The following is a summary of properties leased by the Company at December 31, 2003:
The consolidated statements of operations data set forth below for each of the three years in the period ended December 31, 2003, and the consolidated balance sheet data at December 31, 2003 and 2002 are derived from, and are qualified by reference to, the audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K. The consolidated statements of operations data set forth below for the two years in the period ended December 31, 2000, and the consolidated balance sheet data at December 31, 2001, 2000 and 1999, 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 Annual Report on Form 10-K.
During 2003, we operated primarily in Minnesota, Colorado and Michigan. In 2001, we closed our regional offices in Missouri (which served Missouri, Illinois and Kansas) and Massachusetts (which served Massachusetts, Connecticut, New Hampshire, Rhode Island and Maine). Collectively, these regional offices had remaining premiums in force totaling $1.4 million at December 31, 2002. We completed running off this business in February 2003.
Challenges, risks, uncertainties and trends - We derive our revenue almost entirely from workers’ compensation insurance premiums and investment income including gains and losses from sales of securities. A small portion of our revenue is derived from non-insurance workers’ compensation services. We are subject to the
Workers’ compensation claims and related expenses can be volatile. Worker’s compensation is a long-tailed property and casualty insurance line. Claims for a given year are open on average for twelve to thirteen years and it is not unusual for workers’ compensation insurers to have claims open for thirty or more years. We have operated our insurance company since 1992 and therefore have limited experience (12 years), and accordingly, are subject to volatility. See further discussion under “Claim and Claim Settlement Expenses”.
Workers’ compensation pricing is cyclical. In 2003, we were able to increase premium rates on renewing policies 1.4%. This compares to rate increases of 9.0%, 18.5% and 11.7% realized in 2002, 2001 and 2000, respectively. These increases came after many years of pricing decreases that unfavorably affected the industry in the late 1990’s. If we are unable to maintain rate increases, our profit margin will be adversely affected. See further discussion under “Premiums in Force and Gross Premiums Earned”.
Reinsurance costs for workers’ compensation have increased. Reinsurance costs for the entire sector increased over the prior year continuing a pattern of cost increases beginning in 2001. These higher costs, if not recovered through increased pricing from our customers, will adversely affect our profit margin. See further discussion under “Premiums Ceded”.
Low interest rates reduce our investment income. Interest rates for investment grade instruments are at historic lows. Our investment income is directly affected by the interest rate at which we invest our free cash flow. The current rate environment has contributed to a significant mortgage refinancing boom, resulting in prepayment of our mortgage backed investments and an increase in our cash on hand in ACIC. A continuation of this trend and environment will adversely affect our investment income. See further discussion under “Investment Income and Net Realized Investment Gains”.
Financial Summary - This financial summary presents our discussion and analysis of the consolidated financial condition and results of operations of RTW, Inc. This review should be read in conjunction with the Consolidated Financial Statements at December 31, 2003.
In addition to the factors affecting premiums earned, total revenues also declined as net realized investment gains decreased to $685,000 in 2003 from $1.7 million in 2002;
At December 31, 2003, we maintained a $3.6 million valuation allowance against deferred tax assets. This allowance was originally established at December 31, 2001 at $14.5 million, and was decreased by $7.9 million in 2002 and $3.0 million in 2003. The $3.0 million and $7.9 million decreases in the valuation allowance favorably affected our income tax expense in 2003 and 2002, respectively. See further discussion under “Income Taxes.”
Our premiums in force increased 7.2% to $58.1 million at December 31, 2003 from $54.2 million at December 31, 2002. Premiums in force in our Minnesota and Colorado regions grew $9.0 million and $1.2 million, respectively, in 2003. The increases in the Minnesota and Colorado regions were offset by a $4.9 million decrease in Michigan, resulting primarily from our non-renewal of approximately $8.0 million of PEO business, partially offset by new business written. We also completed run-off of the remaining policies in our Missouri and Massachusetts regions in February 2003. Average premiums in force decreased to $53.6 million in 2003 from $65.1 million in 2002 and $95.2 million in 2001. In order to improve profitability, we aggressively targeted policies that did not meet our underwriting profit margin standards for non-renewal or
Our gross premiums earned decreased 12.9% to $54.4 million in 2003 from $62.5 million in 2002. This decrease resulted primarily from: (i) the decrease in average premiums in force; offset by (ii) final audit premiums which increased gross premiums earned by $323,000 in 2003, compared to a $1.7 million decrease in 2002.
