The following is a summary of properties leased by the Company at December 31, 2000:
The consolidated statements of operations data set forth below for each of the three years in the period ended December 31, 2000, and the consolidated balance sheet data at December 31, 2000 and 1999 are derived from, and are qualified by reference to, the audited consolidated financial statements included elsewhere in this Form 10-K. The consolidated statements of operations data set forth below for the two years in the period ended December 31, 1997, and the consolidated balance sheet data at December 31, 1998, 1997 and 1996, are derived from audited consolidated financial statements not included herein. The information set forth below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Company’s consolidated financial statements and related notes included elsewhere in this Form 10-K.
Adjusted to reflect a three-for-two stock split in May 1996. For additional information relating to income (loss) per share, see Note 2 of Notes to Consolidated Financial Statements.
The Company -RTW, Inc. (RTW) and its wholly owned insurance subsidiary, American Compensation Insurance Company (ACIC), provide disability management services to employers. Collectively, “we,” “our” and “us” refers to these entities in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
Our gross premiums earned increased 7.5% in 2000 from 1999 and total revenues increased 7.1% in 2000 from 1999 due primarily to a 14.0% increase in premiums in force to $99.4 million at December 31, 2000 from $87.2 million at December 31, 1999;
Claim and claim settlement expenses increased significantly to 92.7% of premiums earned for 2000 from 60.8% for 1999 due to the following:
The 2000 results include a $15.9 million increase in reserves for unpaid claim and claim settlement expenses to reflect unfavorable development of prior period claims compared to the 1999 results which include an $8.1 million decrease in reserves for unpaid claim and claim settlement expenses reflecting favorable development of prior period claims.
We recorded estimates of ceded paid and unpaid claim and claim settlement expenses under our $25,000 to $300,000 excess of loss reinsurance agreement totaling $21.8 million in 2000 including $400,000 amortized from a deferred retrospective reinsurance gain resulting in a corresponding reduction in 2000 claim and claim settlement expenses. These amounts differed from our 1999 results which include an estimate of ceded paid and unpaid claim and claim settlement expenses totaling $22.0 million and $740,000 amortized from the deferred retrospective reinsurance gain.
We aggressively targeted policies that did not meet our underwriting profit margin standards for non-renewal or re-underwriting at increased rates at policy expiration in 2000 and 1999. For 2000, we
In the following pages, we take a look at the 2000, 1999 and 1998 operating results for items in our Consolidated Statement of Operations and also explain key balance sheet accounts in greater detail.
The premium we charge a policyholder is a function of their payroll, industry and prior workers’ compensation claims experience. In underwriting a policy, we receive policyholder payroll estimates for the ensuing year. We record premiums written on an installment basis matching our billing to the policyholder and earn premiums on a daily basis over the life of each insurance policy based on the payroll estimate. We record the excess of premiums billed over premiums earned for each policy as unearned premiums on our balance sheet. When a policy expires, we audit employer payrolls for the policy period and adjust the estimated payroll and the policyholder’s premium to its actual value. The result is a “final audit” adjustment recorded to premiums earned when the adjustment becomes known. Final audit premiums recognized during the period include billed final audit premiums plus (or minus) the change in estimate for premiums on unexpired and expired unaudited policies.
meet our underwriting profit margin standards for non-renewal or re-underwriting at increased rates at policy expiration in 2000 and 1999. For 2000, we successfully priced up or non-renewed 90% of expiring premium exhibiting poor loss characteristics, resulting in $21.3 million of premiums renewed at higher prices as well as $17.6 million in premiums that were not renewed. In 1999, we successfully priced up or non-renewed 67% resulting in $10.9 million of premiums renewed at higher prices and $10.8 million in premiums that did not renew.
Our gross premiums earned increased 7.5% to $95.9 million in 2000 from $89.2 million in 1999. This increase resulted from the increase in premiums in force and an increase in final audit premiums earned to $5.5 million in 2000 from $4.7 million in 1999.
