The Company owns the following fixed assets, all of which are used in the conduct of its business:
(3) Pursuant to a tender offer completed in 2000, all outstanding Class A Common Shares of Midwest Holding were exchanged and redeemed as of December 31, 2000. See Notes 2 and 11 to the audited consolidated financial statements included in Item 8 of this Form 10-K.
Investment Committee of the Board of Directors are the preservation of assets, maximizing pre-tax total portfolio return and assuring adequate liquidity to meet operational requirements, primarily the payment of insurance claims. Fixed maturity investments and equity securities are classified as available for sale and therefore are carried at fair value. The real estate investment trusts are recorded at appraised value and short-term investments are recorded at cost which approximates fair value.
The Company's cash flow from operations was $1,544,000 in 2000 versus $2,187,000 in 1999 and $(9,605,000) in 1998. The 2000 cash flow from operations was favorably impacted by premium adjustments received from reinsurers on reinsurance contracts for prior years and federal tax refunds, including interest received from the Internal Revenue Service for the 1992 to 1996 tax years. These positive cash flows were partially offset by the payment of policyholder dividends. The 1999 cash flow from operations was favorably impacted by premium adjustments received from reinsurers on reinsurance contracts for prior years and greater premium received at the end of 1999 due to earlier billing of policies with January 2000 effective dates. The 1998 cash flow from operations was unfavorably impacted by premium adjustments paid to reinsurers on reinsurance contracts for prior years and less premium received at the end of 1998 due to later billing of policies with January 1999 effective dates. Also contributing to the unfavorable 1998 cash flow were increases in underwriting and other operating expenses. Underwriting expenses in 1998 increased primarily from additional staff needed to manage insurance business growth and added costs from the conversion to a new insurance company operating system. Other operating expenses increased in 1998 primarily from launching the operations of Solutions, including the acquisition of MedPower.
of coverage exceeded the anticipated additional losses on that layer. Although the premiums ceded on the new reinsurance agreement should be roughly the same as the prior reinsurance agreement, the added loss exposure from the increase in Midwest Medical's retention could potentially lead to greater losses incurred. Another change in the new reinsurance agreement is the use of a "flat" ceded premium rate. A flat rate contract lessens the volatility of reinsurance premium payments compared to the previous swing-rated contract based upon losses paid. This allows Midwest Medical to estimate future ceded premium payments with greater certainty.
Approximately $9,541,000 was paid to Class A shareholders pursuant to the tender offer. An $8,500,000 loan from Midwest Medical to Midwest Holding largely funded these payments. Midwest Medical primarily used proceeds from sales of domestic equity securities to provide the loan. The loan is a non-interest-bearing note that will be retired in 2001 by Midwest Holding through dividends received from Midwest Medical.
Periodically, the Board of Directors of Midwest Medical declares dividends payable to Midwest Holding to provide capital for non-insurance business operations, including new business ventures. Prior to the stock restructure in 2000, dividends from Midwest Medical were also used to support the redemption value of Midwest Holding's Class A Common Stock. Midwest Medical declared and paid dividends to Midwest Holding of $3,000,000, $2,050,000 and $2,000,000 in 2000, 1999 and 1998, respectively.
4. Accounts that did not renew in 2000 resulted in a decrease of approximately $317,000 in 2000 net premiums earned.
Net premiums earned increased $11,569,000 in 1999 from 1998. New business generated approximately $5,700,000 of additional earned premium. The remaining increase was the result of the following significant factors:
1. Effective in 1999, a policyholder dividend program replaced the previous retrospective premium program. In 1998, retrospective premium credits of $6,719,000 were recorded for Minnesota, North Dakota and Iowa policyholders. The retrospective premium credits of $317,000 recorded in 1999 represented actual payments made that were greater than what had been previously estimated and accrued. The difference between years resulted in a $6,402,000 increase in 1999 net premiums earned.
