MMI leases approximately 360,000 square feet of office space throughout the United States and a suite in the London Underwriting Center in the United Kingdom. MMI's principal leasehold obligation relates to its corporate office located in Deerfield, Illinois. The Deerfield, Illinois office space consists of approximately 136,000 square feet. The lease expires December 31, 2009. MMI's principal regional and subsidiary offices are in Atlanta, Georgia; Oakland, California; Independence, Missouri; and London, England.
(1) The Company acquired Unionamerica Holdings plc in December 1997 in a transaction accounted for as a pooling of interests. As such, the consolidated financial statements include Unionamerica's balance sheet and results of operations for all periods presented.
(3) Operating income represents income from continuing operations before extraordinary losses of $707,000 in 1997 and $4,737,000 in 1995 and after-tax realized investment gains (losses) of $(627,000) in 1999, $1,740,000 in 1998, $1,410,000 in 1997, $(596,000) in 1996, and $1,106,000 in 1995.
(4) The Company adopted a new standard on earnings per share in 1997. All earnings per share amounts have been restated to conform to the new requirements. Per share and weighted average shares are presented on a diluted basis.
(5) In 1997, operating income includes a charge, net of tax, of $8,937,000 or $.46 per share related to the acquisition of Unionamerica.
REVENUES. Gross premiums written increased by 13.6% to $498.5 million in 1999 from $439.0 million in 1998. Medical malpractice gross premiums written decreased 11.9% to $209.0 million in 1999 from $237.3 million, international gross premiums written increased 44.8% to $239.0 million in 1999 from $165.1 million in 1998 and other gross premiums written increased 37.6% to $50.5 million in 1999 from $36.7 million 1998. Net premiums written increased by 9.2% to $387.4 million in 1999 from $354.8 million in 1998.
LOSSES AND EXPENSES. Losses and loss adjustment expenses ("LAE") increased by 56.5% to $456.3 million in 1999 from $291.5 million in 1998. Medical malpractice liability losses and LAE increased by 6.6% to $206.1 million in 1999 from $193.3 million in 1998. Medical malpractice losses and LAE increased due to unfavorable loss experience recognized in the third quarter 1999 of $57.9 million due primarily to a change in the legal environment affecting a specific block of business. That business, which the Company has exited completely as of December 31, 1998, consists of groups of for-profit long-term care facilities. As a result of several large judgments and settlements, one of which affected the Company, average case values have increased significantly. The Company undertook a major review of all such cases and increased reserves on open cases to reflect the environmental change and increased its reserve for unreported cases and claim development on this block of business. This reserve strengthening totaled $35.0 million.
International losses and LAE increased 160.2% to $229.0 million in 1999 from $88.0 million due to $96.0 million of loss reserve strengthening covering the 1995-1999 policy years that was recorded in the third and fourth quarter, 1999. The third quarter strengthening totaled $31.0 million and approximately one-half of the reserve increase related to short-tail lines, primarily property and medical expense business with the remaining reserve development occurring in the casualty lines including medical malpractice and commercial auto. Loss reserve
development of $65.0 million in the fourth quarter related to casualty lines, primarily United Stated medical malpractice and surplus lines business. The reserve increases reflect a continuation of competitive market conditions and increasing trends in frequency and severity. Other losses and LAE increased 108.9% to $21.1 million in 1999 from $10.1 million in 1998 due to an increase in other earned premium as well as losses recorded in 1999 in recognition of unfavorable experience in the medical expense insurance business.
The combined ratio, which includes the sum of losses and LAE and insurance segment expenses divided by earned premiums, increased to 154.6% in 1999 compared to 115.8% in 1998. The loss ratio increased by 37.7 percentage points and the expense ratio increased by 1.1 percentage points in 1999, as compared to 1998. The loss ratio increase is due to reserve strengthening in the medical malpractice and international lines of business. The loss reserve development reflected in medical malpractice and international losses and loss adjustment expenses represented an increase in the 1999 loss ratio of 41.1 percentage points.
Interest expense decreased by 1.0% to $10.1 million in 1999 from $10.2 million in 1998. Debt outstanding totaled $164.0 million at December 31, 1999 as compared to $118.8 million at December 31, 1998. MMI borrowed $45.0 million in December, 1999.
INCOME TAXES (CREDITS). Income taxes were a credit of $55.6 million in 1999 compared to a provision of $1.6 million in 1998. The decrease in income tax expense is due to a pre-tax loss in 1999.
