The physical properties used by FPIC and its subsidiaries are summarized below:
The selected financial data presented below for the fiscal years ended December 31 should be read in conjunction with FPIC’s consolidated financial statements and the notes thereto, which are included in Item 8. Financial Statements and Supplementary Data, herein. For additional information with respect to FPIC’s business see
Management’s Discussion and Analysis (“MD&A”) of Results of Operations and Financial Condition
The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking statements. Any written or oral statements made by us or on our behalf may include forward-looking statements, which reflect our current views with respect to future events and financial performance. These forward-looking statements can be identified by such words as, but are not limited to, “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project,” “plan,” “foresee,” “hope,” “should,” “will,” “will likely result” or “will continue” and other similar expressions. These forward-looking statements are subject to certain risks, uncertainties and other factors that could cause actual results to differ materially from such statements. These risks, uncertainties and other factors that could adversely affect our operations or cause actual results to differ materially from anticipated results include, but are not limited to, the following:
The dependence of our insurance management segment upon a major customer, Physicians’ Reciprocal Insurers (“PRI”), for its revenue, and consequently, the effects of premium rate adequacy, claims experience, policyholder retention, and PRI’s overall financial position on its ability to maintain or grow its premium base;
Risk factors associated with the impact of rising interest rates on the market value of our investments;
General economic conditions, either nationally or in our market areas, that are worse than expected;
Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of their dates. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.
We believe the critical accounting policies discussed in the remainder of this section of our MD&A affect our more significant judgments and estimates used in preparation of the consolidated financial statements. These may be further commented upon in applicable sections on Results of Operations, Financial Position and Liquidity and Capital Resources that follow. Information about the significant accounting policies we use in the preparation of our consolidated financial statements is included in Note 2, Significant Accounting Policies, to our consolidated financial statements included in Item 8. Financial Statements and Supplementary Data of this Form 10-K.
Management sets the loss and LAE reserves taking into account the results of multiple actuarial techniques applied as well as other assumptions, some of which are not strictly mathematical in nature. As of December 31, 2004, management utilized and integrated, within our loss and LAE reserves estimation process, calculations contained in an actuarial study performed by an independent actuarial firm. Our aggregate loss and LAE reserves as of December 31, 2004 are recorded at our best estimate, which is primarily based upon the independent actuarial study supplemented by additional considerations and assumptions by management. The independent actuarial firm’s reports on our reserves for the years ended December 31, 2004 and 2003 have been filed with state insurance regulators along with the statutory financial statements of our insurance companies.
In addition, due to the relatively small number of claims ultimately resulting in an indemnity payment and the average cost per claim, any change in the trends assumed in the ultimate values for these factors may be expected to result in a significant change in the reserve estimates. Because our aggregate loss and LAE reserves are so large, this also means that virtually any change in the level of our carried reserves will be material to results of operations and may be material to our financial position. As an example, a 1% increase or decrease in carried reserves, net of reinsurance, as of December 31, 2004, would result in an after-tax addition or reduction in reported net income of approximately $1.9 million, or 7% of our consolidated net income for the year ended December 31, 2004. A typical range of reasonable values for MPL reserve estimates is considered to be as wide as 15%; thus, in addition to the performance of the business itself, our results of operations and financial position are very sensitive to our reserve estimates and judgments.
For additional information and data concerning our liability for losses and LAE see Management’s Discussion and Analysis of Financial Condition: December 31, 2004 Compared to December 31, 2003.
We have obtained independent appraisals annually since the adoption of FAS 142, the most recent of which was performed as of December 31, 2004, which indicate that our goodwill and other intangible assets are fully recoverable. Our remaining goodwill of $18.9 million will continue to be subject to impairment testing through independent appraisal or otherwise at least annually, and potentially more often should a triggering event occur. A triggering event under FAS 142 might include such things as a significant adverse change in legal factors or business climate, an adverse action or assessment by a regulator, unanticipated competition, or a loss of key personnel.
NET INCOME for the year ended December 31, 2004 was $28.2 million, or $2.70 per diluted share, an increase of 70% and 58%, respectively, when compared with net income of $16.6 million, or $1.71 per diluted share, for the year ended December 31, 2003. All of our segments reported higher net income for 2004 compared with 2003. Significantly improved underwriting results and lower interest costs on our long term debt in 2004 mainly contributed to the growth in insurance segment net income. Growth in premiums written by PRI for 2004 contributed to growth in insurance management revenues and net income.
