The following is a summary of properties leased by the Company at December 31, 2001:
The consolidated statements of operations data set forth below for each of the three years in the period ended December 31, 2001, and the consolidated balance sheet data at December 31, 2001 and 2000 are derived from, and are qualified by reference to, the audited consolidated financial statements included elsewhere in this Form 10-K. The consolidated statements of operations data set forth below for the two years in the period ended December 31, 1998, and the consolidated balance sheet data at December 31, 1999, 1998 and 1997, are derived from audited consolidated financial statements not included herein. The information set forth below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Company’s consolidated financial statements and related notes included elsewhere in this Form 10-K.
During 2001, we operated in Minnesota, Wisconsin, South Dakota, Colorado, Missouri, Illinois, Kansas, Michigan, Indiana, Massachusetts, Connecticut, New Hampshire, Rhode Island and Maine. In the fourth quarter of 2001, we closed our regional offices in Missouri (which served Missouri, Illinois and Kansas) and Massachusetts (which served Massachusetts, Connecticut, New Hampshire, Rhode Island and Maine). Collectively, these offices had premiums in force totaling $22.2 million at December 31, 2001. We expect to run off this business in 2002.
Significant Accounting Policies - Our significant accounting policies are summarized in Note 1 - “Summary of Significant Accounting Policies” to our financial statements. Our significant accounting policies include those policies related to our accounting for: (i) premiums earned; (ii) unpaid claim and claim settlement expenses, including reserves for incurred but not reported claims; (iii) policy acquisition costs; and (iv) investments. These accounting policies are further discussed in detail within each section of this “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
Financial Summary - This financial summary presents our discussion and analysis of the consolidated financial condition and results of operations of RTW, Inc. This review should be read in conjunction with the Consolidated Financial Statements at December 31, 2001.
RTW reported an increase in gross premiums earned to $97.4 million in 2001 from $95.9 million in 2000. Total revenues decreased significantly in 2001 to $50.1 million from $83.3 million in 2000 due to a significant increase in premiums ceded to reinsurers.
We reported a net loss of $23.7 million in 2001 compared to a net loss of $9.7 million in 2000 and net income of $6.2 million in 1999. We reported basic and diluted net loss per share of $2.30 in 2001 compared to basic and diluted net loss per share of $0.89 in 2000 and basic and diluted net income per share of $0.50 in 1999. The primary factors affecting our 2001 operating results included the following:
Our gross premiums earned increased slightly in 2001 from 2000, due primarily to a 4.7% increase in average premiums in force to $95.2 million for 2001 from $90.9 million in 2000;
Premiums earned decreased 47.6% in 2001 from 2000. Premiums earned in 2001 were significantly reduced by premiums ceded under our quota share reinsurance agreement that was effective January 1, 2001 and were also reduced by premiums ceded under an excess of loss reinsurance agreement, effective for claims occurring on or after July 1, 1998, that was in runoff in 2001. Premiums earned in 2000 were significantly reduced by premiums ceded under the excess of loss reinsurance agreement. Premiums ceded in 2001 include $45.1 million in quota share premiums ceded as well as $7.3 million in premiums ceded under the excess of loss reinsurance agreement, compared to $13.4 million and $13.3 million of excess of loss premiums ceded in 2000 and 1999, respectively.
At December 31, 2001, we established a $14.1 million valuation allowance against deferred tax assets resulting in a corresponding increase in income tax expense. No valuation allowance was provided against the deferred tax assets recorded in 2000 or 1999.
Our premiums in force decreased 15.8% to $83.7 million at December 31, 2001 from $99.4 million at December 31, 2000 due to an $18.8 million decrease in premiums in force in our Minnesota, Colorado, Missouri and Massachusetts markets offset by a $3.1 million increase in premiums in force in our Michigan market. Average premiums in force increased 4.7% to $95.2 million in 2001 from $90.9 million in 2000. We aggressively targeted policies that did not meet our underwriting profit margin standards for non-renewal or re-underwriting at increased rates at policy expiration in 2001, 2000 and 1999.
Reinsurance rates for workers’ compensation insurers have increased throughout the industry due to settlements related to Unicover reinsurance treaties, resulting in increased costs for workers’ compensation insurers. Reinsurance rates continue to increase and the availability of statutory coverage is limited as a result of the terrorist acts against the United States on September 11, 2001. Insurers, including RTW, have raised premium rates in reaction to these costs; and
A number of workers’ compensation insurers financial ratings, including our own, have decreased due to reserve adjustments recorded in 2001, 2000 and 1999, reducing their ability to compete.
