MA-Alabama is the fee owner of one office building located in the metropolitan area of Birmingham, Alabama. MA-Alabama purchased the building in March 1989 and during 1993 sold the
office building which it formerly occupied. MAI and its subsidiaries are occupying approximately 55,000 square feet of office space in the building. The remaining office space of approximately 101,000 square feet in the building is leased to unaffiliated persons or is available to be leased. The office building is currently unencumbered.
MAI is the fee owner of one office building located in the metropolitan area of St. Louis, Missouri. MA-Alabama is occupying approximately 7,700 square feet as the base for its St. Louis operations and the remaining office space of approximately 6,500 square feet in this building is leased to unaffiliated persons or is available to be leased. At December 31, 1999 the building secured a bank loan in the approximate amount of $357,000; however, this loan was repaid in full in January 2000. This office building is currently under contract to be sold with the closing scheduled for April 2001. This operation will be relocated to other leased office space in St. Louis.
MA-Alabama's other locations and MA-West Virginia maintain additional office space under leases with unaffiliated persons that are not considered material.
(A) Net income for 1998 was reduced by $1.1 million which represents the cumulative effect (net of tax) of an accounting change for guaranty fund assessments due to the adoption of the American Institute of Certified Public Accountants' Statement of Position 97-3. The cumulative effect reduced net income per share of common stock (Basic and Diluted) by $0.04 per share.
ITEM. 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
During 2000, the Company's Board of Directors increased the authorization for purchases of its common stock by 1 million shares in July and by an additional 1 million shares in December. The Company applied approximately $9.6 million to the purchase of its shares in 2000.
The Company is exposed to various market risks, including both interest rate risk and equity price risk. Interest rate risk represents the risk of changes in value of a financial instrument caused by fluctuations in market interest rates. The Company handles market risks in accordance with its established investment policies. The goal of these policies is to implement a strategic asset allocation that maximizes the long-term rate of return at a minimum level of risk given a set of asset classes and restrictions. Market risk control relates principally to ratings of issuers and length to maturity. The Company does not enter into derivative transactions.
At December 31, 2000 fixed maturity securities totaling $603.5 million, at fair value, comprised 76% of the Company's invested assets of $796.5 million. Thus, the most significant market risk to the Company is interest rate risk related to the fixed maturity portfolio. The Company believes it is in a position to keep these investments until final maturity and does not invest in fixed maturity securities for trading
purposes. Nevertheless, fluctuations in market interest rates may significantly impact the fair value of this portfolio.
The Company estimates that the fair value of its fixed maturity portfolio and the weighted average effective duration would respond to fluctuations in market interest rates as follows:
At December 31, 2000 the fair value of the Company's investment in common stocks, excluding preferred stocks as discussed in the following paragraph, was $48.0 million which included net unrealized losses of $2.3 million. These securities are subject to price risk. A hypothetical 10% increase in the market prices as of December 31, 2000 would increase the fair value of these securities to $52.8 million; a hypothetical 10% decrease would reduce the fair value to $43.2 million. The selected hypothetical change does not reflect what could be considered the best or worst scenarios.
At December 31, 2000 the Company has a limited investment in preferred stocks. These securities were carried at fair value of $32.9 million at December 31, 2000, including net unrealized gains of $0.9 million. These securities carry fixed rates of return and thus, like fixed maturities, are primarily subject to interest rate risk. The fixed maturities table above does not include preferred stocks.
The Company is not aware of any material problems resulting from Year 2000 issues as respects its internal systems, or the products and services of third parties, nor is the Company aware of any claims against its insureds resulting from Year 2000 related matters. The Company will continue to monitor its mission critical computer applications to ensure that any latent Year 2000 matters that may arise are addressed promptly.
RESULTS OF OPERATIONS - YEAR ENDED DECEMBER 31, 2000 COMPARED TO YEAR ENDED DECEMBER 31, 1999
Direct and assumed medical malpractice premiums written during the year ended December 31, 2000 increased by $1.4 million as compared to the same period of 1999, from $178.6 million to $180.0 million. After giving effect to insureds that did not renew, a net increase of approximately $5.3 million resulted from rate increases and writing premiums at approved higher rates; see next paragraph. Partially offsetting this $5.3 million increase was a decrease of $3.9 million resulting from one-time additional premiums written in January 1999 related to the purchase of a book of business.
The Company writes accident and health, workers compensation and multi-line premiums from time to time as opportunities arise. These policies historically yield lower margins than the Company's other lines of business and thus are not a primary focus of operations. However, this business does provide an opportunity to utilize the Company's capital and produces revenue from fees and commissions. Given the uncertain market conditions in these areas, variations in premiums are to be expected as pricing conditions change rapidly. For the year ended December 31, 2000 as compared to the same period of 1999, direct and assumed workers compensation and multi-line premiums increased $14.1 million, and direct and assumed accident and health premiums written increased by $6.8 million. The Company believes the contributions of the accident and health and workers compensation fronting and reinsurance programs do not warrant the resources that have been devoted to them and as a consequence the Company will not have as large a commitment to these areas in the future.
The Company cedes reinsurance to provide for greater diversification of business, allow management to control exposure to potential losses arising from large risks, and provide capacity for additional growth. Premiums ceded are estimated based on the terms of the respective reinsurance agreements. The estimated expense is continually reviewed and any adjustments that become necessary are included in current operations. Amounts recoverable from reinsurers are estimated in a manner consistent with the loss liability associated with the reinsured policies. The Company continually reviews the levels of coverage ceded and the related costs.
