Management's Discussion & Analysis The following discussion and analysis should be read in conjunction with the consolidated financial statements and the notes appearing elsewhere in this report. The consolidated financial statements include the results of the Company's wholly-owned subsidiary, McCreary Corporation, since July 1, 1995. All amounts have been rounded to the nearest $100,000.
The Company's financial position and results of operations are subject to fluctuations due to a variety of factors. Unexpected changes in loss trends in any period could have a materially adverse effect on the Company. In addition, reevaluations of loss and loss adjustment expense (LAE) reserves could result in an increase or decrease in reserves and a corresponding adjustment to earnings. LAE are costs associated with the settlement of claims. The Company's historical results of operations are not necessarily indicative of future earnings.
During fiscal 1997, the Company had an exceptional year in almost every financial category, with most business segments growing revenues over 20%. In addition to the top-line growth, the Company's growth in net income exceeded 24% and, despite a competitive Florida medical professional liability market, FPIC was able to grow its direct premiums written 21%. The Company also continued to diversify its revenues in areas other than its physicians MPL core market. Excluding investment income, the amount of revenue generated from non-core market sources grew to 23.7% of total revenues at year-end 1997.
Considerable growth was achieved in other product areas such as legal defense for healthcare provider licensure investigations, group accident and health insurance coverage and errors & omissions and directors & officers liability insurance for managed care organizations. Net premiums earned for these products increased 150%, from $0.8 million in 1996 to $2.0 million in 1997.
The combined ratio for the fiscal year, calculated using generally accepted accounting principles (GAAP), declined 1.7% from 95.5% in 1996 to 93.8% in 1997. This positive trend was primarily the result of a 1.2% decrease in the loss ratio and a 0.5% decrease in the FPIC's company's overall expense ratio.
On a consolidated basis, the Company's total investment portfolio grew $29.8 million, or 12.5%, from $238.5 million in 1996 to $268.3 million in 1997. The growth in investments exceeded expectations and consisted of a $5.6 million year-over-year increase in market value for securities held, the reinvestment of $15.7 million in net interest income and a net contribution of $8.5 million from operations and other sources. Net investment income earned increased $1.2 million from $13.6 million in 1996 to $14.8 million in 1997.
On December 1, 1997, the Company acquired Frontier Insurance Company's Florida physician MPL business. These policies were acquired on a "best efforts" renewal basis, with an estimate that only 50% of the $16 million in premium written would likely be renewed by FPIC. This led to establishment of an initial expected written premium target of $8 million and 40% of this amount was negotiated as the purchase price. At closing the $3.2 million purchase price was paid by issuing 111,663 shares of Company common stock at an average price of $28.66 each.
An additional benefit to FPIC in conjunction with this transaction was the assumption over time of Frontier's legal division in Florida. This entity acts as an in-house legal department which FPIC believes could lead to a more efficient way to litigate claims. While relationships with outside legal firms will always be an important, value-added component of the claims litigation process, FPIC will continually seek innovative ways to reduce costs and improve litigation results.
Another component of FPIC's product diversification plan is the recent agreement to underwrite and administer the Florida Dental Association (FDA) group health plan. The FDA health plan is
a very unique cross-selling opportunity whereby FPIC will underwrite a small employer, limited risk, accident and health program for dentists. In addition, the Company's McCreary subsidiary will receive a fee for administering the program. The majority of the premium will begin rolling over in April of 1998. Based on the amount of premium currently in the plan, the Company anticipates $7 million to $8 million of net premiums will be earned in 1998.
In summary, the Company will continue to seek accretive acquisitions, expand geographic territories and develop value-added products and services. As the Company grows, cross-selling opportunities will also be identified to distribute more efficiently these new products and services to our core market and growing base of new customers.
Our assessment of the current Florida MPL market indicates the growth prospects for 1998, without any acquisitions, appear to be slowing and may fall to a single digit rate. Some of the reasons we might experience slower MPL growth in the Florida market are:
2) The Company anticipates there will continue to be increasing competition in the Florida MPL market both from the large number of writers already present and new MPL writers entering the state. This competition conceivably could keep pressure on rates.
Indications are the MPL industry has entered the early stages of a consolidation phase and, as a result of this trend, a number of MPL companies could either merge or be acquired. Management is committed to a disciplined acquisition strategy as a way to increase shareholder value and, in the normal course of business, will evaluate business combinations with other companies. Management believes ideal candidates should be as strong or stronger than the Company, on a relative basis, and that the combination be immediately accretive to earnings. There are a number of capital sources available to finance these transactions including internally generated funds, bank credit facilities and newly issued debt and/or equity securities.
