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 Oak Brook, Illinois, Indianapolis, Indiana and Columbus, Ohio. The Company also leases operating equipment under cancelable and noncancelable agreements. As of December 31, 1996, the Company has entered into $5.5 million of commitments to build a new 53,000
square foot home office facility in Okemos, Michigan and to purchase new furniture and equipment.
The following discussion and analysis should be read in conjunction with the consolidated financial statements and the notes thereto included elsewhere in this report.
The Company's total assets were $357.4 million and $330.7 million as of December 31, 1996 and 1995, respectively. The increase in total assets as of December 31, 1996 was primarily the result of strong cash flows from PICOM's operations due mainly to a decrease in paid losses and loss adjustment expenses of $10.0 million as compared to 1995. As of December 31, 1996 and 1995, the Company had invested assets of $300.1 million and $280.6 million,
As of December 31, 1996 and 1995, 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 and tax-exempt U.S. municipal bonds. As of December 31, 1996 and 1995, these fixed maturity securities aggregated $286.3 million and $260.0 million, respectively. Approximately $281.3 million, or 98.25% of the fixed maturity securities held by the Company as of December 31, 1996, were rated investment grade or better.
The following table provides a profile of the Company's fixed maturity portfolio by rating as of December 31, 1996:
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 shareholders' equity by $511,000, net of deferred federal income taxes, as of December 31, 1995. Accordingly, all fixed maturity securities are classified as
available-for-sale and are carried at fair value as of December 31, 1996 and 1995.
Equity securities as of December 31, 1996 and 1995 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, 1996 and 1995, equity securities had unrealized gains of $62,000 and $33,000, respectively.
HealthPro(sm) - Offers professional liability coverage for other health care specialists such as nurses, psychologists and optometrists;
LawyerCare(sm) - Offers professional liability coverage for lawyers and law firms.
During 1996 and 1995, the Company continued to balance its need for upward rate adjustments with the goal of maintaining market share in very competitive environments in Michigan, Illinois, Indiana and Ohio. As a result, the Company offered discounts to its published premium rates to retain market share and experienced margin or price reductions as a result of competitive market conditions in those years. 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%, as compared to net investment income of $14.7 million for 1995 despite a significant shift in the investment portfolio towards municipal bonds which, due to their tax-exempt status, offer lower pre-tax yields. The increase in net investment income was due principally to increases in invested assets because of positive cash flows from operations. The weighted average tax equivalent book yield of the fixed maturity portfolio was 6.7%
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. The assumptions used in establishing the Company's reserves are reviewed and updated regularly as new data becomes available. Any adjustments necessary are generally reflected in current operations. The loss and loss adjustment expense reserves are determined by the Company's actuary, who is an officer of the Company and a Fellow of the Casualty Actuarial Society. Management of the Company believes that the loss and loss adjustment expense reserves are adequate and are at or above the actuarial best estimate. 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).
Net income for 1996 was $9.6 million, or $2.75 per share, on revenues of $72.2 million. This compares to net income of $7.9 million, or $2.31 per share, 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, 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.
Net premiums written in 1995 were $55.2 million, an increase of 13.1% over 1994 net premiums written of $48.8 million. Of such increase in net premiums written, approximately $7.9 million resulted from the purchased book of physicians and surgeons business written by PICOM-Illinois, which began writing business effective January 1, 1995. In addition, 1995 net premiums written increased due to a $453,000 increase in HealthServices(sm) and HealthPro(sm) premiums and a $487,000 increase in LawyerCare(sm) premiums. These increases were offset by a decrease in DoctorCare(sm) premiums of $2.4 million that resulted from the
continued consolidation of individual practices into group practices and general competition in the Michigan and Illinois insurance markets. Of the net premiums written in 1995, approximately 93.8% was generated by DoctorCare(sm) and CorpCare(sm) coverages, 2.9% was generated by HealthServices(sm) and HealthPro(sm) coverages, 0.9% was generated by LawyerCare(sm) coverage and 2.4% was generated by other types of coverage. Of the net premiums written in 1994, approximately 95.0% was generated by DoctorCare(sm) and CorpCare(sm) coverages, 2.3% was generated by HealthServices(sm) and HealthPro(sm) coverages, 0.1% was generated by LawyerCare(sm) coverage and 2.6% was generated by other types of coverage.
