The estimation of ultimate liability for losses and loss adjustment expenses is an inherently uncertain process and does not represent an exact calculation of that liability. We do not discount our reserves to recognize the time value of money. We maintain reserves for claims incurred but not reported to provide for future reporting of already incurred claims and developments on reported claims. The reserve for claims incurred but not reported is determined based on historical loss trends. Although considerable variability is inherent in such estimates, we believe that the reserve for unpaid losses and loss adjustment expenses is adequate. The methodology for making such estimates and establishing the resulting liabilities is continually reviewed, and any adjustments are reflected as an expense in the period in which the adjustment is made.
The reserve adjustments included a total of approximately $22.7 million increase on prior accident years, primarily the 1999 and 2000 years. In addition, the current accident year loss estimates were increased to approximately $145.9 million to reflect our revised assumptions regarding loss development patterns. The adjustments were made primarily as a result of losses in our Ohio, Florida and Kentucky medical professional liability markets. Ohio and Florida are relatively new markets for us and have higher policy limits. Thus, actual loss development can be volatile and difficult to predict. With these revised loss assumptions, the 2001 accident year net loss and loss adjustment expense ratio is 121.9%. We discontinued offering higher policy limits in Ohio and Florida in the third quarter of 2001.
Medical professional liability underwriting expenses were $23.3 million for the year ended December 31, 2001, an increase of $2.7 million, or 13.1%, compared to 2000. The underwriting expense ratio was 19.5% for the year ended December 31, 2001, compared to 18.8% for 2000. This increase was due primarily to the growth of premiums in states where we pay higher commissions than we pay in Michigan, where we have an arrangement with SCW Agency Group, Inc. where we pay commissions at rates that are lower than market. Our President and Chief Executive Officer is the principal owner of SCW Agency Group, Inc. In addition, we recorded the maximum ceded premium on all affected swing-rated reinsurance treaties due to the higher losses, which amounted to a $6.3 million increase in ceded premiums.
Health incurred loss and loss adjustment expenses totaled $18.4 million for the year ended December 31, 2001, an increase of $8.4 million or 84.0%, compared to 2000. The incurred loss and loss adjustment expense ratio increased to 98.7% for the year ended December 31, 2001, from 90.6% for 2000. The increase in loss ratio was due to overall increases in health care costs, primarily in the state of Michigan. We are increasing health insurance premium rates to offset these higher health loss costs.
We recorded $23.5 million in federal income tax benefit for the year ended December 31, 2001, compared to a $4.8 million expense during 2000, due to the loss for 2001. The effective tax rate was 34.9% for the year ended December 31, 2001, compared to 28.7% for 2000. The 2000 effective tax rate was lower due to the greater impact of tax exempt interest.
On March 9, 2002, new tax laws extended the net operating loss carryback period from two years to five years. As a result, approximately $12.4 million of the Company's net operating loss carryforward at December 31, 2001 will be utilized to recover taxes previously paid in tax years 1996, 1997, and 1998. This additional loss carryback will result in an increase to the reported federal income taxes recoverable with a corresponding decrease in deferred federal income taxes in the first quarter of 2002.
Losses and loss adjustment expenses increased $12.7 million, or 15.2%, to $96.0 million in 2000. The 2000 reported loss ratio was 87.6% compared to 86.5% in 1999. The accident year loss ratio, which excludes the effects of prior year developments of loss reserves, was 95.6% in 2000 compared to 107.0% in 1999. The medical professional liability loss ratio increase was due to higher losses in some of our newer markets, particularly Ohio and Florida.
Medical professional liability policy acquisition and underwriting expenses were $20.6 million in 2000 compared to $22.2 million in 1999. As a percentage of premiums earned, the medical professional liability
Losses and loss adjustment expense increased $8.5 million, or 29.1% to $37.7 million in 2000. The loss ratio was 80.3% in 2000 compared to 79.5% in 1999. The increase in loss ratio was the result of increased losses, partially offset by rate increases.
Workers' compensation underwriting expenses were $13.3 million in 2000 compared to $12.3 million in 1999. As a percentage of premiums earned, the underwriting expense ratio decreased to 28.3% in 2000, from 33.5% in 1999. This decrease was also due to the expense reduction measures that we began implementing in the fourth quarter of 1999, including the closing of our Indianapolis workers' compensation service office.
HEALTH INSURANCE OPERATIONS. Health net premiums earned were $11.1 million for the year ended December 31, 2000, a increase of $6.3 million, or 131.3%. The increase was primarily due to expansion of a preferred provider organization in western Michigan.
The personal and commercial loss ratio was 76.7% in 2000 and 81.9% in 1999. The 1999 personal and commercial loss ratio reflected higher winter storm losses.
