We own our home office in East Lansing, Michigan which comprises approximately 89,000 square feet. In addition, we lease office space as needed in our major markets to provide a local presence. Our leases tend to be approximately five years in length. We currently lease a total of approximately 88,000 square feet of space in East Lansing, Michigan; Chicago, Illinois; Louisville, Kentucky; Boca Raton, Florida; Eden Prairie, Minnesota; Las Vegas, Nevada; and Albuquerque, New Mexico. We also own various real estate investment properties as part of our investment portfolio.
The following selected financial data, other than the selected statutory data, are derived from our consolidated financial statements which were prepared in accordance with generally accepted accounting principles. The data should be read in conjunction with the consolidated financial statements, related notes and other financial information included elsewhere in this report. The selected statutory data are derived from our annual statements which were prepared in accordance with statutory accounting practices as required by insurance regulatory authorities. See Note 19 of the consolidated financial statements included under Item 8 for a discussion of the principal differences between GAAP and statutory accounting practices.
(a) Operating results for the year ended December 31, 1999 include the effects of a one-time settlement with the Internal Revenue Service. Without this settlement, net income for the year ended December 31, 1999 would have been approximately $4.6 million.
(b) APAssurance's mergers with New Mexico Physicians Mutual Insurance Company and State Mutual Insurance Company in 1997 were accounted for under the pooling method of accounting.
(c) The weighted average shares outstanding for the period from December 13, 2000, the date of the closing of the conversion, through December 31, 2000 were 11,134,981 basic common shares and 11,260,797 common shares assuming dilution. The weighted average shares outstanding for the year ended December 31, 2001, were 11,071,529 basic common shares. As the Company was in a net loss position for the year ended December 31, 2001, no effect of awards or options were calculated as the impact would be anti-dilutive. There were no cash dividends declared during the periods presented.
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 following discussion contains certain forward-looking statements relating to our anticipated future financial condition and operating results and our current business plans. These forward-looking statements represent our outlook only as of the date of this report. While we believe any forward-looking statements we have made are reasonable, actual results could differ materially since the statements are based on our current expectations and are subject to risks and uncertainties. These risks and uncertainties are detailed elsewhere in this report and from time to time in other reports filed by the Company with the Securities and Exchange Commission. See the disclosures under "Item 1 -- Business -- Uncertainties Relating to Forward-Looking Statements."
We are a leading provider of medical professional liability insurance coverage, writing this coverage in 14 states throughout the country. This insurance coverage protects physicians and other health providers from claims filed against them for alleged acts of medical malpractice. Medical professional liability insurance represented 64.7% of our direct premiums written in 2001. In addition, we write workers' compensation insurance in 13 states, insuring a variety of business classes. During 2001, we also provided a limited amount of general personal and commercial coverage and participated in a health insurance program.
We purchase reinsurance to limit risk on our individual exposures, stabilize underwriting results and increase our capacity to write insurance. By purchasing reinsurance, we transfer a portion of our loss exposure to a reinsurer. Purchasing reinsurance does not discharge us from our obligation to our insureds. If the reinsurer fails to meet its obligations, we remain liable to pay the insured. We have various reinsurance agreements in place. In general, we retain the first $500,000 of a claim; reinsurers pay amounts in excess of $500,000 per claim.
We annually review the financial stability of all of our reinsurers. This review includes a ratings analysis of each reinsurer participating in a reinsurance contract. On the basis of this review, as of December 31, 2001, we concluded that there was no material risk of not being paid by our reinsurers. We have not experienced any material difficulties in collecting amounts due from reinsurers. We believe that our reinsurance is maintained with financially stable reinsurers and that any reinsurance security we have is adequate to protect our interests. However, our inability to collect on our reinsurance, or the inability of our reinsurers to make payments under the terms of reinsurance, due to insolvency or otherwise, could have a material adverse effect on our future results of operations and financial condition.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates and assumptions that affect amounts reported in the accompanying consolidated financial statements and related footnotes. These estimates and assumptions are evaluated on an on-going basis based on historical developments, market conditions, industry trends and other information we believe to be reasonable under the circumstances. There can be no assurance that actual results will conform to our estimates and assumptions, and that reported results of operations will not be materially adversely affected by the need to make accounting adjustments to reflect changes in these estimates and assumptions from time to time. The following policies are those we believe to be the most sensitive to estimates and judgments. Our significant accounting policies are more fully described in Note 1 to our consolidated financial statements.
UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES. The reserves for unpaid losses and loss adjustment expenses are actuarially estimated using the Company's claim experience. These estimates are subject to the effects of trends in loss severity and frequency. When a claim is reported to us, claims personnel establish a "case reserve" for the estimated amount of the ultimate payment. This estimate reflects an informed judgment based upon insurance reserving practices appropriate for the relevant line of business, and on the experience and knowledge of the estimator regarding the nature and value of the specific claim, the severity of injury or damage, and the policy provisions relating to the type of loss. Case reserves are periodically adjusted by the claims staff, as more information becomes available.
INVESTMENTS. Investments represent our largest asset and are the primary source of funds to pay insurance claims. All of our fixed maturity securities are classified as available-for-sale, which are those securities that would be available to be sold in the future in response to our liquidity needs, changes in market interest rates and asset-liability management strategies. Available-for-sale securities are reported at their estimated fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of other comprehensive income, net of deferred taxes. Investment income includes amortization of premium and accrual of discount on the yield-to-maturity method relating to investments acquired at other than par value.
RESERVE FOR EXTENDED REPORTING PERIOD CLAIMS. The reserve for extended reporting period claims coverage is recorded during the term of the original claims-made policy, utilizing the pure-premium approach, in amounts believed to be adequate to pay for estimated future claims reported subsequent to a current policyholder's death, disability or retirement. Amounts are estimated on a basis similar to the estimates made in respect of the reserve for unpaid losses and loss adjustment expenses. Changes in this reserve are reflected as an expense in the period in which the adjustment is made.
REINSURANCE. In accordance with industry practice, we cede to other insurance companies some of the potential liability under insurance policies we have underwritten. This practice, called reinsurance, helps us reduce our net liability on individual risks, stabilize our underwriting results and increase our underwriting capacity. As payment for sharing a portion of our risk, we are also required to share a part of the premium we receive on the related policies. We determine the amount and scope of reinsurance coverage to purchase each year based upon an evaluation of the risks accepted, consultations with reinsurance brokers and a review of market conditions, including the availability and pricing of reinsurance. Our reinsurance arrangements are generally renegotiated annually.
Set forth below are our GAAP ratios by product line for each of the last three years. The loss ratio compares our losses and loss adjustment expenses to our net premiums earned and indicates how much we expect to pay to policyholders for claims and related settlement expenses compared to the amount of premiums we earn. The lower the percentage, the more profitable our insurance business. The underwriting expense ratio compares our expenses to obtain new business and renew existing business plus normal operating expenses to our net premiums earned and is used to measure how efficient we are at obtaining business and operating the company. The lower the percentage, the more efficient we are. Sometimes, however, a higher underwriting expense can result in better business and improve our loss ratio and overall profitability. The
MEDICAL PROFESSIONAL LIABILITY INSURANCE OPERATIONS. Medical professional liability net premiums earned were $119.7 million for the year ended December 31, 2001, an increase of $10.2 million, or 9.3%, compared to 2000. The increase in net premiums earned was mainly due to price increases and reduced discounts we instituted in all states. Also, we experienced greater penetration of the Florida and Illinois markets. However, these factors were offset by the reduction in the number of insured physicians in Ohio and Kentucky due to re-underwriting efforts. We are currently seeking regulatory approval of significant additional rate increases.