During 1995 and 1994, the Company continued to balance its need for upward rate adjustments with the goal of maintaining market share in a very competitive environment in both Michigan and Illinois. As a result, the Company offered discounts to its published premium rates to retain market share and experienced margin or price reductions as a result of competitive market conditions in those years. 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.
reserves, as supported by a detailed actuarial study. In addition, underwriting results for 1995 improved significantly from 1994, when adverse results arose from a surge in the number of lawsuits filed by the plaintiff bar in the two week period preceding the April 1, 1994 effective date of Michigan's tort reform law.
Underwriting expenses were $9.3 million in 1995, a 27.5% increase over underwriting expenses of $7.3 million in 1994. As a percentage of premiums earned, the underwriting expense ratio was 16.8% in 1995, up from the underwriting expense ratio of 15.1% in 1994. The increase in underwriting expenses in 1995 relative to 1994 is attributable to the Company's purchase in 1995, through PICOM-Illinois, of the right to solicit and write a block of medical professional liability business in Illinois. Such acquisition resulted in an $18 million increase in the Company's direct written premiums (before reinsurance) in 1995. The acquisition and operating expenses associated with PICOM-Illinois, were partially offset by a non-recurring profit commission of $336,000 arising from the commutation of a reinsurance contract.
The Company recorded $8.3 million in federal income tax expense in 1995 as compared to $2.7 million in 1994. The Company's effective federal income tax rate approximated 34.0% in both 1995 and 1994. Regular tax net operating loss carryforwards of approximately $23.3 million at December 31, 1994 were fully utilized by the Company during 1995.
Net income for 1995 was $7.9 million, or $2.31 per share, on revenues of $70.6 million. This compares to net income of $5.2 million, or $1.45 per share, on revenues of $59.9 million in 1994. The strong 1995 earnings were primarily attributable to a significant improvement in underwriting results, including favorable development of prior years' reserves. Additionally, net income for 1995 was reduced by $8.1 million (net of deferred federal income taxes), or $2.37 per share, 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.
Commissioner of Insurance and are projected to close by June 30, 1997.
Professionals Group has obtained a commitment for a seven year, $22.5 million unsecured term loan from a bank, bearing interest at LIBOR plus 75 basis points, and payable monthly. With the proceeds received from this loan, Professionals Group's Board of Directors has authorized a $20.0 million capital contribution to PICOM, which will purchase the surplus certificate from MEEMIC.
After consummation of the aforedescribed transactions with MEEMIC, the Company has agreed to assist MEEMIC in acquiring the net assets of Michigan Educators Insurance Agency, Inc.("MEIA"). MEIA is an insurance agency that has the exclusive right to distribute MEEMIC insurance products. Upon its purchase, MEIA's marketing and sales functions would be consolidated with MEEMIC's. To fund this purchase, MEEMIC will utilize the proceeds of the surplus certificate, plus a $20.0 million promissory note to be issued by a subsidiary of MEEMIC, which will be guaranteed by Professionals Group. Additionally, Professionals Group will issue warrants for 275,000 shares of its common stock to MEIA shareholders.
Professionals Group was incorporated in January 1996 for the purpose of serving as the holding company for PICOM and its subsidiaries. Effective August 31, 1996, Professionals Group acquired all of the issued and outstanding shares of PICOM common stock through the merger of a wholly-owned insurance company subsidiary of Professionals Group with and into PICOM (the "Reorganization"). By virtue of the Reorganization, each issued and outstanding share of PICOM common stock was converted into one share of common stock, no par value per share, of Professionals Group and PICOM became a wholly-owned subsidiary of Professionals Group.
On July 5, 1995, PICOM repurchased 254,823 shares 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.
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 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 11 to the Company's consolidated financial statements).
For the year ended December 31, 1996, the following table provides certain information 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 ("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, 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. The levels and ratios are as follows:
PICOM and PICOM-Illinois have calculated their ratios of Total Adjusted Capital to Authorized Control Level RBC and each were in excess of 3:1 at both December 31, 1996 and 1995.
