(1) Effective January 1, 1995, the Company began writing a book of business previously written by an Illinois insurance company. (2) The Company discounted loss and loss adjustment expense reserves through 1994. In 1993 and 1992 the Company changed its loss and loss adjustment expense reserve discount rate from 3.75% to 3% and 5.625% to 3.75%, respectively. These reductions in reserve discount rate were treated as changes in accounting estimates and resulted in decreases in net income of $2.0 million for 1993 and $5.3 million for 1992. The effects of such changes in the reserve discount rate, which were previously presented as changes in accounting methods, have been reclassified and presented as changes in accounting estimates. Effective January 1, 1995, the Company eliminated its practice of discounting loss and loss adjustment expense reserves for GAAP reporting purposes, which was treated as a change in accounting method. (3) Weighted average shares outstanding are in thousands. Prior period amounts have been restated for the effects of 10% stock dividends on December 16, 1996 and December 1, 1994 and 1993, respectively. (4) In 1995 the Company reduced its estimated liability for loss and loss adjustment expense reserves by $12.3 million for redundancies. The ratio includes the increase in reserve for extended reporting period claims. (5) Operating income excludes the after-tax effect of net realized investment gains and losses, cumulative effect changes in accounting methods and the after-tax effect of changes in accounting estimates. For 1995, the after-tax effect of the reserve reduction has also been excluded.
respectively. As of December 31, 1996 and 1995, invested assets represented approximately 84% and 85%, respectively, of the Company's total assets at those dates.
The Company's fixed maturity investment portfolio is sensitive to interest rate changes. As of December 31, 1996 and 1995, the fixed maturity portfolio had unrealized gains of approximately $298,000 and $2.9 million, respectively. The decrease in unrealized gains was due to slightly higher interest rates at year end 1996 compared to year end 1995. As of December 31, 1996, the fixed maturity portfolio had a weighted average modified duration of approximately four years. A one hundred basis point increase in market interest rates would decrease the value of this portfolio by approximately three percent, whereas a one hundred basis point decrease in market interest rates would increase the value of this portfolio by approximately three percent.
Results of Operations -- Year Ended December 31, 1996 Compared to Year Ended December 31, 1995:
For purposes of the following discussion, the Company's Service Marks are defined as follows:
DoctorCare(sm) - Offers professional liability coverage for individual physicians, surgeons and dentists;
HealthServices(sm) - Offers professional liability coverage for health care organizations such as hospitals, clinics, hospices and surgery centers; and
Net premiums written in 1996 were $55.5 million, an increase of 0.6% over 1995 net premiums written of $55.2 million. The increase in net premiums written resulted from a $2.7 million increase in CorpCare(sm) premiums, a $1.1 million increase due to expansion of business into Indiana and Ohio, a $789,000 increase in HealthServices(sm) and HealthPro(sm) premiums and a $973,000 increase in LawyerCare(sm) and other premiums. These increases were offset by a decrease in DoctorCare(sm) premiums of $5.3 million that resulted from the continued consolidation of individual practices into group practices and general competition in the Michigan and Illinois insurance markets. Of the net premiums written in 1996, approximately 90.7% was generated by DoctorCare(sm) and CorpCare(sm) coverages, 4.3% was generated by HealthServices(sm) and HealthPro(sm) coverages, 1.6% was generated by LawyerCare(sm) coverage and 3.4% was generated by other types of coverage. Of the net premiums written in 1995, approximately 93.8% was generated by DoctorCare(sm) and CorpCare(sm) coverages, 2.9% was generated by HealthServices(sm) and HealthProsm coverages, 0.9% was generated by LawyerCare(sm) coverage and 2.4% was generated by other types of coverage.
and 6.5% as of December 31, 1996 and 1995, respectively. During 1996, the Company posted net realized investment losses of $473,000, whereas net realized investment losses in 1995 were negligible. The 1996 net realized investment losses resulted from the Company's repositioning of its fixed maturity portfolio to increase after-tax yield.
