intention of the parties to establish a trust
(hereinafter called the "Trust") in order to implement the terms and conditions
of the Plan.
NOW, THEREFORE, the parties do hereby establish the Trust and agree that
the Trust shall be comprised, held and disposed of as follows:
SECTION 1
PURPOSE OF TRUST
(a) The Trust hereby established shall be irrevocable.
(b) The Trust is intended to be a grantor trust, of which Participant is
the grantor, within the meaning of subpart E, part I, subchapter J, chapter 1,
subtitle A of the Internal
<PAGE>
Revenue Code of 1986, as amended, and shall be construed accordingly.
(c) The principal of the Trust, and any earnings thereon shall be held
separate and apart from other funds of Employer and shall be used exclusively
for the uses and purposes as set forth herein.
SECTION 2
CONTRIBUTIONS TO TRUST
(a) The Employer shall, at the direction of Participant and pursuant to
the terms of the Plan, make contributions to the Trust.
(b) The Plan also allows Participant Rollover Contributions to the Trust.
(c) The Trustee must consent prior to a contribution of property.
SECTION 3
PAYMENTS BY TRUST
(a) The Trustee will make distributions from this Trust in accordance with
this Section 3. A distribution date under this Section 3, unless otherwise
specified within the Plan, is March 1 or as soon as administratively practicable
following a distribution date.
(b) Separation From Service.
(1) If Participant terminates employment from the Employer for any
reason other than death, and on or before December 31, 2002, Trustee shall
distribute all of the assets of the Trust in lump sum to Participant on the
distribution date of the first calendar year beginning after Participant's
termination of employment from the Employer and thereafter this Trust shall
terminate.
(2) If Participant has not terminated employment from the Employer on
or before December 31, 2002, Trustee shall distribute all of the assets of
the Trust in lump sum to Participant on the distribution date of the first
calendar year beginning after December 31, 2002, and thereafter this Trust
shall terminate.
(c) Death of Participant. Upon the death of Participant while this Trust
is still in
<PAGE>
existence, Trustee shall immediately distribute all of the assets of the Trust
in lump sum to Participant's Beneficiary and thereafter this Trust shall
terminate.
(d) Notwithstanding anything contained herein to the contrary, Participant
shall have the right without the consent of any other person to withdraw on a
calendar year basis the net income of the trust in an amount not to exceed
Participant's tax liability attributable to such net income. Trustee may rely on
Participant's written certification of such tax liability. Trustee shall
distribute such amount to Participant on or before the April 15 immediately
following such calendar year.
SECTION 4
BENEFICIARIES
(a) Participant may from time to time designate, in writing, any person or
persons to whom Trustee will pay the assets of the Trust payable in the event of
his death. Trustee will prescribe the form for the written designation of
Beneficiary.
(b) If Participant fails to name a Beneficiary in accordance with Section
4(a), or if the Beneficiary named by Participant predeceases him, Trustee will
pay the assets of the Trust to Participant's estate.
SECTION 5
INVESTMENT AUTHORITY
(a) All rights associated with assets of the Trust shall be exercised by
Trustee or the person designated by Trustee, and shall in no event be
exercisable by or rest with Participant, except as specified in Section 5(c) of
this Trust.