2. The estimated reinsurance premium applicable to the treaty years 1992-1994 and 1995-1997, which is based in part on reinsured claims experience, was reduced $5,920,000 on a net basis in 1999. This compares to a net reduction for those treaty years of $2,550,000 in 1998, resulting in a net increase in premium between years of $3,370,000.
Realized capital gains increased $3,282,000 to $10,502,000 in 2000 and decreased $1,861,000 to $7,220,000 in 1999. During 2000, sales of equity securities realized $12,245,000 of net capital gains while sales of bonds realized $(1,743,000) of net capital losses. Approximately $7,000,000 of the net realized capital gains on equity securities resulted from the sale of appreciated technology common stocks in the first quarter, as holdings in the technology sector were trimmed in order to maintain appropriate portfolio diversification. Sales of equity securities in the latter part of 2000 to provide for stock restructure redemption payments to Class A shareholders resulted in another $3,000,000 of net realized capital gains. All other 2000 realized capital gains and losses resulted from the management of the portfolio on a pre-tax total return basis. During 1999, sales of equity securities realized $10,312,000 of net capital gains while sales of bonds realized $(3,092,000) of net capital losses. Approximately $(1,757,000) of the net realized capital losses on bonds came from the repositioning of the bond portfolio during the last two months of 1999. The Company's new fixed income manager, who assumed management of the portfolio on November 2, 1999, recommended repositioning the bond portfolio primarily to shorten its duration. All other 1999 realized capital gains and losses resulted from the management of the portfolio on a pre-tax total return basis. The Company employs three outside professional advisors to manage the portfolio: one to manage investment-grade fixed income securities, one to manage large-cap domestic equities and one to manage international equities. The managers operate within the Company's adopted investment policy, as approved by the Investment Committee of the Board of Directors. The Investment Committee meets with outside investment managers approximately four times per year.
Losses and loss adjustment expenses are the costs associated with the settlement of insurance claims and are the Company's principal expense. Incurred loss and loss adjustment expenses were $39,587,000 in 2000 compared to $41,468,000 in 1999 and $37,494,000 in 1998. This resulted in a decrease of 4.5% in 2000 versus an increase of 10.6% in 1999. As shown in Note 5 to the audited consolidated financial statements, the current year's provision for loss and loss adjustment expense, which is based upon policyholder exposure, expected frequency of losses and severity of losses, increased by $1,521,000 in 2000 and $4,015,000 in 1999. The increases in both 2000 and 1999 were primarily driven by additional policyholder exposure from the increase in premium volume particularly from newer business lines such as large, healthcare systems and hospitals. Loss and loss adjustment expenses also include adjustments of prior years' estimates. These adjustments to the liability for loss and loss adjustment expense are evaluated by management and supported by an outside actuarial review performed at the conclusion of the year. As shown in Note 5 of the audited consolidated financial statements, these evaluations resulted in a reduction in estimated liabilities applicable to prior years of $7,876,000 and $4,474,000 in 2000 and 1999, respectively. The more favorable development on prior years is the primary reason for the decrease in incurred loss and loss adjustment expenses in 2000, while less favorable development on prior years is the primary reason for the increase in incurred loss and loss adjustment expenses in 1999.
Policyholder dividends of $8,108,000 were declared by the Board of Directors of Midwest Medical in 2000 and will be paid to physician, clinic and hospital policyholders in 2001. Policyholder dividends of $10,175,000 were declared by the Board of Directors of Midwest Medical in 1999 and were paid to physician, clinic and hospital policyholders in 2000. As described in Note 4 of the audited consolidated financial statements, the policyholder dividend program was instituted in 1999 and replaced the previous retrospective premium credit program for physicians. The primary reasons Midwest Medical switched to a policyholder dividend program were to allow greater flexibility in determining amounts to be refunded to policyholders and to more closely resemble programs of peer companies, thus making the financial statement impact similar. The latter reason helps to eliminate confusion in the marketplace when comparing the financial performance of Midwest Medical to its competitors.
