The Company leases approximately 47,000 square feet of space from the Medical Society of New Jersey in Lawrenceville, New Jersey, where its home office operations are located. The lease agreement, which expires on September 30, 2003,includes an option to renew for a term of two years on October 1, 2003, and a separate option to renew for a term of three years on October 1, 2005, and terminating on September 30, 2008. The Company is currently assessing its home office space requirements. During 2002, the Company closed its two
(2) Basic and diluted loss per share of Common Stock for the year ended December 31, 2002 is computed using the weighted average number of common shares outstanding during the year of 13,385,124.
The following discussion should be read in conjunction with the consolidated financial statements and the related notes thereto appearing elsewhere in this Annual Report. The consolidated financial statements for 2002 include the accounts and operations of The MIIX Group and its wholly-owned subsidiaries.
Reinsurance. Reinsurance recoverables include the balances due from reinsurance companies for paid and unpaid losses and ALAE that will be recovered from reinsurers, based on contracts in force. Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policy. Reinsurance contracts do not relieve the Company from its primary obligations to policyholders. Failure of reinsurers to honor their obligations could result in losses to the Company. The Company evaluates the financial condition of its reinsurers and monitors concentrations of credit risk with respect to the individual reinsurers, which participate in its ceded programs to minimize its exposure to significant losses from reinsurer insolvencies. The Company holds collateral in the form of letters of credit or trust accounts for amounts recoverable from reinsurers that are not designated as authorized reinsurers by the domiciliary Departments of Insurance.
Loss and Loss Adjustment Expenses. The Company estimates its liability for losses and LAE using actuarial projections of ultimate losses and LAE and other quantitative and qualitative analyses of conditions expected to affect the future development of claims and related expenses. The estimated liability for losses is based upon paid and case reserve estimates for losses reported, adjusted through judgmental formulaic calculations to develop ultimate loss expectations; related estimates of incurred but not reported losses and expected cash reserve developments based on past experience and projected future trends; deduction of amounts for reinsurance placed with reinsurers; and estimates received related to assumed reinsurance. Amounts attributable to ceded reinsurance derived in estimating the liability for loss and LAE are reclassified as assets in the consolidated balance sheets as required by FAS No. 113. The liability for LAE is provided by estimating future expenses to be incurred in settlement of claims provided for in the liability for losses and is estimated using similar techniques.
o Incurred Development Method o Bornhuetter-Ferguson Method o Frequency-Severity Method o ALAE-to-Indemnity Ratio Method o Audit Method
The Company also has direct and assumed liabilities under covered extended reporting endorsements associated with claims-made policy forms, which generally provide, at no additional charge, continuing coverage for claims-made insureds in the event of death, disability or retirement. These liabilities are carried within unearned premium reserves and are estimated through formula calculations that have been verified by the Company's independent actuarial firm using techniques, which possess elements of both loss reserves and pension liabilities, and thus include additional assumptions for mortality, morbidity, retirement, interest and inflation.
Investments. The Company has designated its entire investment portfolio as available-for-sale. As such, all investments are carried at their fair values. The fair value of securities is based upon quoted market prices when available. Where market prices or broker quotations are not available, the fair value is estimated based upon discounted cash flow, applying current interest rates for similar financial instruments with comparable terms and credit quality. The estimated fair value of a financial instrument may be significantly different from the amount that could be realized if the security were sold immediately.
The Company's business is subject to a number of risks and uncertainties, including the following:
During the quarter ended December 31, 2002, the Company recorded an adjustment of $20.5 million to net loss and LAE reserves. The effect of the latest reserve adjustment was to further erode MIIX's Risk Based Capital ("RBC") to $18.7 million, which is substantially below the Mandatory Control Level specified in the New Jersey insurance statutes. At the Mandatory Control Level, the Insurance Commissioner of the New Jersey Department of Banking and Insurance is authorized to place MIIX in supervision, rehabilitation or liquidation. The Company's insurance subsidiary, MIIX, is in discussions with the New Jersey Insurance Commissioner about potential additional regulatory actions. The Company cannot determine the form of the regulatory supervision that may be instituted by the Commissioner.
Indemnity Payments in Medical Professional Liability Cases are Rising and There is a Risk that a Very High Jury Award Could be Rendered Against the Company.