DISCONTINUED OPERATIONS. The loss from discontinued operations related to the March 31, 1999 sale of Healthcare Credentials Management Services (HCMS) was $5.6 million in 1999, comprised of $4.5 million loss on disposal and $1.1 million loss from operations. The loss from operations was $4.2 million in 1998. Net of taxes, the loss was $3.6 million in 1999 and $2.7 million in 1998.
NET INCOME (LOSS). Net income decreased to a loss of $104.5 million in 1999 from net income of $11.4 million in 1998 principally as a result of adverse reserve development from the medical malpractice and international lines of business, as well as the restructuring charge recorded in the third quarter 1999.
1998, medical malpractice premiums earned included $35.8 million in such one time premiums, an increase of $28.8 million from 1997.
The combined ratio, which includes the sum of losses and LAE and insurance segment expenses, divided by earned premiums was 111.1% in 1997. The loss ratio increased by 11.3 percentage points and the expense ratio decreased by 6.6 percentage points in 1998. The loss ratio increase is due to the loss reserve development totaling $20.8 million recorded in the third quarter 1998 as well as higher loss ratios related to one-time premiums and an increase in the current year's loss ratio. The expense ratio decline in 1998 is primarily due to the inclusion of the acquisition related expenses in 1997 and one-time premiums in 1998, which have a proportionally lower level of acquisition expense.
INCOME TAXES. Income taxes were $1.6 million in 1998 compared to $10.2 million in 1997. The decrease in income tax expense is due to a decline in the pre-tax income in 1998.
DISCONTINUED OPERATIONS. Healthcare Credential Management Services (HCMS) was sold on March 31, 1999. The loss on discontinued operations from the sale was $4.2 million in 1998 and $2.8 million in 1997. Net of taxes, the loss was $2.7 million in 1998 and $1.8 million in 1997.
Investing activities, substantially in fixed income securities, have been the principal use of cash flow from operations. Cash provided by investing activities was $25.1 million in 1999. Cash used by investing activities was $28.9 million in 1998 and $24.4 million in 1997. The Company has no material commitments for capital expenditures.
TRUST PREFERRED CAPITAL SECURITIES. In December 1997, MMI issued $125.0 million in 30 year non-callable Capital Securities of MMI Capital Trust I, a subsidiary of MMI. The Capital Securities were rated ba1 by Moody's Investor Service and BBB- by Standard & Poor's Rating Services as of March 29, 2000. The Capital Securities pay cumulative distributions at the annual rate of 7 5/8% semiannually in arrears and have a maturity date of December 15, 2027. Payments on the Capital Securities are fully and unconditionally guaranteed by MMI. Total proceeds, net of expenses, were $118.7 million.
RISK-BASED CAPITAL. The NAIC has adopted risk-based capital solvency standards for domestic insurers. Under these standards, several solvency thresholds are calculated based on the underwriting, credit, and investment risks of a company. As of December 31, 1999 the statutory capital and surplus of each of the Company's domestic insurance subsidiaries exceeded its risk-based-capital requirements.
In February 1999, MMI acquired Applied Risk Management (ARM), Inc., a privately held third party administrator and consulting firm that specializes in workers' compensation. Subsequent to the acquisition, ARM was integrated into Professional Risk Management (PRM), Inc., an MMI subsidiary that provides third party administration and consulting related to professional and general liability risks and claims primarily for self-insured organizations. The purchase price for ARM, including expenses, was $7.7 million in cash.
In a series of transactions in 1998, the Company acquired a 49% interest in Marketform Holdings Limited (MHL), a London-based underwriting agency specializing in non-U.S. medical malpractice insurance and 95%
ownership of Marketform Corporate Member Limited (MCML), a dedicated Lloyd's corporate member. The total consideration was $4.5 million in cash and $1.3 million in short-term notes payable.
The Company implemented an enterprise-wide plan to address Year 2000 ("Y2K") issues across all of its technology platforms as well as to reasonably assure that its critical business partners are prepared for business continuity beyond January 1, 2000. The rollover to Year 2000 proved to be uneventful for MMI. No adverse impact or issues were experienced and the Company enjoyed normal operations throughout the first quarter of 2000. The total cost to address all Y2K related issues was $.7 million.
The fair value of the Company's short-term investment portfolio at December 31, 1999 and 1998 approximated its carrying value due to its short-term duration. Market risk was estimated as the potential decrease in fair value resulting from a hypothetical 100 basis point increase in interest rates for the issues contained in the short term investment portfolio, and was not materially different from the December 31, 1999 or 1998 carrying values.