Incurred losses and loss adjustment expenses (including the increase in reserve for extended reporting period claims) for 1996 totaled $49.1 million, up 33.0%, as compared to incurred losses and loss adjustment expenses of $36.9 million for 1995. As a percentage of premiums earned, the incurred loss and loss adjustment expense ratio (including the increase in reserve for extended reporting period claims) was 86.6% in 1996 compared to 66.3% in 1995. The 1995 loss and loss adjustment expense ratio was favorably impacted by 22.1 percentage points due to the Company's reduction of its reserves by $12.3 million at year-end 1995 because of favorable development of prior years' loss reserves, as supported by a detailed actuarial study.
Underwriting expenses were $11.1 million in 1996, a 19.4% increase over underwriting expenses of $9.3 million in 1995. As a percentage of premiums earned, the underwriting expense ratio was 19.6% in 1996, up from the underwriting expense ratio of 16.8% in 1995. The increase in underwriting expenses in 1996 relative to 1995 is attributable to non-recurring legal, accounting and related expenses associated with the formation of the Professionals Group holding company system, a one-time stock bonus paid to directors, officers and employees in 1996 and start-up expenses associated with the Company's expansion of business into Indiana and Ohio.
The Company recorded $2.4 million in federal income tax expense in 1996 as compared to $8.3 million in 1995. The Company's effective federal income tax rate approximated 20.3% in 1996 compared to 34.0% in 1995. The decrease in the effective income tax rate is due to the Company's increased holdings in tax-exempt municipal bonds as well as an adjustment to the prior years' tax liability.
Results of Operations -- Year Ended December 31, 1995 Compared to Year Ended December 31, 1994:
Net investment income, excluding realized capital gains and losses, was $14.7 million for 1995, up 10.0%, as compared to net investment income of $13.4 million for 1994. The increase in net investment income was due principally to increases in invested assets because of positive cash flows from operations. During 1994, the Company posted net realized investment losses of $2.0 million, whereas net realized investment losses in 1995 were negligible.
Liquidity describes the ability to generate sufficient cash flows to meet the cash requirements of continuing operations. Liquidity, in the context of insurance operations, is typically determined by two distinct operations: underwriting and investing. Net cash flows from underwriting operations are used to build an investment portfolio, which in turn produces future cash from investment income. The Company continuously monitors available cash and short-term investment balances in relation to projected cash needs to maintain adequate balances for current payments while maximizing cash available for longer term investment opportunities.
The payment of losses, loss adjustment expenses and operating expenses in the ordinary course of business represents the Company's principal need for liquid funds. Payments for losses and loss adjustment expenses are distributed fairly evenly throughout the year. Payments for reinsurance are made within thirty days subsequent to the end of each quarter, with adjustments made after each reinsurance year. Historically, cash used to pay for these items has been provided by operations. The Company did not borrow any funds in the years ended December 31, 1996, 1995 and 1994; however, as of December 31, 1996, the Company has entered into $5.5 million of commitments to build a new home office facility in Okemos, Michigan and to purchase new furniture and equipment. As of December 31, 1996, no other material commitments for capital expenditures existed, and management believes the Company's present liquidity, together with its expected cash flow from operations, will be sufficient to fund these commitments for capital expenditures.
In February 1997, the Company entered into an agreement with Michigan Educational Employees Mutual Insurance Company ("MEEMIC"), a Michigan-domiciled specialty writer of personal automobile and homeowners coverages for Michigan teachers and other educational employees. The agreement contemplates a series of simultaneous transactions which include the Company's purchase of a $21.0 million surplus certificate from MEEMIC, a quota share reinsurance agreement whereby PICOM will reinsure a portion of MEEMIC's net retained lines, a management services agreement between the Company and MEEMIC and the election of Professionals Group's nominees to MEEMIC's Board of Directors. These transactions are subject to regulatory approval by the Michigan
At a future date, Professionals Group and MEEMIC expect to pursue demutualization of MEEMIC. Such demutualization would be subject to regulatory approval by the Michigan Commissioner of Insurance and approval of MEEMIC's policyholders. No specific timetable has been set for this proposed demutualization and there can be no assurances that MEEMIC will be demutualized.