During the past several years, the Company has experienced very high jury verdicts and settlements against its insureds and its insureds will, in all likelihood, continue to be subject to high awards in the future. High jury awards lead to high settlement amounts, and both result in increased losses to the Company. This risk is heightened by the failure of states in which the Company does business, particularly New Jersey and Pennsylvania, to
The Company has recognized net investment losses in its investment portfolio of $3.5 million and $2.2 million, respectively, in each of 2002 and 2001 due to declines in investment values of securities held in the portfolio. The Company has also experience reduced investment income due to lower market yields. In addition, the Company began repositioning the portfolio in 2002 to manage the runoff of the Company's insurance subsidiaries. As a result of selling in a declining market, the Company recognized losses on some of the securities it sold. In addition, approximately $263.0 million has been invested in short-term investments to provide for an expected acceleration of claims. If claim payments continue at current levels these short-term investments will be inadequate and the investment portfolio will be diminished faster than anticipated. Further declines in the value of its investment portfolio could impact on the Company's statutory surplus and result in further regulatory action with respect to the Company, including rehabilitation or liquidation of the Company.
The Company's Reinsurance Coverage Could be Impacted By Continued Operating Losses or Additional Loss and ALAE Reserve Adjustments.
In March 2003, the New York Stock Exchange ("NYSE") notified The MIIX Group that it no longer satisfied one of the applicable listing criteria and that its stock was subject to delisting. MIIX Group is now below criteria as its total market capitalization is less than $50 million over a 30 trading day period and its stockholder equity is now less than $50 million. The Company is currently subject to oversight by the NYSE as a result of failing to meet the stock price and minimum capitalization requirements in 2002. The Company believes that there is a substantial likelihood that it will not be able to cure these latest deficiencies and that its Common Stock will be delisted from the NYSE in the coming year. If so, The MIIX Group may qualify to trade its Common Stock on the OTC Bulletin Board or in the "pink sheets" maintained by the National Quotation Bureau, Inc. Delisting from the NYSE would likely significantly decrease the liquidity of The MIIX Group Common Stock and make it more difficult for stockholders to sell their Common Stock, which could reduce the trading price and increase transaction costs of trading their shares.
At the current time, the Company is attempting to diversify its business by providing third party administration and consulting services to medical malpractice companies and other health care organizations. There is no assurance that the Company will be successful in obtaining new customers in connection with their new service business. At the current time, the Company only has one customer, MIIX Advantage, for these services. Even if the Company was to obtain more customers for these services, the Company is required to obtain the approval of the New Jersey Insurance Commissioner. The Company may not receive the Insurance Commissioner's approval of its business strategy.
Advantage. The loss of any of its key executives and/or senior managers may materially, adversely impact the Company's ability to continue to manage its business effectively.
The Company's cash flow has declined significantly over the past two years as a result of increased losses and loss of premium revenue. The Company expects that its cash flow will continue to decline substantially. In addition, given that MIIX's RBC is below the Mandatory Control Level, the New Jersey Insurance Commissioner could take further regulatory action that would have the effect of reducing the Company's cash flow. The Company currently does not have any sources of liquidity other than the revenues from MIIX Advantage, net investment income, proceeds from the sales of securities and reinsurance recoverables. It does not maintain any credit facilities and it is unlikely that it could access the capital markets in the foreseeable future. Any further significant reduction in the Company's cash flow would have a material adverse effect on the Company's financial condition, and could result in bankruptcy or insolvency of the Company. Based on current information, the Company believes that it will have sufficient cash to operate its business this year. See "Management's Discussion and Analysis of Financial Condition and Results of Operation -- Liquidity and Capital Resources."
The Company is Subject to Litigation That Could Have a Material Adverse Effect on Its Financial Condition.
Because of the foregoing risks and uncertainties, the Company's financial statements and the discussion that follows in Management's Discussion and Analysis of Financial Condition and Results of Operation should not be relied upon by investors as predictive of future results.
The Aggregate Contract in 2002 provided coverages on an aggregate excess of loss and quota share basis. The primary coverage afforded under the Aggregate Contract attaches above a Company retention measured as a 65% loss and allocated loss adjustment expense ratio ("loss and ALAE ratio"). Reinsurers provide coverage for an additional 75% loss and ALAE ratio, with an aggregate annual limit of $100 million. The Company has maintained aggregate excess of loss coverage generally similar to that described above since 1993.
The Company's underwriting expenses decreased during 2002 primarily due to the Company having ceased insurance operations resulting in reduced commissions, premium taxes, and a reduction in compensation and benefits resulting from downsizing actions taken during 2002.