Premiums Ceded: Reinsurance agreements allow us to share certain risks with other insurance companies. We purchase reinsurance to (i) protect us from potential losses in excess of the level we are willing to accept and (ii) to achieve premium to surplus leverage ratios that are at acceptable levels. From 1995 to 2000, our primary reinsurance was excess of loss coverage that limited our per-incident exposure. In June 2001, we also entered into a quota share reinsurance treaty that was effective January 1, 2001 to reduce our premiums earned and bring our premium to surplus leverage ratios in line with management targets and rating agency expectations. We expect the companies to which we have ceded reinsurance to honor their obligations. In the event that these companies are
For claims occurring after June 30, 1998 through policy termination on December 31, 2000, and on a runoff basis into 2001, we further limited our per incident exposure by purchasing excess of loss coverage for losses from $25,000 to the lesser of $300,000 or the WCRA selected retention level in Minnesota and from $25,000 to $300,000 in other states from a single reinsurer. This agreement was finalized after its effective date and activity occurring from July 1, 1998 through September 30, 1998 was recorded on a retrospective basis resulting in the deferral of a gain totaling $2.0 million at December 31, 1998. We amortized $400,000 of the deferred gain as a reduction of claim and claim settlement expenses in each of 2001 and 2000 and $740,000 in 1999 resulting in an un-amortized deferred gain of $449,000 at December 31, 2001. The deferred gain is being amortized into income using the effective interest rate inherent in the amounts paid to the reinsurer and the estimated timing and amounts of recoveries from the reinsurer. Activity occurring on or after October 1, 1998 is recorded prospectively. This contract was terminated effective December 31, 2000, however the policy remained in effect in 2001 for policies in force at December 31, 2000 through expiration, not to exceed fifteen months after the effective termination date. Policies written or renewing after December 31, 2000 are not covered under this lower-level excess of loss reinsurance policy.
In June 2001, we entered a 50% quota share reinsurance policy that had an effective date of January 1, 2001 in order to reduce our net premium to surplus leverage ratio and maintain a secure financial strength rating for our insurance subsidiary. Due to the percentage of amounts ceded under the quota share policy and its January 1, 2001 effective date, premiums earned, claim and claim settlement expenses and policy acquisition costs were substantially reduced in 2001. We further increased the amounts ceded to 80% effective December 1, 2001 under this quota share reinsurance policy.
Premiums ceded to reinsurers increased to $56.5 million in 2001 from $17.7 million in 2000. Excluding premiums ceded totaling $45.1 million under the new quota share policy in 2001, premiums ceded decreased significantly to $11.4 million in 2001 compared to $17.7 million in 2000. The decrease in premiums ceded, excluding quota share policy premiums, resulted primarily from the run-off of premiums ceded under our $25,000 to $300,000 policy.
2002 Outlook: The 2002 outlook for gross premiums earned and premiums ceded include the following factors:
increase in 2002; however, the ultimate increase is unknown at this time. Overall, we expect premiums in force and gross premiums earned to decrease significantly in 2002.
Investment Income and Net Realized Investment Gains (Losses): Our investment income includes earnings on our investment portfolio. Our net realized investment gains (losses), displayed separately on our Consolidated Statements of Operations, include gains and losses from sales of securities. In 2000 and through January 2001, we invested entirely in U.S. domiciled investment-grade taxable and tax-exempt fixed maturity investments. In February 2001, we repositioned our portfolio and sold our tax-exempt securities, purchasing taxable securities to take advantage of our net operating loss carry-forward generated in 2000 and to maximize the after-tax yield of our investment portfolio. We currently invest entirely in U.S. domiciled investment-grade taxable fixed maturity investments and classify our investments as available-for-sale. We intend to hold our available-for-sale investments to maturity, but may sell them before maturity in response to tax planning considerations, changes in interest rates, changes in prepayment risk and changes in funding sources or terms, or to address liquidity needs. Our primary investment objective is to maintain a diversified, high-quality, fixed-investment portfolio structured to maximize our after-tax investment income without taking inappropriate credit risk. For further discussion of investments, see the “Investments” section of this Management’s Discussion and Analysis.
