Our loss experience is a major component of our results of operations. When we receive notice of a claim that is covered under a policy we have issued, our claims adjusters establish a reserve for the expected cost to settle the claim, including estimates of any related legal or other expenses associated with resolving the claim. These reserves are referred to as “case basis” reserves. In addition, at the end of each reporting period, certain losses will have occurred that have not been reported to us. Accordingly, we establish reserves for such incurred but not reported, or IBNR, losses and related loss adjustment expenses. Our incurred loss and loss adjustment expenses represent any payments made to settle losses, including related loss adjustment expense payments, as well as any change in our case basis and IBNR reserves.
SCW has been a significant agent for us for many years. The commission rates we have paid to SCW have been either the same or less than the commission rates we paid to our other agents. In addition, with limited exceptions, the only medical professional liability insurance sold by SCW in Michigan was written by the Company. We are not required to sell insurance solely through SCW. We believe these factors have created a more favorable agency relationship for us than we have with our other agents.
A portion of the coverage that physicians purchase under claims-made policies is for an additional death, disability and retirement (“DDR”) insurance benefit. This DDR coverage provides coverage to the physician for any prior incidents occurring during the coverage period that are reported after their death, disability or retirement. The loss exposure associated with this product is known as extended reporting period claims. The reserve for extended reporting period claims coverage is recorded during the term of the original claims-made policy, based on the present value of future estimated benefits, including morbidity and mortality assumptions, less the present value of expected future premiums associated with this DDR coverage. The reserves for these claims fluctuate based on the number of physicians who are eligible for this coverage and their age. Any changes in the DDR reserves are reflected as an expense in the period in which we become aware that an adjustment is necessary. At December 31, 2004 and 2003, our recorded DDR reserves were $14.0 million, which includes a discount related to the present value calculation of approximately $5.9 million.
General and administrative expenses increased $1.0 million during 2004, primarily due to increased legal, audit and other professional fees incurred as a result of actions taken to comply with the Sarbanes-Oxley Act and related SEC requirements and the exploration of strategic alternatives by the Board of Directors. We anticipate general and administrative expenses to decrease in 2005 to levels below those incurred in 2004, but not as low as previously experienced in prior years as the Company will continue to incur costs associated with ongoing Sarbanes-Oxley compliance.
Our net premiums written and earned during 2004 increased a greater percentage than direct premiums written as effective January 1, 2004 we began retaining a 30% participation in our primary excess of loss reinsurance layer. This increase in net written premiums also resulted in the larger percentage increase in net earned premiums. Effective January 1, 2005, we will only have one excess of loss reinsurance treaty. This treaty will provide $1.5 million of coverage on losses in excess of $500,000, except in Michigan where we will retain the first $1 million of exposure. Our participation in the treaty will be 20% during 2005. We do not anticipate that these changes will have a material impact on either premiums or losses in 2005.
APCapital’s only material assets are the capital stock of American Physicians and its other subsidiaries, cash obtained from the proceeds from its junior subordinated deferrable interest debentures, or debentures, issued in 2003, and dividends from its subsidiaries. APCapital’s ongoing cash flow will consist primarily of dividends and other permissible payments from its subsidiaries and investment earnings on funds held. The payment of dividends to APCapital by its insurance subsidiaries is subject to limitations imposed by applicable law. APCapital’s primary uses of cash, on both a short and long-term bases include periodic interest payments, operating expenses, and the repayment of the debentures. In January 2004, APCapital made a $25 million cash surplus contribution to American Physicians to increase its statutory capital and surplus. In December 2004, American Physicians, paid an $8 million dividend to APCapital to ensure that the holding company had cash to service debt costs and other operating expenses. In addition, this allowed APCapital the ability to make a surplus contribution of $4.0 million to Insurance Corporation of America, to meet regulatory requirements concerning adequate surplus levels. APCapital also received a dividend of $800,000 from its subsidiary APIndemnity in December 2004. After the dividends and contribution, APCapital’s cash and cash equivalent resources totaled approximately $4.2 million, which will be held at APCapital for future debt service costs. The $4.2 million of cash and cash equivalents held at APCapital is adequate to service interest payments on the debentures for over two years.
(ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
In our opinion, management’s assessment that American Physicians Capital, Inc. did not maintain effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, because of the effect of the material weakness described above on the achievement of the objectives of the control criteria, American Physicians Capital, Inc. has not maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
Changes in deferred policy acquisition costs for the years ended December 31, 2004, 2003, and 2002 are summarized as follows:
In 2003, the Company formed American Physicians Capital Statutory Trust I and APCapital Trust II (the “Trusts”) by contributing equity of $464,000 to each trust. The trusts were formed for the purpose of issuing mandatorily redeemable trust preferred securities (“TPS”). Each trust issued $15 million of TPS to another trust formed by an institutional investor. The trusts received a total of $29.1 million in net proceeds, after the deduction of a total of approximately $906,000 of commissions paid to the placement agents in the transactions. These commissions were ultimately paid by APCapital, and have been capitalized and are included in other assets on the accompanying Consolidated Balance Sheet. Issuance costs will be amortized over five years as a component of amortization expense.
expected to reverse, and has determined, based on its reported net losses in 2003 and 2002, that sufficient taxable income may not exist in the periods of reversal. Accordingly, the Company has recorded a deferred tax asset valuation allowance for the entire net deferred tax asset.
The following table reflects the number of shares repurchased during the years ended December 31, 2004, 2003 and 2002, the cost of shares repurchased, the average price per share repurchased during those periods, as well as the cumulative inception to date totals.
American Physicians, APS and ICA, domiciled in the State of Michigan, are included in the accompanying Consolidated Financial Statements in accordance with GAAP. These organizations are subject to regulation by the State of Michigan Office of Financial and Insurance Services and file financial statements using statutory accounting practices prescribed or permitted by the state insurance regulators. Prescribed statutory accounting practices include a variety of publications of the National Association of Insurance Commissioners (“NAIC”), as well as state laws, regulations and general administrative rules. Permitted
Effective March 31, 2004, ownership of APS was transferred from the holding company, APCapital, to American Physicians as a surplus contribution. The amount of statutory surplus reflected at December 31, 2004 does not include APS’s surplus as it is already recorded by American Physicians.
APSpecialty Insurance Corporation - a stock insurance company incorporated under Michigan law (APSpecialty), formerly RML Insurance Company.