CORPORATE, INVESTMENTS AND OTHER. Investment income, excluding realized investment gains, increased $6.2 million, or 20.2%, to $36.8 million in 2000. The increase reflects a shift of some of our portfolio from tax exempt securities to higher yield taxable corporate securities in the first quarter of 2000 and a higher amount of invested assets. Net realized investment gains were $1.2 million and $1.8 million during 2000 and 1999, respectively.
Additional restructuring charges of $919,000 were incurred in 2000. This includes approximately $802,000 in severance charges related to the elimination of 14 staff members located in our New Mexico and Lapeer branch offices and our health insurance operation at our East Lansing, Michigan home office. These events are expected to generate annual savings of approximately $2.0 million in salaries and rent. At December 31, 2000 there was $454,000 accrued for restructuring charges that were paid in 2001.
We recorded $4.8 million in federal income tax expense in 2000, compared to a refund of $23.8 million in federal income taxes during the same period in 1999. The effective tax rate was 28.7% in 2000, compared to
Total assets increased $60.9 million to $1.04 billion at December 31, 2001, compared to $978.0 million at December 31, 2000. The increase was due primarily to increases in reinsurance recoverables, federal income tax recoverable, and accrued investment income.
Loss and loss adjustment expense reserves increased $113.7 million to $597.0 million at December 31, 2001, from $483.3 million at December 31, 2000. This increase was due to increased writings in both the workers' compensation and medical professional liability lines and the reserve enhancements incurred in the third and fourth quarters of 2001.
In March 2001, our board of directors authorized the purchase of up to 5% of its then outstanding common stock, representing approximately 581,000 shares. The Company's purchase of any of its shares is subject to limitations that may be imposed by applicable securities laws and regulations and the rules of the Nasdaq Stock Market. The timing of the purchases and the number of shares to be bought at any one time depend on market conditions and our capital requirements. In July and November of 2001, our board of directors authorized the repurchase of a total of 1.1 million additional shares. As of December 31, 2001, the Company has purchased a total of 1,369,170 shares under the three authorized programs, at a cost of $25.2 million. The Company intends to continue repurchasing its shares, in the market and otherwise, when appropriate using available cash resources.
The Financial Accounting Standards Board has issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities," which is effective for fiscal years beginning after June 15, 2000 (as amended by SFAS Nos. 137 and 138). SFAS No. 133 requires that all derivative instruments be recorded on the balance sheet at fair value. Changes in the fair value of derivatives are recorded each period in current earnings or other comprehensive income, depending on whether a derivative is designated as part of a hedge transaction, and if it is, the type of hedge transaction. Because we currently do not use derivative instruments, the adoption of SFAS No. 133 did not affect our results of operations or financial position.
The FASB issued SFAS No. 144 "Accounting for Impairment or Disposal of Long-lived Assets." This Standard will be effective for the Company on a prospective basis, beginning January 1, 2002. SFAS No. 144 clarifies and revises existing guidance on accounting for impairment of property, plant, and equipment, amortized intangibles, and other long-lived assets not specifically addressed in other accounting literature. Management does not expect the adoption of this Standard to have a significant impact on our 2002 financial results.
To the Board of Directors and Shareholders of American Physicians Capital, Inc.
AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS DECEMBER 31, 2001 AND 2000
CONSOLIDATED STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
Federal income taxes of $8,481, $(28,104) and $(152) were paid (received), net in 2001, 2000, and 1999 respectively.
The Company purchased Stratton-Cheeseman Management Company during 1999. In conjunction with the acquisition, a liability of $955,000 was assumed and a note payable of $7.3 million was issued (Note 4).
AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and include the accounts of American Physicians Capital, Inc. ("APCapital") and its wholly-owned subsidiaries, Insurance Corporation of America ("ICA"), APSpecialty Insurance Company (formerly RML Insurance Company), ("APS"), APConsulting LLC, APDirect Sales, LLC, Alpha Advisors, Inc. and American Physicians Assurance Corporation ("APA"), formerly known as Mutual Insurance Corporation Of America ("MICOA"), together referred to as the "Company". All significant intercompany accounts and transactions are eliminated in consolidation.
All of the Company's fixed maturities are classified as available-for-sale, which are those securities that would be available to be sold in the future in response to the Company's liquidity needs, changes in market interest rates and asset-liability management strategies. Available-for-sale securities are reported at estimated fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of other comprehensive income, net of deferred taxes.
AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
value as they bear current market interest rates. Real estate is carried at historical cost, less accumulated depreciation. Real estate of $33,411,000 and $33,953,000 in 2001 and 2000, respectively and mortgage loans of $4,474,000 in 2001 and $4,605,000 in 2000 and are included in other investments on the balance sheet.