YEAR ENDED DECEMBER 31, 2002, COMPARED TO YEAR ENDED DECEMBER 31, 2001
approximately $4.9 million associated with the commutation of a large institutional policy during the fourth quarter of 2002. Assumed premiums earned decreased by $0.4 million or 100.0% to $0 from $0.4 million in 2001 primarily due to nonrenewal of a large poorly performing excess of loss reinsurance contract effective January 1, 2001. Ceded premiums earned decreased by $8.1 million or 12.1% to $59.3 million in 2002 from $67.5 million in 2001 primarily due to lower direct earned premium, offset by additional ceded premiums of $44.8 million associated with the reserve adjustment during 2002 as compared to $40.1 million associated with the reserve adjustment during 2001.
Total premiums written in 2002 were $96.2 million, a decrease of $135.7 million, or 58.5% from total premiums written of $231.9 million in 2001. The net decrease in total premiums written is primarily due to the Company's cessation of writing or renewing premiums in all states, in accordance with each state's specific non-renewal requirements.
NET INVESTMENT INCOME. Net investment income decreased $19.4 million, or 24.2%, to $60.8 million in 2002 from $80.2 million in 2001. The decrease was primarily attributable to the combined effects of lower market yields and a decrease in average invested assets resulting mainly from claims payments and a corresponding increase in average short-term investments held during 2002. Because two of the Company's insurance subsidiaries, MIIX and LP&C, are in solvent runoff, the Company is modifying its investment portfolio to (1) manage an expected increase in accelerated claims and a lower invested asset base and (2) improve the overall average credit quality of the portfolio. This modification involves selling the portfolio's longer duration securities, opportunistically selling below investment grade holdings and using the proceeds to acquire shorter duration, high quality securities. The Company is attempting to modify the duration and credit quality of the portfolio, however, at a time when the market is extremely volatile. Accordingly, the Company has experienced and may potentially experience losses primarily in the sale of its below investment-grade securities.
for the fourth quarter ended December 31, 2002 to maintain the loss and LAE reserve at management's best estimate levels. Loss and LAE reserve for the quarter ended December 31, 2002 included an increase to direct and assumed loss and LAE reserves of $85.1 million reduced by ceded loss and ALAE reserves of $64.6 million. Adjustments to direct and assumed loss and LAE reserves included a net increase in Pennsylvania hospitals of $42.0 million, a net increase to New Jersey physicians business of $34.7 million, a decrease to Pennsylvania physicians of $6.1 million and a net increase to all other states hospitals and physicians business of $10.1 million and $4.4 million, respectively. The net adjustment primarily reflects adverse severity trends, and to a certain extent acceleration of claims, particularly with respect to Pennsylvania hospital claims and to New Jersey physicians for coverage years prior to 1999.
For the three months ending March 31, 2002, the Company strengthened loss reserves based on updated actuarial information, which became available as of March 31, 2002. The Company recorded a $29.5 million net adjustment to loss and LAE reserves as of March 31, 2002. Prior year gross and ceded loss and LAE reserves were increased by $54.5 million and $25.0 million, respectively. The strengthening in prior year gross loss and LAE reserves consists of $31.3 million attributable to physician business written by LP&C for the coverage years of 1998-2001, $31.3 million related to New Jersey physicians primarily for business earned during 1994-1996, and other increases of $8.0 million relating primarily to Pennsylvania institutional business for the 1999-2001 coverage years. These increases were partly offset by reductions in prior year gross loss and LAE reserves of $9.5 million related to Pennsylvania physician business earned primarily during 1998 and 1999 and $6.6 million related to New Jersey physician business earned during 2001, reflecting the Company's recent improvements in underwriting, risk selection and pricing disciplines.
CUMULATIVE EFFECT OF AN ACCOUNTING CHANGE, NET OF TAX. On January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets," which requires that goodwill no longer be amortized as an expense, but instead reviewed and tested for impairment under a fair value approach. The cumulative effect of adopting SFAS No. 142 was a charge of $2.4 million on January 1, 2002. On April 1, 2001, the Company adopted EITF 99-20, "Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets," which established new guidelines for recognition of income and other-than-temporary declines for interests in securitized assets. The cumulative effect of adopting EITF 99-20 was $5.3 million, net of $2.8 million tax, on April 1, 2001.