Losses and LAE increased $7.0 million, or 15%, from $47.0 million in 1996 to $54.0 million in 1997 reflecting, in part, the increase in insureds. The GAAP loss ratios of 82.5% in 1997 and 83.7% in 1996 reflect the stability the Company has experienced in its loss trends in recent years. In connection with the Company's bi-annual reserving review, which includes a reevaluation of the adequacy of reserve levels for prior years' claims, the Company reduced its reserves for claims occurring in prior periods by $15.1 million in 1997 and $14.7 million in 1996. There is no
Direct premium written increased $7.7 million, or 14%, from $56.6 million in 1995 to $64.3 million in 1996. This increase was despite a 2.4% decrease in rates. This increase was primarily attributable to growth in the number of insureds. Reinsurance premium ceded increased $3.4 million, or 148%, from $2.3 million in 1995 to $5.7 million in 1996 due to a return of ceded premium of $3.4 million upon the expiration of a reinsurance contract in 1995 which was recorded as a decrease to ceded premium. Excluding this transaction, reinsurance premium ceded would have decreased $0.1 million. Net premium earned increased $3.4 million, or 6%, from $52.7 million in 1995 to $56.1 million in 1996 due to the increase in direct premium written and the decrease in ceded premium. Excluding the one time effect of the return of ceded premium received in conjunction with the above-mentioned reinsurance contract, net premium earned increased $6.8 million from $49.3 million to $56.1 million.
Net investment income increased $1.6 million, or 13%, from $12.0 million in 1995 to $13.6 million in 1996. Investment income in 1995 is net of a $0.5 million writedown of the Company's home office building. The increase was primarily attributable to a higher level of invested assets. The increase was achieved despite a shift in the portfolio to a higher concentration of tax-free securities. The Company's investment policy is to acquire investment grade fixed income securities with an average duration of approximately four years. The average duration of the portfolio increased from 3.6 years in 1995 to 4.2 years in 1996.
Factors that could adversely affect the loss and LAE reserve estimate and future redundancies include, but are not limited to, inflation, changes in frequency and severity trends or changes in the judicial or legislative environment. The Company cannot predict whether similar redundancies will be experienced in future years.
For the reasons stated above, net income increased $1.6 million, or 14%, from $11.7 million in 1995 to $13.3 million in 1996.
The payment of losses and LAE, and operating expenses in the ordinary course of business is the principal need for the Company's liquid funds. Cash used to pay these items has been provided by operating activities. Cash provided from these activities was sufficient during 1997 to meet the Company's needs. Management believes these sources will be sufficient to meet the Company's cash needs for operating purposes for at least the next twelve months. However, a number of factors could cause increases in the dollar amount of losses and LAE and may therefore adversely affect future reserve development and cash flow needs. Management believes these factors include, among others, inflation, changes in medical procedures, increasing use of managed care and adverse legislative changes. In order to compensate for such risk, the Company: (i) maintains what its management considers to be adequate reinsurance; (ii) conducts regular actuarial reviews of loss reserves every six months; and (iii) maintains adequate asset liquidity (by managing its cash flow from operations coupled with its fixed income maturities). On September 30, 1997, the Company secured a $10 million revolving credit facility with a Florida lending institution to meet certain non-operating cash needs as they may arise. The credit facility terminates May 31, 1999 and bears interest at various rates at the option of the Company at the time of borrowing. The interest rates range from LIBOR plus 0.50% to Prime less 0.50%. The Company is not charged a fee nor is it required to maintain compensating balances in connection with this credit facility. As of December 31, 1997, the Company had borrowed $2 million against the credit facility for non-operating purposes, at a rate of approximately 6.26%. The Company will continue to evaluate its need to obtain financing sources to meet future non-operating needs.
regulatory guidelines, to pay dividends of approximately $12.4 million without prior regulatory approval.
FPIC is subject to assessment by the Florida Insurance Guaranty Association, Inc. (FIGA) as well as similar associations in other states where it is licensed, for the provision of funds necessary for the settlement of covered claims under certain policies of insolvent insurers. Standard assessments levied annually by these associations on an "as needed" basis are expensed as paid.
does acquire one or more businesses, management's ability to identify suitable businesses to acquire and to effectively integrate the combined operations of such businesses with the Company may cause the Company's actual results to differ materially from the results anticipated in these forward-looking statements. Assumptions relating to the foregoing are difficult or impossible to predict accurately and many are beyond the control of the Company. In light of the significant uncertainties inherent in the forward-looking information included herein, the inclusion of such information should not be regarded as a representation by the Company or any other person that the objectives or plans of the Company will be achieved.
The financial statements and schedules listed in Item 14(a)(1) and (2) are included in this Report beginning on Page 29.