TOTAL REVENUES for the year ended December 31, 2004 increased $35.1 million, or 17%, to $236.8 million from $201.7 million for the year ended December 31, 2003. The increase in total revenues for the year 2004 is primarily due to higher net premiums earned as the result of rate increases and lower ceded reinsurance premiums in our insurance segment and higher claims administration and management fees in our insurance management segment associated with growth in written premiums at PRI. Net investment income also increased for the year 2004 primarily resulting from growth in our fixed income securities arising from growth in our insurance invested assets. Net realized investment gains also increased for the year 2004.
TOTAL EXPENSES for the year ended December 31, 2004 increased $15.7 million, or 9%, to $191.4 million from $175.7 million for the year ended December 31, 2003. The increase in total expenses for the year 2004 is primarily due to higher other underwriting expenses at our insurance segment and claims administration and management expenses at our insurance management segment. Our GAAP underwriting (combined) ratio improved to 92% for 2004 from 98% for 2003. Other underwriting expenses increased for the year primarily due to lower ceding commissions associated with lower ceded premiums earned, resulting from the terminations of a large reinsurance agreement and fronting programs. Claims administration and management expenses were higher as a result of growth in premiums written by PRI and the related growth in insurance management revenues and operations. Offsetting these higher expenses were lower borrowing costs (interest plus the costs of related hedging instruments) on our debt. We also incurred charges of $2.5 million, in 2003, to unwind interest rate swap agreements, which did not recur during 2004. Income tax expense was higher for 2004 when compared to 2003 primarily due to higher taxable income. Income tax expense for 2004 also includes a small provision for income tax contingencies identified in a current Internal Revenue Service (“IRS”) examination.
Net income for the year ended December 31, 2003 was $16.6 million, or $1.71 per diluted share, an increase of 11% and 8%, respectively, when compared with income before accounting change of $14.9 million, or $1.58 per diluted share for the year ended December 31, 2002. All three of our business segments were profitable in 2003. The year 2003 was the third year in a row of significant improvements in insurance pricing. In addition, our insurance management and third party administration (“TPA”) segments reported improved profits.
Total revenues for the year ended December 31, 2003 decreased $20.2 million, or 9%, to $201.7 million from $221.9 million for the year ended December 31, 2002. Total expenses for the year ended December 31, 2003 decreased $22.4 million, or 11%, to $175.7 million from $198.1 million for the year ended December 31, 2002. Most of the decline in our revenues and expenses in 2003 when compared with 2002 was the result of growth management initiatives we put in place in 2002, designed to level the amount of growth in our policyholder counts and significant additional ceded reinsurance coverage following an unprecedented period of growth at our insurance subsidiaries in 2001 and 2002. Our MPL insurance markets hardened significantly since 2000. Net investment income was also lower in 2003. While the equity markets recovered in 2003, interest rates fell to record lows for the third straight year, although rates did recover somewhat by the end of 2003 and exceeded 2002 year end levels.
Our insurance segment is made up of FPIC’s four insurance subsidiaries. Holding company operations are also included in the insurance segment due to the segment’s size and prominence and the substantial attention devoted to the segment.
Due to recent increases in profitability and the growing equity and statutory surplus of our insurance businesses, we terminated future cessions under the Hannover Re net account quota share reinsurance agreement, effective July 1, 2004. With this termination, business is no longer ceded under the agreement beginning with business written and renewed in the third quarter of 2004. The business already ceded through June 30, 2004, will continue to be subject to the agreement as it runs off.
INSURANCE NET INCOME increased 139% to $16.3 million for the year ended December 31, 2004 from $6.8 million for the year ended December 31, 2003. The increase in net income was primarily the result of increases in net premiums earned driven by rate increases implemented during 2003 and declines in the proportion of our premiums ceded to reinsurers as a result of the lower cost of our excess of loss reinsurance program, and lower interest costs related to debt and intersegment expenses. Partially offsetting these developments were a reduction in ceding commissions and an increase in other underwriting expenses. The decrease in ceding commissions resulted from the elimination of further cessions under the Hannover Re net account quota share reinsurance agreement as of July 1, 2004. The increase in other underwriting expenses was driven by the cancellation of fronting programs and an increase in corporate expenses associated with Sarbanes-Oxley compliance. Other expenses increased due to growth in finance charges associated with the Hannover Re net account quota share reinsurance agreement.