Gross premiums earned decreased slightly in 1999 to $89.2 million from $89.9 million in 1998. This decrease resulted from a decrease in final audit premiums earned to $4.7 million in 1999 from $7.2 million in 1998, partially offset by the impact of an increase in premiums in force to $87.2 million in 1999 from $82.1 million in 1998.
Many state legislatures where we provide coverage reduced benefits that injured employees are paid, resulting in lower loss costs of workers’ compensation insurance and decreased corresponding premiums paid by the policyholder;
As the loss cost structure of workers’ compensation declined, more insurance companies entered or re-entered the workers’ compensation insurance market, resulting in increased competition; and
For claims occurring after June 30, 1998, we further limited our per incident exposure by purchasing excess of loss coverage for losses from $25,000 to the lesser of $300,000 or the WCRA selected retention level in Minnesota and from $25,000 to $300,000 in other states from a single reinsurer. This agreement was finalized after its effective date and activity occurring from July 1, 1998 through September 30, 1998 was recorded on a retrospective basis
Premiums ceded to reinsurers decreased to $17.7 million in 2000 from $18.0 million in 1999. This decreased cost resulted from an excess of loss premium rate decrease in Minnesota in 2000 compared to 1999. This cost decrease was partially offset by increased excess of loss costs resulting from increased premiums earned in non-Minnesota states.
2001 Outlook: The 2001 outlook for gross premiums earned and premiums ceded include the following factors:
We will continue to review business at policy expiration in 2001 and non-renew or re-underwrite at increased rates, any business not meeting our standards. We expect that this aggressive targeting of policies will put downward pressure on premiums in force in our Minnesota and Missouri markets; however, we expect that continued growth in premiums in force in our Colorado, Michigan and Massachusetts markets, as well as premium rate increases in our Minnesota and Missouri markets will lead to growth in gross premiums earned for 2001;
Investment Income and Net Realized Investment (Losses) Gains: Our investment income includes earnings on our investment portfolio. Net realized investment (losses) gains include gains and losses from sales of available-for- sale securities and are displayed separately on our Consolidated Statement of Operations. In 2000, we invested entirely in U.S. domiciled investment grade taxable and tax-exempt fixed maturity investments and classified our investments as available-for-sale. In February 2001, we repositioned our portfolio by selling our tax-exempt securities and repurchasing taxable fixed maturity investments to increase our after-tax yield. We intend to hold our available-for-sale investments to maturity, but may sell before maturity in response to income tax considerations, changes in interest rates, prepayment risk and funding sources or terms, or to address liquidity needs. Our primary investment objective is to maintain a diversified, high-quality, fixed-investment portfolio structured to maximize our after-tax investment income without taking inappropriate credit risk. For further discussion of investments, see the “Investments” section of this Management’s Discussion and Analysis.
Investment income decreased 15.6% to $6.5 million in 1999 from $7.7 million in 1998. Investment income decreased due to (i) reduced funds available for investment and (ii) an increase in the percent of tax-exempt securities held in our portfolio. Funds available for investment decreased to $108.1 million at December 31, 1999 from $126.6 million at December 31, 1998, due to decreased net cash provided by operating activities and investment income as discussed in the preceding paragraph. Tax-exempt securities increased to 56.3% of our investment portfolio at year-end 1999 compared to 52.6% at year-end 1998 and we first began purchasing tax-exempt securities in the second quarter of 1998. Tax-adjusted investment yields were 6.6% in 1999 and 1998.
Net realized investment losses were $607,000 in 2000 and included $500,000 for the write-down of a security whose decrease in value was deemed other than temporary. Net realized investment gains were $84,000 in 1999 and $1.0 million in 1998.