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 may affect the statutory carrying value of assets and liabilities. The codification project is expected to be completed in 1997 and effective in 1999. 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.
after December 15, 1995. SFAS No. 123 prescribes a method of accounting for stock-based compensation that recognizes compensation cost based on the fair value of the 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. Because the Company elected the disclosure-only provisions of this standard in 1996, there was no impact on the Company's consolidated results of operations for 1996.
PROFESSIONALS INSURANCE COMPANY MANAGEMENT GROUP AND SUBSIDIARY Consolidated Statements of Income
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 PICOM are collectively referred to as "the Company."
The Merger has been accounted for in a manner similar to a pooling of interests, whereby Professionals Group has carried forward to its accounts the assets and liabilities of PICOM at their respective amounts as reported by PICOM.
PICOM is a Michigan-domiciled property and casualty insurance company providing professional liability insurance for physicians, surgeons, dentists, hospitals, other health care providers and lawyers and law firms in Michigan, Ohio and Indiana. PICOM is also licensed in Illinois, Iowa and Pennsylvania. PICOM, through a wholly owned insurance subsidiary also writes business in Illinois (see note 2).
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 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, 1996, the estimated market value of the Company's bond portfolio was greater than its amortized cost.
PICOM Insurance Company of Illinois (PICOM-Illinois) - an Illinois-domiciled property and casualty insurance company providing professional liability insurance for physicians and surgeons in the State of Illinois. PICOM-Illinois was formed in December 1994 to write the book of business purchased effective January 1, 1995 (see note 15).
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, 1996 and 1995, 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.
Short-term investments, which consist principally of commercial paper, money market funds and U.S. government securities, are stated at cost, which approximates fair value.
Through December 31, 1994, the Company discounted loss and loss adjustment expense reserves to present value. Effective January 1, 1995, the Company eliminated its practice of discounting, a change in method of accounting (see note 9).
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 the related premiums are earned.
Proceeds and related gross realized gains and gross realized losses on sales of fixed maturities follow:
Realized gains (losses) and increases (decreases) in net unrealized gains (losses) follow:
During 1994, the Company sold all its Federal National Mortgage Association interest-only strip bonds, having an aggregate amortized cost of $1,146,255, from its held-to-maturity portfolio for $1,455,032, resulting in a net gain of $308,777. The sale of these securities resulted from management's decision to eliminate the interest rate risk associated with these investments, and accordingly, management does not intend to invest in this type of security prospectively. Because these investment securities were unique in the Company's investment portfolio, management's intent to hold other debt securities until maturity was not affected by these sales.
The significant components of federal income tax expense (benefit) are as follows:
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, 1996, 1995 and 1994, the reasons for these differences, and the tax effects thereof, are as follows:
At December 31, 1996 and 1995, property and equipment consisted of the following:
Effective January 1, 1995, the Company eliminated its practice of discounting loss and loss adjustment expense reserves for GAAP reporting purposes, a change in method of accounting. The Company believes it is preferable not to discount reserves because it is more conservative and is practiced by most publicly held insurers. This change in method of accounting resulted in a one-time cumulative charge of $8,125,000, net of deferred federal income taxes, as of January 1, 1995.
The Company establishes conservative reserves for the most recent accident years and adjusts the reserves as new information becomes available. This conservative reserving practice has resulted in favorable development in estimates of prior years' reserves.
Had the elimination of discounting been retroactively applied, total incurred losses would have been $44,547,000 in 1994.
The Company currently maintains two defined contribution employee benefit plans--a 401(k) plan and a money purchase plan--which cover substantially all employees meeting certain eligibility requirements.
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 1996, 1995 and 1994, the Company incurred expenses of $215,000, $82,000 and $64,000, respectively, under this plan.
On May 1, 1996, in a transaction approximating $1,244,000, the Company paid $309,000 and issued 44,000 shares of common stock held in treasury (valued at $935,000) in exchange for all of the issued and outstanding shares of American Insurance Management Corporation. The acquisition was accounted for as a purchase. The effect of the acquisition was not material to the Company's consolidated results of operations.
