The following table sets forth selected consolidated financial and operating data for the Company.
Basic and diluted loss per share of common stock for the year ended December 31, 2000 is computed using the weighted average number of common shares outstanding during the year of 14,100,043. Basic earnings per share of common stock for the year ended December 31, 1999 is computed using the weighted average number of common shares outstanding during the year of 13,497,110. Diluted earnings per share of common stock for the year ended December 31, 1999 is computed using the weighted average number of common shares outstanding during the year of 13,534,052. Basic and diluted earnings per share for the years ended December 31, 1998 and prior gives effect to the issuance of approximately 12,025,000 shares of Common Stock to Distributees in the Company's reorganization consummated on August 4, 1999.
The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward-looking statements. This Form 10-K, the Company's Annual Report to Shareholders, any Form 10-Q or any Form 8-K of the Company or any other written or oral statements made by or on behalf of the Company may include forward-looking statements which reflect the Company's current views with respect to future events and financial performance. These forward-looking statements are subject to uncertainties and other factors that could cause actual results to differ materially from such statements. These uncertainties and other factors (which are described in more detail elsewhere in this Form 10-K) include, but are not limited to: the Company having sufficient liquidity and working capital; the Company's ability to achieve consistent profitable growth; the Company's ability to diversify its product lines; the continued adequacy of the Company's loss and loss adjustment expense reserves; the Company's avoidance of any material loss on collection of reinsurance recoverables; increased competitive pressure; the loss of significant customers; general economic conditions, including changing interest rates; rates of inflation and the performance of the financial markets; judicial decisions and rulings; changes in domestic and foreign laws, regulations and taxes; geographic concentration of the Company's business; effects of acquisitions and divestitures; further control by insurance department regulators, including the possibility of rehabilitation or liquidation; and various other factors. The words "believe," "expect," "anticipate," "project," and similar expressions identify forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of their dates. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
Income Taxes. The Company accounts for income taxes in accordance with Financial Accounting Standards ("FAS") No. 109, "Accounting for Income Taxes." Deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance against deferred tax assets is recorded if it is more likely than not, that all or some portion of the benefits related to the deferred tax assets will not be realized. Valuation allowances are based on estimates of taxable income and the period over which deferred tax assets will be recoverable. In the event that actual results differ from these estimates or these estimates are adjusted in future periods, the Company may need to establish a valuation allowance, which would impact our financial position and results of operations. A valuation allowance has been established for approximately the full value of the deferred tax assets at December 31, 2001.
Goodwill and Intangible Assets. Goodwill represents the aggregate cost of companies acquired over the fair value of net assets at the date of acquisition and is being amortized into income using the straight-line method over periods ranging from ten to fifteen years. Management regularly reviews the carrying value of goodwill by determining whether the unamortized value of the goodwill can be recovered through undiscounted future operating cash flows of the acquired operation.
In the event goodwill is impaired, a loss is recognized based on the amount by which the carrying value exceeds the fair value of the respective asset. Fair value is determined primarily using anticipated cash flows at a rate commensurate with the risk involved. Losses on assets to be disposed of are determined in a similar manner, except that fair values are reduced for the cost of disposal.
Loss and Loss Adjustment Expenses. The Company estimates its liability for loss and LAE using actuarial projections of ultimate losses and LAE and other quantitative and qualitative analyses of conditions expected to affect the future development of claims and related expenses. The estimated liability for losses is based upon paid and case reserve estimates for losses reported, adjusted through judgmental formulaic calculations to develop ultimate loss expectations; related estimates of incurred but not reported losses and expected cash reserve developments based on past experience and projected future trends; deduction of amounts for reinsurance placed with reinsurers; and estimates received related to assumed reinsurance. Amounts attributable to ceded reinsurance derived in estimating the liability for loss and LAE are reclassified as assets in the consolidated balance sheets as required by FAS No. 113. The liability for LAE is provided by estimating future expenses to be incurred in settlement of claims provided for in the liability for losses and is estimated using similar techniques.
The liabilities for losses and LAE and the related estimation methods are continually reviewed and revised to reflect current conditions and trends. The resulting adjustments are reflected in the operating results of the current year. While management believes the liabilities for losses and LAE are adequate to cover the
ultimate liability, the actual ultimate loss costs may vary from the amounts presently provided and such differences may be material.