Medical professional liability incurred loss and loss adjustment expenses totaled $168.6 million for the year ended December 31, 2001, an increase of $72.6 million, or 75.6%, compared to 2000. The incurred loss and loss adjustment expense ratio increased to 140.9% for the year ended December 31, 2001 from 87.6% for 2000. The increase in loss ratio was due primarily to reserve adjustments taken in the third and fourth quarters, which related to prior accident years and revisions made to current year expected losses. Due to the unexpected significant increase in reported losses and claim severity primarily in our newer markets in the third quarter of 2001, including an unusually high frequency of large claims, we undertook and completed a comprehensive internal actuarial study. As a result of this study, we revised the actuarial assumptions upon which loss reserves are based and adjusted loss reserves accordingly.
WORKERS' COMPENSATION INSURANCE OPERATIONS. Workers' compensation net premiums earned were $58.4 million for the year ended December 31, 2001, an increase of $11.4 million, or 24.3%, compared to 2000. The increase in net premiums earned was due primarily to retroactive premium adjustments and reduced credits following audits, as well as growth in the number of policies written in the states of Minnesota, Illinois and Indiana. We are seeking regulatory approval of significant additional rate increases.
Workers' compensation incurred loss and loss adjustment expenses totaled $62.7 million for the year ended December 31, 2001, an increase of $25.0 million, or 66.3%, compared to 2000. The incurred loss and loss adjustment expense ratio increased to 107.4% for the year ended December 31, 2001 from 80.3% for 2000. The increasing loss ratio was due to an overall pattern of increasing losses, especially in our newer states, Illinois, Iowa and Kentucky, where we have less historical data on which to base our estimates. As a result of these high loss patterns, we increased our prior year reserves in almost all markets by a total of $5.6 million. The current accident year loss estimates were increased to $57.1 million, primarily in the markets noted above. After these adjustments, the 2001 accident year net loss and loss adjustment expense ratio is 97.8%.
Workers' compensation underwriting expenses were $16.4 million for the year ended December 31, 2001, an increase of $3.1 million, or 23.3%, compared to 2000. The underwriting expense ratio decreased to 28.1% for the year ended December 31, 2001, from 28.3% for 2000. The decrease resulted primarily from our expense reduction initiatives, lower assessments and fees, and premium increases.
HEALTH INSURANCE OPERATIONS. Health net premiums earned were $18.7 million for the year ended December 31, 2001, an increase of $7.6 million, or 68.5%, compared to 2000. The increase was due to one health insurance program through a preferred provider organization in western Michigan. We discontinued all of our other health insurance programs during 2001.
Health underwriting expenses were $4.2 million for the year ended December 31, 2001, an increase of $500,000, or 13.5%, compared to 2000. The underwriting expense ratio decreased to 22.5% for the year ended December 31, 2001 from 33.2% for 2000. The reduction was directly related to our expense reduction initiatives and premium increases.
PERSONAL AND COMMERCIAL LINES INSURANCE OPERATIONS. Personal and commercial net premiums earned were $5.7 million for the year ended December 31, 2001, a decrease of $7.1 million, or 55.5%, compared to 2000. The decrease was due to our exiting this line of business. There will be no premiums in future periods.
Personal and commercial incurred loss and loss adjustment expenses totaled $8.1 million for the year ended December 31, 2001, a decrease of $1.7 million or 17.3%, compared to 2000. The incurred loss and loss adjustment expense ratio increased to 143.2% for the year ended December 31, 2001, from 76.7% for 2000. The increasing loss ratio was due primarily to a higher amount of winter storm-related losses in 2001 and the adverse effects of discontinuing this line of business.
Personal and commercial underwriting expenses were $1.2 million for the year ended December 31, 2001, a decrease of $3.4 million, or 73.9%, compared to 2000. The underwriting expense ratio decreased to 21.8% for the year ended December 31, 2001 from 35.8% for 2000. The reduction was directly related to our exit from this line of business beginning in the fourth quarter of 2000.