In 2003, 2002 and 2001, we were able to increase premium rates on renewing policies an average of 1.4%, 9.0% and 18.5%, respectively. We have been able to increase premium rates in our markets due to the following:
Reinsurance rates for workers’ compensation insurers have increased due to: (i) reductions in reinsurer’s surplus as a result of the September 11, 2001 terrorist acts against the United States; (ii) recent unprofitability resulting from highly competitive reinsurance pricing; (iii) settlements related to certain reinsurance treaties written in the late 1990’s; (iv) five major reinsurers leaving the market in 2003; and (v) low investment yields. These rate increases have resulted in increased costs for workers’ compensation insurers. Insurers, including RTW, have raised premium rates to offset these increases in reinsurance premiums; and
Premiums Ceded: Reinsurance agreements allow us to share certain risks with other insurance companies. We purchase reinsurance to protect us from potential losses in excess of the level we are willing to accept. We expect the companies to which we have ceded reinsurance to honor their obligations. In the event that these companies are unable to honor their obligations to us, we will be required to pay these obligations ourselves. We are not aware of any developments with respect to our reinsurers that would result in uncollectible reinsurance balances.
Under our excess of loss reinsurance policies, we pay reinsurers to limit our per-incident exposure and record this cost to premiums ceded as a reduction of gross premiums earned. In Minnesota, we are required to purchase excess of loss coverage for our Minnesota policies from the Minnesota Workers’ Compensation Reinsurance Association (WCRA). The following table summarizes our reinsurance coverage (all losses ceded on a per occurrence basis):
Premiums ceded to reinsurers increased to $8.1 million in 2003 from $2.2 million in 2002. The increase in premiums ceded, resulted primarily from: (i) our cost for excess of loss reinsurance coverage in our non-Minnesota regions increased substantially in 2003 while our Minnesota cost decreased only slightly; (ii) we decreased our retention to $200,000 in all our regions in 2003 by purchasing increased excess of loss coverage in order to further reduce volatility in our operating results; and (iii) the 2003 results include a $92,000 increase in excess of loss premiums ceded resulting from a change in estimated reinsurance cost for the WCRA compared to a $1.4 million decrease in excess of loss premiums ceded in 2002.
Premiums ceded to reinsurers decreased to $2.2 million in 2002 from $11.4 million in 2001. The decrease in premiums ceded resulted from: (i) a $7.3 million reduction in premiums ceded under our $25,000 to $300,000 excess of loss reinsurance policy; (ii) a $1.4 million reduction in excess of loss premiums ceded resulting from a change in estimated reinsurance cost for Minnesota excess of loss coverage; and (iii) a decrease in gross premiums earned offset by an increase in non-Minnesota excess of loss costs in 2002.
2004 Outlook: The 2004 outlook for premiums in force, gross premiums earned and premiums ceded include the following factors:
Premium rates are expected to increase only slightly on new and renewing policies as we filed our rates at the high end in each region in which we operated in 2003 and 2002, leaving little room to further increase rates in 2004. We expect to continue to improve and add to our agency relationships in 2004. Coupled with an improved A.M. Best rating, we expect to increase premiums in force in 2004 with new business increases occurring primarily in our Minnesota and Michigan regions;
Premiums ceded under excess of loss policies will increase significantly as a percent of gross premiums earned when compared to the results attained for 2003. We have established a $200,000 retention in all our regions in 2004. The cost of excess of loss reinsurance has increased at all retention levels and for all regions in 2004.