(b) With respect to the Trust, Trustee shall have the following powers and
rights, in addition to those vested in it elsewhere in this Trust Agreement or
by law:
<PAGE>
(1) To invest the Trust in such bonds, notes, debentures, mortgages,
equipment, trust certificates, investment trust certificates, preferred or
common stock, insurance and annuity contracts, common or collective trust
funds (including common or collective trust funds of Trustee), mutual
funds, or in such other property, real or personal, as Trustee may deem
advisable;
(2) To retain, manage, improve, repair, operate and control all
property, real or personal, at any time comprising part of the Trust;
(3) To manage, sell, contract to sell, grant options to purchase,
convey, exchange, partition, lease for any term (even though such term
commences in the future or may extend beyond the duration of the Trust),
and otherwise dispose of the assets of the Trust from time to time in such
a manner, for such consideration, and upon such terms and conditions as
Trustee in its discretion shall determine;
(4) To vote any corporate stock either in person or by proxy for any
purpose; to exercise or sell any stock subscription or conversion right; to
participate in voting trusts; to consent to, take any action in connection
with, and receive and retain any securities resulting from any merger,
consolidation, reorganization, readjustment of the financial structure,
liquidation, sale, lease, or other disposition of the assets of any
corporation or other organization the securities of which may constitute a
portion of the Trust;
(5) To keep any property in the name of a nominee with or without
disclosure of any fiduciary relationship;
(6) To take any action with respect to conserving or realizing upon
the value of any property in the Trust; to collect, pay, contest,
compromise, or abandon demands of or against the Trust; and
(7) To perform any and all acts in its judgement necessary or
desirable for the proper and advantageous administration and distribution
of the Trust.
(c) A Participant has the right to direct Trustee with respect to the
investment or reinvestment of the assets in the Trust only if the Trustee
consents in writing to permit such direction. If Trustee consents to
Participant direction of investment, Trustee will accept direction from the
Participant on a written election form containing such conditions, limitations
or other provisions which Trustee deems appropriate. Trustee and the Employer
<PAGE>
shall establish written procedures relating to Participant direction of
investment under this Section 5(c). Trustee is not liable for any loss resulting
from a Participant's direction of the investment of any part of the assets in
this Trust.
SECTION 6
DISPOSITION OF INCOME
During the term of this Trust, all income received by the Trust, net of
expenses and taxes, shall be accumulated and reinvested, except as otherwise
provided in Section 3(d) of this Trust.
SECTION 7
ACCOUNTING BY TRUSTEE
Trustee shall keep accurate and detailed records of all investments,
receipts, disbursements, and all other transactions required to be made,
including such specific records as shall be agreed upon in writing between
Participant and Trustee. Within 60 days following the close of each calendar
year and within 60 days after the removal or resignation of Trustee, Trustee
shall deliver or mail to Participant a written account of its administration of
the Trust during such year or during the period from the close of the last
preceding year to the date of such removal or resignation, setting forth all
investments, receipts, disbursements and other transactions effected by it,
including a description of all securities and investments purchased and sold
with the cost or net proceeds of such purchases or sales (accrued interest paid
or receivable being shown separately), and showing all cash, securities and
other property held in the Trust at the end of such year or as of the date of
such removal or resignation as the case may be.
SECTION 8
RESPONSIBILITY OF TRUSTEE
(a) Trustee shall act with the care, skill, prudence and diligence under
the circumstances then prevailing that a prudent person acting in like capacity
and familiar with such matters would use in the conduct of an enterprise of a
like character and with like aims, provided, however, that Trustee shall incur
no liability to any person for any action taken pursuant to a direction, request
or approval given by Participant which is contemplated by, and in conformity
with, the terms of the Plan or this Trust and is given in writing by
Participant. In the event of a dispute between Participant and Trustee, Trustee
may apply to a court of
<PAGE>
competent jurisdiction to resolve the dispute.
(b) Trustee shall have, without exclusion, all powers conferred on
Trustees by applicable law, unless expressly provided otherwise herein.
(c) Notwithstanding any powers granted to Trustee pursuant to this Trust
Agreement or to applicable law, Trustee shall not have any power that could give
this Trust the objective of carrying on a business and dividing the gains
therefrom, within the meaning of section 301.7701-2 of the Procedure and
Administrative Regulations promulgated pursuant to the Internal Revenue Code.
SECTION 9
COMPENSATION AND EXPENSES OF TRUSTEE
The Employer shall pay all administrative expenses and Trustee's fees (in
accordance with Trustee's published schedule of fees in effect from time to
time) and expenses, including reimbursement of Trustee's expenses incurred in
the performance of Trustee's services hereunder.