Net realized investment gains were $1.2 million in 2001 and resulted primarily from our portfolio repositioning in February 2001. Net realized investment losses were $607,000 in 2000 and included $500,000 for the write-down of a security whose decrease in value was deemed other than temporary. Net realized investment gains were $84,000 in 1999.
closing old claims, paying earlier to close those claims. Combined with relatively flat premiums in force since December 1998, our cash flows from timing on claims payments have decreased. Cash flows will be adversely affected by: (i) premiums ceded under our quota share policy, and (ii) decreases in cash flows resulting from claim payments on claims from 2002 and prior years as we reduce our 2002 premiums in force and premiums earned in 2002 and result in the use of cash in 2002.
In February 2002, we again repositioned our portfolio to realize investment gains. We recognized gains totaling $1.1 million as a result of this repositioning. Further recognition of realized gains and losses will depend on sales of our investments, if any, to meet our short-term cash requirements or as we replace securities to manage our portfolio returns; and
New and renegotiated reinsurance treaties may reduce our future cash flow and future investment income.
Other Income: We recorded and received a refund totaling $2.1 million from the WCRA in 2001. The WCRA periodically reviews its surplus position and refunds excess surplus to its members. This refund represents our share of the excess surplus of the WCRA at December 31, 2000.
Claim and Claim Settlement Expenses: Claim expenses refer to medical and indemnity benefits that we paid or expect to pay to claimants for events that have occurred. The costs of investigating, resolving and processing these claims are referred to as claim settlement expenses. We record these expenses, net of amounts recoverable under reinsurance contracts, to claim and claim settlement expenses in the Consolidated Statements of Operations.
Claim and claim settlement expenses decreased to $53.5 million in 2001 from $72.4 million in 2000. As a percent of premiums earned, claim and claim settlement expenses increased to 130.7% in 2001 from 92.7% in 2000. These changes are due to the following:
We recorded estimates of ceded paid and unpaid claim and claim settlement expenses under our $25,000 to $300,000 excess of loss reinsurance agreement totaling $15.2 million in 2001 including $400,000 amortized from a deferred retrospective reinsurance gain resulting in a corresponding reduction in 2001 claim and claim settlement expenses. These amounts compare to our 2000 results which include an estimate of ceded paid and unpaid claim and claim settlement expenses totaling $21.8 million and $400,000 amortized from the deferred retrospective reinsurance gain.
We increased renewal premium rates an average of 18.5% in 2001 and 11.7% in 2000 compared to premium rates for the same periods in 2000 and 1999, respectively, reversing a trend of continued rate declines during years prior to 2000; and
We recorded estimates of ceded paid and unpaid claim and claim settlement expenses under our $25,000 to
We increased renewal premium rates an average of 11.7% in 2000, reversing a trend of continued rate declines in 1999 and prior years; and
The ultimate result of the above factors on 2002 claim and claim settlement expenses as a percent of premiums earned, is unknown at this time.
Ceding commissions received under our new quota share reinsurance policy totaling $18.5 million in 2001 has reduced policy acquisition costs. Under our 2001 quota-share program, the reinsurer returns to us 41% of the premiums we cede in ceding commissions to reimburse us for salaries and overhead costs related to managing cases
and claims, policy acquisition costs and other underwriting expenses. Excluding the effect of ceding commissions from the quota share contract, policy acquisition costs decreased slightly to $14.0 million in 2001 from $14.1 million in 2000 and 1999. As a percent of gross premiums earned, policy acquisition costs, before ceding commissions from quota share, decreased to 14.4% in 2001 compared to 14.7% in 2000 and 15.8% for 1999. The decrease in 2001 reflects the following:
Premium tax expense decreased slightly to 1.9% of gross premiums earned in 2001 for 2.0% of gross premiums earned in 2000 and 1999;
Other policy acquisition costs increased slightly to 4.6% of gross premiums earned in 2001 from 4.4% in 2000 and decreased when compared to 5.4% in 1999. Other policy acquisition costs decreased in 2001 and 2000 from levels in 1999 as we focused on improving our underwriting organizational structure resulting in (i) decreased personnel and overhead costs and (ii) decreased spending on marketing programs; and
We incurred ceding commission expense resulting from adjustments to claim and claim settlement expense estimates for 1992 to 1994 totaling $260,000 in 2001, $460,000 in 2000 and $321,000 in 1999.
