The Company leases approximately 47,000 square feet of space from the Medical Society of New Jersey in Lawrenceville, New Jersey, where its home office operations are located. During 2002, the Company closed its two regional offices where it rents office space in Indianapolis (5,000 square feet) and Dallas (5,000 square feet). The Company believes that its office space is adequate for its present needs and that it will be able to secure additional office space in the future if necessary.
(1) On April 1, 2001, the Company adopted the provisions of EITF No. 99-20, "Recognition of Interest Income and Impairment of Purchased and Retained Beneficial Interests in Securitized Financial Assets." This standard established new guidelines for recognition of income and other-than-temporary decline for interests in securitized assets. EITF 99-20 requires the Company to recognize an other-than-temporary decline if the fair value of the security is less than its book value and the net present value of expected future cash flows is less than the net present value of expected future cash flows at the most recent, prior, estimation date. The difference between the book value of the security and its fair value must be recognized as an other-than-temporary decline and the security's yield is adjusted to market yield. This new guidance also adopts the prospective method for adjusting the yield used to recognize interest income for changes in estimated future cash flows since the last quarterly evaluation date. On April 1, 2001, the Company recognized $5.3 million of other-than-temporary declines, net of tax ($0.39 per diluted share) as the cumulative effect of a change in accounting principle.
(2) Basic and diluted loss per share of common stock for the year ended December 31, 2001 is computed using the weighted average number of common shares outstanding during the year of 13,524,959.
The Company's discussion and analysis of its financial condition and results of operations are based upon the Company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and judgments that affect the reporting amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. On an on-going basis, management evaluates its estimates, including those related to income taxes, loss and loss adjustment expenses ("LAE") reserves, contingencies and litigation. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
Premiums. Premiums are recorded as earned over the period the policies to which they apply are in force. Premium deposits represent amounts received prior to the effective date of the new or renewal policy period. The reserve for unearned premiums is determined on a monthly pro-rata basis. Gross premiums include both direct and assumed premiums earned.
On August 4, 1999, the reorganization of the Exchange was consummated. The reorganization was conducted according to a Plan of Reorganization adopted by the Board of Governors of the Exchange on October 15, 1997 and approved by members of the Exchange at a special meeting held on March 17, 1999 and by the Commissioner of the New Jersey Department of Banking and Insurance ("the Commissioner"). The Plan has been challenged in two court actions. On February 14, 2000, the Appellate Division of the Superior Court of New Jersey affirmed the Commissioner's order approving the Plan of Reorganization, rejecting all of appellants' contentions, in response to an appeal filed by three individual insureds challenging the Commissioner's order. On September 19, 2000, the appellants' petition for review of the Appellate Division decision by the New Jersey Supreme Court was denied. The matter has now been finally concluded in the Company's favor. A second court action challenging certain aspects of the Plan of Reorganization and seeking damages and injunctive relief that was filed by five individual insureds in January 1999 was dismissed by the trial court in August 1999 and an appeal was filed. On July 11, 2001, the Appellate Division issued an opinion affirming the dismissal of plaintiffs' Complaint in all respects. On August 30, 2001, plaintiffs filed a Petition for Certification to the Supreme Court seeking review of the Appellate Division's decision. On January 2, 2002, the Supreme Court denied plaintiffs' petition for certification. Plaintiffs subsequently filed a motion for reconsideration, which was denied on March 20, 2002.
and other actuarially significant data. The process may result in changes in rates for certain exposure classes.
The Aggregate Contract in 2001 provided coverages on an aggregate excess of loss and quota share basis. The primary coverage afforded under the Aggregate Contract attaches above a Company retention measured as a 75% loss and allocated loss adjustment expense ratio ("loss and ALAE ratio"). Reinsurers provide coverage for an additional 75% loss and ALAE ratio, with an aggregate annual limit of $200 million. The Company has maintained aggregate excess of loss coverage generally similar to that described above since 1993.
NET INVESTMENT INCOME. Net investment income decreased $5.0 million, or 5.8%, to $80.2 million in 2001 from $85.2 million in 2000. The decrease was primarily attributable to the combined effects of lower market yields and a decrease in average
FUNDS HELD CHARGES. Funds held charges increased $35.0 million, or 466.2%, to $42.5 million in 2001 from $7.5 million in 2000. Funds held charges relate to the Company's ceded aggregate reinsurance contracts, for which balances due to reinsurers are withheld as collateral for losses and loss adjustment expenses ceded under the contracts. Funds held charges increased $19.8 million resulting from adjustments to loss reserves, ceded losses and ceded premiums during 2001. Funds held charges during 2000 decreased by $13.2 million as a result of adjustments to loss reserves, ceded losses and ceded premiums during 2000. Funds held charges are calculated based upon the beginning of quarter funds held balances and are adjusted based upon changes to ceded premiums associated with changes in ceded losses.
