The Company's corporate headquarters are located in Jacksonville, Florida. The headquarters property is an 8-story, 70,000 sq. ft. office building owned by the Company where 26,600 sq. ft. of space is occupied for its offices and 8,500 sq. ft. is occupied by McCreary's subsidiary, EMI. The Company and its subsidiaries lease additional facilities that management believes are adequate for the Company's current needs.
The selected financial data presented below for the fiscal years ending December 31 should be read in conjunction with the Company's Consolidated Financial Statements and notes thereto, which are included elsewhere herein. All per share amounts have been stated giving retroactive effect for the stock split that occurred as a result of the reorganization in June 1996.
FPIC Insurance Group, Inc. ("FIG" or the "Company") is the largest provider of medical professional liability (MPL) insurance in Florida, based on the total number of physicians and dentists insured. On June 11, 1996, the shareholders of Florida Physicians Insurance Company, Inc. (FPIC) approved the formation of a holding company, FPIC Insurance Group, Inc., to be the parent company for FPIC, the McCreary Corporation (McCreary) and FPIC Insurance Agency, Inc. (the Agency). McCreary also includes its wholly-owned subsidiary, Employers Mutual Inc. (EMI), acquired in January 1997.
As part of its expansion efforts, the Company completed three transactions in 1997: Employers Mutual, Inc., a third party administrator was purchased in January; a 20% interest in APS Insurance Services Inc., an Austin-based management company for a Texas MPL insurer, was acquired in July; and FPIC's acquisition of Frontier Insurance Company's Florida book of physician MPL business that began renewing in December. The positive impact of these three transactions should be fully realized in the 1998 fiscal year.
Relative to FPIC's core MPL business, total insureds increased 14.8%, from 5,952 in 1996 to 6,831 in 1997. Physician insureds grew 15.2%, from 4,229 in 1996 to 4,872 in 1997. Dental insureds grew 5.9%, from 1,674 in 1996 to 1,772 in 1997. All other MPL insureds grew 281.6%, from 49 in 1996 to 187 in 1997. Net premiums earned on the company's MPL business grew 14.8%, from $55.3 million in 1996 to $63.5 million in 1997.
FPIC experienced another solid year of underwriting results, with frequency of claims reported continuing its downward trend. In addition, loss experience on the 1995 and prior report years is developing as expected and, in some instances, better than expected. Report years 1996 and 1997 are not mature enough to accurately project at this time.
For the year the total return in FPIC's fixed-income investment portfolio was 8.27%, equating to a 9.47% taxable equivalent yield when adjusted for the municipal bond allocation. While FPIC invests primarily in high grade fixed-income securities with an average duration of less than five years, the return on average investments dropped from 5.9% in 1996 to 5.8% in 1997 primarily due to a higher level of invested assets and a greater allocation to federally tax-exempt securities. The total amount of the portfolio invested in tax-free securities increased from 41% in 1996 to 50% in 1997. The current investment policy permits greater allocation to tax-free securities when the taxable equivalent yield exceeds that of taxable securities of comparable credit, maturity and structure. The benefit of this strategy is evidenced by the drop in the Company's effective tax rate from 31% in 1996 to 29% in 1997.
The Company continued to expand TPA operations during the year with McCreary Corporation's acquisition of EMI in January 1997. Combining these operations doubled McCreary's revenues, from $5.3 million in 1996 to $10.5 million in 1997, and increased net income 85.7%, from $0.7 million in 1996 to $1.3 million in 1997.
EMI's primary product, customized administration for emerging managed care organizations, also provides McCreary a new product niche. EMI, with its experienced staff of managed care professionals, will provide managed care related products and services that are specifically geared toward easing the burden that managed care has placed on all healthcare providers. To further enhance profitability, McCreary is focused on creating significant cost savings through investment in technology.
As previously mentioned, on July 1, 1997 the Company acquired a 20% interest in APS Insurance Services, Inc. (APS) for $2,000,000. APS is the management company for American Physicians Insurance Exchange (APIE), which is a Texas MPL insurer with approximately $17 million in direct premiums written in 1997. As a result of this transaction, the Company now directly writes MPL business in Texas for those APIE insureds who require a strongly rated A.M. Best company. During 1997, there were approximately $2.5 million of direct premiums written by the Company under this arrangement.