Insurance premium income is recognized on a daily pro rata basis over the respective terms of the policies in-force and unearned premiums represent the portion of premiums written which are applicable to the unexpired terms of policies in-force.
Reinsurance premiums and losses related to reinsured business are accounted for on basis consistent with those used in accounting for the original policies issued and the terms of the reinsurance contracts. Reinsurance recoverables and prepaid reinsurance premiums are accounted for in accordance with Statement of Financial Accounting Standards ("SFAS") No. 113, "Accounting and Reporting for Reinsurance." Premiums ceded to other companies have been reported as a reduction of premium income. Reinsured losses incurred are reported as a reduction of gross losses incurred.
The Financial Accounting Standards Board has issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", which is effective for fiscal quarters of all fiscal years beginning after June 30, 2000 (as amended by SFAS Nos. 137 and 138). SFAS No. 133 requires that all derivative instruments be recorded on the balance sheet at fair value. Changes in fair value of derivatives are recorded each period in current earnings or other comprehensive income, depending on whether a derivative is part of a hedge transaction, and if it is, the type of hedge transaction. Because the Company does not use derivative instruments, the adoption of SFAS No. 133 did not affect the Company's results of operations or financial position.
The FASB issued SFAS No. 144 "Accounting for Impairment or Disposal of Long-lived Assets." This Standard will be effective for the Company on a prospective basis, beginning January 1, 2002. SFAS No. 144 clarifies and revises existing guidance on accounting for impairment of property, plant, and equipment, amortized intangibles, and other long-lived assets not specifically addressed in other accounting literature. Management does not expect the adoption of this Standard to have a significant impact on the Company's 2002 financial results.
SFAS No. 130, "Reporting Comprehensive Income", requires unrealized gains or losses on the Company's available-for-sale securities to be included in other comprehensive income. Realized investment (losses) gains on securities held as of the beginning of the year totaling ($4,103,000) in 2001, $3,686,000 in 2000, and $1,348,000 in 1999, and had unrealized appreciation of $100,000 at the beginning of 2001, $4,139,000 at the beginning of 2000 and $412,000 at the beginning of 1999.
The composition of fixed maturities by maturity at December 31, 2001 was:
The amortized cost and estimated fair value of debt securities at December 31, 2001, by contractual maturity, are shown above. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Activity in unpaid losses and loss adjustment expenses during 2001, 2000, and 1999 is as follows:
Incurred loss and loss adjustment expenses for prior years increased during 2001 due to unfavorable development, and declined during 2000 and 1999 as a result of favorable development. The unfavorable development in 2001 was primarily the result of higher medical professional liability loss severities which occurred in the Company's Ohio, Florida and Kentucky markets. In addition, losses in certain new markets developed much higher than originally estimated. Management believes the estimate of the ultimate liability for losses and loss adjustment expenses at December 31, 2001 is reasonable and reflective of anticipated ultimate experience. However, it is possible that the Company's actual incurred loss and loss adjustment expenses will not conform to the assumptions inherent in the determination of the liability. Accordingly, it is reasonably possible that the ultimate settlement of losses and the related loss adjustment expenses may vary significantly from the estimated amounts included in the accompanying financial statements.
The Company's policy is to enter into reinsurance contracts only with highly rated reinsurers and periodically reviews these reinsurers for financial impairment. Reinsurance contracts do not relieve the Company from its obligations to policyholders. If the reinsurance company is unable to meet its obligations under existing reinsurance agreements, the Company remains liable for ceded reserves for unpaid losses and loss adjustment expense and unearned premiums.
The Company had reinsurance recoverables from the following reinsurers at December 31, 2001 and 2000:
Amounts due from reinsurers on the accompanying balance sheet consisted of the following:
On March 9, 2002, new tax laws extended the net operating loss carryback period from two years to five years. As a result, approximately $12.4 million of the Company's net operating loss carryforward at December 31, 2001 will be utilized to recover taxes previously paid in tax years 1996, 1997, and 1998, and will be reflected in the first quarter of 2002.
Under SFAS No. 107, the Company's investment securities, cash and cash equivalents, premiums receivable, reinsurance recoverable on paid losses, and note payable constitute financial instruments. The carrying amounts of all financial instruments, other than investment securities, which are presented in Note 5 approximated their fair values at December 31, 2001 and 2000.
In November 1999, the Company closed two offices in Indiana and Ohio and restructured the home office staff. A total of 35 people, primarily clerical staff, were terminated at the time of the office closure and restructuring. These events resulted in a charge of approximately $955,000, including $802,000 of severance costs and $74,000 of out-placement services.
At December 31, 2001, substantially all activities related to the office closings were complete.
Prior to the acquisition of SCMC, the Company had no employees and contracted with SCMC to provide management services to the Company through October 31, 1999. The aggregate amount paid to SCMC during 1999 approximated $29,533,000, including management fees of $3,209,000. The remaining amounts paid related to pass-through costs, primarily for compensation costs and related employee benefit expense.
