The Company owns its principal executive offices in Okemos, Michigan which houses the majority of its employees. The Company also owns, primarily for investment purposes, an office building in Williamston, Michigan. The Company leases office facilities in Lisle, Illinois, Indianapolis, Indiana and Columbus, Ohio. The Company also leases operating equipment under cancelable and noncancelable agreements.
(1) Effective January 1, 1995, the Company began writing a book of business previously written by an Illinois insurance company. Effective July 1, 1997, the Company began assuming 40% of the net premiums of a Michigan insurance company. (2) The Company discounted loss and loss adjustment expense reserves through 1994. In 1993 the Company changed its loss and loss adjustment expense reserve discount rate from 3.75% to 3%. This reduction in reserve discount rate was treated as a change in accounting estimate and resulted in a decrease in
In December 1995, the Company reclassified all of its fixed maturity securities previously classified as held-to-maturity to available- for-sale, as permitted by the Special Report, "A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities" issued by the Financial Accounting Standards Board ("FASB"). This one-time reclassification increased stockholders' equity by $511,000, net of deferred federal income taxes, as of December 31, 1995. All fixed
maturity securities are classified as available-for-sale and are carried at fair value as of December 31, 1997 and 1996.
Equity securities as of December 31, 1997 and 1996 consisted primarily of common stock held in Physicians Insurance Company of Wisconsin, Inc., an unrelated stock insurance company providing professional liability insurance to health care providers primarily in Wisconsin. As of December 31, 1997 and 1996, equity securities had net unrealized gains of $127,000 and $62,000, respectively.
Professional liability related net premiums written were $51.0 million in 1997, a decrease of 8.0% when compared to professional liability net premiums written of $55.5 million in 1996. The decrease in professional liability premiums reflects continued price-based competition, particularly in the Michigan and Illinois insurance markets. The decrease in professional liability premiums in 1997 was offset by the reinsurance premiums assumed from MEEMIC, which increased net premiums written by $20.1 million. See "Liquidity and Capital Resources."
Loss and loss adjustment expense reserves are determined on the basis of individual claims and actuarially determined estimates of future losses based on the Company's past loss experience and projections as to future claims frequency, severity, inflationary trends and settlement patterns. Estimating professional liability reserves is a complex process which is heavily dependent on judgment and involves many uncertainties. As a result, reserve estimates may vary significantly from the eventual outcome. It has been the practice of the Company to establish its loss and loss adjustment expense reserves conservatively, as it relates to immaturely developed accident years, to minimize potential uncertainties. Nevertheless, the Company's reserves have been established within the range of acceptable values estimated by the Company's consulting actuary and are recorded based on such actuarial estimates. The assumptions used in establishing the Company's reserves are regularly reviewed by management and revised as new data becomes available. Any adjustments necessary are generally reflected in current operations.
Incurred losses and loss adjustment expenses related to the personal automobile and homeowners insurance assumed from MEEMIC (the "personal liability insurance") totaled $13.1 million for 1997. As a percentage of premiums earned, such personal liability insurance generated an incurred loss and loss adjustment expense ratio of 65.0% in 1997. The Company believes that such personal liability insurance produced a low loss ratio primarily due to less severe weather-related incidents in Michigan during 1997.
The Company recorded $2.9 million in federal income tax expense in 1997 as compared to $2.4 million in 1996. The Company's effective federal income tax rate approximated 20.7% in 1997 compared to 20.3% in 1996. The slight increase in the effective income tax rate is due mainly to certain merger and acquisition expenses which are not deductible for federal income tax purposes.
Policy acquisition and underwriting expenses were $11.1 million in 1996, a 19.4% increase over policy acquisition and 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 such 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 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. In 1997, the Company used a portion of its cash flow from operations to fund its purchase of a new home office facility, including furniture and equipment, for $7.1 million. As of December 31, 1997, no 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 any future potential commitments for capital expenditures.
