Following is the selected financial data of the Company for the five years ended December 31, 2001. This data should be read in conjunction with the audited consolidated financial statements and notes thereto appearing under Item 8 of this Form 10-K.
(1) Amounts derived from audited consolidated financial statements of Midwest Holding included in Item 8 of this Form 10-K.
The majority of the Company's assets are invested in investment-grade bonds, common stocks, real estate investment trusts and short-term investments. These investments totaled $247,293,000 and $263,436,000 at December 31, 2001 and 2000, respectively, which represented 86.0% and 87.3% of total assets. The Investment Committee of the Board of Directors establishes the Company's investment policy. The main objectives of the current investment policy are the preservation of assets, maximizing pre-tax total portfolio return, and assuring adequate liquidity to meet operational requirements primarily the payment of insurance claims. Fixed maturity investments and equity securities are classified as available for sale and therefore are carried at fair value. The real estate investment trusts are recorded at appraised value and short-term investments are recorded at cost which approximates fair value.
Increases in new business and premium rates drove greater cash receipts from policyholder premiums in 2001. The increase in new business opportunities is primarily the result of the easing of competitive pressures in Midwest Medical's markets. Two main competitors, The St. Paul Companies and PHICO, have recently exited from the medical malpractice insurance marketplace and other competitors are generally raising rates aggressively or exiting certain segments of the medical malpractice market. Increasing reinsurance costs and claims severity has caused and will likely continue to cause Midwest Medical to raise premium rates in the near term. Midwest Medical, however, has generally not had to raise rates to the same degree as other insurers in many parts of the United States medical malpractice insurance market.
Over $65,000,000 of premium has been returned to policyholders since 1993 through policyholder dividends or retrospective premium credits. The policyholder dividend program replaced the retrospective premium credit program beginning in 1999. Policyholder dividends are generally paid in four equal installments in February, May, August and November of the year following their declaration by the Board of Directors.
In the past, loss and operating expense payments have generally been met from policyholder premium receipts with any excess cash invested. In 2001, operating cash needs primarily from claim payments exceeded premium receipts requiring approximately $8,800,000 of cash from the investment portfolio. Premium receipts are expected to once again cover loss and operating expenses in 2002 due to the recent increase in premium volume and rates. Management regularly analyzes loss liabilities to project the cash flow required in future years. Since the overall investment portfolio is highly liquid, exact matching of bond maturities and loss liabilities is not a goal. Bond maturities are primarily selected to maximize total return.
During 2000, Midwest Holding completed a stock restructure that exchanged and redeemed all outstanding Class A Common Shares. Under the terms of the stock restructure, Class A shareholders received $66 for each Class A share owned, plus one Class C share. The stock restructure paid approximately $9,541,000 to Class A shareholders for the redemption of their Class A shares. An $8,500,000 loan from Midwest Medical to Midwest Holding largely funded these payments. Midwest Medical primarily used proceeds from sales of domestic equity securities to provide the loan. The loan was a non-interest bearing note and was retired in May 2001 by Midwest Holding through a dividend received from Midwest Medical. More details about the stock restructure, Class A and Class C Common Stock are found in Note 3 to the audited consolidated financial statements.
Periodically, the Board of Directors of Midwest Medical declares dividends payable to Midwest Holding to provide capital for holding company and non-insurance business operations including new business ventures. In 2001, a dividend from Midwest Medical was also used by Midwest Holding to retire an $8,500,000 loan used to fund stock restructure payments in 2000. Midwest Medical declared and paid dividends to Midwest Holding of $11,400,000, $3,000,000 and $2,050,000 in 2001, 2000 and 1999, respectively.
Net premiums earned increased $8,753,000 in 2001 from 2000. The increase was the result of the following significant factors:
5. Due primarily to the increase in premiums written, current year reinsurance costs were $1,685,000 greater in 2001 compared to 2000. This decreased 2001 net premiums earned.
1. The estimated reinsurance premium applicable to the treaty years 1992-1994 and 1995-1997, which is based in part on reinsured claims experience, increased $634,000 on a net basis in 2000. This compares to a net reduction for those treaty years of $5,920,000 in 1999 resulting in a net decrease in premium between years of $6,554,000.
3. Due primarily to the new reinsurance program for fraud and abuse provided at no additional cost to Midwest Medical policyholders, current year reinsurance costs were $968,000 greater in 2000 compared to 1999. This decreased 2000 net premiums earned.
Other revenues increased $1,610,000 from $2,413,000 in 1999 to $4,023,000 in 2000. Interest on federal tax refunds of $1,716,000 recorded by Midwest Medical in 2000 primarily caused the increase. Revenues from the new information technology consulting division of Solutions also contributed to the increase. A decrease in income from Midwest Holding's officer life insurance policies partially offset the above increases.
