net income of $2.0 million for 1993. The effects of such change in the reserve discount rate, which was previously presented as a change in accounting method, has been reclassified and presented as a change in accounting estimate. 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.
The Company's total assets were $413.2 million and $357.4 million as of December 31, 1997 and 1996, respectively, an increase of 15.6%. The increase in total assets as of December 31, 1997 was due mainly to bank borrowings received that were used to fund the Company's purchase of a $21.5 million surplus note issued by MEEMIC (see "Liquidity and Capital Resources") and to positive cash flows from operations.
As of December 31, 1997 and 1996, the Company had invested assets of $342.6 million and $300.1 million, respectively. Such 14.1% increase in invested assets resulted mainly from bank borrowings received that were used to fund the Company's purchase of a $21.5 million surplus note from MEEMIC (see "Liquidity and Capital Resources") and positive cash flows from operations. As of December 31, 1997 and 1996, invested assets represented approximately 83% and 84%, respectively, of the Company's total assets at those dates.
As of December 31, 1997 and 1996, the Company's investment portfolio was dominated by fixed maturity securities and primarily consisted of U.S. government and agency bonds, high-quality corporate bonds, mortgage-backed securities, redeemable preferred stocks and tax-exempt U.S. municipal bonds. As of December 31, 1997 and 1996, these fixed maturity securities aggregated $313.6 million and $286.3 million, respectively. Approximately $288.2 million of the fixed maturity portfolio was comprised of rated securities of which 99.7% were rated investment grade or better at December 31, 1997. Approximately 87.1% of the non-rated fixed maturity portfolio was comprised of the surplus note investment in MEEMIC.
The Company's fixed maturity investment portfolio is sensitive to interest rate changes. As of December 31, 1997 and 1996, the fixed maturity portfolio had net unrealized gains of approximately $4.7 million and $298,000, respectively. The increase in net unrealized gains was due to slightly lower interest rates at year end 1997 compared to year end 1996. As of December 31, 1997, 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 and one-half percent, whereas a one hundred basis point decrease in market interest rates would increase the value of this portfolio by approximately three percent.
During 1997 and 1996, the Company continued to balance its need for rate adjustments with the goal of maintaining market share in very competitive environments in Michigan, Illinois, Indiana and Ohio. Although the Company has maintained profitability and is endeavoring to offset lower premiums charged through more selective underwriting practices, there can be no assurance that these practices will be successful in the long run.
Net investment income, excluding realized capital gains and losses, was $18.7 million for 1997, an increase of 18.9% over net investment income of $15.7 million for 1996. The increase in net investment income mainly resulted from an increase in average invested assets associated with bank borrowings received that were used to fund the Company's purchase of a $21.5 million surplus note from MEEMIC (see "Liquidity and Capital Resources") and positive cash flows from operations. The weighted average tax equivalent book yield of the fixed maturity portfolio was 6.9% and 6.7% as of December 31, 1997 and 1996, respectively. During 1997, the Company
posted net realized investment losses of $207,000, whereas net realized investment losses in 1996 were $473,000.
Professional liability insurance incurred losses and loss adjustment expenses (including the increase in reserve for extended reporting period claims) for 1997 totaled $44.6 million, a decrease of 9.2%, as compared to professional liability insurance incurred losses and loss adjustment expenses of $49.1 million for 1996. As a percentage of premiums earned, the professional liability insurance incurred loss and loss adjustment expense ratio (including the increase in reserve for extended reporting period claims) improved slightly to 85.9% in 1997, as compared to 86.6% in 1996. The Company has continued to employ more selective underwriting practices during this time of highly competitive market conditions. Accordingly, the professional liability incurred loss and loss adjustment expense ratio has remained stable. There can be no assurances, however, that these selective underwriting practices will be successful in the long run.