The second condition of this transaction calls for an adjustment to the purchase price based on the above formula, to be paid in cash, at the end of the 12 month underwriting period which ends November 30, 1998. This cash payment will reflect any deviation from what develops as the actual renewal results of the book versus what the expected renewal results were at time of closing. Our current estimate now indicates FPIC will renew only 33% of the original $16 million book, a reflection of both the increased MPL competition in Florida and FPIC's more stringent underwriting and pricing policies. If correct, this difference will result in a cash payment back to the Company from Frontier of approximately $1.1 million in early 1999, reducing the purchase price.
In 1997, the Company made several unsolicited offers to negotiate with Physicians Protective Trust Fund (PPTF), a Florida trust fund providing MPL to physicians, for an amount up to $180,000,000 in Company common stock. After several meetings and numerous discussions with the advisors and senior management of PPTF, the Company was unable to negotiate a definitive agreement with PPTF and all discussions ceased in the fourth quarter of 1997. Although the proposal is still outstanding, it is our belief that the management of PPTF is committed to and is diligently pursuing a merger with PICOM Insurance Company (PICOM). At present the Company does not intend to make any other proposals to PPTF.
1) Until the proposed business combination of PPTF and PICOM is either consummated or terminated, there could be a tendency for PPTF insureds not to change carriers during the year due to the potential payout to PPTF policyholders. In the past two years former PPTF insureds have been a consistent source of growth for FPIC.
3) Effective January 1, 1998, FPIC instituted a rate increase averaging 5% overall, with certain diagnostic and primary care specialties increasing 30%. Within these specialties FPIC has continued to realize deteriorating loss experience with loss ratios reaching levels that, over time, could negatively impact earnings.
The Company's strategy is to increase pricing on these negatively developing medical specialties to the level where, at a minimum, some contribution is being made toward covering related fixed expenses. These specialties make up less than 10% of FPIC's direct premiums written and a portion of this market could be lost in 1998. To date, however, a loss in these specialties is not evident based on early 1998 renewal results. Conversely, FPIC continues to remain very competitive in its target specialties and claims-free program, where applications for new business continue at a strong pace.
While management continues to closely monitor the growth in core MPL business, the Company is committed to adding new products and services that should result in revenue and profitability
growth rates consistent with 1996 and 1997. Any acquisitions, mergers or business combinations that might occur should further enhance these expectations.
Net investment income increased $1.2 million, or 9%, from $13.6 million in 1996 to $14.8 million in 1997. The increase was primarily attributable to a higher level of invested assets. The increase was achieved despite a shift in the portfolio from 41% of tax free securities in 1996 to 50% of tax-free securities in 1997. The Company's investment policy is to acquire investment grade fixed income securities with an average duration of approximately five years. Due to the falling interest rate environment, maturities in the portfolio were extended and the average duration of the portfolio was increased from 4.2 years in 1996 to 5.0 years in 1997.
assurance that reserve adequacy reevaluations will produce similar reserve reductions in the future. Factors that could adversely affect the loss and LAE reserve estimate and future redundancies include, but are not limited to, inflation, changes in frequency and severity trends or changes in the judicial or legislative environment. The Company cannot predict whether similar redundancies will be experienced in future years.
Other underwriting expenses increased $0.8 million, or 12%, from $6.6 million in 1996 to $7.4 million in 1997. This increase was primarily attributable to acquisition costs relating to the increase of insureds and the related premium written, and the expansion into other product lines.
Other operating expenses more than doubled from $4.1 million in 1996 to $8.5 million in 1997. These expenses are for MCC and this increase was primarily attributed to the inclusion of the EMI operations in the 1997 financial statements.
For the reasons stated above, net income increased $3.3 million, or 25%, from $13.3 million in 1996 to $16.6 million in 1997.
Net realized investment losses in 1996 were $0.1 million as compared to net realized investment gains of $0.2 million in 1995. With the buy and hold approach described earlier, net realized investment gains or losses are expected to be minimal.
Claims administration fees and commission income increased from $2.6 million in 1995 to $5.2 million in 1996. This increase is attributable to the inclusion of a full year of income form McCreary.
Losses and LAE increased $2.2 million, or 5%, from $44.8 million in 1995 to $47.0 million in 1996 reflecting, in part, the increase in insureds. The GAAP loss ratios of 83.7% in 1996 and 85.1% in 1995 reflect the stability the Company has experienced in its loss trends in recent years. In connection with the Company's bi-annual reserving review, which includes a reevaluation of the adequacy of reserve levels for prior years' claims, the Company reduced its reserves for claims occurring in prior periods by $14.7 million in 1996 and $14.0 million in 1995. There is no assurance that reserve adequacy reevaluations will produce similar reserve reductions in the future.
Other underwriting expenses increased $1.5 million, or 29%, from $5.1 million in 1995 to $6.6 million in 1996. This increase was primarily attributable to acquisition costs relating to the increase of insureds and the related premium written.
Other operating expenses more than doubled from $2.0 million in 1995 to $4.1 million in 1996. These expenses are for McCreary and this increase was primarily attributed to the inclusion of a full year of McCreary operations in the 1996 financial statements.
Income taxes increased $0.1 million, or 2%, from $5.9 million in 1995 to $6.0 million in 1996. Income tax expense was flat even though net income before tax increased by $1.7 million, from $17.6 million in 1995 to $19.3 million in 1996, due to the shift in the investment policy from taxable to tax-free securities.
At December 31, 1997, the Company held approximately $11.2 million in investments scheduled to mature during the next twelve months, which combined with net cash flows from operating activities, are expected to provide the Company with sufficient liquidity and working capital. As highlighted in the accompanying Consolidated Statements of Cash Flows, the Company generated positive net cash from operations of $29.1 million in 1997.
Shareholder dividends payable by the Company's insurance subsidiary, FPIC, are subject to certain limitations imposed by Florida law. In 1998, FPIC is permitted, within insurance
In recent years the National Association of Insurance Commissioners (NAIC) has developed risk-based capital ("RBC") measurements for insurers. The measurements provide state regulators with varying levels of authority based on the adequacy of an insurer's RBC. At December 31, 1997, FPIC's statutory annual statement reported a total adjusted surplus to policyholders of $87.9 million, which is $77.7 million more than the NAIC's authorized RBC control level of $10.2 million. The authorized control level permits an insurance regulator to take whatever regulatory actions are considered necessary to protect the best interests of the policyholders and creditors of the insurer, which may include placing the insurer under regulatory control (i.e., rehabilitation or liquidation). The Florida Department of Insurance has not adopted the NAIC's RBC standards, although it does use the standard to identify companies that may need regulatory attention.
In addition to the standard FIGA assessments, the Florida Legislature may levy special assessments to settle claims caused by certain catastrophic losses. FPIC would be assessed on a basis of premium written. No provision for special assessments was made in the 1997 financial statements. However, damages caused by future catastrophes, such as hurricanes, could subject the Company to additional assessments.
The advent of the year 2000 will pose significant issues for organizations across the country and will require consideration of converting or replacing millions of lines of code. The year 2000 issue exists due to program developers creating databases and programs to store and process a year as a two-digit field. The Company addressed the year 2000 issue when it converted its database and reprogrammed its system software in 1994.
The statements which are not historical facts contained in this report are forward-looking statements that involve certain risks and uncertainties. These forward-looking statements include the plans, objectives and expectations of management for future operations relating to the products and future economic performance of the Company. The forward-looking statements are based on assumptions that the Company will continue to: (i) price and market its insurance products competitively; (ii) reserve appropriately for losses and LAE; (iii) maintain its successful handling of claims; and (iv) retain existing agents and key management personnel. The forward-looking statements are also based upon assumptions that (i) competitive conditions within the MPL insurance business will not change materially or adversely; (ii) demand for MPL insurance will remain strong; (iii) the market will accept the Company's new products and services; and (iv) the Company's reinsurers will remain solvent. In addition, if the Company