CORPORATE, INVESTMENTS AND OTHER. Net investment income, excluding realized investment gains and losses, was $47.9 million for the year ended December 31, 2001, an increase of $11.1 million, or 30.2%, compared to 2000. Approximately $7.8 million of the annual increase is attributable to investment of the proceeds of our initial public offering received in December 2000. In addition, in 2000 we liquidated approximately $35.0 million in equity securities, invested the proceeds in interest income producing government and corporate bonds and shifted some of our portfolio from tax-exempt securities to higher yielding taxable corporate securities. Net realized losses and gains were ($5.6 million) and $1.2 million during the year ended December 31, 2001 and 2000, respectively. Approximately $6.0 million of the 2001 loss was attributable to a security whose decline in market value in 2001 we considered to be other than temporary. We maintain a portfolio of cash and short-term investments to meet operating cash needs, fund the share repurchase programs and fund potential acquisitions. Recent reductions in short-term interest rates have reduced the yields generated by this portfolio.
We incurred an additional restructuring charge of $2.5 million in 2001. The elimination of nine staff members located in our now closed Michigan personal and commercial branch office resulted in $567,000 of this charge. The remainder of the charge was related to severance costs incurred in the elimination of 11 staff members at our East Lansing home office in the Information Systems department and Senior Management. These actions were taken as part of an overall corporate restructuring. The expected annual savings for the entire restructuring is $1.4 million. At December 31, 2001, there was $1,130,000 accrued for restructuring charges that was paid in January 2001.
underwriting expense ratio decreased to 18.8% in 2000 from 23.0% in 1999. This decrease was due primarily to expense reduction measures that we began implementing in the fourth quarter of 1999 and the acquisition of the management company in 1999.
WORKERS' COMPENSATION INSURANCE OPERATIONS. Net premiums earned increased by $10.2 million, or 27.7%, to $47.0 million in 2000. The majority of this increase was in the Minnesota market.
Health incurred loss and loss adjustment expenses totaled $10.0 million for the year ended December 31, 2000, an increase of $400,000 or 4.2%. The incurred loss and loss adjustment expense ratio decreased to 90.6% for the year ended December 31, 2000, from 199.3% for 1999. The decrease in loss ratio was due to a one-time reserve establishment incurred in 1999.
PERSONAL AND COMMERCIAL LINES INSURANCE OPERATIONS. Personal and commercial lines net premiums earned increased $2.1 million, or 19.6%, to $12.8 million in 2000 primarily due to rate increases. However, with the conclusion of 2000, we began the process of winding down the personal and commercial segment.
The primary sources of our liquidity, on both a short- and long-term basis, are funds provided by insurance premiums collected, net investment income, recoveries from reinsurance and proceeds from the maturity or sale of invested assets. The primary uses of cash, on both a short- and long-term basis, are losses, loss adjustment expenses, operating expenses, reinsurance premiums and taxes. In addition, we are indebted to a related party in the amount of $9 million in connection with the purchase of Stratton-Cheeseman Management Company. The indebtedness is due in annual installments, without interest, over the next eight years. At December 31, 2001, we had no material commitments for capital expenditures.
Our net cash flow from operating activities was approximately $13.0 million for 2001, compared to $70.0 million for 2000. The decrease was primarily due to the large net loss in 2001 and a federal income tax recovery and related interest totaling $39.3 million in 2000. We invest our positive cash flow from operations in both fixed maturity securities and equity securities. Our investment strategy seeks to maximize after-tax income through a high quality, diversified, duration sensitive, taxable bond and tax-preferenced municipal bond portfolio, while maintaining an adequate level of liquidity. Should we experience a dramatic decrease in premiums and operating cash flow, funds to operate the Company and to pay claims would come from investment earnings and liquidation of the investment portfolio.
In 2001, on a consolidated basis, we had $106.4 million of cash available and an investment portfolio of $646.1 million. The large cash position at December 31, 2001 reflects the residual of the net proceeds of $142.5 million from our stock offerings in December 2000. The portfolio includes $16.9 million of bonds maturing in the next year to meet short-term cash flow needs. On a long-term basis, fixed income securities are purchased on a basis intended to provide adequate cash flows from future maturities. At December 31, 2001, $281.6 million of bonds mature in the next one to five years and $264.8 million mature in the next five to ten years.
