The Company leases approximately 230,000 square feet of office space throughout the United States and a suite in the London Underwriting Centre in the United Kingdom. The Company's major leasehold obligation relates to its corporate office located in Deerfield, Illinois. The Deerfield, Illinois office space consists of approximately 135,000 square feet. The lease is for a term of fifteen years expiring June 30, 2006. The Company has the right to terminate this lease in 2001 and 2002 under certain circumstances. In 2001, the Company has the option of renting an additional 15,000 square feet in Deerfield, Illinois. The Company's principal regional and subsidiary offices are in Atlanta, Georgia; San Francisco, California; Independence, Missouri; and Washington, D.C.
(6) In 1997, operating income includes a charge, net of tax, of $8,937,000 or $.46 per share related to the acquisition of Unionamerica.
The following discussion of the results of operations and financial condition of the Company should be read in conjunction with the Company's financial statements and notes thereto included elsewhere in this report.
Consulting and fee income decreased by 5.2% to $48.9 million in 1998 from $51.6 million in 1997 due primarily to a decrease in physician credential verification revenues. Consulting and fee income as a percentage of net premiums earned and consulting and fee income was 12.4% in 1998 compared to 15.2% in 1997.
LOSSES AND EXPENSES. Losses and loss adjustment expenses ("LAE") increased by 39.2% to $291.5 million in 1998 from $209.4 million in 1997. Medical malpractice liability losses and LAE increased by 50.0% to $193.3 million in 1998 from $128.9 million in 1997. Medical malpractice liability losses and LAE increased due to unfavorable loss experience related to two specific but small areas of the Company's domestic operations: long-term care and a disparate group of clinic clients. In the third quarter 1998, the Company recorded $17.5 million of additional losses and LAE related to this business. The increase in medical malpractice losses and LAE also includes losses related to the increase in one time premiums in the first quarter 1998 that were recorded at a higher loss ratio than the core medical malpractice business as well as an increase in the core loss ratio for the current year's business. International losses and LAE increased 15.2% to $88.0 million in 1998 from $76.4 million due to a growth in earned premiums as well as a third quarter provision of $3.3 million for claims related to asbestos exposures written in prior years. Other losses and LAE increased 146.3% to $10.1 million in 1998 from $4.1 million in 1997 due to an increase in other earned premium.
Insurance and administrative expenses increased by 3.3% to $161.7 million in 1998 from $156.6 million in 1997. Included in the 1997 total is $9.7 million of expenses related to the Company's acquisition of Unionamerica, which was completed in December 1997. Before the effect of the acquisition related expenses, insurance and administrative expenses increased 10.1%, principally due to increased commission expense related to premium growth.
The combined ratio, which includes the sum of losses and LAE and insurance segment expenses, divided by earned premiums, increased to 115.8% in 1998 compared to 111.1% in 1997. The loss ratio increased by 11.3 percentage points and the expense ratio decreased by 6.6 percentage points in 1998, as compared to 1997. The loss ratio increase is due to the loss reserve development totaling $20.8 million recorded in the third quarter 1998 as well as higher loss ratios related to one-time premiums and an increase in the current year's loss ratio. The expense ratio decline in 1998 is primarily due to the inclusion of the acquisition related expenses in 1997 and one-time premiums in 1998, which have a proportionally lower level of acquisition expense.
NET INCOME. Net income decreased by 66.9% to $11.4 million in 1998 from $34.4 million in 1997 as a result of loss reserve development recorded in the third quarter 1998 as well as a decrease in consulting and fee revenues in 1998.
NET INCOME PER SHARE. Diluted net income per common and common equivalent share decreased to $.59 in 1998 from $1.77 in 1997. Included in the 1998 and 1997 amounts are a reduction of $.88 for loss reserve development and $.46 per share for the expenses, net of tax, incurred in connection with the Unionamerica acquisition, respectively. Also included is an increase of $.09 in 1998 and an increase of $.07 in 1997 related to net realized gains on investments, net of tax, as well as an extraordinary loss of $.04 in 1997.
REVENUES. Gross premiums written increased by 4.1% to $372.2 million in 1997 from $357.7 million in 1996. Medical malpractice gross premiums written increased 5.0% to $200.5 million in 1997 from $191.0 million. International gross premiums written increased 6.0% to $152.0 million in 1997 from $143.4 million in 1996 and other gross premiums written decreased 15.5% to $19.7 million in 1997 from $23.3 million in 1996. Net premiums written increased by 5.8% to $306.9 million in 1997 from $290.1 million in 1996.