YEAR ENDED DECEMBER 31, 2001, COMPARED TO YEAR ENDED DECEMBER 31, 2000
NET PREMIUMS EARNED. Net premiums earned were $146.9 million in 2001 compared to $184.1 million in 2000, a decrease of approximately $37.2 million or 20.2%. This net decrease is composed of decreased direct and assumed premium offset by an increase in ceded premiums earned. Direct premiums earned decreased $2.7 million or 1.2% to $213.9 million in 2001 from $216.6 million in 2000 and resulted from a higher level of direct premiums earned during the first quarter of 2000 associated with higher direct premiums written in the fourth quarter of 1999 and the first quarter of 2000. Assumed premiums earned decreased by $13.5 million or 96.9% to $400,000 from $13.9 million in 2000 primarily due to nonrenewal of a large poorly performing excess of loss reinsurance contract effective January 1, 2001. Ceded premiums earned increased by $21.1 million or 45.3% to $67.5 million in 2001 from $46.5 million in 2000 primarily due to additional ceded premiums of $36.3 million associated with a gross reserve adjustment in the fourth quarter of 2001 as compared to $19.9 million associated with the reserve adjustment during the second quarter of 2000.
Total premiums written in 2001 were $231.9 million, an increase of $5.8 million, or 2.6% from total premiums written of $226.1 million in 2000. This net increase consisted of a net increase in direct premiums written of $19.4 million and a decrease in assumed premiums written of $13.6 million associated with the non-renewal, effective January 1, 2001, of a large excess of loss reinsurance contract. The net increase in direct premiums
written was composed of net increases in Pennsylvania, New Jersey, Ohio and other states of $12.4 million, $6.4 million, $2.2 million and $3.1 million, respectively, and net decreases in Maryland and other states of $3.5 million and $1.3 million, respectively. The increases and decreases by state resulted from the combined effects of significant selected rate increases offset by disciplined underwriting actions. In New Jersey, written premiums in 2001 also included $10.5 million of premiums associated with early renewals of certain policies in a program initiated in 2001 to move the business off of a common January 1 renewal date.
NET INVESTMENT INCOME. Net investment income decreased $5.0 million, or 5.8%, to $80.2 million in 2001 from $85.2 million in 2000. The decrease was primarily attributable to the combined effects of lower market yields and a decrease in average invested assets resulting mainly from the impact on cash flow of the Company's premium financing program initiated during the last quarter of 2000. Average invested assets at amortized cost decreased to approximately $1.26 billion in 2001 from $1.27 billion in 2000. The average pre-tax yield on the investment portfolio decreased to 6.38% in 2001 from 6.69% in 2000 primarily as the result of lower market yields and ongoing changes in asset allocation due to a changing market yield environment.
LOSS AND LOSS ADJUSTMENT EXPENSES (LAE). Losses and LAE decreased $28.4 million, or 10.2%, to $250.8 million in 2001 from $279.2 million in 2000. Losses and LAE were net of ceded losses and LAE of $97.5 million in 2001 and $44.2 million in 2000. The ratio of net losses and LAE to net premiums earned increased to 170.8% in 2001 from 151.7% in 2000.
As a result of reserve studies conducted by the Company, the Company's outside actuary and a second actuarial firm specializing in medical malpractice reserving, the Company recorded a $64.5 million net adjustment to loss and LAE as of December 31, 2001. During 2001, the Company increased direct and assumed prior year loss and LAE reserves of $113.1 million and $4.8 million, respectively. During 2001, ceded reserves associated with the Company's aggregate reinsurance contracts increased by $61.7 million. The increase in prior year loss and LAE reserves resulted from three primary factors: increased loss severity, particularly in the Pennsylvania institutions and New Jersey physicians book; adverse development in the form of additional frequency and severity relating to physicians business in certain states, primarily in Pennsylvania, Texas and Ohio; and adverse development associated with reserves held on an assumed excess of loss reinsurance contract which was non-renewed January 1, 2001. The increase in current year loss and LAE reserves resulted primarily from increased severity levels and reduced profitability indications from prior accident years.
During 2000, loss and LAE were significantly impacted by the reserve strengthening actions taken by the Company at June 30, 2000 that resulted from a loss and LAE study conducted by the Company. Following the reserve study, gross loss and LAE reserves were increased by $92.4 million, including $48.4 million for 1999 and prior accident years and $14.0 million for accident year 2000. Ceded loss and LAE reserves were increased by $22.3 million. Net loss and LAE reserves were increased by $70.1 million. The increase in loss and LAE
reserves in 2000 resulted from three primary factors: increased loss severity combined with a lengthened loss development period on the New Jersey physician book; greater than expected loss frequency and severity on the Pennsylvania physician and institutional book; and greater than anticipated loss frequency and, particularly, severity in the Company's book of physician and institutional business outside of New Jersey and Pennsylvania.