SECTION 10
RESIGNATION/REMOVAL OF TRUSTEE
(a) Trustee may resign at any time by written notice to Participant, which
shall be effective 30 days after receipt of such notice unless Participant and
Trustee agree otherwise.
(b) Trustee may be removed by Participant on 30 days notice or upon
shorter notice accepted by Trustee.
(c) Upon resignation or removal of Trustee and appointment of a successor
Trustee, all assets shall subsequently be transferred to the successor Trustee.
The transfer shall be completed within 60 days after receipt of notice of
resignation, removal or transfer, unless Participant extends the time limit.
<PAGE>
(d) If Trustee resigns or is removed, a successor shall be appointed, in
accordance with Section 11 hereof, by the effective date of resignation or
removal under paragraph (a) or (b) of this section. If no such appointment has
been made, Trustee may apply to a court of competent jurisdiction for
appointment of a successor or for instructions.
SECTION 11
APPOINTMENT OF SUCCESSOR
(a) If Trustee resigns or is removed in accordance with Section 10(a) or
(b) hereof, Participant may appoint any third party, such as a bank trust
department or other party that may be granted corporate trustee powers under
state law, as a successor to replace Trustee upon resignation or removal. The
appointment shall be effective when accepted in writing by the new Trustee, who
shall have all of the rights and powers of the former Trustee, including
ownership rights in the Trust assets. The former Trustee shall execute any
instrument necessary or reasonably requested by Participant or the successor
Trustee to evidence the transfer.
(b) The successor Trustee need not examine the records and acts of any
prior Trustee and may retain or dispose of existing Trust assets, subject to
Sections 7 and 8 hereof.
SECTION 12
AMENDMENT
This Trust Agreement may not be amended.
SECTION 13
MISCELLANEOUS
(a) Any provision of this Trust Agreement prohibited by law shall be
ineffective to the extent of any such prohibition, without invalidating the
remaining provisions hereof.
<PAGE>
(b) The assets of the Trust may not be anticipated, assigned (either at
law or in equity), alienated, pledged, encumbered or subjected to attachment,
garnishment, levy, execution or other legal or equitable process.
(c) This Trust Agreement shall be governed by and construed in accordance
with the laws of Missouri.
SECTION 14
EFFECTIVE DATE
The effective date of this Trust Agreement shall be ______________, 19____.
SECTION 15
COMBINATION OF TRUSTS
Trustee, at Trustee's discretion, may combine, for collective investment
purposes, into one trust fund this Trust and any other trust created pursuant to
the Plan. However, Trustee must maintain separate records of account for the
assets of each trust.
IN WITNESS WHEREOF, Participant and Trustee have caused this Trust
Agreement to be executed this _____ day of ___________________________________,
19____.
"PARTICIPANT"
---------------------------------------
"TRUSTEE"
COMMERCE BANK, N.A.
By:
------------------------------------
<PAGE>
EXHIBIT 11.1
MEDICAL DEFENSE HOLDING CO. AND SUBSIDIARIES
COMPUTATION OF EARNINGS PER SHARE
For the Years Ended December 31, 1997, 1996 and 1995
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Weighted average common shares outstanding................ 1,031,025 1,019,602 1,019,602
Weighted average common stock options
expressed as common stock equivalents................ 17,688,120 23,281,244 23,980,378
----------- ----------- -----------
Weighted average common shares outstanding................ 18,719,145 24,300,846 24,999,980
=========== =========== ===========
Net (loss) income (applicable to common stock) (1)........ $ 582,319 $(5,501,042) $ 1,198,665
=========== =========== ===========
Basic earnings per share (1).............................. $ 0.56 $ (5.39) $ 1.18
=========== =========== ===========
Diluted earnings per share (1)............................ $ 0.03 $ n/a (2) $ 0.05
=========== =========== ===========
</TABLE>
(1) In February of 1997, the Financial Accounting Standards Board published
Statement of Financial Accounting Standard No. 128, Earnings Per Share
("SFAS 128"), which requires certain changes in the reporting of earnings
per share. The Company was required to adopt SFAS 128 at December 31, 1997.