Insurance net income decreased 18% to $6.8 million for the year ended December 31, 2003 from $8.3 million for the year ended December 31, 2002. The decrease in net income was the result of lower net realized investment gains, lower net investment income, higher debt-related costs, and higher net intersegment expenses, comprised mainly of commissions payable to the insurance management segment. The holding company, which is grouped with the insurance segment for reporting purposes, incurred debt-related costs of $1.5 million after-tax ($2.5 million before-tax) during 2003 as a result of unwinding interest rate swap agreements in the second and fourth quarters in connection with the repayment and retirement of our term loan and revolving credit facility. Our improved underwriting margin (defined as net premiums earned less net losses and LAE and other underwriting expenses) of $4.9 million after-tax was mostly attributable to pricing improvements. Approximately $1.3 million of the after-tax improvement in 2003 was attributable to the Hannover Re net account quota share reinsurance agreement.
Direct and assumed premiums written decreased 1% to $340.7 million for the year ended December 31, 2003 from $344.7 million for the year ended December 31, 2002. The small decrease primarily reflects the offsetting trends of price improvements at all our insurance companies and growth in our core MPL book of business in Florida, offset by lower premiums on fronted business and legal professional liability business and lower MPL premiums in certain other states.
NET PREMIUMS WRITTEN increased 35% to $192.5 million for the year ended December 31, 2004 from $143.1 million for the year ended December 31, 2003. Approximately $33.9 million, or 69%, of the $49.4 million increase in net premiums written for 2004 was the result of the termination of the Hannover Re net account quota share reinsurance agreement, effective June 30, 2004. First Professionals had been ceding 50% of its direct MPL insurance premiums under this reinsurance agreement. In addition to the factors affecting direct premiums, lower reinsurance costs in 2004 as compared with 2003 under the excess of loss reinsurance program also contributed to higher net premiums written.
Net premiums written increased 2% to $143.1 million for the year ended December 31, 2003 from $140.2 million for the year ended December 31, 2002. The small increase in net premiums written is attributable to the growth management initiatives put into place during 2002, and is basically the result of planned reductions in our overall numbers of policyholders in 2003, and continuing pricing improvements, which have largely offset one another.
NET PREMIUMS EARNED increased 14% to $149.7 million for the year ended December 31, 2004 from $131.7 million for the year ended December 31, 2003. The termination of the Hannover Re net account quota share reinsurance agreement, accounted for approximately $11.6 million, or 64%, of the $18.0 million increase in net premiums earned for 2004. The remaining increase in net premiums earned is primarily due to the effects of pricing improvements at First Professionals, APAC and Intermed, which have all implemented significant rate increases in recent years. Partially offsetting these increases in net premiums earned was a reduction in assumed premiums earned due to the non-renewal of the excess of loss reinsurance treaty between First Professionals and PRI.
Our investment revenues, which are comprised of NET INVESTMENT INCOME and NET REALIZED INVESTMENT GAINS AND LOSSES, increased 20% to $24.5 million for the year ended December 31, 2004 from $20.3 million for the year ended December 31, 2003. Net investment income increased primarily as a result of recent growth in our fixed income investment portfolio corresponding with increases in our insurance business. Net realized investment gains increased primarily as a result of lower other-than-temporary impairments in 2004 when compared with 2003. During 2003 we recognized losses of $5.3 million for other-than-temporary impairments of two private equity holdings, of which $4.5 million was related to our investment in American Professional Assurance Ltd. (“APAL”). In 2004 we recognized an additional other-than-temporary impairment of $0.8 million related to our investment in APAL. With the recognition of this impairment, we have written our investment in APAL down to $0. Net realized investment gains in 2004 also included a gain of $2.1 million related to the sale of an investment in a limited partnership.
Our investment revenues decreased 20% to $20.3 million for the year ended December 31, 2003 from $25.5 million for the year ended December 31, 2002. Net investment income declined primarily as the result of the prolonged status of prevailing interest rates at historically low levels. As a result, current funds were primarily invested in fixed income securities with shorter maturities and durations and we maintained significant short-term invested cash. While these holdings reduce our exposure to losses should the interest environment change and rates begin to rise, they also produce lower current income. Net realized investment gains decreased due to charges of $5.3 million for other-than-temporary impairments of two private equity holdings, including $4.5 million related to our investment in APAL.