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. As of December 31, 1996, no grants have been 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 or above 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. As of December 31, 1996, stock options totaling 4,500 shares of the Company's common stock had been granted under the Directors Plan at an exercise price of $21.63. No options were exercised or canceled during 1996.
The Financial Accounting Standards Board has issued Statement of Financial Accounting Standards ("SFAS") No. 123 "Accounting for Stock-Based Compensation," which is effective for fiscal years beginning after December 15, 1995. 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.
The Company has elected the disclosure-only provisions of SFAS No. 123. Accordingly, had compensation cost for the Directors Plan been based on the fair value of options at grant date, the Company's 1996 net income (in thousands) and net income per common share 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 1996: dividend yield of 0%; expected volatility of 30.4%; risk free interest rate of 6.75%; and expected lives of 7 years. The proforma effect on net income for 1996 is not representative of the proforma effect on net income for future years because additional stock option awards could be made in future years.
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. The aggregate minimum purchase price of $3,586,954, net of accumulated amortization approximating $717,400 and $358,700, was recorded as an intangible asset at December 31, 1996 and 1995, respectively. To the extent the ultimate purchase price exceeds the minimum, such excess will be capitalized. During 1996, it was determined that the actual purchase price is expected to exceed the minimum. As a result, an additional $400,000 was capitalized in 1996.
As of December 31, 1996, the Company has entered into $5.5 million of commitments to build a new home office facility and to purchase new furniture and equipment. No other material commitments for capital expenditures exist.
The sum of quarterly net income per share data for 1995 does not equal the annual amount due to changes in the weighted average number of common shares outstanding during the respective periods.
Under SFAS No. 107, the Company's investment securities, cash, short-term investments, 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, 1996 and 1995.
In February 1997, the Company entered into an agreement with Michigan Educational Employees Mutual Insurance Company (MEEMIC), a Michigan-domiciled mutual insurance company, which contemplates a series of simultaneous transactions that include the purchase of a $21 million surplus certificate from MEEMIC, a quota share reinsurance agreement whereby PICOM will reinsure a portion of MEEMIC's net retained lines, a management services agreement between the Company and MEEMIC and the election of Professionals Group's nominees to MEEMIC's Board of Directors. These transactions, subject to regulatory approval by the Michigan Commissioner of Insurance, are projected to close by June 30, 1997.
Professionals Group has obtained a commitment for a seven year, $22.5 million unsecured term loan from a bank, bearing interest at LIBOR plus 75 basis points and payable monthly. With the proceeds received from this loan, Professionals Group's Board of Directors has authorized a $20 million capital contribution to PICOM, which will purchase the surplus certificate from MEEMIC.
After consummation of the aforedescribed transactions with MEEMIC, the Company has agreed to assist MEEMIC in acquiring the net assets of Michigan Educators Insurance Agency, Inc. (MEIA). MEIA is an insurance agency that has the exclusive right to distribute MEEMIC's insurance products. Upon its purchase, MEIA's marketing and sales functions would be consolidated with MEEMIC's. To fund this purchase, MEEMIC will utilize the proceeds of the surplus certificate, plus a $20 million promissory note to be issued by a MEEMIC subsidiary which will be guaranteed by the Company. Additionally, Professionals Group will issue warrants for 275,000 shares of its common stock to MEIA shareholders.
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 of MEEMIC's policyholders. No specific timetable has been set for this proposed demutalization.
We have audited the accompanying consolidated balance sheets of Professionals Insurance Company Management Group (formerly PICOM Insurance Company) and subsidiary as of December 31, 1996 and 1995, and the related consolidated statements of income, shareholders' equity and cash flows for the years then ended. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule as of and for the period ended December 31, 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 financial statements referred to above present fairly, in all material respects the consolidated results of its operations and its cash flows of Professionals Insurance Company Management Group and Subsidiary as of December 31, 1994 and for the year ended December 31, 1994 in conformity with generally accepted accounting principles.
Under terms of Professionals Group's tax sharing agreement with its direct and indirect subsidiaries, income tax provisions for the individual companies are computed on a separate company basis.