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
In April 1997, Professionals Group borrowed $22.5 million under a seven-year unsecured bank term loan, bearing interest at an adjustable rate of LIBOR plus 62.5 basis points (the "Credit Agreement"). Under the Credit Agreement, interest, which accrued at the rate of 6.40% per annum as of December 31, 1997, is payable quarterly and principal is payable in installments on April 30 of each year as follows: 1998 - $2,500,000; 1999 - $2,500,000; 2000 - $3,000,000; 2001 - $3,000,000; 2002 - $3,500,000; 2003 - $3,500,000; and 2004 - $4,500,000. Professionals Group used $20.0 million of the proceeds of this loan to make a capital contribution to PICOM, which in turn, used the proceeds to purchase a $21.5 million Surplus Note from MEEMIC.
In April 1997, the Company completed certain transactions with MEEMIC involving the Company's purchase of a twelve-year, $21.5 million surplus note from MEEMIC, bearing interest at 8.5% per annum (the "MEEMIC Surplus Note") and its reinsuring, on a quota-share basis, 40% of MEEMIC's net premiums beginning July 1, 1997. In connection with these transactions (i) the Company agreed to provide MEEMIC with information systems services and certain consulting services under a management services agreement for a base fee of $2.0 million; (ii) Professionals Group nominees were elected to all positions on the Board of Directors of MEEMIC; and (iii) the Company agreed to assist MEEMIC in acquiring the net
On September 22, 1997, MEEMIC Insurance Services Corporation (MEEMIC Services Corp.), a newly formed subsidiary of MEEMIC, purchased the net assets of MEIA. The purchase price equaled 3.75% of premiums written by MEEMIC Services Corp. through July 2004, subject to a guaranteed minimum purchase price of $43.0 million. To fund this purchase, MEEMIC Services Corp. paid cash of $22.5 million (utilizing the proceeds of the MEEMIC 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 such additional consideration. The Company believes the likelihood that the guarantee would become payable is minimal.
The Company assisted MEEMIC in MEEMIC's acquisition of the net assets of MEIA for the reasons that follow: The Company believes that by virtue of such acquisition, MEEMIC acquired greater control over the distribution and pricing of its insurance products. The Company anticipates that such control will enable MEEMIC to increase the volume of its insurance business. Given the terms of the Company's reinsurance agreement with MEEMIC, an increase in the volume of MEEMIC's insurance business will increase the amounts of insurance and insurance premiums ceded to PICOM.
At a future date, the Company and MEEMIC expect to pursue demutualization of MEEMIC. Such demutualization would be subject to regulatory approval by the Michigan Commissioner of Insurance and approval by MEEMIC's policyholders. No specific timetable has been set for demutualization and there can be no assurances that MEEMIC will be demutualized.
In May 1996, and in a transaction valued at approximately $1.2 million, PICOM acquired all of the issued and outstanding shares of American Insurance Management Corporation, a privately held Indiana corporation that serves as the attorney-in-fact for American Medical Insurance Exchange, an inactive Indiana interinsurance reciprocal exchange. While the acquisition was accounted for as a purchase, the effect of the acquisition was not material to the Company's consolidated results of operations (see also Note 12 to the Company's consolidated financial statements).
The consolidated financial statements and related data presented herein have been prepared in accordance with generally accepted accounting principles which require the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation. The primary assets and liabilities of the Company are monetary in nature. As a result, interest rates have a more significant impact on the Company's performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or magnitude as the cost of paying losses and loss adjustment expenses. Moreover, increases in market interest rates, which often occur during periods of high inflation, reduce the fair value of the Company's fixed maturity securities. Conversely, reductions in market interest rates increase the fair value of fixed maturity securities.
Inflation increases the costs of settling insurance claims over time. Because insurance premiums are established before the amount of losses and loss adjustment expenses, and the extent to which inflation may affect such expenses, are known, the Company attempts to anticipate the future impact of inflation when establishing rate levels. The Company may be limited in raising its premium levels for competitive and regulatory reasons, in which case the Company, rather than its insureds, would be required to absorb the effects of inflation. Future economic changes which result in prolonged and increasing levels of inflation could cause increases in the dollar amount of loss and loss adjustment expense reserves and thereby adversely affect future reserve development. To minimize such risk, the Company maintains what management considers to be strong and adequate reinsurance, conducts regular actuarial reviews of reserves and maintains adequate asset liquidity.