The ability of Professionals Group to fund its operations and to pay dividends on its common stock will be dependent upon its receipt of dividends, loans or advances from its insurance company subsidiaries (particularly PICOM). The ability of those subsidiaries to pay dividends is subject to regulatory restrictions. Generally, these restrictions limit the amount of dividends such subsidiaries can pay to their respective parent in any 12-month period to the greater of statutory net income for the preceding year (excluding realized gains and losses on sales of investments), or ten percent of policyholders' surplus as of the end of the preceding year. As of January 1, 1997, approximately $14.9 million of dividends could be paid by Professionals Group's direct insurance
subsidiaries without prior regulatory approval. In 1996, Professionals Group's insurance subsidiaries paid cash dividends aggregating $3.5 million to Professionals Group. None of Professionals Group's insurance subsidiaries paid any cash dividends in either 1995 or 1994. There can be no assurance as to any future dividends by Professionals Group or any of its subsidiaries (see also Note 11 to the Company's consolidated financial statements).
In the normal course of business, the Company seeks to reduce the loss that may arise from events that cause unfavorable underwriting results, provide additional capacity for growth and protect shareholders' equity by reinsuring certain levels of risk in various areas of exposure with other insurance enterprises or reinsurers. At the present time, the Company has both excess of
loss reinsurance and errors and omissions insurance. Although reinsurance agreements contractually obligate the Company's reinsurers to reimburse the Company for their proportionate share of losses, they do not discharge the primary liability of the Company. The Company is contingently liable for the ceded amount of reserves for unpaid losses and loss adjustment expenses and unearned premiums in the event the assuming insurance organizations are unable to meet their contractual obligations.
The Company continually reviews its reinsurers, considering a number of factors, the most critical of which is their financial stability. Based on these reviews, the Company evaluates its position with its reinsurers with respect to existing and future reinsurance. To date, the Company has not experienced any material difficulty in collecting reinsurance recoverables. No assurance can be given, however, regarding the future ability of any of the Company's reinsurers to meet their future obligations. Among the insurers to which the Company cedes reinsurance are certain Lloyd's of London Syndicates.
In recent years, Lloyd's has reported substantial losses which have had adverse effects on Lloyd's in general, and on certain syndicates in particular. The substantial losses and other adverse developments could affect the ability of certain syndicates to continue to operate. It is not possible to predict what effects the circumstances described above may have on Lloyd's and the Company's contractual relationship with Lloyd's Syndicates in future years.
The purpose of these regulatory efforts is to improve the solvency of insurers. While the impact of these regulatory efforts on the Company's insurance operations cannot be quantified until enacted, the Company believes it will be adequately positioned to compete in an environment of more stringent regulation.
In March 1995, the FASB issued Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of," which is effective for fiscal years beginning after December 15, 1995. SFAS No. 121 requires that long-lived assets and certain identifiable intangibles to be held and used, or disposed of, by an entity be reviewed for impairment, and be reported at the lower of the carrying amount or fair value less costs to sell, if applicable. The adoption of SFAS No. 121 did not have a material effect on the Company's consolidated results of operations or financial condition during 1996.