Premiums ceded decreased by approximately $4.4 million for the year ended December 31, 2000 as compared to the year ended December 31, 1999, primarily related to workers compensation, accident and health, and multi-line premiums earned. While the total earned amount of these premiums increased between the two periods, the proportion of the premiums that were ceded decreased during 2000. As a result, ceded premiums were lower for the year ended December 31, 2000.
Consolidated net investment income was $41.5 million in 2000 compared to $39.3 million in 1999. The $2.2 million increase is attributable to increased invested amounts and increased average yields. Monthly average invested assets in 2000 were $11 million higher than in 1999. The average yield in invested assets was 5.4% in 2000 compared to 5.2% in 1999.
The principal investment objective of the Company is to achieve a high level of after-tax income while minimizing risk. Although fixed maturity securities are purchased with the initial intent to hold such securities until their maturity, disposals of securities prior to their respective maturities may occur if management believes such disposals are consistent with the Company's overall investment objectives, including maximizing after-tax yields. The Company anticipates a reduction of invested assets in 2001 in order to complete the consolidation with Professionals Group as discussed under "Liquidity."
Consolidated losses and loss adjustment expenses (losses) and the related current year loss ratio are summarized in the following table (dollars in thousands). The current year loss ratio is based on net premiums earned.
The current accident year loss ratio (current accident year net loss divided by net premiums earned) increased to 100% from 96%. This change is due to increasing trends in severity and frequency of medical malpractice claims recognized by the Company during the year 2000. As a result of these same trends, the per claim average ultimate payment of indemnity and loss adjustment expenses for recent accident years appears likely to exceed comparable averages for previous years. Although such per claim average remains within the level contemplated by the previously established reserves, the effect was favorable loss development during the year ended December 31, 2000 of $22.5 million versus $53.6 million during the year ended December 31, 1999. If these trends continue, the Company may experience higher levels of incurred losses in subsequent periods. See Note 6 of the Notes to Consolidated Financial Statements for additional information concerning losses.
Underwriting, acquisition and insurance expenses decreased reflecting lower Guaranty Fund assessments and the attention the Company paid to expense controls during the year. The increase in ceding commissions earned is principally higher cessions on worker compensation programs. See Note 5 of the Notes to Consolidated Financial Statements.
The largest component of the increase in direct and assumed premiums written was a $17.2 million increase in medical malpractice premiums. The increase in medical malpractice premiums includes assumed premiums of $3.9 million from the existing policies of the book of business acquired effective January 1, 1999, an increase in assumed medical malpractice premiums of $1.9 million, and $6.6 million of additional direct premiums resulting from the renewal of the book of business acquired in 1999.
The Company writes accident and health, workers compensation and multi-line premiums from time to time as opportunities arise. These policies historically yield lower margins than the Company's other lines of business and thus are not a primary focus of operations. However, this business does provide an opportunity to utilize the Company's capital and produces revenue from fees and commissions. Given the uncertain market conditions in these areas, variations in premiums are to be expected as pricing conditions change rapidly. For the year ended December 31, 1999 as compared to the same period of 1998, direct and assumed workers compensation and multi-line premiums written increased $2.3 million, while direct and assumed accident and health premiums written decreased by $10.5 million. The decrease was primarily due to the termination in 1999 of a large program having written premiums of approximately $9 million in 1999 as compared to $20 million in 1998. The premiums for this program were heavily ceded, thus mitigating the impact of the terminated program.
Losses incurred include two components: a) actuarial evaluation of incurred loss levels for the current accident year, and b) actuarial re-evaluation of incurred loss levels for prior accident years. These components take into consideration prior loss experience, loss trends, and changes in the frequency and severity of claims. Any adjustments related to previously established amounts are included in current operations.
The current accident year loss ratio (current accident year net loss divided by net premiums earned) decreased to 96% from 100%. This change reflects the Company's recognition of the decreasing trend in severity and frequency of medical malpractice claims. The effect was favorable loss development during the year ended December 31, 1999 of $53.6 million versus $47.3 million during the year ended December 31, 1998.
The Company's effective tax rate for both years ended December 31, 1999 and 1998 was 26%. The 1998 effective rate includes taxes netted against the "Cumulative effect of accounting change" on the 1998 Consolidated Statement of Income. The effective tax rates were lower than the statutory rate of 35% primarily because of the effect of tax-exempt investment income. The deferred tax asset did not include loss carryforwards at either December 31, 1999 or December 31, 1998.
The U.S. securities laws, including the Private Securities Litigation Reform Act of 1995, provide a "safe harbor" for certain forward-looking statements. This report contains forward-looking statements (identified by words such as, but not limited to, "believe", "expect", "intend", "anticipate", "estimate", and other analogous expressions) including statements concerning: earnings, losses, capital requirements, loss reserves, the retention of current business, competition, the expansion of product lines, the development or acquisition of business in new geographical areas, the proposed consolidation with Professionals Group, and other matters.
The Consolidated Financial Statements and Financial Statement Schedules of MAI and subsidiaries listed in Item 14(a) have been included herein beginning on page 39. The Supplementary Financial Information required by Item 302 of Regulation S-K is included in Note 12 of the Notes to Consolidated Financial Statements of MAI and its subsidiaries.