from terminating our contract with St. Paul RE (SPR). This amount was reinvested in January and February 2003. In order to reduce the near term interest rate risk on the portfolio, we built our cash position throughout 2003 by holding cash received on mortgage-backed security prepayments and through sales of securities in September 2003 with the expectation that interest rates will rise in the near term. Subsequent to December 31, 2003, we began to diversify our portfolio by investing in tax-exempt municipal securities to take advantage of the tax benefits of those securities and interest rate spreads. We classify our investments as available-for-sale. We intend to hold our available-for-sale investments to maturity, but may sell them before maturity in response to tax planning considerations, changes in interest rates, changes in prepayment risk and changes in 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 to $4.5 million in 2003 from $5.1 million in 2002. After excluding $736,000 of interest earned on our deposit receivable from SPR in 2002, for which there was no equivalent amount earned in 2003, investment income increased slightly to $4.5 million in 2003 from $4.4 million in 2002. Investment income increased slightly as average invested assets increased to $96.0 million in 2003 from $77.9 in 2002. This increase in investment income resulting from the increase in assets invested was offset by a decrease in interest rates during 2003. Interest rates declined early in the year, reaching a low point in June 2003 before returning to beginning of the year levels by December 2003. Approximately $20.3 million of mortgage-backed securities in our investment portfolio were repaid earlier than expected due to the significant consumer mortgage refinancing that occurred in 2003. The funds that came available could not be reinvested at comparable rates, causing the book investment yield to decline from 2002. Our book investment yield, excluding cash and cash equivalents, declined to 4.6% at December 31, 2003 from 4.9% at December 31, 2002. The investment yields realized in future periods will be affected by yields attained on new investments.
Investment income decreased to $5.1 million in 2002 from $6.4 million in 2001. Investment income decreased as our invested assets decreased to $81.4 million at December 31, 2002 from $89.2 million at December 31, 2001 and our investment yields decreased as we moved out of corporate securities in 2002 and reinvested in lower yielding securities due to changes in market interest rates and our desire to lower risk by buying higher rated government and mortgage-backed securities. This decrease was partially offset by an increase in interest earned on our deposit receivable to $736,000 in 2002 from $518,000 in 2001. Our invested assets decreased due to decreases in operating cash flow in 2002 and 2001, resulting primarily from: (i) reduced premiums in force and premiums written; (ii) timing differences between paying premiums ceded and recovering paid claim and claim settlement expenses; (iii) the receipt of premiums and the payment of claim and claim settlement expenses; and (iv) net cash provided by lower investment income. Investment yields decreased to 4.9% for 2002 from 6.1% for 2001. The investment yields realized in future periods would be affected by yields attained on new investments.
2004 Outlook: We expect that income from our investment portfolio for 2004 will be affected by the following:
Our investment in tax-exempt municipal bonds will reduce investment income and favorably affect net income as investment yields will be lower on a pre-tax basis but will be higher on a tax-adjusted basis;
Cash flows for 2004 are expected to be adversely affected by decreases in cash flows resulting from claim payments on claims from 2003 and prior years offset by cash flows from our premiums as we increase our premiums earned in 2004;
Claim and Claim Settlement Expenses: Claim expenses refer to medical and indemnity benefits that we have 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, to claim and claim settlement expenses in the accompanying Consolidated Statements of Operations.
We experienced a decrease in the estimated number of ultimate claims for 2003 compared to 2002 and 2001. The number of estimated ultimate claims by accident year decreased to approximately 9,600 in 2003 from 11,500 in 2002 and 22,100 in 2001. The net decrease correlates directly to: (i) the decrease in gross earned premiums; and (ii) the re-underwriting that we completed with respect to our in force policies in 2002 and 2001. The gross and net average estimated cost per claim (which includes both claim and claim settlement expenses) totaled approximately $5,000 and $4,200 in 2003 compared to $5,500 and $4,900 in 2002 and $4,500 and $3,400 in 2001, respectively. The 2003 decrease in gross and net average estimated cost per claim is primarily the result of our improved ability to manage cases and claims offset by increases in severity (i.e., the average cost of a claim) caused mainly by inflationary pressures. The trend of increasing severity is attributable to a combination of factors that include increasing medical costs and increasing indemnity payments (reimbursements to injured workers for lost wages) per claim. We have also observed a decline in the number of claims being reported over the last several years. The declining frequency of claims contributes to the increasing severity trend because the frequency decline has been concentrated in less expensive claims (claims involving less time-off from work and less severe injuries).