FUNDS HELD CHARGES. Funds held charges increased $35.0 million, or 466.2%, to $42.5 million in 2001 from $7.5 million in 2000. Funds held charges relate to the Company's ceded aggregate reinsurance contracts, for which balances due to reinsurers are withheld as collateral for losses and LAE ceded under the contracts. Funds held charges increased $19.8 million resulting from adjustments to loss reserves, ceded losses and ceded premiums during 2001. Funds held charges during 2000 decreased by $13.2 million as a result of adjustments to loss reserves, ceded losses and ceded premiums during 2000. Funds held charges are calculated based upon the beginning of quarter funds held balances and are adjusted based upon changes to ceded premiums associated with changes in ceded losses.
CUMULATIVE EFFECT OF AN ACCOUNTING CHANGE FOR CERTAIN DEBT SECURITIES, NET OF TAX. On April 1, 2001, the Company adopted EITF 99-20, "Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets," which established new guidelines for recognition of income and other-than-temporary declines for interests in securitized assets. The cumulative effect of adopting EITF 99-20 was $5.3 million, net of $2.8 million tax, on April 1, 2001.
The New Jersey Department of Banking and Insurance on May 3, 2002 approved MIIX's new business plan which provided for the Company to be placed into voluntary solvent runoff effective May 3, 2002. The Virginia Bureau of Insurance placed LP&C in solvent runoff effective February 22, 2002 and approved its plan on May 10, 2002. MIIX and LP&C ceased writing business in all states in accordance with each state's specific withdrawal requirements. As a result, the Company expects that cash flow from operations in the future will continue to be negative, as payments of outstanding claims and expenses exceed its revenues from MIIX Advantage and net investment income. In 2002, the Company entered into a management contract and other financial arrangements with a newly formed physician-supported medical malpractice insurance company. The revenues from these agreements and investment income will be the Company's only source of revenues in the foreseeable future. The Company plans to grow its consulting business by providing similar services to self-insured entities and other health care provider owned insurers. In order to do so, it will need the approval of the New Jersey Department of Banking and Insurance. The Company cannot assure stockholders that such approval will be forthcoming.
On May 23, 2002, the Company repaid the $9.1 million loan balance under a credit facility with Amboy National Bank largely with the proceeds from the sale of substantially all the net assets of HNL. Thereafter, the credit facility closed. The Company's $9.1 million fixed-maturity investments in Amboy National Bank matured and the funds were reinvested in short-term securities. The Company currently does not have any bank financing.
Less Than 1 1-3 Years More Than 3 Total Year Years Operating leases: (in thousands)
Market risk represents the potential for loss due to adverse changes in the fair value of financial instruments. Through the Company's investment portfolio, it is exposed to risks related to unforeseen changes in interest rates, credit quality, prepayments and valuations. The Company uses analytical tools and monitoring systems to continually assess and react to each of these elements of market risk.
The tables below provide, as of December 31, 2002 and 2001, information about the Company's fixed maturity investments, which are sensitive to changes in interest rates, showing principal amounts and the average yield applicable thereto by expected maturity date and type of investment. The expected maturities displayed have been compiled based upon the earlier of the investment call date or the maturity date or, for mortgage-backed securities, expected payment patterns based on statistical analysis and management's judgment. Actual cash flows could differ, perhaps significantly, from the expected amounts.
In addition to interest rate risk, fixed maturity securities like those comprising the Company's investment portfolio involve other risks such as default or credit deteriorating quality. The Company manages these issues by limiting the amount of higher risk corporate obligations (determined, among other variables, by credit rating assigned by private rating agencies) in which it invests.
and principal payments will differ considerably due to changes in the level of interest rates. The Company purchases mortgage-backed and asset-backed securities structured to enhance credit quality and/or provide prepayment stability. Short term investments are composed of highly rated money market instruments.
The Company also holds a portfolio of equity investments. At December 31, 2002, the cost and fair value of equity investments was $4.8 million and $5.2 million, respectively. At December 31, 2001, the cost and fair value of equity investments was $7.1 million and $6.6 million, respectively. A 10% decline in value of the equity investments at December 31, 2002 would result in after-tax accumulated unrealized gains on equity investments of $0.4 million or 1.6% of total stockholders' equity gross of net after-tax unrealized gains on investments.