NET LOSSES AND LAE INCURRED increased 5% to $125.2 million for the year ended December 31, 2004 from $119.0 million for the year ended December 31, 2003. The increases in our net losses and LAE incurred relative to net premiums earned and corresponding decrease in our loss ratio reflects pricing and other improvements in our insurance business and the resulting improvement in our underwriting results. Our loss and LAE ratios (defined as the ratio of net losses and LAE incurred to net premiums earned) were 84% and 90% for the years ended December 31, 2004 and 2003, respectively.
Net losses and LAE incurred decreased 15% to $119.0 million for the year ended December 31, 2003 from $139.6 million for the year ended December 31, 2002. Net losses and LAE incurred for 2003 decreased $31.9 million, or 23%, as a result of ceded losses and LAE under the Hannover Re net account quota share reinsurance agreement. Excluding the effect of ceded losses and LAE under the Hannover Re net account quota share reinsurance agreement, net losses and LAE for 2003 increased $11.3 million, or 6%, which was primarily due to increased losses at Intermed and APAC in 2003. Our loss and LAE ratios were 90% and 92% for the years ended December 31, 2003 and 2002, respectively. The negative effects on the loss and LAE ratios of our smaller companies were offset to a significant extent by improvement in the losses and LAE incurred relative to net premiums earned at First Professionals. In addition to being much larger than Intermed and APAC, First Professionals began implementing significant pricing improvements earlier and has done so over a longer period.
Net paid losses and LAE on professional liability claims increased 6% to $119.3 million for the year ended December 31, 2004 from $112.4 million for the year ended December 31, 2003 and increased 22% to $112.4 million for the year ended December 31, 2003 from $92.5 million for the year ended December 31, 2002. These increases were generally to be expected and consistent with recent growth in our insurance business, considering the inherent time lag until the related claims are settled and closed. The average net paid loss per professional liability claim with indemnity payment for calendar year 2004 declined 9% to $0.19 million from $0.21 million for calendar year 2003. The decrease is primarily the result of increased reinsurance coverage on claims settled and paid during 2004, including ceded losses under the Hannover Re net account quota share reinsurance agreement.
Newly reported claims and incidents were down significantly (29%) in 2004 when compared with 2003. A portion of these declines relates to a speed up in claims reporting experienced during 2003. This resulted in a higher than usual number of claims reported in 2003, as plaintiffs’ attorneys accelerated case filings to precede the effective date of tort reform legislation passed in Florida in the fall of 2003 followed by lower than usual reported claims in subsequent periods.
The number of claims with an indemnity payment (“CWIP”) during 2004 increased 24% from the number of CWIP in 2003. The percentage of CWIP to all closed claims for 2004 was 14%, or 1 percentage point higher than the 2003 CWIP percentage of 13%. While our 2004 and 2003 CWIP percentages are higher than 2002’s CWIP percentage of 12%, the 2002 through 2004 percentages are significantly lower than the CWIP percentages for 2000 and 2001, which were 20% and 18%, respectively. This significant improvement is largely the result of a harder claims philosophy and related management initiatives implemented beginning in 2001. We also believe that the application of disciplined underwriting and risk selection criteria have helped minimize claims.
OTHER UNDERWRITING EXPENSES increased 33% to $12.5 million for the year ended December 31, 2004 from $9.4 million for the year ended December 31, 2003. The increase in other underwriting expenses is primarily the result of recent growth in our insurance business and a decrease in ceding commissions resulting from the elimination of cessions under the Hannover Re net account quota share reinsurance agreement during the third quarter of 2004. Also contributing to the 2004 increase were direct costs associated with compliance with the Sarbanes-Oxley Act of 2002 of approximately $1.5 million and lower ceding commissions under reinsurance agreements.
INTEREST EXPENSE ON DEBT decreased 56% to $2.6 million for the year ended December 31, 2004 from $5.9 million for the year ended December 31, 2003. The significant decrease in interest expense on debt for 2004 is primarily due to the retirement of our former bank debt during 2003, which carried higher total borrowing costs, through refinancing in the form of private issuances of long term debt securities and by repayment using internally generated funds. Included in interest expense on debt for 2003 are charges of $2.5 million related to the unwinding of swap agreements associated with our former bank debt.
