Following is the selected financial data of MMIHC for the five years ended December 31, 1997. This data should be read in conjunction with the consolidated financial statements and notes thereto appearing under Item 8 of this Form 10-K.
(3) Includes pro forma shares computed to give retroactive effect to the merger of MMIHC/MMIC with MLM. See Note 1 to the consolidated financial statements included in Item 8 of this Form 10-K.
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 1997, 1996 and 1995 are found in Note 2 to the consolidated financial statements. This limited redemption value preserves the capital of MMIC as other 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.
The Year 2000 Issue is the result of computer programs being written using two digits rather than four to define the applicable year. Any of the Company's computer programs that have time sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions, send billings, or engage in similar normal business activities.
The current year's provision for loss and loss adjustment expense, which is based upon policyholder exposure, expected frequency of losses, and severity of losses, was fairly stable for the years 1997, 1996 and 1995. The loss and loss adjustment expenses reflected in the consolidated financial statements, and shown in the Reconciliation of Liability for Loss and Loss Adjustment Expense as total incurred loss and loss adjustment expense, include adjustments of prior years' estimates.
Incurred loss and loss adjustment expenses for 1997 and 1996 of $31,834,000 and $32,257,000, respectively, are significantly less than the $37,560,000 in 1995. During the course of each year and particularly at each year end, management reevaluates the liability for loss and loss adjustment expense. This evaluation is supported by outside actuarial evaluation at year end. During 1997 and 1996 these evaluations resulted in a reduction is estimated liabilities applicable to prior years of $8,352,000 and $8,844,000, respectively. A smaller reduction of $2,287,000 was recorded in 1995. This difference is the primary reason for the lower incurred loss and loss adjustment expense in 1997 and 1996.
The schedule which follows summarizes the development of the liability for loss and loss adjustment expense from 1987 through 1997. This schedule is also presented net of reinsurance which the Company believes best explains the development as it affects operating results. The Company has a conservative loss reserving policy which, when coupled with a moderation of malpractice insurance losses which began in approximately 1986 for the Company and across the industry, has resulted in redundancies in liabilities larger than expected. The table indicates that the redundancy in loss liabilities, which developed when more actual results were known, has been significantly reduced from the high at December 31, 1990. Loss and loss adjustment expense liabilities have not been discounted in the Company's financial statements.
NET PREMIUMS EARNED increased $1,749,000 in 1997 from 1996 while policyholders' rate levels remained relatively level for 1996 and 1997. An increase in the number of policyholders in 1997 increased premium by $500,000. The remaining increase was the result of the several increase/decrease factors listed below:
1. The estimated reinsurance premium applicable to the treaty years 1992-1994 and 1995-1997, which is based in part on reinsured claims experience, was reduced resulting in a net INCREASE in premium between years of $3,875,000.
3. In 1996 $2,194,000 was received from the commutation of a reinsurance treaty covering the years 1989 and 1990. This increased 1996 premiums. Since there was no counterpart in 1997 it causes a DECREASE in premiums from 1996 to 1997 of $2,194,000.
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 1997 the Company restructured the fixed portfolio and in this process experienced realized capital gains of $4,916,000. In addition, normal investment transactions resulted in additional realized capital gains of $1,568,000 for a total of $6,484,000. 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. This policy was revised in 1997 as previously discussed under Liquidity and Capital Resources. The Investment Committee meets with the outside managers approximately four times per year.
INCOME TAXES. In 1997 the Company's book net income before taxes was $13,763,000. Deductions from book income, primarily tax exempt interest income from municipal bonds reduces income subject to tax. This current year's tax based on taxable earnings was increased by a reduction in deferred taxes of $1,494,000 to arrive at the income tax charged to operations $4,463,000 as shown in the financial statements.
NET INCOME for the Company during the last three years totaled $18,506,000 which was added to retained earnings. A significant portion of net income for these years resulted from the reversal of loss liabilities established in prior years and realized capital gains on investments.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Midwest Medical Insurance Holding Company and Subsidiaries at December 31, 1997 and 1996, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth herein.
The consolidated financial statements have been presented in conformity with generally accepted accounting principles, which differ in certain respects from statutory accounting practices followed by MMIC in reporting to the Department of Commerce of the State of Minnesota (see Note 10).
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.
Other investments are equity interests in non-traded real estate investment trusts and are recorded at cost which approximates fair value.
Realized gains and losses on sales of investments are reported on a pre-tax basis as a component of income and are determined on the specific identification basis.
The liability for unpaid losses and loss adjustment expenses represents an estimate of the ultimate cost of all such amounts which are unpaid at the balance sheet dates. The liability is based on both case-by-case estimates and statistical analysis and projections using the historical loss experience of 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.
MMIC has a retro premium program whereby physicians may receive credits against future premiums based upon loss experience of MMIC. Amounts to be returned under the program are accrued when approved by the Board of Directors and reflected as a reduction in net premium earned.
Underwriting costs are expensed when incurred. Due to the nature of its operations, MMIC does not pay significant amounts in commissions.
The Company uses the asset and liability method of accounting for income taxes. Deferred income tax assets or liabilities are recognized for the temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and amounts used for income tax purposes.
In 1997, the Financial Accounting Standards Board issued Statement No. 128, EARNINGS PER SHARE. Statement 128 replaced the calculation of primary and fully diluted earnings per share with basic and diluted earnings per share. Unlike primary earnings per share, basic earnings per share excludes any dilutive effects of all earned but unissued shares of Class A common stock (see Note 2). Diluted earnings per share is very similar to the previously reported fully diluted earnings per share. All earnings per share amounts for all periods have been presented and, where appropriate, restated to conform to the Statement 128 requirements.
In addition to the unrealized gains and losses per the above schedule, MMIHC has unrealized gains on certain investments in mutual funds. The mutual fund assets are classified as other assets in the consolidated balance sheet and are held to coordinate with
The amortized cost and market value of fixed maturities at December 31, 1997, 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.
any amounts due under this provision must be settled no later than June 5, 2001. As of December 31, 1997, there has been no favorable development and therefore there is no accrual related to this provision.
To reduce overall risk, including exposure to large losses, the Company participates in various reinsurance programs. MMIC would only become liable for losses in excess of stipulated amounts in the event that any reinsuring company were unable to meet its obligations under the existing agreement. Management is not aware of any such default at
Total ceded reinsurance premiums, before the effects of treaty commutations, for the years ended December 31, 1997, 1996 and 1995 were $3,329,000, $6,416,000 and $7,544,000, respectively. Loss and loss adjustment expenses incurred are net of applicable reinsurance of $2,455,000, $2,459,000 and $7,873,000 for the years ended December 31, 1997, 1996 and 1995, respectively.
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, 1997, 1996 and 1995 were $393,000, $371,000 and $294,000, respectively.
The Company also provides medical benefits to retirees through a defined benefit post-retirement plan which covers substantially all employees. The net periodic post-retirement benefit cost for the years ended December 31, 1997, 1996 and 1995 was $27,000, $30,000 and $25,000, respectively. As of December 31, 1997 and 1996, the net post-retirement benefit plan asset (liability) recognized in the consolidated balance sheets was $4,000 and $12,000, respectively. The plan is funded through contributions to mutual funds.
The following is a reconciliation of net income and shareholders' equity under generally accepted accounting principles with that reported for MMIC on a statutory basis (in thousands):