The combined ratio, which includes the sum of losses and LAE and insurance segment expenses, divided by earned premiums, increased to 111.1% in 1997 compared to 105.2% in 1996. The effect on the expense ratio of expenses related to the acquisition of Unionamerica amounted to an increase of 3.4 percentage points. The loss ratio decreased by 1.4 percentage points and the expense ratio increased by 7.3 percentage points in 1997, as compared to 1996. Also contributing to the increase in the expense ratio were increased commissions on excess casualty business written in the international segment which carries higher acquisition expenses than the other international lines of business.
NET INCOME. Net income decreased by 14.2% to $34.4 million in 1997 from $40.1 million in 1996 as a result of expenses related to the acquisition of Unionamerica and a decline in the rate of growth of insurance premium and an increase in the combined ratio partially offset by the loss from discontinued operations in 1996.
Investing activities, substantially in fixed income securities, have been the principal use of cash flow from operations. Cash used by investing activities was $28.9 million in 1998, $24.4 million in 1997 and $88.4 million in 1996. The Company has no material commitments for capital expenditures.
TRUST PREFERRED CAPITAL SECURITIES. In December 1997, MMI issued $125.0 million in 30 year non-callable Capital Securities of MMI Capital Trust I, a subsidiary of MMI. The Capital Securities were rated Baa1 by Moody's Investor Service and BBB- by Standard & Poor's Rating Services as of February 26, 1999. The Capital Securities pay cumulative distributions at the annual rate of 7 5/8%, semiannually, in arrears and have a maturity date of December 15, 2027. Payments on the Capital Securities are fully and unconditionally guaranteed by MMI. Total proceeds, net of expenses, were $118.7 million.
STOCKHOLDERS' EQUITY. The Company's stockholders' equity was $412.9 million as of December 31, 1998, compared to $399.0 million as of December 31, 1997. Changes in stockholders' equity are primarily attributable to net income of the Company, dividends to stockholders, changes in unrealized gains or losses on investments and issuances of Common Stock. Cash dividends to stockholders totaled $6.1 million in 1998, $4.2 million in 1997 and $2.9 million in 1996. As of December 31, 1998, unrealized gains on investments were $44.2 million, net of deferred taxes of $15.1 million, thereby increasing stockholders' equity by $29.1 million. As of December 31, 1997 the Company had an unrealized gain, net of taxes, of $24.3 million.
Effective January 1, 1997, the Company purchased substantially all of the net assets of Equifax Medical Credentials Verification Services (EMCVS), a unit of Atlanta-based Equifax, Inc., and acquired by merger all of the outstanding stock
of Professional Risk Management, Inc. (PRM), a privately held California third-party administrator that specializes in managing enterprise liability risk for organizations that self-insure. The total purchase price for these acquisitions was $8.3 million in cash and $2.0 million in MMI Common Stock. These acquisitions were accounted for as purchases and the operations of EMCVS and PRM are included in the Company's consolidated financial statements since their dates of acquisition.
Effective April 1, 1996, the Company purchased substantially all of the net assets of Management Science Associates (MSA). MSA provides employee relations and human resource consulting services to healthcare organizations and had revenues of approximately $6.6 million in 1995. The purchase price for MSA was $8.3 million in cash, which was funded principally by an increase in borrowings under the Company's credit agreement.
The phases of the Company's work plan are assessment, role definitions, inventory and analysis, coding, testing and implementation/confirmation. The majority of system modifications and conversions have been completed. The Company is working closely with its business partners and suppliers to ensure alignment in addressing the Y2K issue.
The Company has completed the assessment, role definition and inventory and analysis phases which encompass hardware, software (third party and internally developed), embedded technologies, and non-information technologies (IT) systems.
The Company is addressing Y2K compliance of third party IT vendors through a combination of written correspondence and internal testing. All identified critical third party IT vendors have been contacted and asked to document compliance. All Y2K compliance by material third party vendors has been either internally tested by the Company or documented by the third party. The Company is currently planning the implementation for any necessary modifications based on vendor comments.