Other operating expenses increased $2,608,000 from $3,589,000 in 1998 to $6,197,000 in 1999. Approximately $1,648,000 of the increase was from the Services subsidiary that began active operations in January 1999, as described in Item 1 of this Form 10-K. Services' primary expenses are commissions and salaries paid to its staff. The remaining increase resulted largely from greater salary expenses incurred by Solutions, added equipment and depreciation costs incurred by MedPower and new product development costs incurred by Midwest Holding.
Income before income taxes decreased to $2,552,000 in 1999 compared to $8,637,000 in 1998. The decrease resulted primarily from greater loss liabilities estimated for 1999, policyholder dividends that were greater in 1999 than the retrospective premium credits in 1998 and lower realized capital gains due to the capital losses sustained on the repositioning of the bond portfolio at the end of 1999.
All forward-looking statements address matters that involve risks and uncertainties. Accordingly, in addition to the factors discussed in this Form 10-K, there are or will be other important factors that could cause actual results to differ materially from those indicated in such statements. These factors include, but are not limited to:
3. greater severity or frequency of the types of losses that the Company insures;
The audited consolidated financial statements of Midwest Medical Insurance Holding Company and Subsidiaries are presented on the following pages 24 through 58 of this Annual Report on Form 10-K.
On November 30, 1988, the Insurance Exchange was reorganized into a stock insurance company, Midwest Medical Insurance Company, under the statutes of the State of Minnesota. Concurrently, Medical Management merged with the Midwest Medical Insurance Holding Company, which then acquired all outstanding shares of the reorganized stock company.
Effective June 5, 1996, Midwest Medical merged with Medical Liability Mutual Insurance Company of Nebraska, a physician-owned professional liability insurance company providing insurance coverage to Nebraska physicians. As provided for in the agreement and plan of merger, Medical Liability Mutual was merged into Midwest Medical. The merger was accounted for as a pooling-of-interests.
During 1997, Midwest Holding formed Midwest Medical Solutions, Inc. as a business development company to strengthen and promote the independence and interdependencies of physicians, clinics and hospitals that Midwest Medical serves. Business development opportunities being pursued include practice enhancement, strategic consulting and technology services and support.
Midwest Medical provides, upon payment of an additional premium, a reporting endorsement which extends the period in which claims otherwise covered by the "claims made" policy may be reported to Midwest Medical. In the event of death or permanent disability of a policyholder, the reporting endorsement is issued without additional premium. Upon retirement, as defined in the policy, a policyholder with at least five years of consecutive coverage with Midwest Medical is eligible for a credit toward the additional premium for the reporting endorsement.
The consolidated financial statements include the accounts of Midwest Holding and its wholly-owned subsidiaries, Midwest Medical, Services and Solutions, which includes Solution's wholly-owned subsidiary, MedPower. All transactions between Midwest Holding and its subsidiaries have been eliminated in consolidation with the exception of the distribution of capital to Midwest Holding by Midwest Medical in the form of dividends.
Hereafter, Midwest Holding, Midwest Medical, Services, Solutions and MedPower shall be collectively referred to as the Company unless the reference pertains to a specific entity.
The consolidated financial statements have been presented in conformity with accounting principles generally accepted in the United States, which differ in certain respects from statutory accounting practices followed by Midwest Medical in reporting to the Department of Commerce of the State of Minnesota (see Note 10).
The Company manages its investment portfolio to achieve its long-term investment objective of providing for the financial stability of the Company through preservation of assets and maximization of total portfolio return. Although management believes the
Company has the ability to hold its fixed maturity investment portfolio to maturity, these investments are classified as "available for sale," as management may take advantage of opportunities to increase total return through sales of selected securities in response to changing market conditions.