The mix of taxable and tax-exempt securities in our portfolio may change over time to accommodate our tax situation. Fixed maturity, tax-exempt securities may have the effect of reducing investment income recognized and decreasing pre-tax investment yields but generally contribute more to after-tax net income as a result of the favorable treatment tax-exempt income receives for federal income tax purposes; and
We recorded estimates of ceded paid and unpaid claim and claim settlement expenses under our $25,000 to $300,000 excess of loss reinsurance agreement totaling $21.8 million in 2000 including $400,000 amortized from a deferred retrospective reinsurance gain resulting in a corresponding reduction in 2000 claim and claim settlement expenses. These amounts differed from our 1999 results which include an estimate of ceded paid and unpaid claim and claim settlement expenses totaling $22.0 million and $740,000 amortized from the deferred retrospective reinsurance gain;
The 2000 results include a $15.9 million increase in reserves for unpaid claim and claim settlement expenses to reflect unfavorable development of prior period claims compared to the 1999 results which include an $8.1 million decrease in reserves for unpaid claim and claim settlement expenses reflecting favorable development of prior period claims. Our year-end actuarial review of loss reserves indicated an increase in the cost incurred or developing in connection with older claims, particularly in Minnesota where we have been writing policies since 1992. Given this indication, we adjusted our actuarial assumptions to reflect this change in loss experience resulting in the increase in reserves;
We aggressively targeted policies that did not meet our underwriting profit margin standards for non-renewal or re-underwriting at increased rates at policy expiration in 2000 and 1999. For 2000, we successfully priced up or non-renewed 90% of expiring premium exhibiting poor loss characteristics, resulting in $21.3 million of premiums renewed at higher prices as well as $17.6 million in premiums that were not renewed. In 1999, we successfully priced up or non-renewed 67% resulting in $10.9 million of premiums renewed at higher prices and $10.8 million in premiums that did not renew. As a result of this focus in 2000 and 1999, we experienced a decrease in claim frequency;
The 1999 results include an $8.1 million decrease in reserves for unpaid claim and claim settlement expenses to reflect favorable development of prior period claims compared to the 1998 results which include an $11.0 million increase in reserves for unpaid claim and claim settlement expenses to reflect adverse development of prior period claims. The favorable development in 1999 is primarily the result of a strong focus on claim closure. Our open claims decreased 9.7% to 5,252 at December 31, 1999 from 5,816 at December 31, 1998. Additionally, the 1998 results included a $400,000 Minnesota Special Compensation Fund (SCF) adjustment recorded in the second quarter of 1998. The SCF assesses us to cover the costs of second injuries that are substantially greater, because of a pre-existing physical impairment, than what would have resulted from the second injury alone.
Continued favorable effects of ceding paid and unpaid claim and claim settlement expenses under our $25,000 to $300,000 excess of loss reinsurance agreements resulting in a reduction of claim and claim settlement expenses. This reduction will decrease significantly from the reduction recorded in 2000 as the $25,000 to $300,000 excess of loss policy was terminated at December 31, 2000 and will only benefit claims for policies that were in effect at December 31, 2000 and run-off in 2001;
Increased premium rates will result in increasing premiums earned without a corresponding increase in claim and claim settlement expenses, ultimately decreasing claim and claim settlement expense as a percent of premium earned. Changes in premium rates due to legislative changes in estimated loss costs, increased competition and improving customer loss experience may offset rate improvements; and
Policy Acquisition Costs: Policy acquisition costs are costs directly related to writing an insurance policy and consist of commissions, state premium taxes, underwriting personnel costs and expenses, sales and marketing costs, other underwriting expenses, and ceding commissions adjustments with our reinsurers. Ceding commissions are amounts that reinsurers pay to us for placing reinsurance with them. Ceding commissions represent adjustments based on actual claim and claim settlement expenses related to premiums ceded in prior years. Under our reinsurance agreements, ceding commission is adjusted to the extent that actual claim and claim settlement expenses vary from levels specified in the agreements.
Premium tax expense remained consistent at 2.0% of gross premiums earned in 2000, 1999 and 1998;
We incurred ceding commission expense totaling $460,000 in 2000 compared to $321,000 in 1999 and no cost in 1998.