Income taxes decreased 43% to $2.4 million for the year ended December 31, 2003 from $4.2 million for the year ended December 31, 2002. The decrease in income tax expense for 2003 is primarily due to the decrease in income before income taxes and cumulative effect of accounting change when compared with the prior year and additional tax expense recognized in 2002 associated with the examination of FPIC’s 1998 and 1999 Federal income tax returns by the IRS.
Our insurance management segment is made up of FPIC’s New York subsidiaries. Effective July 1, 2004, operations of Administrators For The Professions, Inc.’s (“AFP”) wholly owned subsidiary, Physicians Reciprocal Managers, Inc. (“PRM”), commenced as the administrator and attorney-in-fact of Pennsylvania Physicians’ Reciprocal Insurers (“PaPRI”). PaPRI is an insurance exchange domiciled in Pennsylvania. It was formed to take the place of the unrelated fronting carrier that previously had underwritten, and ceded as reinsurance to PRI, medical professional liability insurance program business in Pennsylvania. PaPRI commenced underwriting the Pennsylvania program business effective July 1, 2004. PaPRI is not a subsidiary of PRM, AFP or FPIC. As an insurance exchange, the organization of PaPRI is similar to that of a mutual insurance company. PaPRI is also not a subsidiary of PRI, but received its initial capitalization in the form of a subordinated surplus note from PRI.
Financial and selected other data for the insurance management segment for the years ended December 31, 2004, 2003 and 2002 is summarized in the table below. Dollar amounts are in thousands.
Insurance management net income increased 41% to $8.8 million for the year ended December 31, 2003 from income before cumulative effect of accounting change of $6.3 million for the year ended December 31, 2002. The increase in insurance management net income for the year ended December 31, 2003 was primarily due to higher management fees, commission income and intersegment revenues. The growth in these revenues was the result of growth in premiums written at PRI and higher ceded premiums at PRI and our insurance companies for which FPIC Intermediaries receives commissions. Intersegment revenues primarily relate to commission income from First Professionals for the placement of reinsurance and the management of the Pennsylvania fronting program. These amounts are eliminated in the consolidated financial statements.
COMMISSION INCOME increased 13% to $6.2 million for the year ended December 31, 2004 from $5.5 million for the year ended December 31, 2003. The increase in commission income earned in 2004 is primarily the result of an increase in insurance premiums placed by PMA under a PRI professional liability insurance program.
Claims administration and management expenses increased 4% to $21.2 million for the year ended December 31, 2003 from $20.5 million for the year ended December 31, 2002. The increase is due to the combination of an increase in operating expenses at AFP to manage growth at PRI and an increase in operating and commission expenses at PMA associated with an increase in premiums written and placed on behalf of PRI.
Our TPA segment represents the business of our subsidiary Employers Mutual, Inc. Financial and selected other data for our TPA segment for the years ended December 31, 2004, 2003 and 2002 is summarized in the table below. Dollar amounts are in thousands.
TPA NET INCOME increased 12% to $1.0 million for the year ended December 31, 2004 from $0.9 million for the year ended December 31, 2003. The increase is primarily due to an increase in commission income and a decrease in claims administration and management expenses. The increase in commission income is due to an increase in brokerage income from the placement of excess insurance arrangements on behalf of self-insured property and casualty clients. The TPA segment has experienced a decrease in covered lives under the employee benefits and worker compensation programs it administers, but the segment has substantially offset the decrease with higher revenues per program and new business.
TPA net income increased 198% to $0.9 million for the year ended December 31, 2003 when compared with income before cumulative effect of accounting change of $0.3 million for the year ended December 31, 2002. The increase is primarily due to higher claims administration fees and improved operating margins. Growth in the number of covered members serviced by the ambulance service organization to which we provide administrative services along with cost savings and productivity initiatives helped improve our margins in 2003.
See Note 20, Subsequent Event, to the consolidated financial statements for disclosure of the definitive agreement to sell the TPA segment's employee benefits administration business.
INVESTMENTS AND CASH AND CASH EQUIVALENTS increased $61.3 million to $684.0 million as of December 31, 2004 from $622.7 million as of December 31, 2003. The net increase is primarily the result of net cash flows from operating activities associated with recent growth at our insurance and insurance management segments.