The liability for unpaid losses and loss adjustment expenses represents an estimate of the ultimate cost of all such amounts which are unpaid at the balance sheet dates. The liability is based on both case-by-case estimates and statistical analysis and projections using the historical loss experience of Midwest Medical, and gives effect to estimates of trends in claim severity and frequency. These estimates are continually reviewed and, as adjustments become necessary, such adjustments are included in current operations. Midwest Medical believes that the estimate of the liability for losses and loss adjustment expenses is reasonable.
Prior to 1999, Midwest Medical had a retrospective premium program whereby physicians may have received credits against future premiums based upon the loss experience of Midwest Medical. Amounts returned under the program were accrued when approved by the Board of Directors and reflected as a reduction in net premiums earned. Beginning in 1999, the retrospective premium program was replaced by a policyholder dividend program. Policyholder dividends are accrued when approved by the Board of Directors and are recorded as a separate component of losses and expenses in the consolidated statements of income.
Effective November 30, 1988, Midwest Medical policyholders earned Class A Common Shares for each month of service pursuant to a stock allocation formula based on underwriting risk classification. Shares earned by new policyholders were not issued until the end of five years of continuous coverage under a Midwest Medical policy (the vesting date). At the vesting date, the issued shares were recorded at the then current redemption value (see Note 11).
Class A shareholders were required to redeem their shares with Midwest Holding upon termination as policyholders of Midwest Medical. The net redemption value (NRV) of the shares was equal to the net book value of Midwest Holding, excluding the amount of net book value that was attributable to Midwest Medical, divided by the number of outstanding Class A Common Shares of Midwest Holding at the semi-annual valuation dates of June 30 and December 31 of each year. The amount paid upon redemption was the redemption value determined at the most recent semi-annual valuation.
Following is the detail of changes in redeemable stock for each of the three years in the period ended December 31, 2000 (in thousands, except for share and per share amounts):
The amortized cost and market value of fixed maturities at December 31, 2000, by contractual maturity, are shown below (in thousands). 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.
Net unrealized appreciation of fixed maturities increased (decreased) by $3,198,000, $(8,736,000) and $1,837,000 and net unrealized appreciation of equity securities (decreased) increased by $(22,003,000), $14,036,000 and $15,360,000 for the years ended December 31, 2000, 1999 and 1998, respectively. Net unrealized appreciation of other long-term investments increased by $915,000 for the year ended December 31, 2000 as a result of an initial, independent appraisal of the non-traded real estate investment trusts.
In the third quarter of 1999, Midwest Medical's Board of Directors declared a $10,100,000 dividend that was paid to physician and clinic policyholders in four equal installments in February, May, August and November 2000. The dividend was awarded proportionately based on annual premiums for physician and clinic policyholders that were insured by Midwest Medical in 1995 and remain insured throughout 2000.
In the fourth quarter of 1999, Midwest Medical's Board of Directors declared a $75,000 dividend that was paid to hospital policyholders for policies that were written from 1995 through 1998 and that renewed in 2000. The dividend was awarded based on the number of years insured with Midwest Medical and was paid within two months after the hospital policy renewed in 2000.
Prior to 1999, retrospective premium credits were deducted from net premiums earned. Under the new policyholder dividend program, dividends are recorded as a component of losses and expenses. The following illustrates what net premiums earned would have been had retrospective premium credits been issued as policyholder dividends.
A provision of the agreement and plan of merger between Medical Liability Mutual and Midwest Medical requires that any favorable development of certain pre-merger liabilities of Medical Liability Mutual be paid to the former Medical Liability Mutual policyholders who remain active Midwest Medical insureds as of the date of payment through a retrospective premium credit. The agreement further stipulates that any amounts due under this provision must be settled no later than June 5, 2001. As of December 31, 2000, there has been no favorable development and, therefore, no accrual or payments have been made related to this provision.
Midwest Medical continually evaluates emerging trends in the development of loss liabilities, including the trends related to the pre-merger Iowa Physicians and Medical Liability Mutual business. Based on this analysis, management periodically adjusts their estimates of ultimate losses.