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 stockholders' 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. See "Item 1. Business--Reinsurance."
The following table provides certain information for the year ended December 31, 1997, with respect to the Company's reinsurers (see also Note 5 to the consolidated financial statements for amounts recoverable from the Company's reinsurers):
Certain regulations that affect the Company's insurance subsidiaries are promulgated by the National Association of Insurance Commissioners, 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 requirements to assist regulators in monitoring the financial strength and stability of property and casualty insurers. Under the NAIC requirements, regulatory compliance is determined by a ratio of an insurance company's regulatory total adjusted capital, as defined by the NAIC, to its authorized control level of RBC, as defined by the NAIC. Companies below specific ratios are classified within certain levels, each of which requires specific corrective action. As of December 31, 1997 and 1996, PICOM and ProNational Casualty were in compliance with such ratios and were not required to take any corrective action. See "Item 1. Business--Regulation."
The NAIC has proposed a new model investment law that may affect the statutory carrying values of certain investments. Additionally, the NAIC has undertaken a project to codify statutory accounting practices, which, if completed and adopted, may affect the statutory carrying value of assets and liabilities. It is not certain, nor is it possible to predict what impact these projects will have on the Company's insurance subsidiaries, in the event the projects are adopted by the NAIC. See "Item 1. Business--Regulation."
The FASB has also issued SFAS No. 130 "Reporting Comprehensive Income," which is effective for fiscal years beginning after December 15, 1997. This standard requires that an enterprise (a) classify items of other comprehensive income by their nature in a financial statement and (b) display the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital in the equity section of a statement of financial position. The adoption of SFAS No. 130 is not expected to have a material effect on the Company's consolidated results of operations or financial condition.
The Company expects to complete its contemplated modifications and replacements not later than March 31, 1999, which is prior to any anticipated impact on the Company's operating systems. The Company believes that with timely modifications to existing software and conversions to new software, Year 2000 compliance will not pose significant operational problems or have a material impact on the operations of the Company.
PROFESSIONALS INSURANCE COMPANY MANAGEMENT GROUP AND SUBSIDIARIES Consolidated Balance Sheets December 31, 1997 and 1996
PROFESSIONALS INSURANCE COMPANY MANAGEMENT GROUP AND SUBSIDIARIES Consolidated Statements of Income
PROFESSIONALS INSURANCE COMPANY MANAGEMENT GROUP AND SUBSIDIARIES Consolidated Statements of Shareholders' Equity Years ended December 31, 1997, 1996 and 1995
PROFESSIONALS INSURANCE COMPANY MANAGEMENT GROUP AND SUBSIDIARIES Consolidated Statements of Cash Flows
Interest Rate Risk is the risk that interest rates will change and cause a decrease in the value of an insurer's investments. The Company mitigates this risk by attempting to approximately match the maturity schedule of its assets with the expected payout of its liabilities. To the extent that liabilities come due more quickly than assets mature, an insurer would have to sell assets prior to maturity and recognize a gain or loss. At December 31, 1997, the estimated market value of the Company's bond portfolio was greater than its amortized cost.
The most significant estimates that are susceptible to significant change in the near term relate to the determination of the loss and loss adjustment expense reserves and the reserve for extended reporting period claims. Although considerable variability is inherent in these estimates, management believes that the reserves are adequate. The estimates are reviewed regularly and adjusted as necessary. Such adjustments are generally reflected in current operations. Other material estimates that are susceptible to significant change in the near term relate to the recoverability of deferred federal income tax assets.
Investment securities are classified upon acquisition into one of three categories: trading, available-for-sale or held-to-maturity. Trading securities are bought and held principally for the purpose of selling them in the near term. Held-to-maturity securities are those securities the Company has the positive intent and ability to hold until maturity. At December 31, 1997 and 1996, all of the Company's securities are classified as available-for-sale and are those securities that would be available to be sold in response to the Company's liquidity needs, changes in market interest rates and asset-liability management strategies, among others.