The Company has contacted related non-IT parties to ensure Y2K compliance. The Company believes failure of non-IT systems would not have a material effect on the Company's operations.
The Company plans to leverage existing disaster recovery plans relating to technology and business continuity. Both sets of plans will be reviewed in 1999 as to their application to the Y2K issue. In addition, contingency plans are being developed in conjunction with the scheduled 1999 simulations of critical information technologies.
The Company has conducted a comprehensive review of its underwriting guidelines and will, where appropriate, exclude Y2K exposures. The Company believes, as a basic principle of insurance, that non-fortuitous losses are not covered under its policies of insurance even without specific exclusions. With respect to its domestic insurance operations, if underwriting reveals an acceptable risk, an endorsement will be attached that affirmatively grants Y2K coverage under the professional liability coverage part, and excludes Y2K under the general liability coverage part. With respect to reinsurance contracts, it is unusual to apply specific Y2K exclusions to these contracts and there may or may not be such exclusions in the original policies, depending on exposure, class of service or industry, and original coverage. For these reasons, the Company believes that its exposure to Y2K claims is not material. However, because of lack of legal precedent, it is impossible to predict what, if any, exposure insurance companies may ultimately have for Y2K claims whether coverage for the issue is specifically excluded or included.
The Company is subject to foreign currency exchange risk due to several primary reasons, including its United Kingdom-based subsidiaries which incur expenses denominated in British pounds sterling and hold invested assets in foreign currencies which result primarily from business generated in foreign currencies. While there is exposure to several currencies, the predominant exposure is in British pounds sterling.
purchases by approximately $1.8 million throughout the year. The Company does monitor the foreign currency markets and could purchase British pounds sterling in advance if appropriate due to market conditions.
The Company also holds invested assets in foreign currencies which result primarily from business generated in foreign currencies and thus expose the Company to foreign exchange currency risk. The predominant exposure is in British pounds sterling. Revenues from our business in foreign countries are the primary source of funds for our purchase of these investments. The Company purchases these investments as a natural hedge against insurance reserves and other liabilities denominated in the same currency, effectively reducing foreign currency exchange rate exposure. The Company does have a net unhedged foreign currency exposure in its invested assets of approximately 5.4 million British pounds sterling. A hypothetical weakening of 10% in the British pound sterling versus the U.S. dollar would result in a loss of value of approximately $0.8 million. Management reviews its foreign currency exposure risk on a monthly basis and is of the opinion that other foreign currency exchange risk is not material.
In December 1997, the Company completed a private placement of $125.0 million 30-year, mandatorily redeemable preferred capital securities (Capital Securities) of MMI Capital Trust I, a subsidiary of MMI. The Capital Securities pay a dividend of 7.625%, semiannually, in arrears and have a maturity date of December 15, 2027. Total proceeds were $118.7 million, net of expenses. The carrying value of the Capital Securities is $118.8 million as of December 31, 1998. These securities had a fair value of $121.9 million at December 31, 1998. A hypothetical 100 basis point decrease in interest rates would increase the fair value to approximately $137.3 million.
The estimated fair values at current market rates discussed above for financial instruments subject to interest rate risk are the same as those in Note 4 to the consolidated financial statements. The estimated fair value at the adjusted market rates (assuming a 100 basis point increase in market interest rates) are calculated using discounted cash flow methods and duration modeling, where appropriate. The foreign currency exposure risk analysis assumes a year end spot rate on the British pounds sterling of $1.66 at December 31, 1998.
Certain matters referred to above regarding Y2K, market risk and inflation contain forward-looking statements that involve risks and uncertainties. In particular, the general business community's readiness for the Y2K and the Company's potential underwriting exposure to Y2K claims as well as prospective changes in price levels, interest rates and foreign exchange rates are difficult to predict. To that extent, MMI claims the protection of the disclosure liability safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.
We have audited the accompanying consolidated balance sheets of MMI Companies, Inc. and subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1998. Our audits also included the financial statement schedules listed in the Index at Item 14(a). These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits. We did not audit the 1996 financial statements of Unionamerica Holdings plc, a wholly owned subsidiary, which statements reflect total revenues of $145,539,000 for the year ended December 31, 1996. Those statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to data included for Unionamerica Holdings plc, is based solely on the report of the other auditors.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits and the report of the other auditors provide a reasonable basis for our opinion.