The FASB has issued SFAS No. 123 "Accounting for Stock-Based Compensation," which is effective for fiscal years beginning
PROFESSIONALS INSURANCE COMPANY MANAGEMENT GROUP AND SUBSIDIARY Consolidated Statements of Shareholders' Equity Years ended December 31, 1996, 1995 and 1994
PROFESSIONALS INSURANCE COMPANY MANAGEMENT GROUP AND SUBSIDIARY Consolidated Statements of Cash Flows
PROFESSIONALS INSURANCE COMPANY MANAGEMENT GROUP AND SUBSIDIARY Notes to Consolidated Financial Statements December 31, 1996, 1995 and 1994
Prior to the Reorganization Agreement and the Plan of Merger, PICOM loaned $1,500,000 to Professionals Group for the purpose of enabling Professionals Group to form and capitalize INSCO in accordance with the Michigan Insurance Code. Professionals Group invested the entire $1,500,000 in INSCO in exchange for all of the issued and outstanding shares of capital stock of INSCO. The loan from PICOM to Professionals Group had a stated interest rate and maturity date and was secured by a pledge of all of the issued and outstanding shares of INSCO. Subsequent to the Merger, PICOM declared and paid cash dividends totaling $3,530,334 to Professionals Group. Professionals Group then used $1,530,334 of the cash dividend to repay PICOM the outstanding balance plus accrued interest on the loan.
Legal/Regulatory Risk is the risk that the legal or regulatory environment in which an insurer operates will change and create additional costs or expenses not anticipated by the insurer in pricing its products. That is, regulatory initiatives designed to reduce insurer profits or new legal theories may create costs for the insurer beyond those recorded in the financial statements. The Company mitigates this risk through underwriting and loss adjusting practices which identify and minimize the adverse impact of this risk.
Credit Risk is the risk that issuers of securities owned by the Company will default or other parties, including reinsurers, which owe the Company money will not pay. Also, the Company writes a significant amount of business under which policyholders reimburse the Company for policy deductibles. The Company minimizes this risk by adhering to a conservative investment strategy, by maintaining sound reinsurance and credit and collection policies and by providing for any amounts deemed uncollectible.
PICOM Claims Services Corporation - a provider of claims processing services to a nonaffiliated professional liability company.
American Insurance Management Corporation - an Indiana Corporation that serves as the attorney-in-fact for American Medical Insurance Exchange, an Indiana interinsurance reciprocal exchange.
The consolidated financial statements have been prepared in accordance with generally accepted accounting principles (GAAP), which vary in certain respects from statutory accounting practices followed in reporting to insurance regulatory authorities (see note 13 for the effects of such differences).
Available-for-sale securities are recorded at fair value, whereas held-to-maturity securities are recorded at amortized cost. Unrealized gains and losses, net of the related income tax effect, on available-for-sale securities are excluded from income and reported as a separate component of shareholders' equity. Transfers of securities between categories are recorded at fair value at the date of transfer. Unrealized gains and losses associated with transfers of securities from held-to-maturity to available-for-sale are recorded as a separate component of shareholders' equity.
A decline in the fair value of an available-for-sale or held-to-maturity security below cost that is deemed other than temporary results in a charge to income, resulting in the establishment of a new cost basis for the security. All declines in fair values of the Company's investment securities in 1996, 1995 or 1994 were deemed to be temporary.
Investments in preferred stock and common stock of nonaffiliates are stated at fair value. Fair values are based on quoted market prices or dealer quotes. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.
Intangible assets are comprised of goodwill, which represents the excess of cost over the fair value of assets acquired, and the cost of a purchased book of business (see note 15), both of which are being amortized on a straight-line basis over ten years. The carrying value of intangible assets is periodically reviewed by the Company based on the expected future undiscounted operating cash flows of the related entity. Based upon its most recent analysis, the Company believes that no material impairment of intangible assets exists at December 31, 1996.
As more fully described in note 12, the Company records compensation expense for stock options only if the market price of the Company's stock, on the date of grant, exceeds the amount an individual must pay to acquire the stock.