YEAR ENDED DECEMBER 31, 2000, COMPARED TO YEAR ENDED DECEMBER 31, 1999
OTHER REVENUE. Other revenue decreased $0.8 million, or 10.5%, to $7.5 million in 2000 compared to $8.3 million in 1999. In 2000 other revenue was primarily composed of $8.0 million associated with the Company's leasing, brokerage and other businesses, offset by a $0.5 million loss on the sale of substantially all of the assets of the Company's reinsurance intermediary, Pegasus Advisors, Inc., effective July 1, 2000. The sale transaction resulted in a write-off of $1.7 million of goodwill and deferral of $1.2 million of gain in consideration of price adjustments features contained in the sale agreement. In 1999 other revenue consisted primarily of $3.4 million of revenues associated with the Company's leasing, brokerage and other businesses, acquired by the Company in the acquisition of the Underwriter on August 4, 1999, a gain of $3.5 million resulting from common stock received during 1999 in the demutualization of Manulife Financial Corp. and a $1.0 million death benefit received during 1999 from a corporate owned life insurance policy.
The MIIX Group is a holding company whose assets primarily consist of all of the capital stock of its subsidiaries. Its principal sources of funds are dividends and other permissible payments from its subsidiaries and the issuance of debt and equity securities. The insurance company subsidiaries are restricted by state regulation in the amount of dividends they can pay in relation to surplus and net income without the consent of the applicable state regulatory authority, principally the New Jersey Department of Banking and Insurance. New Jersey regulations permit the payment of any dividend or distribution only out of statutory earned (unassigned) surplus. The Department may limit or disallow the payment of any dividend or distribution if an insurer's statutory surplus following the payment of any dividend or other distribution is not deemed adequate in relation to its outstanding liabilities and adequate to meet its financial needs, or the insurer is determined to be in a hazardous financial condition. The other Insurance Subsidiaries are subject to similar provisions and restrictions. No significant amounts are currently available for payment of dividends by Insurance Subsidiaries without prior approval of the applicable state insurance department or Bermuda Registrar of Companies. As a result of these limitations, The MIIX Group does not expect that MIIX Insurance Company will have the ability to declare and pay dividends to The MIIX Group to meet its operating needs.
The primary sources of the Company's liquidity are insurance premiums collected, net investment income, proceeds from the maturity or sale of invested assets, recoveries from reinsurance and revenues from non-insurance operations. Funds are used to pay losses and LAE, operating expenses, reinsurance premiums and taxes. The Company's net cash flow from operating activities was $(23.6) million in 2001 compared to $59.4 million in 2000 and $107.4 million in 1999. The decrease in cash flow during this period was significantly impacted by two items, one impacting cash flows during 2000 and the other impacting cash flows during 2001. During 2000, operating cash flows were significantly increased due to one-time proceeds of $33.0 million collected on termination of the Company's corporate-owned life insurance (COLI) program. Without these one-time proceeds, operating cash flows in 2000 were $26.4 million. During 2001, operating cash flows were significantly impacted by premium financing activity conducted by the Company under a program begun in November 2000. Prior to November 2000, premium financing was conducted by a third party vendor and the company received full proceeds from financed policies shortly after the policies were written from the third party vendor. Excluding the impact of the net premium financing activity of $32.2 million, operating cash flows in 2001 were $8.6 million, a $17.8 million decrease from 2000. This decrease resulted primarily from increases in paid losses and LAE, and underwriting expenses and reduced investment income. Because of the inherent unpredictability related to the timing of the payment of claims, it is not unusual for cash flow from operations for a medical malpractice insurance company to vary, perhaps substantially, from year to year.
Cash dividends paid to shareholders were $0.20 per share in 2001. Payment of dividends is subject to approval by the Board of Directors, earnings and the financial condition of the Company. During 2002, The MIIX Group Board of Directors suspended the payments of dividends to shareholders. Future payments and amounts of cash dividends will depend upon, among other factors, the Company's operating results, overall financial condition, capital requirements, ability to receive dividends from our insurance company subsidiaries which are subject to regulatory approval and general business conditions. See "Risks and Uncertainties."
Management does not expect that significant unrealized losses will be realized on the fixed maturity portfolio given the credit quality of the portfolio at December 31, 2001 and the Company's policy of matching asset and liability maturities. Asset and liability matching is an important part of the Company's portfolio management process. The Company utilizes financial modeling and scenario analysis to closely monitor the effective modified duration of both assets and liabilities in order to minimize mismatching. The goal of effective asset/liability management is to allow payment of claims and operating expenses from operating funds without disrupting the Company's long-term investment strategy.
In addition to interest rate risk, fixed maturity securities like those comprising the Company's investment portfolio involve other risks such as default or credit risk. The Company manages this risk by limiting the amount of higher risk corporate obligations (determined by credit rating assigned by private rating agencies) in which it invests.