The unearned premium reserve increased $12.0 million, or 13.6%, to $100.1 million at December 31, 2001, from $88.0 million at December 31, 2000. The increase was due primarily to the higher seasonal writing in medical professional liability in the third quarter of 2001.
Based on historical trends, market conditions and its business plans, we believe that our existing resources and sources of funds will be sufficient to meet our short- and long-term liquidity needs over the next 18 months and beyond. However, because economic, market and regulatory conditions may change, there can be no assurance that our funds will be sufficient to meet these liquidity needs.
APCapital itself is a holding company whose only material assets are the capital stock of APAssurance and its other subsidiaries and a portion of the net proceeds from the stock offerings completed in December 2000. APCapital is using these funds to finance its long- and short-term liquidity needs, which include operating expenses, financing future acquisitions, additional share repurchases, and additional contributions to its subsidiaries. APCapital's ongoing cash flow will consist primarily of dividends and other permissible payments from its subsidiaries and investment earnings on funds held. The payment of dividends to APCapital by its insurance subsidiaries is subject to limitations imposed by applicable law. APAssurance's ability to pay dividends to APCapital is influenced by a variety of factors, including cyclical changes in the medical professional liability insurance market, APAssurance's financial results, insurance regulatory changes, including changes in the limitations imposed by the Michigan Holding Company Systems Act on the payment of dividends by APAssurance and changes in general economic conditions.
In July 2001, the FASB issued SFAS No. 141 "Business Combinations" and SFAS No. 142 "Goodwill and Intangible Assets." These standards provide guidance on the accounting for acquired businesses. In addition, these standards eliminate the "pooling of interest" method for transactions initiated after June 30, 2001, and effective January 1, 2002, eliminate the amortization of goodwill and intangible assets with an indefinite life. The standards require annual impairment testing and potential loss recognization for goodwill and intangible assets. The change regarding the elimination of goodwill and other intangible amortization will be made prospectively with the adoption of the new standard as of January 1, 2002. Prior period financial results will not be restated. Management is currently evaluating implementation of this standard, however, anticipates that we have no finite lived intangibles, and as a result, will no longer incur amortization expense on our recorded goodwill beginning January 1, 2002.
In our opinion, the consolidated financial statements listed in the index appearing under Item 14, present fairly, in all material respects, the financial position of American Physicians Capital, Inc. and its subsidiaries at December 31, 2001 and 2000 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the index appearing under Item 14 present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedules are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America which require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
On December 13, 2000, the conversion of APA from a mutual company to a stock corporation was consummated according to a Plan of Conversion adopted by the Board of Directors of MICOA on June 28, 2000, with subsequent amendment on October 2, 2000. This plan was approved by MICOA policyholders at a special meeting held on November 29, 2000 and by the State of Michigan Office of Financial and Insurance Services. The Plan of Conversion included several key components, including: formation of APCapital to be the ultimate parent holding company; the conversion of APA from a mutual insurance company to a stock company and wholly-owned by APCapital; the transfer of ICA, APS, APConsulting, APDirect Sales, and Alpha Advisors, Inc. from APA to wholly-owned subsidiaries of APCapital.
In connection with the conversion, 331,638 shares of common stock of APCapital were sold at $13.50 per share under a subscription rights and best efforts offering to MICOA policyholders, officers, directors, employees, and others. APCapital then sold 9,668,362 shares of its common stock in an underwritten public offering ("the Offering") that closed December 13, 2000. On December 13, 2000, an additional 1,450,254 shares were sold to underwriters of the Offering pursuant to an over-allotment option contained in the underwriting agreement. The net proceeds of the Offering were approximately $142.6 million, consisting of gross proceeds of $154.6 million less conversion and offering expenses of $12.0 million.
In March, July and November 2001, APCapital's board of directors authorized three separate 5% programs to purchase outstanding common stock, representing approximately 1,689,000 shares. APCapital repurchased 1,369,170 shares during 2001 at a total cost of $25.2 million.