In November 1995, the Financial Accounting Standards Board issued a "Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities." This guide allowed companies to reassess the appropriateness of the classification of securities as of the date of the implementation guide, but no later than December 31, 1995. As a result, the Company made a one-time transfer of approximately $77,893,000 in investment securities previously classified as held-to-maturity to the available-for-sale classification. The effect of such reclassification increased shareholders' equity by $511,000, net of deferred federal income taxes.
A summary of amortized cost, gross unrealized gains and losses and estimated fair value of investments in securities as of December 31, 1996 and 1995, follows:
The amortized cost and estimated fair value of fixed maturities at December 31, 1996, by contractual maturity, are shown below. Expected maturities on certain corporate and mortgage-backed securities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
During 1995, the Company tendered a fixed maturity security having an amortized cost of $747,146 from its held-to-maturity portfolio for $757,862, resulting in a gain of $10,716. This security was tendered because the future creditworthiness of the issuer was not determinable.
On December 28, 1995, under a reciprocal stock purchase agreement with Physicians Insurance Company of Wisconsin, Inc. (PIC-Wis), the Company acquired 1,583 shares of PIC-Wis' common stock (representing 6.77 % of PIC-Wis' outstanding stock) for $2,500,000, and PIC-Wis acquired 131,579 shares of the Company's common stock (representing 4.2 % of the Company's outstanding stock) for $2,500,000.
At December 31, 1996, U.S. Treasury notes and certificates of deposit with a carrying value of $3,407,000 were on deposit with regulatory authorities, as required by law.
The Company has various excess of loss and quota share reinsurance agreements. As of December 31, 1996, PICOM's and PICOM-Illinois' maximum current net retention, subject to certain adjustments of risk on any single coverage per claim after reinsurance, follows:
At December 31, 1996, amounts due from and premiums prepaid to reinsurers follow:
The increases in ceded premiums and ceded losses and loss adjustment expenses, beginning in 1995, result from PICOM-Illinois' reinsurance program.
On December 31, 1996, the Company assumed all of the loss and loss adjustment expense reserves and unearned premiums of American Medical Insurance Exchange (AMIE), which resulted in a one-time charge to losses and loss adjustment expenses of $613,000. This one-time charge resulted primarily from the elimination of AMIE's practice of discounting its loss and loss adjustment expense reserves.
Prior to 1995, loss and loss adjustment expense reserves were discounted to reflect anticipated investment income. Discounts were based on historical payment patterns and assumed an interest rate at or below the Company's investment yield, which was the same rate used for statutory reporting purposes.
PROFESSIONALS INSURANCE COMPANY MANAGEMENT GROUP AND SUBSIDIARY Notes to Consolidated Financial Statements, Continued
With respect to the 401(k) plan, the Company annually contributes 5% of an employee's salary and matches employee contributions up to 5% of an employee's salary. During 1996, 1995 and 1994, the Company's expense under the 401(k) plan was $295,000, $261,000 and $298,000, respectively.
With respect to the money purchase plan, the Company annually contributes 3% of an employee's salary up to a prescribed maximum, plus 5% of the excess of an employee's salary over the prescribed maximum. During 1996, 1995 and 1994, the Company's expense under the money purchase plan was $112,000, $114,000 and $118,000, respectively.
Approximately $317,200,000 of consolidated assets represents assets of the Company's insurance operations that may not be transferable to the Company in the form of dividends, loans or advances without prior regulatory approval. Specifically, the Michigan and Illinois Insurance Codes limit the amount of dividends that PICOM or PICOM-Illinois can pay to their respective parent in any 12-month period to the greater of statutory net income for the preceding year, excluding realized gains (losses) on sales of investments, or 10% of policyholders' surplus as of the preceding year-end. As of January 1, 1997, approximately $14,899,000 and $601,000 could be paid without prior regulatory approval by PICOM and PICOM-Illinois, respectively. In 1996, PICOM paid $3,530,334 in dividends and PICOM-Illinois paid no dividends. In 1995 and 1994, neither PICOM nor PICOM-Illinois paid any dividends.