Our general and administrative expenses increased to $15.3 million in 2001 from $11.5 million in 2000 and $12.0 million in 1999. As a percent of gross premiums earned, general and administrative expenses increased to 15.8% in 2001 from 12.0% in 2000 and 13.5% in 1999. General and administrative expenses for 2001 include (i) $2.0 million in restructuring charges related to closing our regional offices in Missouri and Massachusetts and closing satellite offices in Brainerd, Minnesota and Overland Park, Kansas; (ii) assessments by state Insurance Guarantee Associations (IGA) totaling $1.1 million in 2001 compared to $236,000 in 2000 and $17,000 in 1999; (iii) one-time business repositioning costs totaling $470,000 in 2001 and corporate oversight costs related to the efforts of the majority shareholders in seeking a buyer for their shares totaling $1.3 million in 1999. After adjusting for these items, general and administrative expenses decreased as a percent of gross premiums earned to 11.7% in 2001 from 11.8% in 2000 and 12.0% in 1999. These decreases reflect:
A reorganization effected in the fourth quarter of 1999 resulted in a net reduction of thirty-three positions. This reorganization reduced costs and centralized and strengthened certain processes late in 1999 and throughout 2000 and 2001.
2002 Outlook: We expect that general and administrative expenses will be affected by the following:
We will aggressively manage all operating costs and expenses in 2002;
We have no plans to open additional state offices in 2002 and expect to reduce overhead costs as a result of our office closures in 2001; and
We paid interest at rates ranging from 8.68% to 9.34% on the outstanding balance of our Term Loan in 2000 compared to 9.50% on the outstanding balance of our Senior Notes during 1999. Interest expense increased to $667,000 in 2000 from $266,000 in 1999 as we increased our notes payable by financing the repurchase of shares from a group headed by our majority shareholder and Chairman, David C. Prosser through an $8.0 million Term Loan and a $2.0 million Revolving Credit Facility with a bank. The Senior Notes were paid in full in December 1999. No amounts were outstanding under the Revolving Credit Facility in 2000 and the Credit Facility was terminated in 2001.
Income tax expense of $8.9 million in 2001 included the $14.1 million valuation allowance adjustment. After excluding the effects of the valuation allowance, the income tax benefit was $5.2 million in 2001 compared to a benefit of $5.7 million in 2000 and an expense of $1.9 million in 1999. As a percent of (loss) income before income taxes, the income tax (benefit) expense before valuation allowance was 34.7% of the loss before income taxes in 2001 compared to 37.2% of the loss before income taxes in 2000 and 23.8% of income before income taxes in 1999. The income tax benefit percentages in 2001 and 2000 have been affected by (i) our loss from operations, (ii) establishing a deferred tax valuation allowance, (iii) increased taxable net income from the service organization (RTW) which is subject to both federal and state income taxes, and (iv) changes in tax-exempt municipal income.
2002 Outlook: Income tax expense will vary based on (i) the income from operations we recognize for 2002, and (ii) the changes in our analysis of the valuation allowance necessary during 2002. The ultimate change is unknown at this time.
Our portfolio of fixed maturity securities at December 31, 2001 included mortgage-backed securities (50.6%), U.S. government securities (29.5%), corporate securities (19.2%), and asset-backed securities (0.6%). Our portfolio is managed by an independent investment manager to maximize our after-tax investment income without taking inappropriate credit risk. In February 2001, we repositioned our portfolio by selling our tax-exempt securities and
Our unpaid claim and claim settlement expenses represent reserves established for the estimated total unpaid cost of claim and claim settlement expenses, which cover events that occurred in 2001 and prior years. The reserves are primarily undiscounted; however, we discounted reserves for selected claims that have fixed and determinable future payments at 5.0% in 2001 and 8.0% in 2000. These reserves reflect our estimates of the total costs of claims that were reported, but not yet paid, and the cost of claims incurred but not yet reported (IBNR). For reported claims, we establish reserves on a “case” basis. For IBNR claims, we estimate reserves using established actuarial methods. Both our case and IBNR reserve estimates reflect such variables as past claims experience, current claim trends and prevailing social, economic and legal environments. Due to our commencing operations in 1992, we have limited historical data to estimate our reserves for unpaid claim and claim settlement expenses and, accordingly, we supplement our experience with external industry data, as adjusted, to reflect anticipated differences between our results and the industry. We reduce the unpaid claim and claim settlement expenses for estimated amounts of subrogation.