The following schedule summarizes the development of the liability for loss and loss adjustment expense from 1991 through 2001. This schedule is presented net of reinsurance, which the Company believes best explains the development as it affects operating results. Midwest Medical has a conservative loss reserving policy that when coupled with a decline in medical malpractice insurance claim frequency since the early 1990's has generally resulted in redundancies in the liability for losses and loss adjustment expenses. The table indicates that the redundancy in loss liabilities, which develop as actual results become known, has significantly decreased since 1991. Downward competitive pressure on premium rates during the latter portion of the 1990's coupled with increasing claims severity have been major contributors to the decrease in redundancies. Loss and loss adjustment expense liabilities have not been discounted in the Company's financial statements.
Development of Liability for Loss and Loss Adjustment Expense (Thousands of Dollars)
Underwriting, acquisition and insurance expenses increased $1,274,000 from $7,570,000 in 2000 to $8,844,000 in 2001. Greater premium volume drove a $1,179,000 increase in commission payments and a $399,000 increase in premium taxes. These increases were partially offset by greater ceding commissions earned by Midwest Medical of approximately $243,000 resulting from the increase in premiums ceded to the treaty reinsurance contract for the current year.
Underwriting, acquisition and insurance expenses increased $373,000 from $7,197,000 in 1999 to $7,570,000 in 2000. Less ceding commissions earned by Midwest Medical due to a decline in the premiums ceded to the treaty reinsurance contract for the current year drove approximately $216,000 of the increase. Greater commissions paid in 2000 due to enhanced agent incentives contributed an additional $215,000. These increases were partially offset by lower premium taxes. Lower written premium volume in 2000 and the $10,175,000 of policyholder dividends paid during the year, which is deductible for premium tax purposes, caused the decline in premium taxes.
Other operating expenses increased $79,000 from $6,822,000 in 2000 to $6,901,000 in 2001. Additional staff for Solutions' technology consulting and practice management software initiatives and greater commissions paid to Services' producers from new business primarily drove the increase. This was partially offset by the decrease in stock restructure expenses, which were all incurred in 2000 by Midwest Holding.
Loss from continuing operations before income taxes was $(6,448,000) in 2001 compared to income of $6,022,000 in 2000. The decrease resulted primarily from greater loss liabilities estimated for the current year, less favorable development on prior years' loss liabilities and lower realized capital gains. This was partially offset by an increase in net premiums earned and lower policyholder dividends. Income in 2000 also benefited from some non-recurring items such as the realized capital gains recorded on sales of domestic equity securities to fund the stock restructure as well as interest on federal tax refunds.
Discontinued operations represent the impact of the sale of MedPower effective July 31, 2001. The Company decided to sell MedPower as continued strong competition in the electronic medical claims processing marketplace diminished the prospect of generating sufficient revenues for MedPower to earn a profit. The Company incurred a loss net of tax of $(135,000) on the 2001 operation of MedPower through July 31 and recorded a loss net of tax of $(240,000) on the sale. Further information regarding MedPower and its sale is found in Notes 1 and 2 to the audited consolidated financial statements.
2. the effects of increased competition on pricing, coverage terms, retention of customers and ability to attract new customers;
The audited consolidated financial statements of Midwest Medical Insurance Holding Company and Subsidiaries are presented on the following pages 24 through 53 of this Annual Report on Form 10-K.
The Board of Directors Midwest Medical Insurance Holding Company and Subsidiaries
The Company's consolidated financial statements include the accounts of Midwest Medical Insurance Holding Company (Midwest Holding) and its wholly owned subsidiaries, Midwest Medical Insurance Company (Midwest Medical), MMIHC Insurance Services, Inc. (Services) and Midwest Medical Solutions, Inc. (Solutions). All transactions between Midwest Holding and its subsidiaries have been eliminated in consolidation, with the exception of the distribution of capital to Midwest Holding by Midwest Medical in the form of dividends for periods prior to 2001.
Hereafter, Midwest Holding, Midwest Medical, Services and Solutions shall be collectively referred to as the Company unless the reference pertains to a specific entity.
Services was incorporated in 1995 and began active operations in January 1999 with the acquisition of a book of business from Johnson-McCann Benefits, Inc. Services is an insurance agency specializing in providing clients with group insurance products such as health, dental, life, disability and workers' compensation.
Prior acts coverage may be purchased by policyholders who were previously insured under a "claims made" policy with another professional liability insurer for an additional premium at the option of the insured in lieu of purchasing reporting endorsement coverage from the previous insurer.
The consolidated financial statements have been presented in conformity with accounting principles generally accepted in the United States, which differ in certain respects from statutory accounting practices followed by Midwest Medical in reporting to the Minnesota Department of Commerce (see Note 11).