As a result of the merger on August 31, 1996 (see note 1), the remaining 50,814 shares of the Company's common stock held in treasury were canceled and retired at cost.
On November 21, 1996 and September 22, 1994, the Company declared 10% stock dividends, issued on December 16, 1996 and December 1, 1994, respectively, to shareholders of record as of December 4, 1996 and October 28, 1994, respectively. All per-share information in the accompanying consolidated financial statements has been adjusted to give retroactive effect to these stock dividends.
PICOM and PICOM-Illinois are required to file financial statements prepared in accordance with statutory insurance accounting practices (SAP) prescribed or permitted by Michigan and Illinois with their respective domiciliary states. The only material statutory accounting method utilized by PICOM that is permitted rather than prescribed is PICOM's discounting of its loss and loss adjustment expense reserves through December 31, 1994 and discounting of loss reserves only thereafter. The impact of such permitted practice is to increase the statutory policyholders' surplus of PICOM by $10,658,000 and $9,393,000 at December 31, 1996 and 1995, respectively. PICOM-Illinois does not utilize any permitted accounting practices.
Accounting practices used to prepare statutory-basis financial statements differ in some respects from GAAP. A reconciliation of statutory capital and surplus at December 31, 1996 and 1995, and statutory net income for the years ended December 31, 1996, 1995 and 1994, of PICOM and PICOM-Illinois, as applicable (as filed with their respective insurance regulatory authorities), to the amounts shown in the accompanying consolidated financial statements follows:
Certain regulations that affect PICOM, PICOM-Illinois and the insurance industry are promulgated by the National Association of Insurance Commissioners (NAIC), which is an association of state insurance commissioners, regulators and support staff that acts as a coordinating body for the state insurance regulatory process. The NAIC has established risk-based capital (RBC) requirements to assist regulators in monitoring the financial strength and stability of property and casualty insurers. Under the NAIC requirements, each insurer must maintain its total capital and surplus above a calculated minimum threshold or take corrective measures to achieve that threshold. PICOM and PICOM-Illinois have calculated their RBC levels based on these requirements and have determined that they passed the RBC test and have capital and surplus in excess of the minimum threshold.
The Company writes approximately 80% of its premiums through approximately 55 independent agents and approximately 20% of its premiums directly. In 1996, 1995 and 1994, respectively, one agent individually produced approximately 10% of the Company's direct premiums written. In 1996, 1995 and 1994, nine agents, in aggregate, produced approximately 55%, 54%, and 68%, respectively, of the Company's direct premiums written.
All premiums are directly billed to policyholders and premiums due are secured by the related unearned premiums. When insureds fail to pay their premiums, coverage is canceled. The Company generally requires policyholders to remit a minimum of 40% of the premium at policy origination date. Subsequent scheduled payments are monitored to prevent the Company from providing coverage beyond the date for which payment has been received. In the opinion of management, the amounts carried on the accompanying consolidated balance sheets are collectible.
The unaudited operating results by quarter for 1996 and 1995, are summarized below:
Net income per common share amounts for the first three quarters of 1996 and all four quarters of 1995 have been restated from those originally reported to reflect the 10% stock dividend declared in 1996 (see note 11).
The Board of Directors and Shareholders Professionals Insurance Company Management Group:
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Professionals Insurance Company Management Group and subsidiary as of December 31, 1996 and 1995, and the results of their operations and their cash flows for the years then ended in conformity with generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
To the Board of Directors and Shareholders of Professionals Insurance Company Management Group and Subsidiary
We have audited the accompanying consolidated statements of income, shareholders' equity and cash flows of Professionals Insurance Company Management Group and Subsidiary (formerly, PICOM Insurance Company and Subsidiaries) for the year ended December 31, 1994. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.
These condensed financial statements should be read in conjunction with the accompanying consolidated financial statements and notes thereto of Professionals Insurance Company Management Group and subsidiary.