The following table is derived from the loss reserve development table and summarizes the effect of reserve re-estimates, net of reinsurance, on calendar year operations for the same eight-year period ended December 31, 2001. The total of each column details the amount of reserve re-estimates made in the indicated calendar year and shows the accident years to which the re-estimates are applicable. The amounts in the total accident year column represent the cumulative reserve re-estimates for the indicated accident year (000’s):
Cash used in operating activities in 2001 was $6.5 million. This is primarily the result of our net loss of $23.7 million; an increase of $55.4 million in amounts due from reinsurers and net realized investment gains totaling $1.2 million offset by an increase of $52.5 million in unpaid claim and claim settlement expenses, which are non-cash accruals for future claims; a decrease in our net deferred income tax asset of $8.8 million; an increase in accrued liabilities totaling $8.2 million; depreciation and amortization expense of $1.6 million and a decrease of $744,000 in unearned premiums, net of premiums receivable. Net cash provided by investing activities was $10.0 million, primarily the result of $92.8 million in proceeds from sales of securities and $872,000 in disposals of furniture and equipment offset by $83.3 million in purchases of securities and $379,000 in purchases of furniture and equipment. Net cash used in financing activities was $2.5 million due primarily to payments on notes payable of $2.5 million.
Our need for additional capital is primarily the result of regulations that require certain ratios of regulatory or statutory capital to premiums written in our insurance subsidiary as defined by state regulatory bodies and insurance rating agencies. We believe that raising additional permanent capital would stabilize our ratio of premium to capital and provide a solid base for the future growth of our insurance subsidiary. As an alternative to raising additional permanent capital, further quota-share reinsurance or other additional reinsurance on an interim basis would have the effect of reducing the ratio of premiums to capital and could be used to satisfy state regulatory requirements.
On September 15, 1998, our Board of Directors approved a share repurchase program authorizing us to repurchase, from time to time, up to $4,000,000 of RTW, Inc. common stock. We repurchased 10,000 shares in 2001 for approximately $9,000, 640,000 shares in 2000 for approximately $2.6 million and 19,500 shares for approximately $87,000 through 1999. We repurchased these shares on the open market or through private transactions based upon market conditions and availability. The repurchased shares will be used for employee stock option and purchase plans and other corporate purposes.
The National Association of Insurance Commissioners (NAIC) has risk-based capital standards to determine the capital requirements of a property and casualty insurance carrier based upon the risks inherent in its operations. These standards require computing a risk-based capital amount that is compared to a carrier’s actual total adjusted capital. The computation involves applying factors to various financial data to address four primary risks: asset risk, insurance underwriting risk, credit risk and off-balance sheet risk. These standards provide for regulatory intervention when the percent of total adjusted capital to authorized control level risk-based capital is below certain levels. Based upon the risk-based capital standards, our percent of total adjusted capital is in excess of authorized control level risk-based capital.
Our insurance subsidiary is subject to substantial regulation by governmental agencies in the states in which we operate, and will be subject to such regulation in any state in which we provide workers’ compensation products and services in the future. State regulatory agencies have broad administrative power with respect to all aspects of our business, including premium rates, benefit levels, policy forms, dividend payments, capital adequacy and the amount and type of investments. These regulations are primarily intended to protect covered employees and policyholders rather than the insurance company. Both the legislation covering insurance companies and the regulations adopted by state agencies are subject to change. At December 31, 2001, our insurance subsidiary was licensed to do business in Minnesota, South Dakota, Wisconsin, Colorado, Missouri, Illinois, Kansas, Michigan, Indiana, Massachusetts, Connecticut, Rhode Island, Pennsylvania, Tennessee, Maryland, Arkansas, Iowa, Florida, Georgia, New Jersey, North Carolina, Texas and Oklahoma.
In March 1998, the National Association of Insurance Commissioners adopted the Codification of Statutory Accounting Principles (the Codification). The Codification is intended to standardize regulatory accounting and reporting to state insurance departments and became effective January 1, 2001. Statutory accounting principles, however, will continue to be established by individual state laws and permitted practices. The State of Minnesota required adoption of the Codification for preparing statutory financial statements for financial periods occurring on or after January 1, 2001. Adoption of the Codification increased our statutory capital and surplus by approximately $2.9 million on January 1, 2001.