PREMIUMS RECEIVABLE decreased $7.0 million to $94.3 million as of December 31, 2004 from $101.3 million as of December 31, 2003. The decrease in premiums receivable is primarily the result of a decrease in premiums written under fronting programs. We terminated the last of our fronting programs as of June 30, 2004. The reduction in policyholders and resulting decrease in premiums written at Intermed also contributed to the decrease in premiums receivable.
The LIABILITY FOR LOSSES AND LAE increased $60.6 million to $635.1 million as of December 31, 2004 from $574.5 million as of December 31, 2003. The increase is mostly attributable to recent growth in our core MPL insurance business.
The top portion of the preceding table ending with the subtotal “Redundancy / (Deficiency)” demonstrates how our net loss and LAE reserves as of the end of each of the last ten calendar years compares with net paid losses and re-estimates of those net reserves after the end of each of these years. A net redundancy means that the reserves carried as of the end of that particular calendar year (including reserves on claims still open, if any) have developed downward. When reserves develop downward, this means that we now believe we will have to pay less for these claims than we had previously set aside in reserves. A net deficiency means that the reserves have been increased since the end of the calendar year. This means that we now believe we will have to pay more for these claims than we previously set aside in reserves. For example, the table indicates that the cumulative net reserves carried at the end of calendar years 1994 through 1998 have been higher than subsequent payments and re-estimates. In contrast, the cumulative net reserves at the end of calendar years 1999 through 2003 have been increased from amounts initially carried as of the end of each of these years.
The bottom portion of the preceding table presents the original cumulative gross reserves, reinsurance recoverables and net reserves as of the end of each calendar year together with summaries of the corresponding latest cumulative re-estimated amounts as of December 31, 2004. The effects on our results of operations of a cumulative redundancy or deficiency in our gross reserves as depicted in the bottom portion of the table in excess of the development in our reserves, net of reinsurance, for those years are entirely offset by corresponding decreases or increases in reinsurance recoverables. The upward development in our gross loss and LAE reserves recognized during 2004 for years 1999 through 2001 is largely consistent with the development in our net reserves as described above. In addition, during 2003, we increased our gross reserves and related reinsurance recoverable amounts for APAC for the years 2000, 2001 and 2002 to conform its gross reserves as a result of its integration under the management of First Professionals. As with our net loss and LAE reserves, the upward development pertaining to years 1999 through 2001 has been largely offset by better than expected loss experience and downward development in our reserves for years 2002 and 2003 since then.
The following table rolls forward FPIC’s consolidated liability for losses and LAE reserves, net of reinsurance, (in thousands) showing the changes for the period beginning January 1, 2002 and ending December 31, 2004.
Our best estimate of reserves for the 2004 year has been determined using historical trends with adjustments added to provide for uncertainties inherent in the claims environment in Florida, including those resulting from significant tort reform initiatives passed by the legislature in 2003 and three constitutional amendments passed by popular initiative in 2004. Because of the uncertainty created by these changes, we believe that booking a more conservative provision in the current year is prudent.
FPIC’s aggregate loss and LAE reserve estimates reported for years 2003 and prior have not increased significantly, as a group, in 2004. FPIC adopted a new harder claims payment philosophy beginning in 2001. The new claims philosophy, which is now approaching its fourth full year, has had the effect so far of reducing FPIC’s overall loss costs relative to its former claims philosophy. It has also had the effect of changing FPIC’s loss development patterns thereby introducing an additional element of uncertainty into the provisions for the individual prior years. We believe that it is best to treat this element of uncertainty conservatively and thus, have not reduced our prior year reserves, in aggregate, but have increased the provisions in some years and reduced them in others. As shown in the 10 year table and further commented upon above, as of December 31, 2004, we have increased our aggregate loss and LAE reserves, net of reinsurance, for the years ended December 31, 2001 and prior as originally reported by $35.2 million and have reduced our reserves for claims related to the years ended December 31, 2002 and 2003 by $19.0 million and $15.7 million, respectively.
For additional information on our accounting policy for loss and LAE reserves, see Note 2, Significant Accounting Policies, to the consolidated financial statements.