Policy acquisition and underwriting expenses were $19.0 million in 1997, a 70.7% increase over policy acquisition and underwriting expenses of $11.1 million in 1996. As a percentage of premiums earned, the underwriting expense ratio increased to 26.4% during 1997, from 19.6% during 1996. The increase in such expenses was mainly due to $1.1 million of non-recurring legal, accounting, investment banker and related expenses associated with the Company's merger and acquisition activities, and $6.6 million of
Net income for 1997 was $11.0 million, or $3.14 per share (assuming dilution), on revenues of $91.6 million. This compares to net income of $9.6 million, or $2.75 per share (assuming dilution), on revenues of $72.2 million in 1996. The favorable 1997 earnings were attributable to the factors described above.
Professional liability net premiums written were $55.5 million in 1996, an increase of 0.6% when compared to professional liability net premiums written of $55.2 million in 1995. The increase in professional liability net premiums written was primarily due to $1.1 million in additional net premiums written by the Company's expansion of business into Indiana and Ohio. This increase was partially offset by decreases in professional liability premiums in the Company's Michigan and Illinois insurance markets.
During 1996 and 1995, the Company continued to balance its need for rate adjustments with the goal of maintaining market share in very competitive environments in Michigan, Illinois, Indiana and Ohio. Although the Company has maintained profitability and is endeavoring to offset lower premiums charged through more selective underwriting practices, there can be no assurance that these practices will be successful in the long run.
Net investment income, excluding realized capital gains and losses, was $15.7 million for 1996, an increase of 6.9% over net investment income of $14.7 million for 1995. Net investment income increased, despite a significant shift in the Company's investment portfolio towards municipal bonds (which, due to their tax-exempt status, offer lower pre-tax yields), due principally to the increases in invested assets associated with positive cash flows from operations. The weighted average tax equivalent book yield of the Company's fixed maturity portfolio was 6.7% 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 net realized investment losses posted in 1996 resulted from the
Company's repositioning of its fixed maturity portfolio to increase after-tax yield.
Professional liability insurance incurred losses and loss adjustment expenses (including the increase in reserve for extended reporting period claims) for 1996 totaled $49.1 million, an increase of 33.0% over incurred losses and loss adjustment expenses of $36.9 million for 1995. As a percentage of premiums earned, the professional liability insurance 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 loss and loss adjustment expense ratio was 22.1 percentage points lower in 1995 due to the Company's $12.3 million reserve reduction at year-end 1995. Such reserve reduction (which reduced the reserves relating to accident years 1986-1993 and reflected lower incurred losses than had been originally reserved for) was made possible by the favorable development of prior years' loss reserves. The factors leading to such favorable development were (i) the Company's practice of establishing its loss and loss adjustment expense reserves conservatively, as it relates to immaturely developed accident years, to minimize potential uncertainties, and (ii) lower than expected claims costs associated in part with tort reform legislation enacted in Michigan between 1986 and 1994. Such tort reform legislation shortened the statute of limitations, introduced a statute of repose with a six year limitation for adults, modified expert witness rules to require more qualified expert witnesses and capped non-economic damages.
At year-end 1994, the Company's loss and loss adjustment expense reserves were discounted using a three percent interest rate assumption. Effective January 1, 1995, the practice of discounting reserves for financial reporting was eliminated and, accordingly, loss and loss adjustment expense reserves have been established on an undiscounted basis thereafter (a more conservative accounting practice used by most publicly-traded insurance companies).
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 which caused a $1.0 million or 8.3% decrease in the expense and effective rate, respectively, as well as a revision to the estimate of the prior years' tax liability which caused a $913,000 or 7.6% decrease in the expense and effective rate, respectively. These decreases were partially offset by adjustments for other items, including dividends received deductions and non-deductible meals and entertainment, respectively, in an aggregate amount of $263,000 or 2.2% of the effective rate. The prior years' tax liability adjustment related to an overestimated tax accrual that was revised with the 1995 Federal tax return filing.