The number of claims reported but unpaid (open claims) and the approximate average gross and net reserves on these claims each period was: 2003 - 1,115 claims, $28,400 average gross reserve, $21,400 average net reserve; 2002 - 339 claims, $72,800 average gross reserve, $55,900 average net reserve; and 2001 - 300 claims, $89,500 average gross reserve, $44,500 average net reserve. The average gross and net reserves per claim are less in 2003 than in 2002 and 2001 as the open claims include newly reported claims from the later half of 2003, including many with much lower severity that have not had time to close, as well as new claims that are incurred but not yet reported. The remaining open claims from 2002 and 2001 are primarily claims with significant injury characteristics resulting in the increase in outstanding average gross and net reserves per claim.
The 2003 results include a $6.7 million decrease in prior years’ reserves for unpaid claim and claim settlement expenses compared to the 2002 results which include an $8.4 million decrease in prior years’ reserves. Our estimate for unpaid claim and claim settlement expenses decreased in 2003 due to the following: (i) our ability to manage and close claims has improved over our historical experience; (ii) the re-underwriting of our book of business has resulted in claims with profiles different than experienced historically; (iii) the frequency of claims reported in 2003 for 2002 and prior years was less than anticipated when we determined our liability in 2002; and (iv) our estimate of the liability for unpaid claim and claim settlement expenses is volatile due to our relatively limited twelve-year historical claim data and our small claim population;
Claim and claims settlement expenses decreased in total due to the overall decrease in average premiums in force and decreased as a percent of gross premiums earned as premium rate increases realized in 2002 and 2003 flow through 2003 premium earned; and
2002 Compared to 2001: Claim and claim settlement expenses decreased significantly to $40.5 million in 2002 from $80.1 million in 2001. As a percent of premiums earned, claim and claim settlement expenses decreased to 67.3% in 2002 from 93.1% in 2001. These changes are due to the following:
The 2002 results include an $8.4 million decrease in prior years’ reserves for unpaid claim and claim settlement expenses compared to the 2001 results which include a $7.7 million increase in prior years’ reserves. Our estimate for unpaid claim and claim settlement expenses decreased in 2002 due to the following: (i) in March 2002, the Minnesota State legislature changed the way the commissioner assessed self-insured employers and insurers for estimated liabilities and administrative expenses of the Minnesota Special Compensation Fund. The assessment changed from being paid by the insurer on an indemnity payment basis to an assessment charged on premium to the policyholder. We decreased our recorded accrual in 2002 to reflect this legislative change; (ii) the frequency of claims reported in 2002 for 2001 and prior years was less than anticipated when we determined our liability in 2001; (iii) we overestimated the liability for our mandatory participation in state and national assigned risk pool operating results for states in which we operate in 2001 and reversed that excess in 2002; and (iv) our estimate of the liability for unpaid claim and claim settlement expenses is volatile due to our relatively limited historical claim data and small claim population;
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 $15.2 million in 2001 resulting in a corresponding reduction in 2001 claim and claim settlement expenses. No such benefit was recorded in 2002;
We increased renewal premium rates an average of 9.0% in 2002 and 18.5% in 2001 compared to premium rates for the same periods in 2001 and 2000, respectively, reversing a trend of continued rate declines during years prior to 2000. Increases in premium rates have the effect of reducing the ratio of claim and claim settlement expenses to gross premiums earned as losses do not increase with premium rate increases; 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 and other underwriting expenses, less ceding commissions from our reinsurers. Ceding commissions are amounts that reinsurers pay to us for placing reinsurance with them.
Premium tax expense increased slightly to 1.8% of gross premiums earned in 2003 from 1.7% of gross premiums earned in 2002 and decreased slightly from 1.9% in 2001; and
Our general and administrative expenses increased to $10.8 million in 2003 from $10.0 million in 2002 and decreased from $17.4 million in 2001. As a percent of gross premiums earned, general and administrative expenses increased to 19.8% in 2003 from 16.0% in 2002 and 17.9% in 2001. General and administrative expenses increased in 2003 and decreased in 2002 as follows:
General and administrative expenses increased in 2003 from 2002 levels. Significant changes include (i) the reversal of a previously recorded contingent reinsurance commission resulting in $375,000 in expense in 2003; (ii) $217,000 in expenses related to severance and relocation in 2003; (iii) increased professional fees; and (iv) costs associated with investing in the necessary staff and infrastructure to position us for growth;
General and administrative expenses increased as a percent of premiums earned, after adjusting for restructuring charges, IGA assessments and one-time charges as we had less revenue relative to our fixed operating costs and expenses. We aggressively managed personnel and other operating costs and expenses during 2003 to appropriately align operating expenses with revenues. All expenses continue to be managed aggressively and reduced where appropriate.