FPIC has various contractual obligations that are recorded as liabilities in our consolidated financial statements. FPIC also has items that represent contractual obligations, commitments and contingent liabilities that are not recorded on its balance sheet or that are considered to possess off-balance sheet risks beyond their respective amounts otherwise reflected in the balance sheet. These include: (1) derivative financial instruments, which are used to hedge interest rate risk, (2) guarantees by us of trust preferred securities issued by separately created, unconsolidated trusts, (3) a contingent liability under an amendment made to AFP’s management agreement with PRI, effective January 1, 2002, and (4) two irrevocable letters of credit issued in favor of the lessor under operating leases.
FPIC uses interest rate collars as a hedge to maintain the total borrowing costs of its long term debt (interest expense on the debt instruments, plus or minus cash flows under the interest rate collar instruments) to within specified ranges. FPIC’s all in borrowing costs on long term debt combined with the corresponding cash flows under the related interest rate collars can fluctuate between $2.3 million to $3.8 million annually, until such time as the interest rate collars expire. The interest rate collars are set to expire on dates corresponding with the first dates under the respective long-term debt agreements at which they can be retired by us at our option, which is five years from the date of issue in each case. See Note 10, Derivative Financial Instruments, to the consolidated financial statements for additional disclosures about FPIC’s derivative financial instruments.
AFP has an exclusive 10 year management agreement with PRI with the current term ending December 31, 2008. During 2002, the management agreement between AFP and PRI was amended to remove the sharing by AFP of 10% of PRI’s statutory net income or loss, effective January 1, 2002. Compensation under the agreement as originally in effect was equal to 13% of PRI’s direct premiums written, with an adjustment for expected return premiums, plus or minus 10% of PRI’s statutory net income or loss. With regard to profit sharing amounts already earned and collected, AFP has agreed pursuant to the amendment, to consider the years 1999, 2000 and 2001 open for re-determination and possible adjustment for a period of five years each (expiring 2004, 2005 and 2006, respectively.) Such adjustments would be based primarily on development of and related adjustments, if any, to loss and LAE reserves for those years. There have been no adjustments to date. AFP had previously earned and collected profit sharing amounts under the original agreement totaling $3.6 million for the three years ended December 31, 2001. In accordance with the amended agreement, AFP also agreed to pay 6% annual interest on the 10% profit share amounts previously earned and collected under the original agreement for 1999, 2000 and 2001, while those years remain open for possible future re-determination and adjustment, if any. In addition, AFP is reimbursed for 50% of the costs associated with the risk management department it maintains for PRI insureds. The management agreement and amendment were reviewed and approved by the New York State Insurance Department. See Note 18, Related Party Transactions, to the consolidated financial statements for additional information about the management agreement with PRI.
FPIC has issued two irrevocable letters of credit in the amount of $500,000 each as collateral under operating leases for the buildings occupied by AFP in Manhasset and Lake Success, New York. FPIC also issues irrevocable letters of credit or places assets in trust under its assumed reinsurance contracts with PRI. These assets in trust or letters of credit serve as collateral to corresponding insurance liabilities recorded on our balance sheet and are not considered to be off-balance sheet obligations. Finally, FPIC is contractually committed to make certain minimum lease payments for the use of property under operating lease agreements.
The following table summarizes our significant contractual obligations and commitments as of December 31, 2004 and the future periods in which such obligations are expected to be settled in cash. In addition, the table reflects the timing of principal payments on outstanding borrowings. Additional information regarding these obligations is provided in Note 9, Long Term Debt, Note 13, Employee Benefit Plans, and Note 14, Commitments and Contingencies, to the consolidated financial statements.
(2) Pension obligations are comprised of approved plan contributions and FPIC's obligation should a plan terminate as of December 31, 2004.
Under our stock repurchase program, we may repurchase shares at such times, and in such amounts, as management deems appropriate. We did not repurchase any shares during 2004 and a total of 365,500 shares remain available to be repurchased under the program. Under certain circumstances, limitations may be placed on FPIC’s ability to purchase its capital stock by the terms of agreements relating to its junior subordinated debentures. For information regarding these limitations, refer to Note 9, Long Term Debt, to the consolidated financial statements. For additional information, see also the discussion of Liquidity and Capital Resources, below.
Unexpected changes in the amounts needed to defend and settle claims;
Unexpected changes in liquidity provided by our insurance management and TPA segments.