The Company is organized into five legal entity business segments consisting of Midwest Holding, Midwest Medical, Services, Solutions and MedPower. The business and accounting policies of the reportable segments are described in Note 1 to the consolidated financial statements. Management evaluates the performance of each business segment based primarily on profit or loss from operations. With the exception of foreign stocks and bonds held as investments by Midwest Medical, all business transactions are conducted in the United States. The following financial information summarizes the results of operations and total assets reported by the five business segments for the years ended 2000, 1999 and 1998 (in thousands).
(2) Other revenues consist primarily of net realized capital gains and interest received on federal income tax refunds.
The Company made income tax payments of $2,298,000, $1,751,000 and $3,041,000 in 2000, 1999 and 1998, respectively.
To reduce overall risk, including exposure to large losses, Midwest Medical participates in various reinsurance programs. Midwest Medical would only become liable for losses in excess of stipulated amounts in the event that any reinsuring company were unable to meet its obligations under the existing agreement. Management is not aware of any such default at December 31, 2000. Midwest Medical evaluates the financial condition of its reinsurers and monitors concentration of credit risk arising from similar geographic regions, activities or economic characteristics of the reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. Reinsurance recoverables on paid and unpaid losses of $15,117,000 and $15,648,000 are associated with a single reinsurer, General Reinsurance Corporation, at December 31, 2000 and 1999, respectively. Midwest Medical also holds collateral under related reinsurance agreements in the form of letters of credit totaling $2,267,000 that can be drawn upon in the event the applicable reinsuring company is unable to pay its obligation to Midwest Medical.
The effect of reinsurance on premiums written and earned for 2000, 1999 and 1998 is as follows (in thousands):
In 1998, Midwest Medical commuted reinsurance treaties covering the period January 1, 1991 through December 31, 1991. Net premiums recovered as a result of these commutations of $789,000 have been included in net premiums earned in 1998. As a result of this and prior treaty commutations, Midwest Medical has no reinsurance coverage for the exposure period October 1, 1986 through December 31, 1991. Due to the nature of Midwest Medical's policies, there is no risk of incurring future losses related to this time period.
Substantially all employees of Midwest Holding are covered by a non-contributory defined contribution pension plan. Contributions to the plan are based upon each covered employee's salary. Substantially all employees at Midwest Holding are also covered by a 401(k) plan that provides a 50% match on employee contributions subject to certain limitations. Total contributions charged to expense for the years ended December 31, 2000, 1999 and 1998 were $583,000, $581,000 and $521,000, respectively.
Midwest Holding also provides medical benefits to retirees through a defined benefit post-retirement plan which covers substantially all employees. The net periodic post-retirement benefit cost for the years ended December 31, 2000, 1999 and 1998 was $36,000, $23,000 and $41,000, respectively. As of December 31, 2000 and 1999, the net post-retirement benefit plan liability was $51,000 and $19,000, respectively.
The following is a reconciliation of net income and shareholders' equity under US GAAP with that reported for Midwest Medical on a statutory basis (in thousands):
Under Minnesota insurance statutes, Midwest Medical is required to maintain statutory surplus in excess of ten times its per risk reinsurance retention limit. Since Midwest Medical limited its retention to $750,000 on any single risk, the minimum statutory surplus level was $7,500,000 for 2000, 1999 and 1998.
The National Association of Insurance Commissioners (NAIC) revised the Accounting Practices and Procedures Manual in a process referred to as Codification. The revised manual will be effective January 1, 2001. Midwest Medical's domiciliary state of Minnesota has adopted the provisions of the revised manual. The revised manual has changed, to some extent, prescribed statutory accounting practices and will result in changes to the accounting practices that Midwest Medical uses to prepare its statutory-basis financial statements. Management believes that although the implementation of Codification will have a negative impact on Midwest Medical's statutory-basis capital and surplus primarily from the recording of a net deferred tax liability, Midwest Medical will remain in compliance with all regulatory and contractual obligations.