The Company also has direct and assumed liabilities under covered extended reporting endorsements associated with claims-made MPL policy forms, which generally provide, at no additional charge, continuing MPL coverage for claims-made insureds in the event of death, disability or retirement. These liabilities are carried within unearned premium reserves and are estimated through formula calculations that have been verified by the Company's independent actuarial firm using techniques, which possess elements of both loss reserves and pension liabilities, and thus include additional assumptions for mortality, morbidity, retirement, interest and inflation.
The MIIX Group sold 3,450,000 shares of its common stock in the offering that closed on August 4, 1999. The net proceeds of the Offering of approximately $37.3 million consisted of gross proceeds of $46.5 million less reorganization and offering costs of $9.2 million and have been used for general corporate purposes, including payment of dividends and the repurchase of shares under a stock buyback program. During August 1999, the Company approved a stock repurchase program authorizing the purchase of up to one million shares of common stock in the open market. During November 1999, the program was amended, authorizing the purchase of up to an additional two million shares. Through December 31, 2000, 3,000,000 shares had been repurchased at a total cost of $39.3 million and 25,933 shares have been issued from treasury at a value of $0.4 million. During 2001, The MIIX Group purchased 84,178 shares at a value of approximately $0.7 million related to a former officer of the Company.
Management periodically reviews the Company's guidelines for premiums, surcharges, discounts, cancellations and nonrenewals and other related matters. As part of this review, rates and rating classifications for its physicians, medical groups and other insureds are evaluated based on current and historical losses, LAE (defined below)
The determination of loss and loss adjustment expense ("LAE") reserves involves the projection of ultimate losses through an actuarial analysis of the claims history of the Company and other professional liability insurers, subject to adjustments deemed appropriate by the Company due to changing circumstances. Management relies primarily on such historical experience in determining reserve levels on the assumption that historical loss experience provides a good indication of future loss experience despite the uncertainties in loss trends and the delays in reporting and settling claims. As additional information becomes available, the estimates reflected in earlier loss reserves have been and may continue to be revised. The Company increased prior year gross reserves by $117.9 million and $47.2 million in 2001 and 2000, respectively. If prior trends continue, the Company may have to increase gross reserves again in 2002, which could materially adversely impact the Company's financial position.
The Company offered traditional occurrence coverage from 1977 through 1986 and has offered a form of occurrence-like coverage, "modified claims made," from 1987 to the present. Occurrence and modified claims made coverages have constituted the majority of the Company's business throughout its history. In recent years, however, the Company had increased its claims made business. Development of losses and LAE is longer and slower for occurrence business than claims made business. In March 2002, the Company began working with the Virginia Bureau of Insurance to place the insurance operations of its subsidiary, LP&C, into run-off, subject to regulatory and contractual requirements. For the immediate future, the Company expects that new Jersey physician business may constitute all or a significant majority of its ongoing writings. New Jersey physician business has primarily been written under the occurrence-like PPP policy.
Reserves for incurred but not reported claims ("IBNR reserves") have consistently represented the majority of total loss and LAE reserves held by the Company. At December 31, 2001 and 2000, gross IBNR reserves composed 60.1% and 60.3%, respectively, of total gross loss and LAE reserves. The decrease in the proportion of IBNR in 2001 is primarily the result of additional claims made basis reserves, which develop more quickly from IBNR reserves into reported case reserves than the Company's occurrence basis loss and LAE reserves. Gross loss and LAE reserves on claims made medical malpractice policies amounted to $357.5 million, or 29.9% of total gross loss and LAE reserves at December 31, 2001, compared to gross loss and LAE reserves on claims made policies of $282.1 million, or 24.7% of total gross loss and LAE reserves at December 31, 2000.
The Company's initial review of loss and LAE payment and case reserving activity for the three months ended March 31, 2002 indicates that the activity, in the aggregate, was higher than expected based on prior actuarial estimates at December 31, 2001. In particular, activity on New Jersey physicians, Pennsylvania institutions and LP&C claims made business was higher than expected, which was partially offset by less than expected activity for the other major business components. The first quarter activity requires evaluation, which is currently in process, to determine the impact, if any, on net loss and LAE reserves at March 31, 2002. It is not unusual for loss and LAE payment and case reserving activity to vary significantly from quarter to quarter.
The Company reinsures its risks primarily under two reinsurance contracts, a specific excess of loss contract ("Specific Contract") and an aggregate excess of loss contract ("Aggregate Contract"). During 2001, the Company's retention for casualty business under the Specific Contract was $10 million per loss. For medical professional liability and commercial general liability business, coverage was provided up to $25 million per loss above the retention. For other casualty business, coverage was provided up to $15 million per loss above the retention. The Company retains a 10% co-participation in covered losses. The Company has maintained specific excess of loss reinsurance coverage generally similar to that described for several years.