2001 Outlook: We expect that policy acquisition costs will stabilize or trend downward as a percent of gross premiums earned in 2001 due to the following:
We expect commission expense as a percent of gross premiums earned to decrease slightly in 2001 as we manage our commission structures in our non-Minnesota states and as our renewal premiums, where we pay lower commission rates, increase as a percent of our total premiums in force;
General and Administrative Expenses: Our general and administrative expenses include personnel costs, office rent, certain state administrative charges based on premiums and other costs and expenses not specific to claim and claim settlement expenses or policy acquisition costs.
We will continue to aggressively manage all operating costs and expenses in 2001;
We expect to realize additional operational efficiency during 2001 through enhancements to our internal processes and procedures, including changes to our operating structure as well as improvements to our internal proprietary computer systems.
We paid interest at 9.50% on the outstanding balance on our Senior Notes during 1999, and at rates ranging from 9.25% to 9.50 % on Senior Notes in 1998. Interest expense decreased to $266,000 in 1999 from $546,000 in 1998 due to principal payments on the Senior Notes in December 1998.
2001 Outlook: Income tax expense will vary based on (i) the income from operations we recognize for 2001, and will (ii) increase as a percent of income before taxes relative to the statutory effective rate as a result of repositioning our portfolio by selling tax-exempt municipal fixed investments in February 2001 and reinvested the proceeds in taxable securities. The ultimate change is unknown at this time.
Our portfolio of fixed maturity securities at December 31, 2000 included tax-exempt municipal securities (57.5%), U.S. government securities (15.4%), corporate securities (10.6%), mortgage-backed securities (14.4%), and asset- backed securities (2.1%). Our portfolio is managed by an independent investment manager to maximize our after-tax investment income without taking inappropriate credit risk. In February 2001, we repositioned our portfolio by selling our tax-exempt securities and repurchasing taxable fixed maturity investments to increase our after-tax yield. We recognized gains totaling $1.1 million as a result of this repositioning. We conservatively manage our fixed maturity portfolio, investing only in investment grade (BBB or better rating from Standard and Poor’s) securities of U.S. domiciled issuers. We do not invest in derivative securities.
Funds provided by our operating cash flows and investment cash flows have historically provided growth in our investment portfolio. Operating cash flows consist of the excess of premiums collected over claim and claim settlement expenses reduced by payments for reinsurance premiums as well as other operating expenses paid. Investment cash flows consist of income on existing investments and proceeds from sales and maturities of investments. We have historically generated positive net cash flows from operations due, in part, to timing differences between the receipt of premiums and the payment of claim and claim settlement expenses. These net cash flows decreased significantly in 2000 and 1999 as we focused on closing old claims, paying earlier to close claims. Combined with relatively flat premiums in force since December 1998, our cash flows from timing on claims payments have decreased. Additionally, as we lowered our reinsurance retention levels to $25,000 in mid-1998, we decreased our current period cash flows as a result of “pre-funding” quarterly premiums under that
We record investments on our balance sheet at fair value, with the corresponding appreciation or depreciation from amortized cost recorded in shareholders’ equity, net of taxes. Because value is based on the relationship between the portfolio’s stated yields and prevailing market yields at any given time, interest rate fluctuations can have a swift and significant impact on the carrying value of these securities. As a result of classifying our securities as available-for-sale, and thus carried at fair value, we expect to encounter adjustments in shareholders’ equity as market interest rates and other factors change. In 2000, we recorded a $500,000 write-down of a security held in our portfolio as we deemed its decline in fair value to be other than temporary in nature. Prevailing market interest rates decreased in 2000 resulting in a $309,000 unrealized gain on investments compared to a $4.3 million unrealized loss in 1999.