The Company is principally engaged in the business of providing medical professional liability, workers' compensation and health insurance throughout the United States with a concentration of writings in the Midwest. During the year, the Company ceased writing personal and commercial insurance.
Equity securities are carried at quoted market values. Fair values of fixed maturities and equity securities are determined on the basis of dealer or market quotations or comparable securities on which quotations are available. Mortgage loans are carried at the unpaid principal balance, which approximates the fair market
Cash equivalents consist principally of commercial paper and money market funds, are stated at cost, which approximates fair value, and have original maturities of three months or less.
Premiums written are earned primarily using pro rata methods over the period of risk. Premiums receivable include $56,679,000 at December 31, 2001 and $38,564,000 at December 31, 2000 of premium installments. Receivable balances consist principally of written premiums from physicians in the states of Michigan, Ohio, Illinois, Florida, and Minnesota. Receivables are generally collateralized by unearned premiums.
Deferred policy acquisition costs ("DAC") include commissions, premium taxes and other costs incurred in connection with writing business. These costs are deferred and amortized over the period in which the related premiums are earned. Future investment income has been considered in determining the recoverability of deferred costs.
Property and equipment are recorded at cost. Depreciation is computed for assets using straight-line and accelerated methods over the following periods: building -- 40 years, furniture -- 10 years, and computer equipment and software -- 5 years. Upon the sale or retirement of property and equipment, balances are removed from the respective accounts and any gain or loss is included in income.
Deferred income taxes are recognized at prevailing income tax rates for temporary differences between financial statement and income tax bases of assets and liabilities and net operating loss carryforwards for which income tax benefits will be realized in future years.
Goodwill consists of the excess of cost over fair market value of net assets of acquired businesses. Goodwill is amortized on a straight-line basis over a period of ten years. Accumulated amortization was $3,863,000 and $4,408,000 at December 31, 2001 and 2000, respectively.
The carrying value of goodwill is reviewed annually to determine if any impairment has occurred. The Company measures the potential impairment of recorded goodwill based on the estimated undiscounted cash flows of the entity acquired over the remaining amortization period. During 2001, it was determined that the goodwill associated with the purchase of Alpha Advisors, Inc. and ICA was impaired based on changes in organizational structure and ongoing operating losses. This resulted in additional amortization expense of $380,000.
Net income (loss) per share is computed by dividing net income (loss) by the weighted average number of shares of common stock and common stock equivalents (stock options and stock grants) outstanding during each year (See Note 17).
The preparation of financial statements in conformity with generally accepted accounting principals ("GAAP") requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements
and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
In July 2001, the FASB issued SFAS No. 141 "Business Combinations" and SFAS No. 142 "Goodwill and Intangible Assets." These standards provide guidance on the accounting for acquired businesses. In addition, these standards eliminate the "pooling of interest" method for transactions initiated after June 30, 2001, and effective January 1, 2002, eliminate the amortization of goodwill and intangible assets with an indefinite life. The standards require annual impairment testing and potential loss recognization for goodwill and intangible assets. The change regarding the elimination of goodwill and other intangible amortization will be made prospectively with the adoption of the new standard as of January 1, 2002. Prior period financial results will not be restated. Management is currently evaluating implementation of this standard, however, anticipates that the Company has no finite lived intangibles, and as a result, will no longer incur amortization expense on its recorded goodwill beginning January 1, 2002.