MMI COMPANIES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
MMI COMPANIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (IN THOUSANDS, EXCEPT PER SHARE DATA)
MMI COMPANIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (IN THOUSANDS, EXCEPT PER SHARE DATA)
MMI COMPANIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
MMI COMPANIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998
MMI classifies all of its fixed maturity and preferred stock investments as "available for sale," requiring that these investments be carried at fair value, with unrealized gains and losses, less related deferred income taxes, excluded from earnings and reported in stockholders' equity as accumulated other comprehensive income.
Realized gains and losses on sales of investments are recognized on the specific identification basis. Realized losses also include losses for fair value declines that are considered to be other than temporary.
The liabilities for unpaid losses and loss adjustment expenses represent the estimated liability for claims reported to MMI plus claims incurred but not yet reported and the related estimated adjustment expenses. The liabilities for losses and related loss adjustment expenses are determined using case-basis evaluations and statistical analyses. Although considerable variability is inherent in such estimates, management believes that the liabilities for unpaid losses and loss adjustment expenses are reasonable. The estimates are continually reviewed and adjusted as necessary; such adjustments are included in current operations.
The costs of furniture and equipment are depreciated over their estimated useful lives of three to seven years using the straight line method. As of December 31, 1998 and 1997, accumulated depreciation amounted to $16,100,000 and $10,700,000, respectively.
Costs in excess of net assets of purchased subsidiaries are being amortized on a straight-line basis over periods ranging from ten to twenty years. As of December 31, 1998 and 1997, accumulated amortization amounted to $12,600,000 and $9,100,000, respectively.
MMI grants stock options for a fixed number of shares to employees with an exercise price equal to the fair value of the shares at the date of grant. MMI recognizes no compensation expense for the stock option grants. Additional stock option information is included in Note 10.
In December 1997, the AcSEC issued SOP 97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments". SOP 97-3 provides guidance on when an insurance enterprise should recognize a liability for guaranty fund or other assessments and how to measure the liability. SOP 97-3 is effective for 1999. MMI has not completed the analysis to determine the full impact but does not anticipate that the adoption of SOP 97-3 will have a significant impact on MMI's consolidated operating results or financial position.
Effective January 1, 1997, MMI purchased substantially all of the net assets of Equifax Medical Credentials Verification Services (EMCVS), a unit of Atlanta-based Equifax, Inc. and acquired by merger all of the outstanding stock of Professional Risk Management (PRM), a privately held California third-party administrator that specializes in managing enterprise liability risk for organizations that self-insure. The total purchase price of EMCVS and PRM was $8,300,000 in cash and $2,000,000 of MMI Common Stock.
Effective April 1, 1996, MMI purchased substantially all of the assets of Management Science Associates, Inc. (MSA). MSA provides employee relations and human resource consulting services to healthcare organizations. The
2. BUSINESS COMBINATIONS (CONTINUED) purchase price for MSA, including expenses, was $8,300,000 in cash, which was funded principally by an increase in borrowings under MMI's credit agreement.
In 1998, 1997 and 1996 respectively, MMI's losses and loss adjustment expenses were net of reinsurance ceded of $99,743,000, $64,000,000 and $33,100,000.
The amortized cost and fair value of fixed maturities at December 31, 1998, by contractual maturity, are as follows (in thousands):
4. INVESTMENTS (CONTINUED) The expected maturities may differ from contractual maturities in the foregoing table because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties, or MMI may have the right to put obligations back to the issuer prior to stated maturity.
Certain investments of the international segment are held in a trust fund set up as collateral for holders of United States insurance policies. At December 31, 1998 and 1997, the fair value of fixed maturities in the trust fund amounted to $6,700,000 and $6,500,000, respectively. The required minimum trust fund was $5,400,000 for 1998 and 1997.
MMI's net payments of income taxes were $7,947,000, $9,302,000, and $5,572,000 during 1998, 1997 and 1996, respectively. As of December 31, 1998, MMI had federal net operating loss carryforwards of approximately $41,880,000 that, if not utilized, expire in 2018.