All expenses will continue to be aggressively managed and reduced where appropriate;
Interest Expense: We incurred interest charges on our Term Loan in 2003, 2002 and 2001. We originally borrowed $8.0 million under the Term Loan in March 2000 and paid the remaining amount due in September 2003.
Income Taxes: We incur federal income taxes on our combined service organization operations (RTW) and insurance operations (ACIC). We incur state income taxes on the results of our service organization’s operations and incur premium taxes in lieu of state income taxes for substantially all of our insurance operations. In certain instances, we may incur state income taxes on our insurance operations. Additionally, certain provisions of the Internal Revenue Code adversely affect our taxable income by accelerating recognition and payment of income taxes. Adjustments to book income generating current tax assets and liabilities include limitations on the deductibility of unpaid claim and claim settlement expenses, limitations on the deductibility of unearned premium reserves, limitations on deductions for bad debt reserves and the acceleration of expensing policy acquisition costs.
Under the first provision of the Job Creation and Worker Assistance Act of 2002, signed into law in March 2002, we were allowed to carry-back our 2001 net operating loss for five years, to 1996, instead of two years under previous law. We filed our tax return in September 2002, and received a refund totaling approximately $3.3 million as a result of this Federal legislative change from carrying-back our 2001 loss. An additional $475,000 receivable was recorded that related to the carry-back that resulted from revising our financial statements for 2001.
Accounting for workers’ compensation insurance operations requires us to estimate the liability for unpaid claim and claim settlement expenses (“reserves”) and the related reinsurance recoverables, (together, the “net reserves”) at each balance sheet date. Our reserves represent the estimated total unpaid cost of claim and claim settlement expenses, which cover events that occurred in 2003 and prior years. 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
Both internal and independent external actuaries review net reserves for adequacy on a periodic basis. This review assumes that past experience, adjusted for the effects of current events and anticipated trends, is an appropriate basis for predicting future events. When reviewing net reserves, actuaries analyze historical data and estimate the effect of various factors on estimated ultimate reserves including: (i) trends in general economic conditions, including the effects of medical and wage inflation; (ii) estimates of trends in claims frequency and severity; (iii) our and industry historical loss experience; and (iv) legislative enactments, legal developments and changes in social and political attitudes. Variables in the reserve estimation process can be affected by both internal and external events, including changes in claims handling procedures, economic inflation, legal trends and legislative changes. Many of these items are not directly quantifiable, particularly on a prospective basis. There is no precise method for subsequently evaluating the effect of any specific factor on the adequacy of reserves because the eventual deficiency or redundancy is affected by many factors. Additionally, there may be significant reporting lags between the occurrence of the loss and the time it is actually reported to the insurer. Due to our commencing operations in 1992, we have limited historical data to estimate our reserves for unpaid claim and claim settlement expenses and, accordingly, we supplement our experience with external industry data, as adjusted, to reflect anticipated differences between our results and the industry.
Our independent actuary provides management with an opinion regarding the acceptable range for adequate statutory reserves based on generally accepted actuarial guidelines. We record our net reserves by considering a range of estimates bounded by the high and low point of the range. Within that range, we record our estimate. We focus in our decision process on improving our financial strength ratings and expect to remain a market for workers’ compensation insurance in all market conditions. In 2003 we established recorded reserves in the upper half of the actuary’s range. The ultimate actual liability may be higher or lower than reserves established.
The following loss reserve development table sets forth the change, over time, of gross reserves established for claim and claim settlement expenses at the end of the last ten years. The following gross loss
The table above represents the development of balance sheet gross reserves for 1993 through 2003. The upper portion of the table shows the cumulative amount paid with respect to the previously recorded reserves as of the end of each succeeding year. The lower portion of the table shows the re-estimated amount of the previously recorded gross reserves, based on experience as of the end of each succeeding year. The estimate is either increased or decreased as more information becomes known about the frequency and severity of claims for individual years.