Effective October 31, 1999, APA purchased 100% of the outstanding stock of Stratton-Cheeseman Management Company ("SCMC") which was substantially owned by the president of the Company, for $19.5 million, consisting of $9.5 million in cash and a commitment to pay $10 million in installments over the next nine years without interest. Installments began April 30, 2001 and are to be made annually thereafter. The Company discounted the non-interest bearing obligation, using a discount rate of approximately 6%, recording a note payable of $7.3 million. The acquisition was accounted for using purchase accounting and resulted in the recognition of $16.6 million in goodwill. The remaining purchase price was allocated to the fair value of the asset acquired, consisting of a $150,000 investment in an unaffiliated entity. The purchase
agreement contains certain provisions, including change of control provisions, for the acceleration or cancellation of the $10 million commitment. If the commitment is accelerated or cancelled, any remaining discount or amounts forfeited will be recorded as an adjustment to goodwill. Annual payments will increase or decrease by $200,000 for each corresponding half-grade level increase or decrease in the Company's A.M. Best Company, Inc. rating during the term of the payments. Any amounts paid for changes in the industry rating will be recorded as compensation expense in the period earned. If the Company terminates the president or if he dies or is disabled, payments will accelerate. Unaudited pro forma revenues and net income, as if this transaction had occurred as of January 1, 1999, do not differ significantly, from revenues and net income presented in the accompanying statement of income.
Bonds with amortized costs of $8,297,000 and $8,764,000 were on deposit with various states as of December 31, 2001 and 2000, respectively. Proceeds on the sales of investments in bonds totaled $27,400,000 in 2001, $212,701,000 in 2000, and $15,243,000 in 1999.
Changes in deferred policy acquisition costs for the years ended December 31, 2001, 2000 and 1999 are summarized as follows:
At December 31, 2001 and 2000, property and equipment consisted of the following:
Reinsurance arises from the Company seeking to reduce its loss exposure on its higher limit policies related primarily to medical malpractice. The Company has mainly entered into excess of loss contracts for medical malpractice and workers' compensation. A reconciliation of direct-to-net premiums, on both a written and earned basis, for 2001, 2000, and 1999 is as follows:
Losses and loss adjustment expenses incurred are net of ceded losses of $44,385,000 for 2001, $30,417,000 for 2000, and $43,132,000 for 1999.
Income taxes incurred do not bear the usual relationship to income before income taxes due to the following:
At December 31, 2001 and 2000, the components of the net deferred tax asset were as follows:
At December 31, 2001, the Company has approximately $37.2 million of net operating loss carryforwards of which $28.6 million expire in 2021 and are not limited to their use and $8.6 million of which expire in 2012 and are limited to approximately $900,000 annually.
On November 17, 1999, the Company received notice from the Internal Revenue Service acknowledging their approval of an outstanding claim for refund totaling $25,267,000 and interest thereon of approximately $9.8 million. The refund was the result of a settlement with the IRS regarding the tax treatment of loss reserves. The interest component, net of fees, is included in other income in 1999 operations. The taxes refunded have been reported as a federal income tax credit in 1999 operations. On February 17, 2000, the Company received the first installment of the refund which totaled $27.6 million of tax and interest. On June 16, 2000, the Company received the second and final installment of $8.5 million, which included interest earned in 2000.
Approximately $992.1 million of consolidated assets represents assets of the Company's insurance operations that are subject to regulation and may not be transferred to APCapital in the form of dividends, loans or advances. The amount of dividends that the Company's insurance subsidiaries can pay to APCapital in any 12-month period is limited to the greater of statutory net income for the preceding year, excluding realized gains (losses) on sales of investments, or 10% of surplus as of the preceding year end. As of January 1, 2002, approximately $12.3 million could be paid by the Company's insurance subsidiaries without prior regulatory approval.
SFAS No. 107, "Disclosures About Fair Value of Financial Instruments", requires disclosures of fair-value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate the value. In situations where quoted market prices are not available, fair values are to be based on estimates using present value or other valuation techniques. SFAS No. 107 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements.
In 2001, a representative from a law firm providing legal services to the Company was appointed an officer of the Company. Legal services provided by this firm to the Company during 2001 was $370,000.
The Company offers benefits under certain defined contribution plans. In 2001, the defined contribution plans provide for Company contributions of 5% of employee compensation, as defined in the plan and a 100% match of employee contributions on the first 3% of contributions and 50% match on the next 2% of contributions (10% of employee compensation and a 25% match of employee contributions on the first 4% of contributions for the years 2000 and 1999). Employer contributions to the plans were approximately $1,654,000, $1,401,000, and $1,405,000 for 2001, 2000 and 1999, respectively.