Information included in this Annual Report and Report on Form 10-K which can be identified by the use of forward-looking terminology such as “may,” “will,” “expect,” “anticipate,” “estimate,” or “continue” or the negative thereof or other variations thereon or comparable terminology constitutes forward-looking information. The following important factors, among others, in some cases have affected and in the future could affect our actual results and could cause our actual financial performance to differ materially from that expressed in any forward-looking statement: (i) our ability to retain renewing policies and write new business with a B- (Unsecure) rating from A.M. Best; (ii) our ability to continue to increase pricing in the markets in which we remain; (iii) the ability of our reinsurers to honor their obligations to us; (iv) our ability to accurately predict claim development; (v) our ability to manage both our existing claims and new claims in an effective manner; (vi) our experience with claims frequency and severity; (vii) competition and the regulatory environment in which we operate; (viii) general economic and business conditions; (ix) our ability to obtain and retain reinsurance at a reasonable cost; (x) changes in workers’ compensation regulation by states, including changes in mandated benefits or insurance company regulation; (xi) interest rate changes; and (xii) other factors as noted in our other filings with the SEC. This discussion of uncertainties is by no means exhaustive but is designed to highlight important factors that may impact our future performance.
Consolidated Statements of Cash Flows - Years Ended December 31, 2001, 2000 and 1999
Notes to Consolidated Financial Statements - Years Ended December 31, 2001, 2000 and 1999
We have audited the accompanying consolidated balance sheets of RTW, Inc. and subsidiary (the Company) as of December 31, 2001 and 2000, and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2001. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
As described in Note 5, the establishment of claim and claim settlement expense reserves is an inherently uncertain process. Additionally, as described in Note 10, underwriting losses in the years ended December 31, 2001 and 2000 have resulted in a significant reduction in the Company’s statutory policyholders’ surplus that adversely affected its credit rating.
We benefit from our ability to reduce workers’ compensation costs and provide employers the ability to control their workers’ compensation programs. We are domiciled in Minnesota and were licensed in Minnesota, Colorado, Missouri, Michigan, Massachusetts, Illinois, Kansas, Connecticut, Wisconsin, Rhode Island, Florida, Iowa, Indiana, Arkansas, Pennsylvania, Tennessee, South Dakota, Maryland, Georgia, New Jersey, North Carolina, Texas and Oklahoma at December 31, 2001. We are also licensed to write workers’ compensation insurance coverage for companies covered under the Longshoreman’s Act. We wrote policies primarily in Minnesota, Colorado, Missouri, Illinois, Kansas, Michigan, Massachusetts, Connecticut and Wisconsin during 2001. In the fourth quarter of 2001, we announced that we would close our regional offices in Missouri and Massachusetts. Beginning February 2002, we began to non-renew all policies in our Missouri and Massachusetts regions and will run off expiring policies in these regions through January 2003. We operate in a single business segment, workers’ compensation insurance.
Available-for-Sale Investments: Our available-for-sale investments are carried at fair value with changes in unrealized gains or losses, net of deferred taxes, reported as other comprehensive income or loss. The fair values of our investments are determined based upon quoted market prices as obtained through commercial pricing services or brokers who provide estimated fair values.
We continually monitor the difference between investment cost and fair value for each of our securities. If any security experienced a decline in value that is determined to be other than temporary, we would reduce the security’s carrying value for the decline and record a realized loss in the Consolidated Statements of Operations. In 2000, we recorded $500,000 against a security whose decline in value was determined to be other than temporary. No securities were reduced for declines in fair value in 2001 or 1999.
Options to purchase 1.5 million shares of common stock at prices ranging from $0.99 to $19.33 were outstanding during 2001 and options to purchase 1.2 million shares of common stock at prices ranging from $2.67 to $19.33 were outstanding in 2000 but excluded from the computation of diluted IPS due to our 2001 and 2000 net losses. Diluted weighted average shares outstanding would have increased by 8,000 shares and 16,000 shares in 2001 and 2000, respectively, had these shares not been anti-dilutive in the computation.
Statutory Deposits - Included in investments are U.S. government securities on deposit with various regulatory authorities, as required by law, with a fair value of $18.6 million and $12.2 million at December 31, 2001 and 2000, respectively.