Consistent with management's classification of its investment in debt and equity securities as available for sale, such investments are carried at fair value, with unrealized holding gains and losses reflected as a component of other comprehensive income, net of applicable deferred taxes.
Other investments are less than 20% equity interests in non-traded real estate investment trusts and are recorded at appraised value.
The liability for unpaid losses and loss adjustment expenses represents an estimate of the ultimate cost of all such amounts which are unpaid at the balance sheet dates. The liability is based on both case-by-case estimates and statistical analysis and projections using the historical loss experience of Midwest Medical and gives effect to estimates of trends in claim severity and frequency. These estimates are continually reviewed and, as adjustments become necessary, such adjustments are included in current operations. Midwest Medical believes that the estimate of the liability for losses and loss adjustment expenses is reasonable.
Premiums received are recorded as earned ratably over the lives of the policies to which they apply. A portion of premiums received is deferred to recognize Midwest Medical's obligation to provide reporting endorsement coverage without additional premium upon the death, disability, or retirement of policyholders. This amount is recorded as an unearned premium reserve and represents the actuarially determined present value of future benefits to be provided less the present value of future revenues to be received.
Acquisition costs are expensed when incurred. As most of its premium is written without the use of intermediaries, Midwest Medical does not pay significant amounts in commissions.
Other revenues consist primarily of Services' commission income from insurance carriers and Solutions' technology consulting and software sales and support to healthcare providers. Generally, such revenues are earned as the related services and products are provided or performed.
Effective November 30, 1988, Midwest Medical policyholders earned Class A Common Shares for each month of service pursuant to a stock allocation formula based on underwriting risk classification. Shares earned by new policyholders were not issued until the end of five years of continuous coverage under a Midwest Medical policy (the vesting date). At the vesting date, the issued shares were recorded at the then current redemption value.
Midwest Holding accounted for these shares by increasing common stock by the par value ($.01 per share) of the newly issued shares, increasing paid-in capital by the excess of the redemption value over par and charging stock compensation expense for the full redemption value. Once vested, policyholders continued to earn shares for each month they remained insured with Midwest Medical according to the stock allocation formula. Midwest Holding accounted for additional shares issued to vested policyholders by increasing common stock for the par value of the shares and decreasing retained earnings by the same amount.
The Board of Directors of Midwest Holding approved a tender offer for the exchange and redemption of substantially all Class A shares owned by Class A shareholders of record on April 30, 2000. Pursuant to the offer, Class A shareholders who tendered their shares received $66 for each Class A share owned, plus one Class C share. The tender offer was conducted from May 2000 until closing effective July 31, 2000. Remaining shares outstanding after closing of the tender offer were subsequently acquired pursuant to
Following is the detail of changes in redeemable stock for each of the two years in the period ended December 31, 2000:
The components of the unrealized appreciation on available for sale securities as of December 31 are as follows:
The amortized cost and market value of fixed maturities at December 31, 2001, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Proceeds from sales of available for sale investments and the related gross realized gains and losses are as follows:
Net unrealized appreciation of fixed maturities increased (decreased) by $4,908,000, $3,198,000 and $(8,736,000) and net unrealized appreciation of equity securities (decreased) increased by $(19,411,000), $(22,003,000) and $14,036,000 for the years ended December 31, 2001, 2000 and 1999, respectively. Net unrealized appreciation of other long-term investments increased by $701,000 and $915,000 for the years ended December 31, 2001 and 2000, respectively, as a result of independent appraisals of the non-traded real estate investment trusts.
Prior to 1999, Midwest Medical had a retrospective premium program whereby physicians may have received credits against future premiums based upon the loss experience of Midwest Medical. Amounts returned under the program were accrued when approved by the Board of Directors and reflected as a reduction in net premiums earned. Payments under the program were generally made in the year following approval by the Board of Directors. Retrospective premium payments of $5,802,000 were made to Minnesota and North Dakota policyholders in 1999.
A provision of the agreement and plan of merger between Iowa Physicians and Midwest Medical required that any favorable development of certain pre-merger liabilities of Iowa Physicians be paid to the former Iowa Physicians policyholders who remain active Midwest Medical insureds as of the date of payment through a retrospective premium credit. This agreement stipulated that any amounts due under this provision be finalized using financial information as of December 31, 1998. During 1999, final payments of $3,058,000 were made to former Iowa Physicians policyholders under the terms of the agreement.
A provision of the agreement and plan of merger between Medical Liability Mutual and Midwest Medical required that any favorable development of certain pre-merger liabilities of Medical Liability Mutual be paid to the former Medical Liability Mutual policyholders who remain active Midwest Medical insureds as of the date of payment through a retrospective premium credit. The agreement stipulated that any amounts due under this provision must be settled no later than June 5, 2001. No payments were made related to this provision.