In connection with the conversion, the Board of Directors adopted the American Physicians Capital, Inc. Stock Compensation Plan (The "Plan"). The plan provides for the award of stock options and stock awards for officers, directors and employees of the Company. These awards must be approved by the compensation committee of the board of directors. The total number of shares of the Company's common stock which shall be available for options and stock awards is 1,200,000 shares.
A summary of the Company's stock option activity is as follows:
In December 2000, the Company granted 135,200 restricted shares of APCapital common stock, having a per share market value of $13.50 to certain officers, board members and employees. The restricted shares vest in annual installments of 10%, 15%, 20%, 25% and 30% on the first through fifth anniversaries, respectively, of the date of grant.
For pro forma disclosure purposes, the fair value of stock options was estimated at the date of grant using a Black-Scholes option pricing model using the following assumptions:
Basic and diluted earnings per share are calculated in accordance with SFAS Statement No. 128, "Earnings per Share."
The following table sets forth the computation of basic and diluted earnings per share for the year ended December 31, 2001 and the period ended December 31, 2000:
The Company participates in various guaranty associations in the states in which it writes business, which protect policyholders and claimants against losses due to insolvency of insurers. When an insolvency occurs, the associations are authorized to assess member companies up to the amount of the shortfall of funds, including expenses. Member companies are assessed based on the type and amount of insurance written during the previous calendar years. The Company accrues for its portion of assessments in accordance with SOP 97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments." Assessments to date are not significant; however, the ultimate liability for future assessments is not known. Accordingly, the Company is unable to predict whether such future assessments will materially affect the financial condition of the Company.
- Assets designated as "nonadmitted assets" are charged directly to surplus for statutory accounting purposes.
- Bonds and U. S. government securities, which the Company does not intend to hold to maturity, are generally carried at amortized cost for statutory accounting purposes.
- Deferred federal income taxes are recognized for generally accepted accounting principles and were not recorded for statutory purposes prior to 2001.
On January 1, 2001, significant changes to the statutory basis of accounting became effective in all states in which the Company is licensed. The cumulative effect of these changes, known as the Codification guidance, was recorded as a direct adjustment to statutory surplus. The effect of adoption resulted in an increase in statutory surplus of $16.7 million.
The unaudited operating results by quarter for 2001, 2000, and 1999 are summarized below:
- --------------- * For periods subsequent to conversion; (for periods where the Company incurred a loss, no effect of awards or options were calculated as the impact would be anti-dilutive).
SCHEDULE II -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT AMERICAN PHYSICIANS CAPITAL, INC. (PARENT COMPANY) CONDENSED BALANCE SHEET DECEMBER 31, 2001 AND 2000
SCHEDULE II -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT AMERICAN PHYSICIANS CAPITAL, INC. (PARENT COMPANY) CONDENSED STATEMENT OF OPERATIONS YEARS ENDED DECEMBER 31, 2001 AND 2000
CONDENSED STATEMENT OF CASH FLOW YEARS ENDED DECEMBER 31, 2001 AND 2000
SCHEDULE II -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT AMERICAN PHYSICIANS CAPITAL, INC. (PARENT COMPANY) NOTES TO CONDENSED FINANCIAL INFORMATION OF REGISTRANT YEAR ENDED DECEMBER 31, 2000
APIndemnity (Bermuda) Ltd. -- A Bermuda company that provides a rent-a-captive vehicle for clients and prospects.
In connection with the conversion, 331,638 shares of common stock of APCapital were sold at $13.50 per share under a subscription rights and best efforts offering to MICOA policyholders, officers, directors, employees, and others. APCapital then sold 9,668,362 shares of its common stock in an underwritten public offering ("the offering") that closed December 13, 2000. On December 13, 2000, an additional 1,450,254 shares were sold to underwriters of the offering pursuant to an over-allotment option contained in the offering agreement. The net proceeds of the offering were approximately $142.6 million, consisting of gross proceeds of $154.6 million less conversion and offering expenses of $12.0 million.