Additionally, MDHC was required to restate 1996 and 1995 earnings per share
data as previously presented.
SFAS 128 requires the computation of basic earnings per share ("EPS") and
diluted EPS. Basic EPS is computed by dividing income (loss) available to
common shareholders by the weighted-average number of common shares
outstanding for the period. Diluted EPS is computed by dividing income
(loss) available to shareholders by the weighted-average number of common
shares plus the weighted-average number of common share equivalents
outstanding for the period.
All of the Company's shares of preferred stock are convertible to common
stock at a ratio of two shares of common stock to one share of preferred
stock, and therefore, are considered common stock equivalents. The Company's
preferred stock has no stated dividend rate, and therefore, these securities
have no effect on computing basic EPS.
As discussed in Note 3, on October 16, 1997 and November 15, 1996, the
Company purchased 1,721,445 and 2,781,338 shares of its convertible
preferred stock, respectively. In addition, during December 1997, the
Company purchased 44,498 shares of its convertible preferred stock from a
small number of shareholders, at their request, on essentially the same
terms as the tender offer completed on October 16, 1997.
On June 26, 1995, MDA was converted to a stock insurance company and became
a wholly owned subsidiary of MDHC. Therefore the net income of $617,713
recorded by MDA as of June 30, 1995, is virtually entirely attributable to
preconversion results and, therefore, is excluded for 1995 earnings per
share presentation purposes.
(2) Anti-dilutive
<PAGE>
EXHIBIT 21.1
MEDICAL DEFENSE HOLDING CO. AND SUBSIDIARIES
SUBSIDIARIES OF REGISTRANT
<TABLE>
<CAPTION>
% of Voting Securities
Jurisdiction of Owned by its
Name of Corporation Incorporation Immediate Parent
------------------- --------------- ----------------------
<S> <C> <C>
Medical Defense Associates.......................................... Missouri 100%
Medical Defense Services Corp....................................... Missouri 100%
Medical Defense Insurance Company................................... Missouri 100%
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 7
<LEGEND> This schedule contains summary financial information extracted from
the Company's financial statements for the twelve months ended December 31, 1997
and is qualified in its entirety by reference to such financial statements.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<DEBT-HELD-FOR-SALE> 74,091,837
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 0
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 81,334,519
<CASH> 2,955,161
<RECOVER-REINSURE> 1,373,000
<DEFERRED-ACQUISITION> 0
<TOTAL-ASSETS> 89,930,625
<POLICY-LOSSES> 58,654,324
<UNEARNED-PREMIUMS> 6,059,398
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 252,429
<NOTES-PAYABLE> 0
<COMMON> 516,614
0
7,436,095
<OTHER-SE> 14,402,099
<TOTAL-LIABILITY-AND-EQUITY> 89,930,625
12,091,778
<INVESTMENT-INCOME> 5,278,764
<INVESTMENT-GAINS> 107,234
<OTHER-INCOME> 586
<BENEFITS> 13,300,937
<UNDERWRITING-AMORTIZATION> 154,784
<UNDERWRITING-OTHER> 2,207,116
<INCOME-PRETAX> 1,365,030
<INCOME-TAX> 782,711
<INCOME-CONTINUING> 582,319
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 582,319
<EPS-PRIMARY> .56
<EPS-DILUTED> .03
<RESERVE-OPEN> 63,205,000
<PROVISION-CURRENT> 13,505,569
<PROVISION-PRIOR> (204,632)
<PAYMENTS-CURRENT> 265,569
<PAYMENTS-PRIOR> 17,008,044
<RESERVE-CLOSE> 58,654,324
<CUMULATIVE-DEFICIENCY> (204,632)
</TABLE>
