The following Selected Consolidated Financial Data is prepared in accordance with generally accepted accounting principles. The Company acquired MDA on June 26, 1995, and the accompanying data which pertains to preacquisition periods have been prepared as if the companies were combined throughout those periods. This data should be read in conjunction with the Consolidated Financial Statements and accompanying notes included elsewhere herein.
(1) For 1995 earnings per common share are reflected for earnings subsequent to June 26, 1995, which is the date that Medical Defense Holding Co. completed its acquisition of Medical Defense Associates and its subsidiaries. For years prior to 1995 no earnings per share data is presented since all earnings are related to Medical Defense Associates preacquisition activities and, therefore, are not considered earnings per common share of Medical Defense Holding Co.'s stockholders.
The professional medical liability market in Missouri continues to be one of intense competition. There are several major competitors and with the "soft" portion of the insurance cycle continuing, the market is abundant with price cutting and discounting. The Company has refused to respond in kind but rather has chosen to maintain its actuarially sound pricing structure.
As a result of the items discussed above, the Company experienced a loss (before provision for income taxes) of $4,705,629, compared to income (before provision for income taxes) of $2,064,641 in 1995. The Company's total tax provision increased $547,150 to $795,413 which was primarily the result of an increase in the deferred tax provision of approximately $3.7 million. This increase in the deferred tax provision was due to an increase in the deferred tax asset valuation allowance of approximately $2.4 million, which relates entirely to loss reserve discounting and represents the difference between the total deferred tax asset related to loss reserve discounting required by the Internal Revenue Service and the amount that is more likely than not to be realized. As a result, the Company's net loss for 1996 was $5,501,042 compared to net income of $1,816,378 for 1995.
Total consolidated assets of the Company at December 31, 1996 were $96,778,494 which was a decrease of approximately $11.4 million or 10.6% as compared to December 31, 1995. This decrease was primarily due to an increase of approximately $6.6 million in the payment of claim loss and loss adjustment expenses when compared to amounts paid in 1995, a $2.0 million decline in premiums from policyholders due to the decline in total policyholders, the purchase of approximately 2.8 million shares of the Company's outstanding preferred stock for approximately $1.1 million, a decline in the net after-tax market value of the Company's fixed-income investment portfolio of approximately $1.1 million due to generally higher interest rate yields at the end of 1996 compared to the end of 1995 which has an inverse effect on the market value of bonds held in the Company's investment portfolio, and an approximate $0.6 million in paid federal income taxes relating to 1995. Over 89% of the Company's total assets at December 31, 1996 are comprised of cash, cash equivalents, or investments and, in addition, the Company's investment portfolio is conservatively invested in high-quality investments as approximately 80% of total assets at December 31, 1996 consisted of either cash or cash equivalents, U.S. Treasury bonds or notes, or U.S. government agency bonds. In addition, the Company does not hold, either directly or indirectly, any real estate owned for investment purposes, any fixed maturity investments rated below AA by nationally recognized rating agencies, or any equities other than stock in affiliates. The composition of the Company's total investments is not anticipated to change substantially in the near future.
Stockholders' equity decreased $7,721,608 as of December 31, 1996, which was a decline of 26.1% from December 31, 1995. This decrease was due to the net loss in 1996 of $5,501,042, the purchase of the Company's preferred stock for $1,112,535, and the net decline in the unrealized gains and losses on fixed maturity investments of $1,108,031, all discussed earlier.
Future cash flow for the Company will be primarily dependent on the ability of its subsidiary, MDA, to pay cash dividends. MDA's cash flow is generated from its insurance operations and investment portfolio. MDA is subject to annual statutory dividend limitations as to the amount of any dividend which may be paid without prior approval of the Director of the Missouri Department of Insurance. For 1997 the maximum dividend payable to the Company from MDA, without prior approval of the Missouri Department of Insurance, is $2,106,023.
During 1996, due to cash flow used by operating activities, the Company's net cash flow provided from investing activities was $6,785,490, as fewer fixed maturity investments were purchased to replace those investments sold or matured. Due to the positive cash flow provided by operations during 1995, the Company was able to increase net cash flow in investing activities for the year ended December 31, 1995 by $6,812,854.
The Company's cash flow from operations and its investment portfolio are utilized to meet its obligations related to payment of losses and loss adjustment expenses, payment of operating expenses, and other needs as deemed necessary from time to time. The Company does not anticipate in the immediate future any major capital expenditures outside the normal course of operations.
The Company anticipates that its future cash flow will be sufficient to meet its ongoing obligations for the foreseeable future.
MEDICAL DEFENSE HOLDING CO. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Medical Defense Holding Co. and Subsidiaries as of December 31, 1996 and 1995 and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles.
Consolidated Statements of Operations for the years ended December 31, 1996, 1995 and 1994
B. Principles of Consolidation: The consolidated financial statements of the Company include Medical Defense Holding Co. and its wholly-owned subsidiaries, MDA, MDS and MDIC. As described in Note 1, the Company acquired MDA on June 26, 1995. The accompanying statements which pertain to preacquisition periods have been prepared as if the companies were combined throughout those periods. All significant intercompany transactions have been eliminated.