Net income for 1996 was $9.6 million, or $2.75 per share (assuming dilution), on revenues of $72.2 million. This compares to net income of $7.9 million, or $2.31 per share (assuming dilution), on revenues of $70.6 million in 1995. The favorable 1996 earnings were attributable to the factors described above. Net income for 1995 was reduced by $8.1 million (net of deferred federal income taxes), or $2.37 per share (assuming dilution), as a result of a cumulative effect change in accounting method associated with the elimination of the Company's practice of discounting its loss and loss adjustment expense reserves during 1995.
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, 1998, approximately $14.2 million of dividends could be paid by Professionals Group's direct insurance subsidiaries without prior regulatory approval. In 1997 and 1996, Professionals Group's insurance subsidiaries paid cash dividends aggregating $4.7 million and $3.5 million, respectively, to Professionals Group. None of Professionals Group's insurance subsidiaries paid any cash dividends in 1995. There can be no assurance as to any future dividends by Professionals Group or any of its subsidiaries (see also Note 12 to the Company's consolidated financial statements).
The Credit Agreement prohibits the payment of cash dividends on Professionals Group's common stock (except for cash paid in lieu of fractional shares related to stock dividends declared). It also required the Company to, among other things, maintain total consolidated stockholders' equity of at least $80.0 million plus 50% of the preceding fiscal year's consolidated net income, maintain a ratio of debt to equity of not more than 0.5:1 and maintain a fixed charges coverage ratio and an interest coverage ratio (as defined in the Credit Agreement) of not less than 1.5:1 and 2.5:1, respectively. The Company was in compliance with, or has received waivers of, all required covenants at December 31, 1997.
On August 15, 1997, Professionals Group announced a definitive agreement to merge PICOM with Physicians Protective Trust Fund. The terms of such merger, which were amended and restated on October 3, 1997 pursuant to a First Amended and Restated Agreement and Plan of Merger dated as of October 3, 1997 by and among Professionals Group, PICOM and PPTF (the "Merger Agreement"), contemplate the combining of the operations of PICOM and PPTF, through the conversion, subject to dissenters' rights, of all membership rights of members of PPTF into an aggregate of 4,089,160 shares of common stock of Professionals Group. The contemplated merger is expected to be accounted for as a pooling of interests (which means Professionals Group will carry forward to its accounts the assets and liabilities of PPTF at the respective amounts reported by PPTF) and is expected to occur in the second quarter of 1998, subject to regulatory and stockholder/policyholder approval.
On July 5, 1995, PICOM repurchased 254,823 shares of its common stock (approximately 7.9% of the then issued and outstanding shares of PICOM Common Stock) owned by Physicians Insurance Company of Ohio at a price of $17 per share. During 1995, PICOM negotiated a reciprocal stock purchase agreement with Physicians Insurance Company of Wisconsin, Inc. ("PIC-WIS"). Under the agreement, PICOM acquired 1,583 shares of PIC-WIS common stock (representing 6.8% of the then outstanding shares of PIC-WIS common stock) for $2.5 million and PIC-WIS purchased 131,579 shares of PICOM common stock (representing 4.2% of the then issued and outstanding shares of PICOM common stock) for $2.5 million. The transaction replaced more than one-half of the equity used to accomplish the previously reported repurchase of shares of PICOM common stock held by Physicians Insurance Company of Ohio.
During 1997, PICOM entered into an agreement with Michigan Lawyers Mutual Insurance Company, whereby PICOM ceded all of its Michigan lawyers professional liability insurance policies in-force to MLM and reinsured 35% of MLM's net premiums. As part of this arrangement MLM will provide certain insurance support services to enable PICOM to introduce its lawyers professional liability product into Illinois, Ohio and Indiana during 1998. The assumed premiums earned and the assumed losses and loss adjustment expenses incurred in connection with the MLM reinsurance agreement were $548,000 and $494,000, respectively, for the year ended December 31, 1997.
Effective July 1, 1997, PICOM began assuming, on a quota-share basis, 40% of the net personal automobile and homeowners insurance risks of MEEMIC. The assumed premiums earned and the assumed losses and loss adjustment expenses incurred in connection with the MEEMIC reinsurance agreement were $20.1 million and $13.1 million, respectively, for the year ended December 31, 1997.
The Financial Accounting Standards Board has issued Statement of Financial Accounting Standards ("SFAS") No. 128 "Earnings Per Share" which is effective for financial statements issued for both interim and annual periods ending after December 15, 1997. Earlier application is not permitted. This standard replaces the presentation of primary earnings per share with a presentation of basic earnings per share and also requires dual presentation of basic and diluted earnings per share for all entities with complex capital structures. The Company adopted SFAS No. 128, as required, in the fourth quarter of 1997 and all prior interim and annual period earnings per share data presented herein has been restated to conform with the provisions of SFAS No. 128. The impact of the adoption of SFAS No. 128 was not material to previously reported earnings per share amounts.
The Company has completed an assessment of its computer programs and has determined that portions of its software will have to be modified or replaced to facilitate the continued operation of its computers in the year 2000 and thereafter. Such modifications and replacements, which are not expected to exceed $500,000, will be expensed as incurred. To date, the Company has incurred and expensed approximately $150,000 (primarily for such assessment, the development of a modification plan, and the development of modifications to existing software).
The costs and timing of the modifications and replacements currently contemplated by the Company are based on management's best estimates, which were derived utilizing numerous assumptions of future events, including the continued availability of certain resources and other factors. However, there can be no guarantee that these estimates will be achieved and actual results could differ materially from those anticipated. Specific factors that might cause such material differences include, but are not limited to, the availability and cost of personnel trained in this area and the ability to locate and correct all relevant computer codes.
PROFESSIONALS INSURANCE COMPANY MANAGEMENT GROUP AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1997, 1996 and 1995
Professionals Insurance Company Management Group (Professionals Group) is an insurance holding company incorporated under Michigan law on January 31, 1996. Professionals Group owns all of the issued and outstanding common stock of PICOM Insurance Company (PICOM), a stock insurance company incorporated under Michigan law. Professionals Group and subsidiaries are collectively referred to as "the Company."
Effective August 31, 1996, and pursuant to a Reorganization Agreement dated May 13, 1996 (the Reorganization Agreement), and an Agreement and Plan of Merger dated May 13, 1996 (Plan of Merger), among Professionals Group, PICOM Interim Insurance Company, a stock insurance company incorporated under Michigan law and a wholly owned subsidiary of Professionals Group (INSCO) and PICOM, Professionals Group acquired all of the outstanding capital stock of PICOM through the merger of INSCO with and into PICOM (the Merger). As a result of the Merger: (1) INSCO was merged into PICOM and INSCO ceased to exist; (2) PICOM, as the surviving corporation, became a wholly owned subsidiary of Professionals Group; (3) each issued and outstanding share of common stock of PICOM (representing 3,188,145 shares) was converted into one share of common stock of Professionals Group, and (4) all of the issued and outstanding shares of INSCO held by Professionals Group were converted into shares of common stock of PICOM.
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 practices and by providing for any amounts deemed uncollectible.
In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the dates of the balance sheets and revenues and expenses for the periods then ended. Actual results may differ from those estimates.
The accompanying consolidated financial statements include the accounts of Professionals Group, and the following wholly owned subsidiaries:
PICOM, including PICOM's two wholly owned subsidiaries, PICOM Claims Services Corporation - a provider of claims processing services to a nonaffiliated professional liability company and ProNational Casualty Company (ProNational Casualty), formerly PICOM Insurance Company of Illinois - an Illinois-domiciled property and casualty insurance company which provided professional liability insurance for physicians and surgeons in the State of Illinois through 1997. ProNational Casualty was formed in December 1994 to write the book of business purchased effective January 1, 1995 (see note 16).
American Insurance Management Corporation - an Indiana Corporation that serves as the attorney-in-fact for American Medical Insurance Exchange, an inactive Indiana interinsurance reciprocal exchange.
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 in the 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 in the separate component of shareholders' equity.
Insurance premium income is recognized on a monthly pro rata basis over the respective terms of the policies in-force and unearned premiums represent the portion of premiums written which is applicable to the unexpired terms of the policies in-force.
Policy acquisition costs, specifically commissions, are deferred, subject to ultimate recoverability from future income, including investment income and amortized to expense over the period in which related premiums are earned.
Deferred federal income tax assets and liabilities are recognized for the expected future tax consequences attributable to differences between the financial statement carrying amount of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which these 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 summary of amortized cost, gross unrealized gains and losses and estimated fair value of investments in securities as of December 31, 1997 and 1996, follows:
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.
The Company has various excess of loss and quota share reinsurance agreements. As of December 31, 1997, the maximum current net retention on business generated by Professionals Group's insurance subsidiaries, subject to certain adjustments of risk on any single coverage per claim after reinsurance, was $300,000. Effective January 1, 1998, the Company's net retention was increased to $500,000 on all business.
The Company first assumed business from other insurance companies on December 31, 1996, when it assumed all of the loss and loss adjustment expense reserves and unearned premiums of American Medical Insurance Exchange (AMIE). Effective July 1, 1997, PICOM began assuming, on a quota-share basis, 40% of Michigan Educational Employees Mutual Insurance Company's (MEEMIC) net business (see note 19).
Premiums earned and losses and loss adjustment expenses have been increased by the following reinsurance assumed amounts for the year ended December 31, 1997:
Professionals Group, together with its subsidiaries, files a consolidated federal income tax return. Income tax expense is computed under the liability method, whereby deferred income taxes reflect the estimated future tax effects of temporary differences between the carrying value of assets and liabilities for financial reporting purposes and those for income tax purposes. A valuation allowance is then required to be established to reduce a deferred tax asset if it is "more likely than not" that the related tax benefits will not be realized.
Actual federal income taxes vary from amounts computed by applying the current federal income tax rate of 34% to income or loss before federal income taxes. For the years ended December 31, 1997, 1996 and 1995, the reasons for these differences, and the tax effects thereof, are as follows:
The tax effects of temporary differences that give rise to deferred federal income tax assets and deferred federal income tax liabilities follow:
In assessing the realizability of deferred federal income tax assets, management considers whether it is more likely than not that some portion of the deferred federal income tax assets will not be realized. Because of the carryforward provisions of the Internal Revenue Code, the expectation that temporary differences will reverse during periods in which taxable income is generated, and the fact that the Company has not incurred an operating loss for either financial or federal income tax reporting purposes since 1987, management believes it is more likely than not that the Company will fully realize the net deferred federal income tax assets. Accordingly, no valuation allowance has been established.
At December 31, 1997 and 1996, property and equipment consisted of the following:
The Credit Agreement contains a covenant which prohibits the payment of cash dividends on Professionals Group's common stock (except for cash paid in lieu of fractional shares related to stock dividends declared). Additional covenants also require the Company to, among other things, maintain total consolidated shareholders' equity of at least $80.0 million plus 50% of the preceding fiscal year's consolidated net income, maintain a fixed charges ratio and an interest coverage ratio (as defined by the Credit Agreement) of not less than 1.5:1 and 2.5:1, respectively. The Company was in compliance with, or has received waivers of, all required covenants at December 31, 1997.
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 1997, 1996 and 1995, the Company's expense under the 401(k) plan was $370,000, $295,000 and $261,000, 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 1997, 1996 and 1995, the Company's expense under the money purchase plan was $145,000, $112,000 and $114,000, respectively.
Approximately $363.8 million of consolidated assets represents assets of the Company's insurance operations that may not be transferred to Professionals Group in the form of dividends, loans or advances without prior regulatory approval. The amount of dividends that Professionals Group's insurance subsidiaries can pay to Professionals Group in any 12-month period is limited 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, 1998, approximately $14,185,000 could be paid by Professionals Group's insurance subsidiaries without prior regulatory approval. In 1997 and 1996, Professionals Group's insurance subsidiaries paid dividends of $4,717,049 and $3,530,334, respectively. In 1995, Professionals Group's insurance subsidiaries did not pay any dividends.