The Company's aggregate reinsurance contracts are maintained on a funds withheld basis, whereby the Company holds the ceded premiums in a funds withheld account for the purpose of paying losses and related loss adjustment expenses. Interest charges are credited on funds withheld at predetermined contractual rates. Each of the
Total premiums written in 2001 were $231.9 million, an increase of $5.8 million, or 2.6% from total premiums written of $226.1 million in 2000. This net increase consisted of a net increase in direct premiums written of $19.4 million and a decrease in assumed premiums written of $13.6 million associated with the non-renewal, effective January 1, 2001, of a large excess of loss reinsurance contract. The net increase in direct premiums written was composed of net increases in Pennsylvania, New Jersey, Ohio and other states of $12.4 million, $6.4 million, $2.2 million and $3.1 million, respectively, and net decreases in Maryland and other states of $3.5 million and $1.3 million, respectively. The increases and decreases by state resulted from the combined effects of significant selected rate increases offset by disciplined underwriting actions. In New Jersey, written premiums in 2001 also included $10.5 million of premiums associated with early renewals of certain policies in a program initiated in 2001 to move the business off of a common January 1 renewal date.
invested assets resulting mainly from the impact on cash flow of the Company's premium financing program initiated during the last quarter of 2000. Average invested assets at amortized cost decreased to approximately $1.26 billion in 2001 from $1.27 billion in 2000. The average pre-tax yield on the investment portfolio decreased to 6.38% in 2001 from 6.69% in 2000 primarily as the result of lower market yields and ongoing changes in asset allocation due to a changing market yield environment.
OTHER REVENUE. Other revenue increased $0.9 million, or 13.2%, to $8.4 million in 2001 compared to $7.5 million in 2000. In 2001, other revenue was primarily composed of $3.1 million in finance charge income resulting from the Company's premium financing program initiated in November 2000 and $5.3 million associated with the Company's non-insurance operations. In 2000, other revenue primarily consisted of $7.1 million associated with the Company's non-insurance operations of which $2.3 million related to the Company's reinsurance intermediary subsidiary, which was sold on July 1, 2000, and premium financing charge income of $0.4 million.
NET INVESTMENT INCOME. Net investment income increased $9.5 million, or 12.6%, to $85.2 million in 2000 from $75.7 million in 1999. Average invested assets increased to approximately $1.27 billion in 2000 from $1.24 billion in 1999. The average pre-tax yield on the investment portfolio increased to 6.69% in 2000 from 6.22% in 1999
primarily as the result of ongoing changes in asset allocation due to a changing market yield environment.
UNDERWRITING EXPENSES. Underwriting expenses decreased $4.0 million, or 9.5%, to $38.6 million in 2000 from $42.6 million in 1999. The ratio of underwriting expenses to net premiums earned also improved to 21.0% in 2000 from 22.7% in 1999. This decrease was primarily the combined result of the Company's continuing focus on expense controls as well as a $0.8 million premium tax offset granted by Pennsylvania in the fourth quarter of 2000 following significant guarantee fund assessments by Pennsylvania over the last few years.
INCOME TAXES. An income tax benefit of $22.1 million was recorded in 2000, resulting in an effective tax benefit rate of 37.8% as compared to income tax expense of $6.6 million and an effective tax rate of 24.2% in 1999. The decrease of $28.7 million in income tax expense in 2000 is primarily the result of a decrease in pre-tax income of $86.0 million resulting in reduced tax of $30.1 million at a 35% tax rate and a net increase in taxes of $1.4 million related to other items including a write-off of $1.7 million of non-deductible goodwill expense in conjunction with the sale of substantially all of the assets of the Company's reinsurance subsidiary as of July 1, 2000.