As of December 31, 1999 the Company estimates that overhead and other payables of approximately $1.5 million per month which must be paid in British pound sterling are to be paid throughout the next year by its UK subsidiaries. The British pound sterling are to be purchased periodically throughout the year, usually with U.S. dollars; and a hypothetical strengthening of the British pound sterling versus the U.S. dollar of 10% would increase the cost of these purchases by up to $1.8 million throughout the year. The Company does monitor the foreign currency markets and could purchase British pound sterling in advance if appropriate due to market conditions.
In December 1997, the Company completed a private placement of $125.0 million 30-year, mandatorily redeemable preferred capital securities (Capital Securities) of MMI Capital Trust I, a subsidiary of MMI. The Capital Securities pay a dividend of 7.625% semi-annually in arrears and have a maturity date of December 15, 2027. Total proceeds were $118.7 million net of expenses. The carrying value of the Capital Securities is $119.1 million and $118.8 million as of December 31, 1999 and 1998, respectively. These securities had a fair value of $98.3 million at December 31, 1999 and $121.9 million at December 31, 1998. A hypothetical 100 basis point decrease in interest rates would increase the fair value to approximately $108.9 million and $137.3 million as of December 31, 1999 and December 31, 1998, respectively.
We have audited the accompanying consolidated balance sheets of MMI Companies, Inc. and subsidiaries as of December 31, 1999 and 1998, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1999. Our audits also included the financial statement schedules listed in the Index at Item 14(a). These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
Chicago, Illinois February 24, 2000, except for Note 17 as to which the date is March 9, 2000.
MMI COMPANIES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands, except share and per share data)
MMI COMPANIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data)
MMI COMPANIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (In thousands, except per share data)
MMI COMPANIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
MMI classifies all of its fixed maturity and preferred stock investments as "available for sale," requiring that these investments be carried at fair value, with unrealized gains and losses, less related deferred income taxes, excluded from earnings and reported in stockholders' equity as accumulated other comprehensive income (loss).
The fair values of investments are reported in Note 4. The fair values of other financial instruments, principally accrued investment income, premiums and fees receivable, notes payable, accrued expenses and other liabilities and amounts due to reinsurers approximate their December 31, 1999 and 1998 carrying values. The fair value of mandatorily redeemable preferred capital securities is reported in Note 6.
Premiums are earned pro rata over the terms of the policies, which are generally one year. Adjustments to estimated premiums are made in the period in which it is determined an adjustment is warranted. Unearned premiums are calculated using the monthly pro rata basis.
The liability for future policy benefits principally represents reserves related to disability policies.
Costs in excess of net assets of purchased subsidiaries are being amortized on a straight-line basis over periods ranging from ten to twenty years. As of December 31, 1999 and 1998, accumulated amortization amounted to $10,000,000 and $12,600,000, respectively. See Note 15.
In June 1999, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 137, "Accounting for Derivative Instruments and Hedging Activities" which delayed the effective date of SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" for one year. SFAS 133 provides guidance for the recognition and measurement of derivatives and hedging activities. The new standard requires an entity to record, at fair value, all derivatives as either assets or liabilities in the balance sheet, and it establishes specific accounting rules for certain types of hedges. SFAS 133 is now effective for fiscal years beginning after June 15, 2000 and will be adopted by MMI when required, if not earlier. The impact, if any, of adopting SFAS 133 on MMI's consolidated financial position, results of operations and cash flows, has not been finalized.
On July 23, 1997, MMI acquired a 39% interest in JMA Holdings Limited (JMAHL), the parent company of Jago Managing General Agency Limited, a Lloyd's managing agency, for total consideration of $9,100,000. The consideration was comprised of $5,900,000 cash and $3,200,000 of short-term notes payable. JMAHL's financial results are included in the Company's consolidated financial statement on the equity basis.
The ARM, EMCVS and PRM acquisitions were accounted for as purchases, and the operations of the acquired businesses are included in MMI's consolidated financial statements since the dates of acquisition. Assets acquired, liabilities assumed, and the excess of cost over net assets purchased were as follows (in thousands):
The pro forma impact of the purchased businesses on results of operations was not material.
MMI's insurance subsidiaries are involved in the cession of reinsurance to other domestic and foreign companies, which permits the recovery of a portion of the gross losses. MMI's insurance subsidiaries would remain liable to the extent that these reinsurance companies are unable to meet their obligations under these arrangements.
MMI evaluates the financial condition of its reinsurers and monitors the geographic spread of risk to minimize the exposure to losses from reinsurer insolvencies. The reinsurers with the largest receivable balance due to MMI are identified as follows (in thousands):
In 1999, 1998 and 1997, respectively, MMI's losses and loss adjustment expenses were net of reinsurance ceded of $97,908,000, $99,743,000 and $64,000,000.