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 1997, 1996 or 1995 were deemed to be temporary.
Premiums and discounts are amortized or accreted, respectively, over the life of the related debt security as an adjustment to yield using the yield-to-maturity method. Dividends and interest income are recognized when earned. Realized gains and losses are included in earnings and are derived using the specific-identification method for determining the cost of securities sold.
PROFESSIONALS INSURANCE COMPANY MANAGEMENT GROUP AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued
Loss and loss adjustment expense reserves represent the accumulation of individual case estimates for reported losses and loss adjustment expenses, bulk adjustments to case estimates and actuarial estimates for incurred but not reported losses and loss adjustment expenses, based upon the Company's actual experience, assumptions and projections as to claims frequency, severity, inflationary trends and settlement payments. The reserve for loss and loss adjustment expenses is intended to cover the ultimate net cost of all losses and loss adjustment expenses incurred but unsettled through the balance sheet date. The reserve is stated gross of reinsurance ceded.
The reserve for extended reporting period claims coverage is recorded during the term of the original claims-made policy, utilizing the pure-premium approach, in amounts adequate to pay for estimated future claims reported subsequent to a current policyholders' death, disability or retirement. Changes in this reserve are charged or credited to income.
Intangible assets are comprised mainly 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 16), 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 item. Based upon its most recent analysis, the Company believes that no material impairment of intangible assets exists at December 31, 1997.
As more fully described in note 13, 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.
Net income per share is computed by dividing net income by the weighted average number of shares of common stock and common stock equivalents (stock options) outstanding during each year after giving effect to stock dividends and treasury shares.
The Company adopted Statement of Financial Accounting Standards No. 128 "Earnings Per Share" (SFAS No. 128) during the fourth quarter of 1997. All income per share amounts presented herein have been restated to conform with the provisions of SFAS No. 128. A reconciliation of the numerators and denominators of the "income per share" and "income per share - assuming dilution" computations for "income before cumulative effect of change in accounting method" are presented below:
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.
The amortized cost and estimated fair value of fixed maturities at December 31, 1997, 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.
At December 31, 1997, U.S. Treasury notes and certificates of deposit with a carrying value of $3,395,000 were on deposit with regulatory authorities, as required by law.
At December 31, 1997, amounts related to reinsurance balances and prepaid reinsurance premiums follow:
The Company establishes conservative reserves for the most recent accident years and adjusts the reserves as new information becomes available. This reserving practice has resulted in favorable development in estimates of prior years' reserves.
On April 4, 1997, Professionals Group borrowed $22.5 million under a seven-year unsecured bank term loan, bearing interest at an adjustable rate of LIBOR plus 62.5 basis points (6.40% at December 31, 1997), and payable quarterly (the "Credit Agreement"). Principal payments are due on April 30, as follows: 1998 - $2,500,000; 1999 - $2,500,000; 2000 - $3,000,000; 2001 - $3,000,000; 2002 - $3,500,000; 2003 - $3,500,000; and 2004 - $4,500,000.
The Company has a stock purchase plan through which employees and directors of the Company and its wholly owned subsidiaries may purchase the Company's common stock by means of payroll deduction. Pursuant to this plan, the Company may elect to match participant purchases, which it is currently matching at the rate of $1.25 (of which $1.00 is used to purchase the Company's common stock and $0.25 is applied to income taxes) for each $1.00 of participant purchases up to a maximum participant purchase of $6,000 per year. In 1997, 1996 and 1995, the Company incurred expenses of $250,000, $215,000 and $82,000, respectively, under this plan.
On November 21, 1996, the Company declared a 10% stock dividend, issued on December 16, 1996 to shareholders of record as of December 4, 1996. All per-share information in the accompanying consolidated financial statements has been adjusted to give retroactive effect to this stock dividend.