In evaluating this information, it should be noted that each amount includes the total of all changes in amounts for prior periods. For example, the amount of redundancy (deficiency) to losses settled in 2002, but incurred in 1999, is included in the cumulative redundancy (deficiency) amounts in 1999, 2000 and 2001. This
table does not present accident or policy year development data, which certain readers may be more accustomed to analyzing. Conditions and trends that have affected development of the reserves in the past may not necessarily occur in the future. Accordingly, it may not be appropriate to extrapolate redundancies or deficiencies based on this table.
The following loss reserve development table sets forth the change, over time, of net reserves established for claim and claim settlement expenses at the end of the last ten years. The following net loss reserve development table is cumulative and, therefore, ending balances should not be added since the amount at the end of each calendar year includes activity for both current and prior years (000’s):
The table above represents the development of balance sheet net reserves for 1993 through 2003. The top three rows of the table reconcile gross reserves to net reserves for unpaid claim and claim settlement expenses recorded at the balance sheet date for each of the indicated years.
The “initial reserves in excess of (less than) re-estimated reserves” rows represent the aggregate change in the estimates over all prior years. For example, the 1998 reserve developed a $4.7 million net deficiency over the course of the succeeding years. The net amount has been included in income and the changes have been recorded in the period identified. The cumulative net deficiencies in 2000 and 1999 are the result of reserve development inherent in the uncertainty in establishing reserves and anticipated loss trends. As discussed above, due to our relatively limited historical claim data and small claim population, our estimate of the liability for net reserves is difficult and volatile. As discussed further below, the reserve redundancy in 2001 is the result of accrual reversals resulting from changes in methods of assessing second injury funds, lower frequency in claims reported from the estimate at December 31, 2001, and reductions in amounts expected to be incurred for our participation in mandatory state and national assigned risk pools.
The following table is derived from the loss reserve development table and summarizes the effect of reserve re-estimates, net of reinsurance, on calendar year operations for the same ten-year period ended December 31, 2003. The total of each column details the amount of reserve re-estimates made in the indicated calendar year and shows the accident years to which the re-estimates are applicable. The amounts in the total accident year column represent the cumulative reserve re-estimate (increase) decrease for the indicated accident year (000’s):
The 2002 results include an $8.4 million decrease in prior years’ reserves for unpaid claim and claim settlement expenses compared to the 2001 results which include a $7.7 million increase in prior years’ reserves for unpaid claim and claim settlement expenses. Our estimate for unpaid claim and claim settlement expenses decreased in 2002 due to the following: (i) in March 2002, the Minnesota State legislature changed the way the commissioner assessed self-insured employers and insurers for estimated liabilities and administrative expenses of the Minnesota Special Compensation Fund. The assessment changed from being paid by the insurer on indemnity payment basis to an assessment charged on premium to the policyholder. We decreased our recorded accrual to reflect this legislative change; (ii) the frequency of claims reported in 2002 for 2001 and prior years was less than anticipated when we determined our liability in 2001; (iii) we overestimated the liability for our mandatory participation in state and national assigned risk pool operating results for states in which we operate in 2001 and reversed that excess in 2002; and (iv) our estimate of the liability for unpaid claim and claim settlement expenses is difficult and volatile due to our relatively limited historical claim data and small claim population.
Our primary sources of cash from operations are premiums collected, reimbursements under reinsurance contracts and investment income. Our investment portfolio is also a source of liquidity, through the sale of
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. We repurchased 18,619 shares in 2003 for approximately $37,000, 41,324 shares in 2002 for approximately $78,000 and 334,750 shares for approximately $2.7 million through 2001. 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.
At December 31, 2003, investments of $21.9 million were held as statutory deposits and pledged as collateral. This did not have an adverse effect on our liquidity. We believe that cash flow generated by our operations and our cash and investment balances will be sufficient to fund continuing operations, and capital expenditures for the next 12 months.