On February 28, 1996, the Company awarded 28,430 shares of common stock held in treasury to directors, officers and employees of the Company as a one-time stock bonus. Compensation expense for this stock bonus approximated $697,000, which was charged to policy acquisition and other underwriting expenses.
The Company has elected the disclosure-only provisions of SFAS No. 123. Accordingly, had compensation cost for the Directors and Incentive Plans been based on the fair value of options at grant date, the Company's 1997 net income (in thousands) and net income per common share - assuming dilution would have been reduced to the proforma amounts below:
The fair value of options at date of grant was estimated using the Black-Scholes option pricing model with the following weighted average assumptions used for grants in 1997: dividend yield of 0%; expected volatility of 35.7%; risk free interest rate of 6.29% and 6.62% for the Incentive Plan and Directors Plan, respectively; and expected lives of 9 years and 7 years for the Incentive Plan and Directors Plan, respectively. The proforma effect on net income for 1997 is not representative of the proforma effect on net income for future years because additional stock option awards could be made in future years.
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, 1997 and 1996, and statutory net income for the years ended December 31, 1997, 1996 and 1995, of PICOM and ProNational Casualty, as applicable (as filed with their respective insurance regulatory authorities), to the amounts shown in the accompanying consolidated financial statements follows:
Effective January 1, 1995, PICOM purchased the right to solicit and write medical professional liability insurance in Illinois that was formerly written by another Illinois insurance company. The purchase price, which is a percentage of annualized gross premiums written through 1999, will be a minimum of $3,452,954, plus $134,000 attributable to a non-compete covenant. To the extent the ultimate purchase price exceeds the minimum, such excess will be capitalized. During 1996, the actual purchase price was estimated to exceed the minimum. As a result, an additional $400,000 was capitalized in 1996. The adjusted purchase price of $3,986,954, net of accumulated amortization of $1,126,000 and $717,000, was recorded as an intangible asset at December 31, 1997 and 1996, respectively.
The unaudited operating results by quarter for 1997 and 1996, are summarized below:
Under SFAS No. 107, the Company's investment securities, cash, short-term investments, long-term debt, drafts outstanding and balance due on purchased book of business constitute financial instruments. The carrying amounts of all financial instruments--other than investment securities, which are presented in note 4--approximated their fair values at December 31, 1997 and 1996.
On September 22, 1997, MEEMIC Insurance Services Corporation (Services Corp.), a newly formed subsidiary of MEEMIC, purchased the net assets of MEIA. The purchase price equals 3.75% of premiums written by Services Corp. through July 2004, subject to a guaranteed minimum purchase price of $43.0 million. To fund this purchase, Services Corp. paid cash of $22.5 million (utilizing the proceeds of the Surplus Note), and agreed to pay $20.5 million to MEIA as additional consideration through 2004, as provided for in the purchase agreement. MEEMIC guaranteed payment of the first $3.0 million and Professionals Group guaranteed payment of the final $17.5 million (payable in years 2001-2004) of the purchase price. The Company believes the likelihood that its guarantee will become payable is minimal.
We have audited the accompanying consolidated balance sheets of Professionals Insurance Company Management Group and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of income, shareholders' equity and cash flows for each of the years in the three year period ended December 31, 1997. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule as of and for the periods ended December 31, 1997 and 1996. These consolidated financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Professionals Insurance Company Management Group and subsidiaries as of December 31, 1997 and 1996, and the consolidated results of their operations and their cash flows for each of the years in the three year period ended December 31, 1997 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.
As discussed in notes 3 and 9 to the consolidated financial statements, the Company changed its method of accounting for loss and loss adjustment expense reserves to eliminate discounting of such reserves in 1995.
PICOM Insurance Company - a stock insurance company incorporated under Michigan law.