The 1999 results include an $8.1 million decrease in reserves for unpaid claim and claim settlement expenses to reflect favorable development of prior period claims compared to the 1998 results which include an $11.0 million increase in reserves for unpaid claim and claim settlement expenses, of which we recorded $3.0 million in the first quarter of 1998 and $8.0 million in the fourth quarter of 1998 to reflect adverse development of prior period claims. Additionally, the 1998 results included a $400,000 Minnesota Special Compensation Fund (SCF) adjustment recorded in the second quarter of 1998. The SCF assesses us to cover the costs of second injuries that are substantially greater, because of a pre-existing physical impairment, than what would have resulted from the second injury alone.
Investment Income and Net Realized Investment Gains: Our investment income includes earnings on our investment portfolio. Net realized investment gains include gains and losses from sales of available-for-sale securities and are displayed separately on our Consolidated Statement of Operations. We currently invest entirely in U.S. domiciled investment grade taxable and tax-exempt fixed maturity investments and classify our investments as available-for-sale. We intend to hold our available-for-sale investments to maturity, but may sell before maturity in response to changes in interest rates, prepayment risk and funding sources or terms, or to address liquidity needs. Our primary investment objective is to maintain a diversified, high-quality, fixed-investment portfolio structured to maximize our after-tax investment income without taking inappropriate credit risk. For further discussion of investments, see the “Investments” section of this Management’s Discussion and Analysis.
under our workers’ compensation insurance policies. These include claims that have been reported but not settled and claims that have been incurred but not yet reported to us. For further discussion of reserve determination, see the “Unpaid Claim and Claim Settlement Expenses” section of this Management’s Discussion and Analysis.
The ultimate result of the above factors, combined with the change in premium rates, on 2000 claim and claim settlement expenses as a percent of premiums earned is unknown at this time.
Policy Acquisition Costs: Policy acquisition costs are costs directly related to writing an insurance policy and consist of commissions, state premium taxes, underwriting personnel costs and expenses, sales and marketing costs and other underwriting expenses, and ceding commissions adjustments with our reinsurers. Ceding commissions are amounts that reinsurers pay to us for placing reinsurance with them. Ceding commissions represent adjustments based on actual claim and claim settlement expenses related to premiums ceded in prior years. Under our reinsurance agreements, ceding commission is adjusted to the extent that actual claim and claim settlement expenses vary from levels specified in the agreements.
We incurred ceding commission expense totaling $321,000 in 1999 compared to no cost in 1998 and a cost of $1,000 in 1997.
The reorganization effected in the fourth quarter of 1999 began earlier in 1999 and resulted in a net reduction of thirty-three positions. This reorganization has reduced costs and centralized and strengthened certain processes.
Our need for additional capital is primarily the result of regulations that require certain ratios of capital to premiums written. In the future, we expect that our need for additional capital will be primarily related to the growth of our insurance subsidiary and the need to maintain appropriate capital to premium ratios as defined by state regulatory bodies. As an alternative to raising additional capital, we believe we could secure quota-share or other additional reinsurance that would have the effect of reducing the ratio of premiums to capital and could be used to satisfy state regulatory requirements.
On September 15, 1998, our Board of Directors approved a share repurchase program authorizing us to repurchase, from time to time, up to $4,000,000 of RTW, Inc. common stock. We will repurchase the shares on the open market or through private transactions depending upon market conditions and availability. Through December 31, 1999 we had repurchased 19,500 shares for approximately $87,000. The repurchased shares will be used for employee stock option and purchase plans and other corporate purposes.
The National Association of Insurance Commissioners (NAIC) has risk-based capital standards to determine the capital requirements of a property and casualty insurance carrier based upon the risks inherent in its operations. These standards require the computation of a risk-based capital amount which is then compared to a carrier’s actual total adjusted capital. The computation involves applying factors to various financial data to address four primary risks: asset risk, insurance underwriting risk, credit risk and off-balance sheet risk. These standards provide for regulatory intervention when the percent of total adjusted capital to authorized control level risk-based capital is below certain levels. Based upon the risk-based capital standards, our percent of total adjusted capital is substantially in excess of authorized control level risk-based capital.