The note payable to an officer of the Company represents the remaining installment payments due to the former owner of SCMC discounted at 6%. This note aggregated $7,194,000 and $7,817,000, at December 31, 2001 and 2000, respectively (see Note 4).
The president of the Company is a majority owner of SCW Agency Group, Inc., formerly Stratton Cheeseman & Walsh, Inc., an agency that sells the Company's medical professional liability insurance in Michigan, Illinois, Kentucky, Florida and Nevada. Direct premiums written by the agency during 2001, 2000 and 1999 totaled $68,896,000, $67,758,000, and $71,902,000, respectively, representing, 29.9%, 33.4% and 37.9% of direct premiums written during such years. Commission expense incurred related to SCW Agency Group, Inc. approximated $4,660,000, $4,633,000, and $4,811,000 in 2001, 2000 and 1999, respectively.
The agency leases approximately 10,000 sq. feet of office space from the Company and the Company received $216,000, $192,000 and $175,000 in rental income in 2001, 2000 and 1999 respectively.
Certain executive officers, board members and employees have been granted options to purchase shares of APCapital common stock. Options granted during 2000 vest in annual installments of 10%, 15%, 20%, 25% and 30% on the first through the fifth anniversaries, respectively, of the date of grant. Options granted during 2001 vest in annual installments of 33%, 33%, and 34% on the first through the third anniversaries, respectively, of the date of grant. All options expire on the tenth anniversary of the grant date.
The Company accounts for its stock-based compensation in accordance with APB Opinion No. 25, "Accounting for Stock Issued to Employees" and related interpretations. The Company's policy regarding stock options is to issue options with an exercise price equal to the market price on the date of grant. Accordingly, no compensation expense has been recognized for options granted in 2001 and 2000. Had
compensation expense for the options been recognized based on the fair value at the grant date consistent with SFAS No. 123, "Accounting for Stock-Based Compensation," the Company's net income and net income per common share-assuming dilution would have been reduced to the pro forma amounts below:
As the Company was in a net loss position for the year ended December 31, 2001, no effect of awards or options were calculated as the impact would be anti-dilutive.
APA, APSpecialty 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 statutory accounting practices encompass all accounting practices not so prescribed. Such practices vary in certain respects from GAAP. The principal variances are as follows:
- Deferred policy acquisition costs are charged against operations as incurred for statutory accounting purposes.
- Unpaid losses and loss adjustment expense and unearned premiums are reported net of the impact of reinsurance for statutory accounting purposes.
The following is statutory surplus at December 31, 2001, 2000, and 1999 and net (loss) income for the years then ended.
The Company is organized and operates principally in the property and casualty insurance industry and has five reportable segments -- medical professional liability, workers' compensation, personal and commercial, other insurance, and corporate and investments. The accounting policies of the segments are the same as those described in the basis of presentation. Expense allocations are based primarily on loss and loss adjustment expenses by line of business and certain other estimates for underwriting expenses; reported segment results would change if different methods were applied. The Company does not allocate assets, investment income and income taxes to operating segments. Segment information, for which results are regularly reviewed by management in making decisions about resources to be allocated to the segments and assess their performance, is summarized as follows:
These condensed financial statements should be read in conjunction with the accompanying consolidated financial statements and notes thereto of American Physicians Capital, Inc. and subsidiaries.
American Physicians Assurance Corporation -- a stock insurance company incorporated under Michigan law (APA), formerly MICOA.
Insurance Corporation of America -- a stock insurance company incorporated under Michigan law (ICA).
APSpecialty Insurance Company -- a stock insurance company incorporated under Michigan law (APS), formerly RML Insurance Company.
APDirect Sales, LLC -- a Michigan corporation that serves as APCapital's direct sales channel.
Alpha Advisors, Inc. -- an Illinois corporation that provides investment management services.
APManagement Ltd. -- A Bermuda company that provides management and compliance services to APIndemnity and to clients and prospects of the financial group.
On December 13, 2000, the conversion of APA from a mutual company to a stock corporation was consummated according to a Plan of Conversion adopted by the board of directors of MICOA on June 28, 2000, with subsequent amendment on October 2, 2000. This plan was approved by MICOA policyholders at a special meeting held on November 29, 2000 and by the State of Michigan Office of Financial and Insurance Services. The Plan of Conversion included several key components, including: formation of APCapital to be the ultimate parent holding company; the conversion of APA from a mutual insurance company to stock company and wholly-owned by APCapital; the transfer of ICA, APS, APConsulting, APDirect Sales, and Alpha Advisors, Inc. from APA to wholly-owned subsidiaries of APCapital.