In December 1997, the Company completed a private placement of $125,000,000 30-year, mandatorily redeemable preferred capital securities (Capital Securities) of MMI Capital Trust I, a subsidiary of MMI. The Capital Securities pay a dividend of 7 5/8%, semiannually, in arrears and have a maturity date of December 15, 2027. Payments on the Capital Securities are fully and unconditionally guaranteed by MMI. Total proceeds were $118,700,000, net of expenses. The effective rate of the Capital Securities is 8.06%. The fair value at December 31, 1998 was $121,934,000 and was estimated using discounted cash flow analyses, based on MMI's current incremental borrowing rates for similar types of borrowing arrangements.
With the proceeds from the Capital Securities, MMI repaid its $103,000,000 in bank debt and had no long-term notes payable as of December 31, 1998 and 1997. In connection with the extinguishment of the notes payable in the
The maximum amount of dividends that can be paid from ACIC to MMI without regulatory approval is the lesser of net investment income or 10% of ACIC's statutory-basis capital and surplus, each as of the preceding December 31. For HPIC, the maximum amount of dividends that can be paid to MMI without regulatory approval is the greater of net income or 10% of capital and surplus, each as of the preceding December 31. Accordingly, the maximum total dividend amount is $19,000,000 in 1999.
Under a Notice of Requirements from its regulatory body in the United Kingdom, the Department of Trade and Industry (DTI), Unionamerica may not pay any dividends unless it has given the DTI 14 days advance notice and the DTI has not objected. The DTI has the power to prohibit or require Unionamerica to reduce the amount of a dividend.
8. STOCKHOLDERS' EQUITY (CONTINUED) On June 14, 1997, the Board of Directors declared a dividend distribution to holders of record on June 30, 1997 of one right (Right) to purchase 1/100 share of Series B Junior Participating preferred stock on each outstanding share of MMI Common Stock. The Rights issued under the Plan become exercisable only when a person or group acquires or announces its intention to acquire 15% or more of the Common Stock of MMI. Under certain conditions, each Right would, upon exercise, entitle stockholders, other than the third party acquirer, to buy $150 worth of a MMI Common Stock equivalent at an exercise price of $75. If MMI is acquired in a merger or other business combination transaction that has not been approved by the Board of Directors, each Right will entitle its holder to acquire common stock of the acquiring company with a market value equal to two times the exercise price of the Right, a purchase value of $150 of the common stock of the acquiring company for $75. At any time prior to the distribution date, the Board of Directors retains the right to amend the Rights Plan and to redeem the Rights at $.01 per Right. The Rights have a ten year term.
Earnings per share are computed based on the weighted average number of outstanding shares of common stock and equivalents, including incremental shares from dilutive stock options since the date of grant using the treasury stock method.
Options to purchase 585,000, 143,000 and 18,000 shares of Common Stock were outstanding during 1998, 1997 and 1996, respectively, but were not included in the computation of the dilutive effect of stock options. These options were excluded from the computation because the options' exercise prices were greater than the average market price of the common shares and, therefore, would be antidilutive.
MMI COMPANIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MMI leases its office space and certain equipment under noncancelable leases. Rental expense for 1998, 1997 and 1996 was $10,100,000, $8,600,000 and $7,400,000, respectively. As of December 31, 1998, aggregate minimum rental commitments under noncancelable leases amounted to $12,800,000 in 1999, $12,900,000 in 2000, $12,700,000 in 2001, $3,900,000 in 2002, $3,400,000 in 2003 and $8,100,000 thereafter.
MMI has a defined-contribution pension plan that covers substantially all domestic employees who have attained age 21 and completed three months of service. MMI contributes 4% of salary for all eligible employees and matches a portion of employee contributions. MMI's contributions charged to operations were $2,900,000 in 1998, $2,700,000 in 1997 and $2,200,000 in 1996.
14. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED) (in thousands, except per share data):
In 1992, MMI sold Ludgate Insurance Company Limited (Ludgate) at a loss, which was reported in discontinued operations. The Company was involved in two lawsuits connected with the sale. Also at issue was a stop-loss reinsurance agreement provided by MMI to Ludgate in connection with the sale. In February 1997, a United Kingdom court rendered a judgment against MMI.
In February 1997, MMI settled both lawsuits and commuted the stop-loss reinsurance agreement. The settlement of all these matters is reflected in the accompanying 1996 consolidated statement of income as a loss from discontinued operations. The pre-tax loss was $7,800,000 with a corresponding tax benefit of $2,700,000, resulting in a charge of $5,100,000.