Monitor our reserves and periodically perform actuarial reviews of loss and LAE reserves; and
During 2003, we completed the placement of $10.0 million in senior notes and created three trusts that issued 30-year trust preferred securities for which the proceeds from such issuances together with cash previously contributed to the trusts were used to purchase junior subordinated debentures from FPIC totaling $36.1 million. We used the proceeds along with other internally generated funds to retire our bank term loan and revolving credit facility, make a capital contribution to our insurance operations and unwind hedge agreements related to the revolving credit facility and term loan.
The securities are uncollateralized and bear floating interest rates equal to the three-month LIBOR plus spreads ranging from 3.85% to 4.20% (the interest rates ranged from 5.98% to 6.60% as of December 31, 2004). The floating interest rates are adjustable quarterly with changes in the three-month LIBOR, and in the case of two offerings, the maximum rate that may be charged under the securities within the first five years is 12.50%. We have also purchased hedging instruments, as described below, designed to maintain the ultimate floating rate interest cost on all of these securities within a stated range for five years from closing. We have the option to call the trust preferred securities at par or its equivalent beginning five years from closing. The trust preferred securities also contain features that allow us the option, under certain conditions, to defer interest payments for up to 20 quarters and to redeem the securities before the first optional call date in five years. In the case of the potential earlier call date, the redemption or call price payable by us may be different than par. The securities have stated maturities of thirty years and are due in May and October 2033.
Indenture agreements relating to FPIC’s junior subordinated debentures and trust preferred securities contain limitations, under certain circumstances, as to (i) the declaration or payment of dividends, or distributions thereon, or the redemption, purchase, acquisition or liquidation with respect to any capital stock of FPIC or its affiliates; (ii) the payment, in certain circumstances, of principal, premium or interest on, or the repayment, repurchase or redemption of, debt securities of FPIC or its affiliates that rank in equal standing with or are junior in interest to the debentures; or (iii) the payment, in certain circumstances, under any guarantees of FPIC or its affiliates that rank equal in standing with, or junior in interest to, capital securities guarantees relating to the issuance of the debentures. Circumstances that would result in such limitations include a continuing event of default, as defined by the indenture agreements, a default with respect to payment of any obligations under capital securities guarantees, or a continuing interest deferral election by FPIC.
The sources of liquidity to FPIC, the holding company, for the payment of its operating expenses, taxes and debt-related expenses are management fees from First Professionals and APAC and overhead allocations to the non-insurance subsidiaries for which FPIC receives reimbursement, and dividends.
FPIC has management agreements with First Professionals and APAC, under which it provides substantially all management and administrative services to these subsidiaries. Under the terms of the agreements, FPIC receives management fees equal to 115% of the costs incurred to manage the two subsidiaries. The additional 15% provision in the First Professionals and APAC management fees is intended to cover overhead, corporate expenses and profit and is eliminated in the consolidated financial statements. In the case of the agreement with APAC, the total annual management fees are also limited to an amount not to exceed those that would have been paid under the terms of its former management agreement.
In December 2004, the Financial Accounting Standards Board issued FAS 123(R), “Share−Based Payment,” which establishes standards for transactions in which an entity exchanges its equity instruments for goods or services. FAS 123(R) requires stock options and other share−based payments made to employees to be accounted for as compensation expense and recorded at fair value. Consistent with the provisions of the new standard, we intend to adopt FAS 123(R) in the third quarter of 2005. Information about the fair value of stock options under the Black−Scholes model and its pro forma impact on our net income and earnings per share for the years ended December 31, 2004, 2003 and 2002 can be found in Note 2, Significant Accounting Policies, to the consolidated financial statements. However, a number of technical implementation issues are yet to be resolved, including the selection and use of an appropriate valuation model, and the ultimate impact of adopting FAS 123(R) is not yet known.
During 2004, the Emerging Issues Task Force (“EITF”) of the Financial Accounting Standards Board reached a consensus with respect to guidance to be used in determining whether an investment within the scope of EITF Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments,” is other-than-temporarily impaired. The guidance was to be applied in other-than-temporary impairment evaluations made in reporting periods beginning after June 15, 2004, however, in October 2004 the implementation date was deferred. Due to the uncertainty as to how all of the relevant outstanding issues will be resolved, FPIC is unable to determine the impact of adopting paragraphs 10-20 of EITF 03-1 until final implementation guidance is issued.