C. MDA Statutory Net Income and Surplus, continued: A reconciliation of net income for the years 1996, 1995 and 1994 and surplus as regards policyholders at December 31, 1996, 1995 and 1994 reported by MDA on a generally accepted accounting principles (GAAP) basis which includes its wholly-owned subsidiaries MDS and MDIC, to the amounts reported by MDA on a statutory basis which includes equity in MDS and MDIC is as follows:
The Company operates as a direct writer of professional liability insurance and thus does not incur sales commissions or other variable sales costs directly related to premium production which are normally associated with deferred acquisition costs. Subsequent to completion of MDA's conversion to a stock insurance company, as discussed in Note 1, all MDA premiums written are subject to Missouri premium taxes. Deferred acquisition costs recorded during 1996 and 1995 relate entirely to Missouri premium taxes. Such deferred costs are amortized over the terms of the underlying policies, written off when policies are canceled and tested for recoverability out of the unearned premium reserve annually.
F. Investments: In May 1993, the Financial Accounting Standards Board published SFAS 115 which requires certain changes in the accounting and reporting on certain investments in debt and equity securities. Among other things, SFAS 115 requires companies to classify securities into three categories. Held-to-maturity debt securities that the Company has the positive intent and ability to hold to maturity, are to be reported at amortized cost. Debt and equity securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities and are to be reported at fair value, with unrealized gains and losses included in earnings. Debt and equity securities not classified in the other two categories are classified as available-for-sale securities and reported at fair value, with unrealized gains and losses excluded from earnings, and reported as a separate component of surplus as regards policyholders.
H. Federal Income Taxes: The Company employs the provisions of Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes ("SFAS 109"). SFAS 109 requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax assets and liabilities are determined based upon the differences between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse.
During 1995 the Company issued 11,999,991 shares of $1.00 par value redeemable convertible preferred stock to the eligible policyholders of MDA in exchange for their mutual policyholders' rights in MDA. Each share of preferred stock is convertible into two shares of Medical Defense Holding Co. Class B Common Stock, at the holder's option, and may be converted at any time prior to redemption. Each share of preferred stock is redeemable, at the Company's option, after three years from the date of issuance, at a price per share of $1.00. The preferred stock does not provide a stated dividend; however, no dividends may be paid on any Company common stock while there are preferred stock shares outstanding. In 1995, 9,802 shares of preferred stock were converted to 19,604 shares of Class B common stock.
The following information summarizes the difference between amortized cost and market value of fixed maturities investments:
The change in net unrealized holding gain or loss on available for sale securities, net of deferred taxes, for the years ended December 31, 1996, 1995 and 1994 are as follows:
For purposes of the above, bonds without prepayment characteristics have been included at their stated maturity date. Bonds with prepayment features are included at their estimated maturity date as supplied by the Company's investment adviser.
Net investment income by source for each of the three years ended December 31, was as follows:
All premiums are receivable from physicians, surgeons, dentists, and related health care providers, primarily concentrated in Missouri.
MDS has a noncontributory defined contribution pension plan covering substantially all employees of the affiliated group. As a matter of policy, pension costs are funded as they accrue. Pension expense was $175,968, $203,710 and $202,471 in 1996, 1995 and 1994, respectively. MDS also has a 401(k) savings plan covering substantially all employees of the affiliated group which the Company provides a 100% matching contribution up to 6% of compensation subject to current IRS limitations. The 401(k) savings plan expense for 1996, 1995 and 1994 totaled $85,042, $79,985 and $79,165, respectively.
Changes in deferred policy acquisition costs at December 31, are summarized as follows:
MDIC reinsured all claims-made policies from February 14, 1983 through August 14, 1987. As of December 31, 1996, MDIC had no outstanding claims that were anticipated to involve reinsurers.
The components of the net deferred tax asset at December 31, 1996 and 1995 are as follows:
Management does not believe it can reasonably determine the amount of loss reserve deferred tax benefit which can be recovered from future taxable income arising more than three years in the future using a more likely than not standard.
The Company's reserves for loss and loss adjustment expenses represent the estimated ultimate cost of all losses and loss adjustment expenses which are unpaid at the balance sheet date.
MDIC's reserves for loss and loss adjustment expenses have not been actuarially reviewed due to the few number of claims outstanding. MDIC's reserves represent less than 1% of total reserves for the periods represented by the financial statements.
Net income per common share is computed using net income divided by the weighted average number of common shares and common share equivalents outstanding. All of the Company's outstanding shares of preferred stock are convertible to common stock at a ratio of two shares of common stock for each one share of preferred stock. Since the Company's preferred stock has no stated dividend rate, and thus, no effective yield, these securities are considered common stock equivalents for the purpose of computing net income per common share.
Other than the preferred stock discussed above, the Company does not have any other potentially dilutive stocks. Therefore, the computations for fully diluted net income per common share are not presented since the results do not differ from primary net income per common share.
Net income per share information is not computed for the period ending December 31, 1994, as the conversion of MDA to a stock insurance company and a wholly-owned subsidiary of MDHC was not completed until June 26, 1995, and therefore, all of the earnings for those periods are attributable to the preconversion earnings of MDA. In addition, the net income of $617,713 recorded by the subsidiary as of June 30, 1995, is virtually entirely attributable to preconversion results and, therefore, is also excluded for 1995 earnings per share presentation purposes.