Cash used in operating activities in 2000 was $8.9 million. This is primarily a result of an increase of $20.6 million in amounts due from reinsurers, our net loss of $9.7 million, an increase in our deferred income tax asset of $1.4 million, a decrease of $1.0 million in unearned premiums, net of premiums receivable, offset by an increase of $29.0 million in unpaid claim and claim settlement expenses, which are non-cash accruals for future claims and depreciation and amortization expense of $1.4 million. Net cash provided by investing activities was $14.1 million, primarily the result of $14.6 million in proceeds from sales of securities and maturities of $510,000 of investments offset by $964,000 in purchases of furniture and equipment. Net cash used in financing activities was $3.1 million due to $10.3 million in retirement of common stock and payments on notes payable of $1.0 million offset by $8.0 million in proceeds from notes payable and $125,000 resulting from the issuance of common stock under our Employee Stock Purchase Plan.
State insurance regulations limit distributions, including dividends, from our insurance subsidiary to us. The maximum amount of dividends that can be paid by ACIC to us in any year is equal to the greater of: (i) 10% of ACIC’s statutory surplus as of the end of the previous fiscal year, or (ii) the statutory net gain from operations (not including realized capital gains) of ACIC in its most recent fiscal year. Based on this limitation, the maximum dividend that ACIC could pay to us in 2001, without regulatory approval, is approximately $2.9 million. (See Note 9 of Notes to Consolidated Financial Statements.) ACIC has never paid a dividend to us and we intend to retain capital in the insurance subsidiary.
On September 15, 1998, our Board of Directors approved a share repurchase program authorizing us to repurchase, from time to time, up to $4,000,000 of RTW, Inc. common stock. Through 1999 we had repurchased 19,500 shares for approximately $87,000. We repurchased an additional 640,000 shares in 2000 for approximately $2.6 million. We repurchased these shares on the open market or through private transactions based upon market conditions and availability. The repurchased shares will be used for employee stock option and purchase plans and other corporate purposes.
An increase of 100 basis points in prevailing interest rates would reduce the fair value of our interest rate sensitive instruments by approximately $4.5 million.
We had no instances of system failure or interrupted operations resulting from our systems or system failures of our significant vendors in 2000 and expect no future problems.
Our insurance subsidiary is subject to substantial regulation by governmental agencies in the states in which we operate, and will be subject to such regulation in any state in which we provide workers’ compensation products and services in the future. State regulatory agencies have broad administrative power with respect to all aspects of our business, including premium rates, benefit levels, policy forms, dividend payments, capital adequacy and the amount and type of investments. These regulations are primarily intended to protect covered employees and policyholders rather than the insurance company. Both the legislation covering insurance companies and the regulations adopted by state agencies are subject to change. At December 31, 2000, our insurance subsidiary was licensed to do business in Minnesota, South Dakota, Wisconsin, Colorado, Missouri, Illinois, Kansas, Michigan, Indiana, Massachusetts, Connecticut, Rhode Island, Pennsylvania, Tennessee, Maryland, Arkansas, Iowa, Florida, Georgia, New Jersey, North Carolina, Texas and Oklahoma.
The Financial Accounting Standards Board has issued Statement of Financial Accounting Standards (SFAS) No. 133, “Accounting for Derivative Instruments and Hedging Activities,” which is effective January 1, 2001 (as amended by SFAS No. 137). SFAS No. 133 requires that all derivative instruments be recorded on the balance sheet at fair value. Changes in the fair value of derivative instruments are recorded each period in current earnings or other comprehensive income, depending on whether a derivative is designated as part of a hedge transaction, and if it is, the type of hedge transaction. We expect that adoption of the new standard will not affect our results of operations or financial position.