Midwest Medical continually evaluates emerging trends in the development of loss liabilities. Based on this analysis, management periodically adjusts their estimates of ultimate losses.
The Company is organized into four legal entity business segments consisting of Midwest Holding, Midwest Medical, Services and Solutions. The business and accounting policies of the reportable segments are described in Note 1 to the consolidated financial statements. Management evaluates the performance of each business segment based primarily on profit or loss from operations. With the exception of foreign stocks and bonds held as investments by Midwest Medical, all business transactions are conducted in the United States. The following financial information summarizes the results of operations and total assets reported by the four business segments for the years ended 2001, 2000 and 1999.
(1) Intersegment eliminations for revenues and expenses are primarily for management and administrative services provided by Midwest Holding. Eliminations for assets consist primarily of investments in wholly-owned subsidiaries, intersegment receivables for management fees and reclassifications between assets and liabilities primarily for taxes.
(1) Intersegment eliminations for revenues and expenses are primarily for management, administrative and investment services provided by Midwest Holding. Eliminations for assets consist primarily of investments in wholly-owned subsidiaries, intersegment receivables for management fees and reclassifications between assets and liabilities for taxes.
(1) Intersegment eliminations for revenues and expenses are primarily for management, administrative and investment services provided by Midwest Holding. Eliminations for assets consist primarily of investments in wholly-owned subsidiaries, intersegment receivables for management fees and reclassifications between assets and liabilities for taxes and reinsurance.
The components of the net deferred income tax (liability) asset as of December 31 are as follows:
Midwest Medical is authorized to issue policies with limits not to exceed $12,000,000 for each claim and $14,000,000 in the aggregate under each policy in any one policy year. Limits in excess of $12,000,000 for each claim and $14,000,000 annual aggregate are available to physicians and clinics through reinsurance placed on a facultative basis by Midwest Medical. Midwest Medical generally retains the first $1,000,000 of each claim and reinsures the remainder through a treaty under which premiums are based on a flat rate and could be subject to adjustment through a profit-sharing provision. For the years 1995 through 2000, Midwest Medical generally retained the first $750,000 of each claim and reinsured the remainder through a treaty under which premiums are subject to adjustment based on experience.
Substantially all employees of Midwest Holding are covered by a non-contributory defined contribution pension plan. Contributions to the plan are based upon each covered employee's salary. Substantially all employees at Midwest Holding are also covered by a 401(k) plan that provides a 50% match on employee contributions subject to certain limitations. Total contributions charged to expense for the years ended December 31, 2001, 2000 and 1999 were $717,000, $583,000 and $581,000, respectively.
Midwest Holding provides an unfunded Supplemental Executive Retirement Plan (SERP) which is a non-qualified, defined benefit retirement plan covering certain Midwest Holding officers. Benefits are based upon years of service and compensation. Although the plan is technically unfunded, Midwest Holding invests in specified assets which are designed to coordinate with the projected obligation under the SERP. The net periodic pension cost for this plan was $636,000, $574,000 and $441,000 for the years ended December 31, 2001, 2000 and 1999, respectively. The liability recognized in the consolidated balance sheets at December 31, 2001 and 2000 related to this plan was $3,561,000 and $3,101,000, respectively.
The National Association of Insurance Commissioners (NAIC) revised the Accounting Practices and Procedures Manual in a process referred to as Codification. The revised manual became effective January 1, 2001. Midwest Medical's domiciliary state of Minnesota adopted the provisions of the revised manual. The revised manual has changed, to some extent, prescribed statutory accounting practices and resulted in changes to the accounting practices that Midwest Medical used to prepare its statutory-basis financial statements. Although the implementation of Codification had a negative impact on Midwest Medical's statutory-basis capital and surplus primarily from the recording of a net deferred tax liability, management believes Midwest Medical remains in compliance with all regulatory and contractual obligations.
Under Minnesota insurance statutes, Midwest Medical is required to maintain statutory surplus in excess of ten times its per risk reinsurance retention limit. Since Midwest Medical limited its retention to $1,000,000 on any single risk, the minimum statutory surplus level was $10,000,000 for 2001.
Dividends that exceed the greater of 10% of Midwest Medical's prior year-end policyholder surplus or Midwest Medical's prior year net income excluding realized capital gains are considered extraordinary under Minnesota insurance statutes. Payment of extraordinary dividends is subject to the approval of the Commissioner of the Minnesota Department of Commerce. At December 31, 2001, the maximum dividend that may be paid by Midwest Medical in 2002 without regulatory approval is approximately $11,813,000. Cash dividends paid to Midwest Holding by Midwest Medical in 2001, 2000 and 1999 were $11,400,000, $3,000,000 and $2,050,000, respectively.