The expected maturities may differ from contractual maturities in the foregoing table because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties, or MMI may have the right to put obligations back to the issuer prior to stated maturity.
Certain investments of the international segment are held in a trust fund set up as collateral for holders of United States insurance policies. At December 31, 1999 and 1998, the fair value of fixed maturities in the trust fund amounted to $14,000,000 and $6,700,000, respectively. The required minimum trust fund for 1999 and 1998, was $13,800,000 and $5,400,000, respectively.
Fixed maturities of the international segment of $235,500,000 in 1999 and $273,200,000 in 1998 were held in a trust fund required by virtue of status as an accredited reinsurer in a number of United States jurisdictions.
Deferred income taxes reflect the net tax effect of temporary differences between the amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of MMI's deferred tax assets and liabilities as of December 31, 1999 and 1998 are as follows (in thousands):
Significant components of the provision for income taxes (credit) are as follows (in thousands):
A reconciliation of income tax computed at the United States federal statutory tax rate of 35% to income tax expense (credit) in the accompanying financial statements is as follows (dollars in thousands):
In December 1997, MMI completed a private placement of $125,000,000 30-year, mandatorily redeemable preferred capital securities (Capital Securities) of MMI Capital Trust I, a subsidiary of MMI. The Capital Securities pay a dividend of 7 5/8%, semiannually, in arrears and have a maturity date of December 15, 2027. Payments on the Capital Securities are fully and unconditionally guaranteed by MMI. Total proceeds were $118,700,000 net of expenses. The effective rate of the Capital Securities is 8.06%. The fair value at December 31, 1999 and 1998 was $98,300,000 and $121,900,000, respectively, and was estimated using discounted cash flow analyses, based on MMI's current incremental borrowing rates for similar types of borrowing arrangements.
With the proceeds from the Capital Securities, MMI repaid its $103,000,000 in bank debt. In connection with the extinguishment of the notes payable in 1997, costs of $700,000, net of taxes of $400,000, that were deferred when paid and amortized over the terms of the notes were expensed and are classified as an extraordinary item in the 1997 financial statements.
In February 1998, MMI obtained an unsecured bank line of credit in an amount up to $100,000,000. MMI drew upon the bank line on December 20, 1999 in the amount of $45,000,000. The interest rate on the loan was 8.5% through December 30, 1999 at which point the loan was converted to a floating rate loan with a rate of 6.3875%,
The statutory accounting practices prescribed or permitted by regulatory authorities for MMI's insurance subsidiaries differ in some respects from GAAP. Reconciliations of statutory-basis capital and surplus and net income (loss) of its domestic insurance operations to MMI's GAAP-basis amounts included in the accompanying financial statements are as follows (in thousands):
The maximum amount of dividends that can be paid from ACIC to MMI without regulatory approval is the lesser of net investment income or 10% of ACIC's statutory-basis capital and surplus, each as of the preceding December 31. Accordingly, the maximum total dividend amount is $18,000,000 in 2000. In 2000, dividend payment by ACIC to MMI require prior regulatory approval.
Pro forma information regarding net income (loss) and net income (loss) per share has been determined as if MMI had accounted for its stock option grants since January 1, 1995 under the plan using the fair value method of SFAS 123, "Accounting for Stock-Based Compensation." For these purposes, the fair value for the stock option grants was estimated at the date of the grant using a Black-Scholes option pricing model with the following weighted-average assumptions for 1999, 1998 and 1997, respectively: risk-free interest rate of 5%, 5% and 6%, a volatility factor of 64%, 33% and 29%, expected life of the option in years of five, five and four, and an annual dividend yield of 4%, 2% and 1%.
MMI has a defined-contribution pension plan that covers substantially all domestic employees who have attained age 21 and completed three months of service. MMI contributes 4% of salary for all eligible employees and matches a portion of employee contributions. MMI's contributions charged to operations were $3,200,000 in 1999, $2,900,000 in 1998 and $2,700,000 in 1997.
MMI operates a non-contributory, defined pension plan (the "Plan"), principally for its international employees. The Plan provides for monthly retirement benefits, normally at ages between 60 to 65, to eligible employees based on employee compensation and length of employment.
The following table is a summary of activity for the Plan (in thousands):
In the third quarter 1999, MMI consummated a plan of restructuring primarily in its consulting and fee businesses and recorded a pretax charge of $14,000,000. Total termination benefits were $1,400,000, involving 50 positions, of which 43 occurred in 1999 and 7 are planned for 2000. The remaining charges primarily are in connection with asset impairments of $8,900,000 and lease abandonment of $3,700,000 related to exiting certain lines of business.
The following outlines the activity related to the charge (in thousands):