Fixed Maturities by Maturity Date - The following table presents the amortized cost and fair value of investments by contractual maturity at December 31, 2001. Actual maturities may differ from those stated as a result of calls and prepayments (000’s):
In March 2000, we borrowed $8.0 million under a term loan agreement to fund the repurchase of common stock from certain of our shareholders and simultaneously entered into a $2.0 million revolving credit facility to be used for general corporate purposes. The revolving credit facility was terminated early in 2001. We paid $1.0 million in principal on the term loan in 2000 and an additional $2.5 million in 2001. The term loan accrues interest, payable quarterly. We may elect to pay an adjusted LIBOR or bank reference rate on the term loan (adjusted LIBOR was 8.22% and 9.34% at December 31, 2001 and 2000, respectively).
We compute all income tax amounts using the liability method. Under this method, deferred tax assets and liabilities are recognized for the expected tax consequences of temporary differences between the tax bases of assets and liabilities and their reported amounts using presently enacted tax rates. Deferred tax assets are recognized for tax credit and net operating loss carry-forwards, reduced by a valuation allowance which is established when it is “more
Differences between the tax basis of assets and liabilities and their reported amounts in the Consolidated Financial Statements that will result in taxable or deductible amounts in future years are called temporary differences. The tax effects of temporary differences that gave rise to net deferred tax assets, included within other assets, are as follows (000’s):
In assessing the realizability of deferred tax assets, we consider recent operating results, the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies. At December 31, 2001, we established a $14.1 million valuation allowance against deferred tax assets resulting in a corresponding increase in income tax expense as a result of this analysis. We expect the remaining deferred tax assets, net of the valuation allowance, at December 31, 2001 to be realized as a result of the reversal of existing taxable temporary differences in the future. No valuation allowance was provided against the deferred tax assets recorded in 2000 or 1999.
Income taxes receivable were approximately $83,000 and $1.7 million at December 31, 2001 and 2000, respectively, and are included in other assets.
Stock Based Compensation - We account for our stock-based compensation plans, the RTW, Inc. 1995 Employee Stock Purchase Plan and Trust (ESPP) and the 1994 Stock Plan, using Accounting Principles Board Opinion No. 25 (APB 25), “Accounting for Stock Issued to Employees,” and related Interpretations. Under APB 25, compensation cost for stock options is measured as the excess, if any, of the quoted market price of our stock at the date of the grant over the amount an employee must pay to acquire the stock.
1995 Employee Stock Purchase Plan - The ESPP provides employees the opportunity to purchase shares of our stock at 85% of the fair value based on the lesser of the beginning or ending share price for each plan year as set forth in the plan. In May 1998, the shares reserved for distribution under the plan were increased from 75,000 to 200,000 shares. The ESPP terminates in ten years and will be carried out in phases, each consisting of one year or a different period of time approved by the Board of Directors. Any employee completing two weeks of service prior to commencing a phase of the plan may participate. Employees may elect to contribute from $10 to 10% of monthly salary to the plan through payroll withholdings. The following summarizes shares purchased and purchase prices for each phase in the most recent three years completed through 2001:
1994 Stock Plan - The 1994 Stock Plan provides for awards of qualified and non-qualified stock options. In July 1998, the Board of Directors increased the shares reserved for distribution under the plan to 2,000,000. Option price, option term, vesting provisions and other limits and restrictions are determined at the time of grant by the Board of Directors or, if established, by a separate committee. The exercise price for all options granted was the market price of the common stock at the date of grant.
The following table summarizes the options outstanding and exercisable at December 31, 2001:
We are permitted a tax deduction equal to the difference between the non-qualified option exercise price and the fair value on the option exercise date. Upon exercise, the proceeds and the amount of the deduction are recorded to common stock. In 1999, we recorded a reduction of income taxes payable and increased common stock by $532,000 to reflect the exercise.
The weighted average fair value of options granted under the ESPP and 1994 Stock Plan during 2001, 2000 and 1999 is estimated at $1.10, $2.24 and $2.53, respectively, on the date of grant using the Black-Scholes option-pricing model with the following assumptions: no dividend yield; volatility of 182.8% in 2001, 64.6% in 2000 and 64.3% in 1999; risk-free interest rates ranging from 1.66% to 7.70%; and an expected life of 1 to 5 years.
Employment Contracts - We entered into one-year employment agreements with our Chairman, David C. Prosser, President and Chief Executive Officer, J. Alexander Fjelstad III, and Executive Vice President, Alfred L. LaTendresse beginning December 13, 2001. Under these agreements, each receives a base salary, subject to review annually for increase by our Board of Directors. Mr. Prosser receives $250,000 which includes $30,000 for his services as Chairman of the Board and $220,000 in base salary. Mr. Fjelstad receives a base salary of $275,000 and Mr. LaTendresse a base salary of $200,000. In addition to base salary, each is eligible for bonuses and expense reimbursements. We also provide these individuals with health, dental, life and disability insurance consistent with that provided to other officers and employees. Additionally, Mr. Fjelstad and Mr. LaTendresse were each granted 200,000 non-qualified options at $0.99 per share on December 13, 2001. Mr. Prosser was granted 200,000 non-qualified options on February 6, 2002 at $1.21 per share.
Employment agreements with Carl B. Lehmann, our former President and Chief Executive Officer expired during 2001 and Mr. Lehmann terminated his employment with us on December 12, 2001. Under supplemental
agreements with Mr. Lehmann in 2000 and 2001, we paid him “stay bonuses” of $200,000 on January 15, 2001 and $100,000 on June 30, 2001.
Combined Retirement Plan - In January 1998, we combined our 401(k) Retirement Plan and Employee Stock Ownership Plan (ESOP) into a single retirement plan, the KSOP. The KSOP retains the features of each separate component except for eligibility and vesting provisions. Under the plan, employees become eligible to participate in the plan on the first day of the month after beginning employment and attaining age 21.
Other Employee Benefit Plans - We maintained bonus plans in 2001, 2000 and 1999 under which all employees, including officers, were eligible for a bonus based, in part, on our operating results. These bonuses aggregated $204,000, $951,000 and $544,000 in 2001, 2000 and 1999, respectively.
On September 15, 1998, our Board of Directors approved a share repurchase program authorizing the repurchase of up to $4.0 million of RTW, Inc. common stock. We may repurchase shares on the open market or through private transactions depending upon market conditions and availability. Through December 31, 2001 we repurchased 669,500 shares for $2.7 million. We will use the repurchased shares for employee stock option and purchase plans and other corporate purposes.
In connection with the repurchase, Mr. Prosser retired from the Company, resigned as Chairman and was paid $225,000 as a termination benefit. He remained a member of our Board of Directors. Additionally, at closing, each member of the Prosser Selling Group entered into a two year standstill and voting agreement under which each agreed, among other things, not to acquire additional securities of RTW and not to initiate or support certain initiatives designed to effect fundamental changes in RTW policy or structure. The two-year voting and standstill agreements expired March 6, 2002. In December 2001, Mr. Prosser returned to RTW as Chairman of the Board (see Note 8).
securities) per right, subject to adjustment. We may redeem the rights, in whole, at $.001 per right, at any time prior to an acquisition by any Acquiring Person of 15% or more of our outstanding common stock and prior to the expiration of the rights. The rights expire on April 17, 2007, unless extended or earlier redeemed by us.
In March 1998, the National Association of Insurance Commissioners adopted the Codification of Statutory Accounting Principles (the Codification). The Codification is intended to standardize regulatory accounting and reporting to state insurance departments and became effective January 1, 2001. Statutory accounting principles, however, will continue to be established by individual state laws and permitted practices. The State of Minnesota required adoption of the Codification for preparing statutory financial statements for financial periods occurring on or after January 1, 2001. Adoption of the Codification increased our statutory capital and surplus by approximately $1.9 million at December 31, 2001.
Rent expense, including contingent rentals, was $2.0 million, $2.1 million and $2.1 million for 2001, 2000 and 1999, respectively.
administrative claims that we believe are likely to have a material adverse effect on our financial condition or results of operations.
Through February 2002, we were party to an agreement under which another insurance company wrote policies on our behalf and ceded 100% of the risk to us through a reinsurance treaty. In connection with this agreement, in February 2001 we provided this insurer with an irrevocable letter of credit totaling $2.1 million to indemnify them for incurred losses.
The accompanying financial statements have been prepared assuming the Company will continue as a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The underwriting losses that we have experienced in the years ended December 31, 2001 and 2000 have resulted in a significant reduction in our statutory policyholders’ surplus (see Note 9). The underwriting losses and reduction in surplus led to a downgrade in our credit rating from B+ (Secure) to B- (Unsecure) on February 28, 2002 that could adversely affect our current scope of our operations. Although it is not possible to predict the impact that the reduction in surplus and the change in our credit rating might have on our future operations, management believes that we will be able to realize the recorded value of our assets and meet our obligations as they come due.