We have audited the accompanying consolidated balance sheets of RTW, Inc. and subsidiary (the Company) as of December 31, 1999 and 1998, and the related consolidated statements of operations, other comprehensive income (loss) and shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 1999. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
Depreciation - We depreciate furniture and equipment on a straight-line basis over the estimated useful lives of the assets (five to ten years). Accumulated depreciation in 1999 and 1998 was $3,879,000 and $2,951,000, respectively.
We ceded Minnesota claims in excess of $290,000, $280,000 and $1,080,000 per occurrence during 1999, 1998 and 1997, respectively, to the Minnesota Workers’ Compensation Reinsurance Association (WCRA). In our non-Minnesota states, we decreased our per-incident exposure to $300,000 in 1999 from $500,000 in 1998 and 1997. We purchased this coverage from various reinsurers in 1998 and 1997 and limited the coverage to one reinsurer in 1999. Additionally, for claims occurring after June 30, 1998, we further limited our per incident exposure by purchasing excess of loss coverage for losses from $25,000 to the WCRA selected retention level in Minnesota and from $25,000 to $300,000 in other states from a single reinsurer. This agreement was finalized after its effective date and activity occurring from July 1, 1998 through September 30, 1998 was recorded on a retrospective basis resulting in the deferral of a gain totaling $1,989,000 at December 31, 1998. We amortized $740,000 of the deferred gain as a reduction of claim and claim settlement expenses in 1999 resulting in an un-amortized deferred gain of $1,249,000 at December 31, 1999. The deferred gain is being amortized into income using the effective interest rate inherent in the amounts paid to the reinsurer and the estimated timing and amounts of recoveries from the reinsurer. Activity occurring on or after October 1, 1998 is recorded prospectively.
The effect of ceded reinsurance on premiums written and claim and claim settlement expenses are as follows (000’s):
No valuation allowance was provided against the deferred tax assets recorded in 1999 or 1998, as we expect to generate sufficient taxable income in the future to offset reversing temporary differences.
Non-Qualified Common Stock Options - Certain non-qualified options were issued prior to the onset of the 1994 Stock Plan. Non-qualified options exercised and outstanding are as follows:
In connection with the closing, each member of the Prosser Selling Group is required to enter into a standstill and voting agreement under which each agrees, for a period of two years following the transaction, not to: (i) acquire additional securities of RTW; (ii) initiate, solicit or propose any corporate transaction such as a merger, reorganization, liquidation, sale or transfer of assets of RTW; (iii) initiate, solicit, support or propose a change in the composition of our Board of Directors or management; (iv) propose any material change in our business or corporate structure, our articles of incorporation or bylaws and make, participate or solicit any proxy to vote or seek to influence any other RTW shareholders with respect to RTW voting securities. Each member of the Prosser Selling Group will also agree to (i) vote his or her shares as recommended by our Board of Directors or in the same proportion as other RTW shareholders vote, and (ii) grant to the Chair of the Special Committee or his designee or successor, a conditional proxy with respect to such member’s shares.
Under the terms of the agreement, we borrowed $6.0 million under a 90-day term loan agreement with a bank and advanced the proceeds to the Prosser Selling Group for a security interest in the shares owned by the group. This term loan is subject to interest at a LIBOR adjusted rate (8.31% at February 29, 2000). We expect to replace the 90-day term loan and fund the remaining repurchase price of the shares in March 2000 with an $8.0 million term loan agreement and $2.0 million revolving credit facility to be used for general corporate purposes. We expect the term loan will accrue interest, payable quarterly, at an adjusted LIBOR rate and expect principal maturities due as follows (000’s):