Consolidated Statements of Operations - Years Ended December 31, 2000, 1999 and 1998
Consolidated Statements of Cash Flows - Years Ended December 31, 2000, 1999 and 1998
Notes to Consolidated Financial Statements - Years Ended December 31, 2000, 1999 and 1998
We have audited the accompanying consolidated balance sheets of RTW, Inc. and subsidiary (the Company) as of December 31, 2000 and 1999, and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2000. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
Series A Junior Participating Preferred Stock, no par value; authorized 250,000 shares; none issued or outstanding
Common stock, no par value; authorized 25,000,000 shares; issued and outstanding 10,293,000 and 12,312,000 shares
Organization - RTW, Inc. (RTW) provides workers’ compensation insurance coverage to employers through its wholly owned insurance subsidiary, American Compensation Insurance Company (ACIC). Collectively, “we,” “our” and “us” will refer to these entities in these “Notes to Consolidated Financial Statements.”
Investments - We invest entirely in fixed maturity investments and classify our investments as available-for-sale in accordance with Statement of Financial Accounting Standards (SFAS) No. 115, “Accounting for Certain Investments in Debt and Equity Securities.”
We continually monitor the difference between investment cost and fair value for each of our securities. If any security experienced a decline in value that is determined to be other than temporary, we would reduce the security’s carrying value for the decline and record a realized loss in the Consolidated Statements of Operations. We recorded $500,000 against a security whose decline in value was determined to be other than temporary in 2000. No securities were reduced for declines in fair value in 1999 or 1998.
Fair Value of Financial Instruments - A number of our significant assets and liabilities (including deferred policy acquisition costs, reinsurance recoverables, furniture and equipment, and unpaid claim and claim settlement expenses) are not considered financial instruments for disclosure purposes. Our premiums receivable and other assets and liabilities which are considered financial instruments are generally of a short term nature. Our term loan bears a floating interest rate. The carrying values of these instruments approximate their fair values. The carrying values and fair values of investments are disclosed in Note 3.
Deferred Policy Acquisition Costs - The costs directly related to writing an insurance policy are referred to as policy acquisition costs and consist of commissions, state premium taxes and other direct underwriting expenses. Although these costs arise when we issue a policy, we defer certain costs, principally commissions and state premium taxes, and amortize these costs to expense as premium revenue is recognized.
Unpaid Claim and Claim Settlement Expenses - Claim expenses refer to amounts that we paid or expect to pay to claimants for events that have occurred. The costs of investigating, resolving and processing these claims are referred to as claim settlement expenses. We record these expenses, net of amounts recoverable under reinsurance contracts, as “Claim and claim settlement expenses” in the Consolidated Statements of Operations.
Our “Unpaid claim and claim settlement expenses” represent reserves established for the estimated total unpaid cost of claim and claim settlement expenses that cover events that occurred on or prior to each balance sheet date. The reserves are primarily undiscounted; however, we discounted selected claims that have fixed or determinable future payments by $1,441,000 in 2000 and $2,873,000 in 1999 after applying an 8% discount factor. These reserves reflect our estimates of the total costs of claims that were reported, but not yet paid, and the cost of claims incurred but not yet reported. Our estimates consider such variables as past loss experience, current claim trends and prevailing social, economic and legal environments. We have limited historical data to estimate our reserves for unpaid claim and claim settlement expenses due to commencing operations in 1992 and supplement our experience with external industry data, as adjusted to reflect anticipated differences between our results and the industry. We reduce the unpaid claim and claim settlement expenses for estimated amounts of subrogation.
Premiums Earned - Premiums on workers’ compensation insurance policies are our largest source of revenue. We record premiums written on an installment basis, matching billing to the policyholder, and earn premiums on a daily basis over the life of each insurance policy. We record the excess of premiums billed over premiums earned for each policy as unearned premiums on our balance sheet. When a policy expires, we audit employer payrolls for the policy period and adjust the estimated payroll to its actual value. The result is a “final audit” adjustment recorded to premiums earned when the adjustment becomes known. Final audit premiums recognized during the period include billed final audit premiums plus (or minus) the change in estimate for premiums on unexpired and expired unaudited policies.