Our contractual obligations consist solely of operating leases for our facilities. Future minimum (base) rental payments required under the leases, as of December 31, 2003, are as follows (000’s):
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, 2003, 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.
EITF 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” requires additional disclosures in our financial statements, but does not affect our consolidated results of operation and financial position at December 31, 2003 and for the year then ended.
Information included in this Report on Form 10-K which can be identified by the use of forward-looking terminology such as “may,” “will,” “expect,” “anticipate,” “estimate,” or “continue” or the negative thereof or other variations thereon or comparable terminology constitutes forward-looking information. The following important factors, among others, in some cases have affected and in the future could affect our actual results and could cause our actual financial performance to differ materially from that expressed in any forward-looking statement: (i) our ability to retain renewing policies and write new business with a B+ (Very Good, Secure) rating from A.M. Best; (ii) our ability to extend our workers’ compensation services to self-insured employers and other alternative markets; (iii) our ability to continue to increase pricing on insured products in the markets in which we remain; (iv) the ability of our reinsurers to honor their obligations to us; (v) our ability to accurately predict claim development; (vi) our ability to provide our proprietary products and services to self-insured parties successfully; (vii) our ability to manage both our existing claims and new claims in an effective manner; (viii) our experience with claims frequency and severity; (ix) medical inflation; (x) competition and the regulatory environment in which we operate; (xi) general economic and business conditions; (xii) our ability to obtain and retain reinsurance at a reasonable cost; (xiii) changes in workers’ compensation regulation by states, including changes in mandated benefits or insurance company regulation; (xiv) interest rate changes; and (xv) other factors as noted in our other filings with the SEC. This discussion of uncertainties is by no means exhaustive but is designed to highlight important factors that may affect our future performance.
We have audited the accompanying consolidated balance sheets of RTW, Inc. (the Company) as of December 31, 2003 and 2002, and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2003. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of RTW, Inc. at December 31, 2003 and 2002, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States.
Organization - RTW, Inc. (RTW) provides insured and fee-for-service workers’ compensation products and services to employers. Insurance products are written for employers through RTW’s 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.
Use of Estimates - We make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the financial statement date and the recorded amounts of revenues and expenses during the reporting period. Our most significant estimates are those relating to our reinsurance recoverables on unpaid claim and claim settlement expenses, unpaid claim and claim settlement expenses, income taxes, deferred income taxes and an accrual for premium adjustments. We continually review our estimates and assumptions and make adjustments as necessary. Our actual results could vary significantly from the estimates we make.
We continually monitor the difference between investment cost and fair value for each of our securities. If any security experiences a decline in value that is determined to be other than temporary, we reduce the security’s carrying value for the decline and record a realized loss in the Consolidated Statements of Operations. No securities were reduced for declines in fair value in 2003, 2002 or 2001.
receivable and other assets and liabilities that are considered financial instruments are generally of a short-term nature. 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. These costs are amortized to expense as premium revenue is recognized and are reported net of ceding commissions in the Consolidated Statement of Operations.
Depreciation - We depreciate furniture and equipment on a straight-line basis over the estimated useful life of the asset (five to ten years). Furniture and equipment are recorded at cost less accumulated depreciation of $4.4 million and $4.0 million at December 31, 2003 and 2002 respectively.
Income Taxes - We compute all income tax amounts using the liability method. Under this method, 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 or regulations is recognized in income in the period that includes the enactment date.
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 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. We also estimate the final audit amount to be billed on unexpired and expired unaudited policies and record a final audit receivable included in premiums receivable on the balance sheet. Final audit premiums recognized during the period include billed final audit premiums plus (or minus) the change in estimate for final audit premiums on unexpired and expired unaudited policies.
The weighted average fair value of options granted under the ESPP and 1994 Stock Plan during 2003, 2002 and 2001 is estimated at $1.48, $2.94 and $2.19, respectively, on the date of grant using the Black-Scholes option-pricing model with the following assumptions: no dividend yield; volatility of 115.3% to 131.5% in 2003, 125.6% in 2002 and 182.8% in 2001; risk-free interest rates ranging from 1.05% to 7.70%; and an expected life of 1 to 5 years.