The Company has established the 1996 Long-Term Stock Incentive Plan (the "Incentive Plan") under which, subject to adjustment, 300,000 shares of the Company's common stock are available to grant incentive and non-qualified stock options, stock appreciation rights (SARs), restricted stock, restricted stock units, performance awards, dividend equivalents and other stock-based awards to employees of, including any officer or officer-director, or consultants to the Company and its subsidiaries. All terms and conditions of any grants under the Incentive Plan are at the discretion of the Compensation Committee of the Company's Board of Directors. During 1997, 146,500 options were granted at the market price of the Company's common stock on the date of grant. These options vest and become exercisable over five years beginning in 1998, and expire in 2007. No charges to operations are recorded with respect to authorization, grant or exercise of options. Proceeds received upon exercise are credited to shareholder's equity. During 1996, no grants were made under the Incentive Plan.
The Company has also established the 1996 Non-Employee Directors Stock Option Plan (the "Directors Plan") under which, subject to adjustment, non-qualified options for 50,000 shares of the Company's common stock may be granted to non-employee directors (maximum of 5,000 shares to one individual) of the Company. Options are granted at the market price of the Company's common stock on the date of grant. Options become exercisable one year from the date of grant and expire seven years from the date of grant. No charges to operations are recorded with respect to authorization, grant or exercise of options. Proceeds received upon exercise are credited to shareholders' equity. During both 1997 and 1996, stock options totaling 4,500 shares of the Company's common stock had been granted under the Directors Plan at exercise prices of $25.28 and $21.63, respectively. No options were exercised or canceled during 1997 or 1996.
The Financial Accounting Standards Board has issued Statement of Financial Accounting Standards No. 123 "Accounting for Stock-Based Compensation" (SFAS No. 123). This standard prescribes a method of accounting for stock-based compensation that recognizes compensation cost based on the fair value of options at grant date. In lieu of applying this fair value based method, a company may elect to disclose only the proforma effects of such application in the footnotes to its financial statements.
Net income per common share - assuming dilution: As reported $ 3.14 Proforma 2.43
PICOM and ProNational Casualty are required to file financial statements prepared in accordance with 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 approximately $10,658,000 at both December 31, 1997 and 1996, respectively. ProNational Casualty does not utilize any permitted accounting practices.
Certain regulations that affect PICOM, ProNational Casualty 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 ProNational Casualty 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 85% of its premiums through independent agents and approximately 15% of its premiums directly. In 1997, 1996 and 1995, the top ten agents produced, in aggregate, approximately 55%, 58% and 55%, respectively, and one agent individually produced approximately 10% of the Company's direct written premiums.
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 requires policyholders to remit a minimum of 20% to 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.
In April 1997, the Company completed an agreement with Michigan Educational Employees Mutual Insurance Company ("MEEMIC"), a Michigan-domiciled specialty writer of personal automobile and homeowners coverages for teachers and other members of the educational community in Michigan, whereby: (i) PICOM purchased a twelve-year, $21.5 million surplus note ("Surplus Note") from MEEMIC, bearing interest at 8.5% per annum; (ii) PICOM reinsures 40% of MEEMIC's net premiums beginning July 1, 1997; (iii) Professionals Group provides MEEMIC with information systems services and certain consulting services under a management services agreement for a base fee of $2.0 million per year; and (iv) Professionals Group nominees were elected to all MEEMIC Board positions. The Company also agreed to assist MEEMIC in acquiring the net assets of Michigan Educators Insurance Agency, Inc. ("MEIA"), the exclusive distributor of MEEMIC insurance products.
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, approval by MEEMIC's policyholders and approval by Professionals Group's shareholders. No specific timetable has been set for demutualization and there can be no assurances that MEEMIC will be demutualized.
Professionals Insurance Company Management Group (Professionals Group) is an insurance holding company incorporated under Michigan law on January 31, 1996. Accordingly, 1996 condensed financial information for Professionals Group is only being presented from the period January 31, 1996 (date of inception) through December 31, 1996.
Professionals Group owns all of the issued and outstanding common stock of the following entities:
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.