The following is a reconciliation of the numerators and denominators of basic and diluted (loss) income per share:
Options to purchase 1,168,000 shares of common stock at prices ranging from $2.67 to $19.33 were outstanding during 2000 but excluded from the computation of diluted IPS due to our 2000 net loss. Diluted weighted average shares outstanding would have increased by 16,000 shares had these shares not been anti-dilutive in the computation.
Options to purchase 1,895,000 shares of common stock at prices ranging from $2.00 to $28.75 were outstanding during 1998 but excluded from the computation of diluted IPS due to our 1998 net loss. Diluted weighted average shares outstanding would have increased by 219,000 shares had these shares not been anti-dilutive in the computation.
We report reinsurance related balances on a “gross” basis on the balance sheet, resulting in reinsurance recoverable amounts on paid and unpaid claim and claim settlement expenses recorded as assets. We estimate amounts recoverable from reinsurers in a manner consistent with the claim liability associated with the reinsured policy.
We ceded Minnesota claims in excess of $310,000, $290,000 and $280,000 per occurrence during 2000, 1999 and 1998, respectively, to the Minnesota Workers’ Compensation Reinsurance Association (WCRA). In our non-Minnesota states, our per-incident exposure was $300,000 in 2000 and 1999 and $500,000 in 1998. We purchased this non-Minnesota coverage from a single reinsurer.
For claims occurring after June 30, 1998, we further limited our per incident exposure by purchasing excess of loss coverage for losses from $25,000 to the lesser of $300,000 or the WCRA selected retention level in Minnesota and from $25,000 to $300,000 in other states from a single reinsurer. This agreement was finalized after its effective date and activity occurring from July 1, 1998 through September 30, 1998 was recorded on a retrospective basis resulting in the deferral of a gain totaling $2.0 million at December 31, 1998. We amortized $400,000 of the deferred gain as a reduction of claim and claim settlement expenses in 2000 and $740,000 in 1999 resulting in an un-amortized deferred gain of $849,000 at December 31, 2000. The deferred gain is being amortized into income using the effective interest rate inherent in the amounts paid to the reinsurer and the estimated timing and amounts of recoveries from the reinsurer. Activity occurring on or after October 1, 1998 is recorded prospectively. This contract was terminated effective December 31, 2000; however the policy remains effective in 2001 for policies in force at December 31, 2000 through expiration, not to exceed fifteen months after the effective termination date. Policies written or renewing in 2001 will not be covered under this lower level excess of loss reinsurance policy.
In March 2000, we borrowed $8,000,000 under a term loan agreement to fund the repurchase of common stock from certain shareholders of the company and simultaneously entered into a $2,000,000 revolving credit facility to be used for general corporate purposes. We paid $1,000,000 in principal on the term loan in 2000. The term loan accrues interest, payable quarterly. We may elect to pay an adjusted LIBOR or bank reference rate on the term loan (adjusted LIBOR was 9.34% at December 31, 2000).
At December 31, 2000, we failed to meet certain financial covenants related to the term loan and credit facility. The term loan and revolving credit facility agreement was amended in March 2001. Under the amendment, term loan principal payments were accelerated and the revolving credit facility was terminated in return for waivers of and amendments to the financial covenants under the term loan agreement. As a result, we paid an additional $1,000,000 in principal on January 31, 2001. We believe that we will be in compliance with the amended financial covenants throughout 2001. No funds were outstanding under the revolving credit facility during 2000.
We compute our deferred tax provision under the liability method, whereby deferred tax assets and liabilities are recognized for the expected tax consequences of temporary differences between the tax bases of assets and liabilities and their reported amounts using presently enacted tax rates. Deferred tax assets are recognized for tax credit and net operating loss carry-forwards, reduced by a valuation allowance which is established when “it is more likely than not” that some portion or all of the deferred tax assets will not be realized. 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.
Differences between the tax basis of assets and liabilities and their reported amounts in the Consolidated Financial Statements that will result in taxable or deductible amounts in future years are called temporary differences. The tax effects of temporary differences that gave rise to net deferred tax asset balances, included within other assets, are as follows (000’s):
Income taxes receivable at December 31, 2000 and 1999 were approximately $1,715,000 and $674,000, respectively.