On May 24, 2000, the Company obtained a $20.0 million revolving credit facility with Amboy National Bank to meet certain non-operating cash needs as they may arise. The credit facility terminates May 17, 2002 and bears a fixed interest rate of 8.0% per annum. The Company has pledged 100% of The MIIX Insurance Company stock as collateral under the credit facility. As of December 31, 2001, the Company had borrowed approximately $9.1 million against the credit facility, which is included in notes payable and other borrowings on the consolidated balance sheet. During the year ended December 31, 2001, the Company incurred interest expense on the loan of approximately $716,000. At December 31, 2001, the Company had fixed maturity investments in Amboy National Bank of approximately $9.1 million earning a fixed interest rate of 6% per annum. The Company's former CEO is a brother of the Senior Vice President and CFO of Amboy National Bank. The Company believes that the terms of the credit facility described above are as fair to the Company as could have been obtained from an unaffiliated third party. The Company has initiated discussions with Amboy National Bank to restructure the terms of the revolving credit facility. The restructuring discussions are ongoing and may rely in part on proceeds from the sale of the Company's leasing subsidiary, Hamilton National Leasing Corporation ("Hamilton"). On March 8, 2002, the Company executed a letter of intent with an unrelated third party to sell Hamilton. The sale transaction is expected to close during the second quarter of 2002. It is unlikely that the Company will be able to repay the credit facility
balance prior to the May 17, 2002 termination date and will be in default on the credit facility unless it is restructured prior to that date.
The Company's cash flow could be further impacted by actions taken by the insurance department regulators of New Jersey and Virginia, as well as the Company's A.M. Best rating, which is currently C+, could hinder the Company's ability to write new business and renew existing business. See "Risks and Uncertainties." Similarly, if the Company cannot execute its revised business plan successfully, its cash flow could be materially adversely affected. See "Business Strategy" and "Regulation - Risk-Based Capital."
At December 31, 2001 and 2000, the Company held collateral of $374.2 million and $306.7 million, respectively, in the form of funds held, and $166.5 million and $173.2 million, respectively, in the form of letters of credit, for recoverable amounts on ceded unpaid losses and LAE under certain reinsurance contracts. Under the contracts, reinsurers may require that a trust fund be established to hold the collateral should one or more triggering events occur, such as a downgrade in the Company's A.M. Best rating below B+, a reduction in statutory capital and surplus to less than $60 million, or a change in control. During February, 2002, A.M. Best downgraded the financial strength rating of the Company to B- (Fair) from A- (Excellent). On March 22, 2002, A.M. Best again lowered the rating of the Company to C+ (Marginal). Following the rating action, reinsurers requested that assets supporting the fund withheld account be placed in trust. The Company is working with reinsurers to establish the required trust accounts and move invested assets into trust in accordance with contract provisions. The Company does not anticipate a material impact on the Company's financial condition or results of operations from placing the funds withheld in trust. In accordance with the provisions of the reinsurance contracts, the funds held are credited with interest at contractual rates ranging from 7.5% to 8.6%, which is recorded as an expense in the year incurred.
During August 1999, the Company approved a stock repurchase program authorizing the purchase of up to 1,000,000 shares of its common stock in the open market. During November 1999, the program was amended, authorizing the purchase of up to an additional 2,000,000 shares. Through December 31, 2000, 3,000,000 shares had been repurchased at a total cost of $39.3 million and 25,933 shares have been issued from treasury at a value of $0.4 million. During 2001, The MIIX Group repurchased 84,178 shares at a value of approximately $0.7 million related to a former officer of the Company.
The tables below provide, as of December 31, 2001 and 2000, information about the Company's fixed maturity investments, which are sensitive to changes in interest rates, showing principal amounts and the average yield applicable thereto by expected maturity date and type of investment. The expected maturities displayed have been compiled based upon the earlier of the investment call date or the maturity date or, for mortgage-backed securities, expected payment patterns based on statistical analysis and management's judgment. Actual cash flows could differ, perhaps significantly, from the expected amounts.
At December 31, 2001, the Company had net after-tax unrealized losses on its fixed maturity investment portfolio of $6.6 million, which included a full-value deferred tax valuation allowance of $2.3 million. The net after-tax unrealized losses of $6.6 million on the fixed maturity portfolio represented 4.7% of total shareholders' equity gross of net after-tax unrealized losses on investments. The net unrealized losses were the result of the rise in market interest rates during 1999 offset, in part, by unrealized gains during 2000 and 2001.
Mortgage-backed and asset-backed securities involve similar risks associated with fixed maturity investments: interest rate risk, reinvestment rate risk and default or credit risk. In addition, mortgage-backed and asset-backed securities also possess prepayment risk, which is the risk that a security's originally scheduled interest and principal payments will differ considerably due to changes in the level of interest rates. The Company purchases mortgage-backed and asset-backed securities structured to enhance credit quality and/or provide prepayment stability.