Options to purchase 1.5 million shares of common stock at prices ranging from $1.98 to $38.67 were outstanding during 2001 but excluded from computing diluted IPS due to our 2001 net loss. Diluted weighted average shares outstanding would have increased by 4,000 shares in 2001 had these shares not been anti-dilutive in the computation.
The gross unrealized loss in all cases is the result of a decline in interest rates and not as a result of a deterioration of the credit quality of the issuers. All issues carry a credit quality of AAA (Standard & Poors). We have the ability to hold all of these securities to maturity. We consider all relevant facts and circumstances in evaluating whether the impairment of a security is other than temporary. Relevant facts and circumstances considered include: (i) the length of time the fair value has been below cost; (ii) the financial position and access to capital of the issuer, including the current and future impact of any specific events; and (iii) our ability and intent to hold the security to maturity or until it recovers in value. To the extent we determine that a security is deemed to be other than temporarily impaired, the difference between amortized cost and fair value would be charged to earnings.
Deposits - Included in investments are U.S. government securities on deposit with various regulatory authorities, as required by law, with a fair value of $21.9 million and $27.7 million at December 31, 2003 and 2002, respectively.
Fixed Maturities by Maturity Date - The following table presents the amortized cost and fair value of investments by contractual maturity at December 31, 2003. Actual maturities may differ from those stated as a result of calls and prepayments (000’s):
We report reinsurance related balances on a “gross” basis on the balance sheet, resulting in reinsurance recoverable amounts on unpaid and on paid 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 decreased our retention in 2003 to further reduce volatility in our operating results.
Our income tax (benefit) expense differs from the federal statutory rate as follows (000’s):
Our liability for employee contributions withheld at December 31, 2003 and 2002 for the purchase of shares in April 2004 and April 2003 under the ESPP was $47,000 and $51,000, respectively.
Options granted, exercised, canceled and outstanding under the 1994 Stock Plan are as follows:
The following table summarizes the options outstanding and exercisable at December 31, 2003:
Employee Stock Ownership Component - We maintain an ESOP for our qualified employees. Our contributions are discretionary. We may contribute cash or shares of our common stock. No contributions were made or expense recorded in 2003, 2002 or 2001.
On November 7, 2002 our Board of Directors approved a one-for-two reverse stock split in order to remedy the minimum bid requirement for continued listing on the Nasdaq National Market. The reverse stock split was effective to shareholders of record on the close of business on November 22, 2002. All share and per share amounts in these Consolidated Financial Statements have been adjusted to reflect the effect of the stock split.
Future minimum (base) rental payments required under the leases, as of December 31, 2003, are as follows (000’s):
Rent expense, including contingent rentals, was $1.0 million, $1.3 million and $2.0 million for 2003, 2002 and 2001, respectively.
In the ordinary course of administering our workers’ compensation programs, we are routinely involved in the adjudication of claims resulting from workplace injuries. We are not involved in any legal or administrative claims that we believe are likely to have a material adverse effect on our financial condition or results of operations.
During 2001, we recorded pre-tax restructuring charges totaling $2.0 million to general and administrative expenses in the Consolidated Statement of Operations. These charges included costs associated with our decision to close our Missouri and Massachusetts regional offices, as well as our Brainerd, Minnesota and Overland Park, Kansas satellite offices. We anticipated that 38 employees in our regional offices, 17 employees in our satellite offices and 2 employees in our Home Office would be affected by these closures. The restructuring charge included $715,000 of severance pay and benefits, of which $106,000 was paid by December 31, 2001 and the remainder of which was paid, primarily in early 2002. Additionally, the restructuring charge included office and equipment lease costs totaling $684,000 of which $80,000 was paid by December 31, 2001 with an additional $195,000 paid in 2002 and furniture and equipment disposals and other costs totaling $600,000 of which $53,000 had been disposed of by December 31, 2001, the remainder of which was disposed of in 2002. At December 31, 2003 and 2002, the remaining accrual included amounts related to future lease payments totaling $248,000 and $409,000, respectively.
The following tables present unaudited quarterly results of operations for the eight quarters ended December 31, 2003:
The following represent pre-tax adjustments recorded during each quarter of 2002 that affected reported net income: