NET BOOK VALUE DECEMBER 31, --------------- Office furniture and equipment $308,758 Leasehold improvements at leased premises, 6600 France Avenue South, Minneapolis, MN 35,127 Computer hardware 166,348 Computer system software 61,476 --------------- Total $571,709 --------------- --------------- The Company owns no real estate. MMIHC leases approximately 15,765 square feet of office space in Edina, Minnesota under a 10-year lease that expires in 2001, subject to the option for MMIHC to renew the lease for an additional five years after the original term. Four-thousand and sixty square feet of office space is leased in West Des Moines, Iowa under a 10-year lease that expires in 2000, with an option for MMIHC to extend the term for an additional five years after the original term. An additional 2,398 square feet of office space is leased in Omaha, Nebraska under a three year lease that expires November 30, 1997. Annual rent expense was $392,282 for 1996 and $379,699 for 1995.
Following is the selected financial data of MMIHC for the five years ended December 31, 1996. This data should be read in conjunction with the consolidated financial statements and notes thereto appearing under Item 8 of this Form 10-K.
OPERATIONS DATA 1996 (1) 1995 (1) 1994 (1) 1993 (1) 1992 (3) - -------------------------------------------------------------------------------- (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
Loss and loss adjustment expense 32,257 37,560 11,334 30,693 19,707 Other underwriting expenses 5,690 6,415 5,509 5,807 6,480 ----------------------------------------------- 37,947 43,975 16,843 36,500 26,187 ----------------------------------------------- Income before income taxes 8,939 14 20,912 18,456 24,989 Income taxes (benefit) 1,458 (1,711) 6,417 6,156 8,528 ----------------------------------------------- Net income $ 7,481 $ 1,725 $14,495 $12,300 $16,461 ----------------------------------------------- -----------------------------------------------
(3) Amounts derived from post-pooling financial statements of MMIHC which have been audited as to combination only.
The Company's bylaws require that MMIHC Class A Common Stock issued to MMIC policyholders be redeemed when a physician ceases to be insured by MMIC for any reason. The redemption value per share is calculated by dividing the net book value of the Company, excluding the net book value of MMIC (other shareholders' equity) from the calculation, by the number of MMIHC Class A Common Shares outstanding. More detail about the redeemable stock and the actual redemptions during the years 1996, 1995 and 1994 are found in Note 3 to the consolidated financial statements. This limited redemption value preserves the capital of MMIC as shareholders' equity. The consolidated statements of changes in other shareholders' equity found in the accompanying financial statements provide the details of additions to and reductions in other shareholders' equity.
From time to time the Board of Directors of MMIC declares dividends payable to MMIHC to maintain the redemption value of the Company's Class A Common Stock. The $1,181,000 dividend declared in November 1994 and the $260,000 dividend in November 1995 were declared in accordance with that principle and paid in February of 1994 and 1995, respectively. In July 1996, a dividend of $327,000 was paid to MMIHC as required by a provision of the MMIC/MLM merger agreement. Per the merger agreement, the amount was sufficient to maintain the per share redemption value of MMIHC's Class A Common Stock at the same per share value immediately after the merger as immediately before the merger.
Development of Liability for Loss and Loss Adjustment Expense (THOUSANDS OF DOLLARS)
NET PREMIUMS EARNED increased $2,248,000 in 1996 from 1995 while the number of insured policyholders and rate levels were relatively the same. The primary reasons for this increase are:
1. In 1996, $2,194,000 was received from the commutation of a reinsurance treaty covering the years 1989 and 1990. This increases 1996 net premiums. There was no similar item in 1995.
3. Offsetting these two major reasons for the increase in 1996 net premiums was one significant item which caused a decrease. The Company recorded an increase of $2,901,000 in an Iowa development experience liability account in 1996. A similar increase of $646,000 was recorded in 1995. The difference between the 1996 and 1995 amounts decreased net premium $2,255,000. Under terms of the MMIC/IPMIT July 1, 1993 merger agreement, if the financial results for the years prior to 1993 are more favorable than expected at December 31, 1992, that favorable development must be returned to the prior IPMIT policyholders who renew coverage with MMIC.
NET PREMIUMS EARNED increased $3,552,000 in 1995 from 1994 even though policyholder rate levels remained the same and the number of policyholders insured also remained stable. The primary reasons for this increase are:
2. The Company recorded an increase of $646,000 in an Iowa development experience liability account in 1995. Under terms of the MMIC/IPMIT July 1, 1993 merger agreement, if the financial results for years prior to 1993 are more favorable than expected at December 31, 1992, that favorable development must be returned to the prior IPMIT policyholders who renew coverage with MMIC. The establishment of this liability reduces earned premiums. A similar increase of $7,227,000 was recorded in 1994. The difference between 1995 and 1994 increased net premium from 1994 to 1995 by $6,581,000.
REALIZED CAPITAL GAINS of $1,771,000 in 1996 and $1,646,000 in 1995 were due to active management of both the bond and equity sections of the portfolio. During 1994, the same investment management philosophy, preservation of assets while securing the highest total return possible, resulted in a net capital loss of $455,000. The Company employs two outside professional advisors to manage the portfolio, one to manage fixed income securities and a separate manager for equities. The managers operate within the Company's adopted investment policy. The Investment Committee meets with the outside managers approximately four times per year.
NET INCOME for the Company during the last three years totaled $23,701,000 which was added to retained earnings. As indicated in the discussion of loss and loss adjustment expenses, a significant portion of net income for these years resulted from the reversal of loss liabilities established in prior years.
In 1994, as discussed in Note 1 to the financial statements, the Company changed its method of accounting for certain investments in debt and equity securities.
Cash - 704 Accrued investment income 2,778 2,875 Reinsurance recoverable (NOTE 8) 22,174 25,112 Other assets 6,451 7,446 Deferred income taxes (NOTE 7) 1,130 2,304 -------------------------- Total assets $261,993 $264,584 -------------------------- --------------------------
Losses and expenses: Losses and loss adjustment expenses (NOTES 6 AND 8) 32,257 37,560 11,334 Other underwriting expenses 5,690 6,415 5,509 -------------------------------------- 37,947 43,975 16,843 -------------------------------------- Income before income taxes 8,939 14 20,912
Effective July 1, 1993, MMIC merged with Iowa Physicians Mutual Insurance Trust (IPMIT), a physician-owned professional liability insurance company providing insurance coverage to Iowa physicians. As provided for in the agreement and plan of merger, IPMIT was merged into MMIC. The merger was accounted for as a pooling-of-interests and, accordingly, the consolidated financial statements include the combined financial position and results of operations of MMIHC and IPMIT for all periods presented.
During 1995, MMIHC formed MMIHC Services, Inc. to provide agency services for the distribution of complementary insurance products and services to physicians, clinics and hospitals.
Hereafter, MMIHC, MMIC and MMIHC Services, Inc. shall be collectively referred to as the Company unless the reference pertains to a specific entity.
Prior to January 1, 1994, fixed maturity investments were carried at the lower of aggregate amortized cost or market. Unrealized losses on the fixed maturity portfolio are recorded as a component of equity, net of applicable deferred taxes. Equity securities are recorded at market. Unrealized gains and losses are reported as a component of equity, net of applicable deferred taxes.
Fair values are based on quoted market prices, where available. For fixed maturity investments not actively traded, fair values are estimated using values obtained from independent pricing services. Short-term investments are principally money market funds backed by U.S. government securities and are recorded at cost which approximates fair value.
The liability for 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 MMIC, 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. MMIC believes that the estimate of the liability for losses and loss adjustment expenses is reasonable.
Premiums received are recorded as earned ratably over the lives of the policies to which they apply. A portion of premiums received is deferred to recognize the Company's obligation to provide reporting endorsement coverage without additional premium upon the death, disability or retirement of policyholders. This amount is recorded as an unearned premium reserve and represents the actuarially determined present value of future benefits to be provided less the present value of future revenues to be received.
The Company cedes reinsurance in order to reduce its liability on individual risks and to enable it to write business at limits it otherwise would be unable to accept. All reinsurance contracts are excess-of-loss contracts which indemnify the Company for losses in excess of a stated retention limit up to the policy limits.
Effective June 5, 1996, MLM policyholders received, in exchange for their ownership interests, 5,447 shares of MMIHC Class A Common Shares which was computed by dividing the December 31, 1995 GAAP basis capital and surplus of MLM by the net book value per share of MMIHC. These shares were distributed to the MLM policyholders ratably in proportion to their ownership of shares of MLM Common Stock. To maintain the net redemption value of the Class A Common Shares (see Note 3), a dividend in the amount of $327,000 was paid by MMIC to MMIHC at the time of the merger. Net premiums earned, losses and loss adjustment expenses and net income for the individual entities for the period ended December 31, 1995 were as follows (in thousands):
MMIHC MLM ADJUSTMENTS COMBINED ---------------------------------------- Net premium earned $27,981 $1,817 $ - $29,798 Losses and loss adjustment expenses 35,472 2,088 - 37,560 Net income 1,425 (172) 472 1,725
In order to restate the components of shareholders' equity and determine the restated income per common share and common share equivalent, management computed the number of shares that would have been issued to MLM policyholders as of December 31, 1995, 1994 and 1993 as if the effective date of the merger had been as of those dates, respectively. Following is that computation (dollars in thousands, except for share and per share amounts).
A provision of the agreement and plan of merger requires that any favorable development of certain pre-merger liabilities of MLM be paid to the former MLM policyholders who remain active MMIC 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, 1996, there has been no favorable development and therefore there is no accrual related to this provision.
MMIHC has issued one share of Class B voting stock which carries with it the right to elect the Board of Directors of MMIHC. The voting rights are currently exercised by the Minnesota Medical Association and the Iowa Medical Society. A majority of the Class A shareholders may at any time, by a two-thirds vote, elect to redeem the Class B share at cost.
The schedule which follows has been restated for the merger of MMIC with MLM. The schedule was further restated in that redemption of shares due to policyholder termination has been changed for all periods to reclassify a pro rata portion of each redemption to paid-in capital with the remainder to retained earnings. As originally presented in prior years, each redemption was charged entirely to retained earnings.
Equity securities $ 20,237 $ 18,183 $ (419) $ 38,001 ----------------------------------------------- -----------------------------------------------
DECEMBER 31, 1995 --------------------------------------------------- GROSS GROSS UNREALIZED UNREALIZED MARKET COST GAINS LOSSES VALUE --------------------------------------------------- Fixed maturities: MMIHC: Industrial and other $ 847 $ 4 $ - $ 851 MMIC: United States Government 96,826 4,933 (179) 101,580 State and other political subdivisions 64,894 2,795 (41) 67,648 Industrial and other 11,977 761 - 12,738 --------------------------------------------------- Total $174,544 $ 8,493 $ (220) $182,817 --------------------------------------------------- ---------------------------------------------------
Equity securities $ 17,670 $ 10,825 $ (184) $ 28,311 --------------------------------------------------- ---------------------------------------------------
1996 1995 --------------------------------------------- MMIHC MMIC MMIHC MMIC --------------------------------------------- Fixed maturities: Gross unrealized gain $4 $ 4,608 $4 $ 8,489 Gross unrealized losses (2) (1,028) - (220) Equity securities: Gross unrealized gains - 18,183 - 10,825 Gross unrealized losses - (419) - (184) --------------------------------------------- 2 21,344 4 18,910 Deferred income taxes - (7,470) - (6,611) --------------------------------------------- $2 $13,874 $4 $12,299 --------------------------------------------- ---------------------------------------------
The amortized cost and market value of fixed maturities at December 31, 1996, 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.
1996 1995 ------------------------------- Retrospective premium credits declared: Minnesota policyholders $ 4,603 $ 5,200 Iowa policyholders active at date of merger and renewing in 1995 2,500 2,300 Favorable development on pre-merger IPMIT liabilities not yet approved for credit 3,735 3,364 ------------------------------- $ 10,838 $ 10,864 ------------------------------- -------------------------------
A provision of the agreement and plan of merger between IPMIT and the Company requires that any favorable development of certain pre-merger liabilities of IPMIT be paid to the former IPMIT policyholders who remain active MMIC 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 December 31, 1998. Actual payments of $2,330,000 and $3,017,000 were made to former IPMIT policyholders in 1996 and 1995, respectively. Actual retrospective premium credits applied to Minnesota policyholder accounts in 1996 and 1995 were $5,198,000 and $6,076,000, respectively.
Balance as of January 1, net of reinsurance recoverables $ 96,424 $ 88,227 $105,589
Incurred related to: Current year 41,101 39,847 36,275 Prior years (8,844) (2,287) (24,941) --------------------------------------- Total incurred 32,257 37,560 11,334
Balance as of December 31, net of reinsurance recoverables 90,342 96,424 88,227
Balance as of December 31, gross $110,037 $120,264 $110,967 --------------------------------------- ---------------------------------------
The Company continually evaluates emerging trends in the development of loss liabilities including the trends related to the pre-merger IPMIT business. Based on this analysis, management periodically adjusts their estimates of ultimate losses. See Note 5 regarding retrospective premium credits paid and accrued.
The deferred income tax (benefit) provision includes the following differences between financial and income tax reporting (in thousands):
The Company made income tax payments of $3,260,000, $832,000 and $8,065,000, in 1996, 1995 and 1994, respectively.
The components of the net deferred income tax asset as of December 31 are as follows (in thousands):
1996 1995 ------------------------- Deferred tax assets: Unpaid losses and loss adjustment expenses $5,319 $6,509 Liabilities not currently deductible 2,311 2,037 Unearned premiums 534 540 Alternative minimum tax credit 496 - Other 510 442 ------------------------- 9,170 9,528 Deferred tax liabilities: Unrealized gains (7,507) (6,642) Other (533) (582) ------------------------- (8,040) (7,224) ------------------------- $1,130 $2,304 ------------------------- -------------------------
The Company has a non-contributory defined contribution pension plan covering substantially all employees. Contributions to the plan are based upon each covered employee's salary. The Company also sponsors a 401(k) plan covering substantially all employees and provides a fifty percent match on employee contributions subject to certain limitations. Total contributions charged to expense for the years ended December 31, 1996, 1995 and 1994 were $371,000, $294,000 and $283,000, respectively.
The Company provides an unfunded Supplemental Executive Retirement Plan (SERP) which is a non-qualified, defined benefit retirement plan covering certain Company officers. Benefits are based upon years of service and compensation. Although the plan is technically unfunded, the Company has purchased life insurance contracts for each officer, the cash value of which is designed to coordinate with the projected benefit payments under the SERP. The cash value of these contracts is included in other assets. The net periodic pension cost for this plan was $323,000, $292,000 and $266,000 for the years ended December 31, 1996, 1995 and 1994, respectively. The liability recognized in the consolidated balance sheets at December 31, 1996 and 1995 related to this plan was $1,909,000 and $1,643,000, respectively.
CLASS A NET REDEMPTION MMIHC COMMON SHARES VALUE PER NET EQUITY OUTSTANDING SHARE --------------------------------------------- (000'S)