1995 Employee Stock Purchase Plan - The ESPP provides employees the opportunity to purchase shares of our stock at 85% of the fair value based on the lesser of the beginning or ending share price for each plan year as set forth in the plan. In May 1998, the shares reserved for distribution under the plan were increased from 75,000 to 200,000 shares. The ESPP terminates in ten years and will be carried out in phases, each consisting of one year or a different period of time approved by the Board of Directors. Any employee completing two weeks of service prior to commencing a phase of the plan may participate. Employees may elect to contribute from $10 to 10% of monthly salary to the plan through payroll withholdings. The following summarizes shares purchased and purchase prices for each phase in the most recent three years completed through 2000:
The fifth one-year phase began in April 2000 and expires in April 2001.
The following table summarizes the options outstanding and exercisable at December 31, 2000:
Employee Contract - We entered into a three-year employment agreement with our President and Chief Executive Officer beginning January 15, 1998. Under this agreement, he receives a base salary of $400,000, subject to review annually for increase by our Board of Directors. In addition to base salary, he is eligible for bonuses, reimbursements and fringe benefits including a $1,000,000 term life insurance policy and an additional payment sufficient to reimburse him for a long-term disability policy paying monthly benefits of $5,000. We also provide him with health, dental, life and disability insurance consistent with that provided to other officers and employees. Under this agreement, we have agreed to indemnify him for his actions on behalf of us. In October 2000, we entered into a supplemental agreement with him under which he agreed to continue to serve in his current capacities until June 30, 2001 and we agreed to pay him “stay bonuses” of $200,000 on January 15, 2001 and $100,000 on June 30, 2001.
401(K) Retirement Component - We sponsor a defined contribution retirement component under Section 401(K) of the Internal Revenue Code for eligible employees. Our contributions are discretionary and are based on contributions made by employees. Expense recognized for 2000, 1999 and 1998 was $152,000, $151,000 and $140,000, respectively.
Our ability to pay cash dividends to shareholders may depend upon the amount of dividends received from our insurance subsidiary. ACIC’s ability to pay dividends is restricted by law or subject to approval of the insurance regulatory authorities of Minnesota.
Under Minnesota insurance law regulating the payment of dividends by ACIC, any such payments must be an amount deemed prudent by ACIC’s Board of Directors and, unless otherwise approved by the Commissioner of the Minnesota Department of Commerce (Commissioner), must be paid solely from the adjusted earned surplus of ACIC. Adjusted earned surplus means the earned surplus as determined in accordance with statutory accounting practices (unassigned funds), less 25% of the amount of such earned surplus that is attributable to unrealized capital gains. Further, without approval of the Commissioner, ACIC may not pay a dividend in any calendar year which, when combined with dividends paid in the preceding twelve months, exceeds the greater of (i) 10% of ACIC’s statutory capital and surplus at the prior year end or (ii) 100% of ACIC’s statutory net gain from operations (not including realized capital gains) for the prior calendar year. For 2001, dividends in excess of $2,930,000 would require prior consent of the Commissioner.
Statutory Surplus and Statutory Net Income (Loss) - Our insurance subsidiary is required to file financial statements with state regulatory agencies. The accounting principles used to prepare the statutory financial statements follow prescribed accounting practices that differ from GAAP. Statutory policyholders’ surplus at December 31, 2000 and 1999, and statutory net (loss) income for the years ended December 31, 2000, 1999 and 1998 are as follows (000’s):
In certain locations, we have an agreement under which another insurance company writes policies on our behalf and cedes 100% of the risk to us through a reinsurance treaty. In connection with this agreement, in February 2001 we provided this insurer with an irrevocable letter of credit totaling $2,118,000 to indemnify them for incurred losses.
The following tables present unaudited quarterly results of operations for the eight quarters ended December 31, 2000: