Professionals Group owns its principal executive offices in Okemos, Michigan. Professionals Group also owns, primarily for investment purposes, an office building in Williamston, Michigan. MEEMIC leases its principal executive offices in Auburn Hills, Michigan. MEEMIC also owns, primarily for investment purposes, an 11.5 acre vacant parcel of land in Auburn Hills, Michigan. The Company leases office facilities in various locations and also leases computer and operating equipment under cancelable and noncancelable agreements.
(1) From July 1, 1997 through June 30, 1999, the Company assumed 40% of the net premiums of MEEMIC. The business assumed from MEEMIC has increased the expense ratio because of the higher ceding commission associated with this personal lines business. On July 1, 1999, MEEMIC Holdings was consolidated into Professionals Group's financial statements as a result of Professionals Group obtaining majority ownership (see also Note 4 to the Company's consolidated financial statements).
(4) In 1998 the Company increased its estimated liability for loss and loss adjustment expense reserves by $25.6 million to reflect actuarial estimates and the application of the Company's reserving practices to its Florida book of business. The ratio includes the increase in reserve for extended reporting period claims.
Professionals Group is organized and operates principally in the property and casualty insurance industry and has two insurance product segments. The professional liability segment provides insurance coverage and services to health care providers through Professionals Group's wholly owned subsidiary, ProNational Insurance Company. The personal lines segment provides personal auto and homeowners coverages primarily to teachers and other educational employees through Professionals Group's majority owned subsidiary, MEEMIC Holdings, Inc. and its wholly owned subsidiary, MEEMIC Insurance Company.
As of December 31, 1999 and 1998, the Company had invested assets of $758.3 million and $691.0 million, respectively. This 9.7% increase in invested assets was primarily due to the acquisition of MEEMIC Holdings, which added $159.7 million. Offsetting this increase was a reduction in the fair value of the fixed maturity portfolio, as further discussed below. Invested assets represented approximately 71% and 78% of the Company's total assets as of December 31, 1999 and 1998, respectively.
All fixed maturity securities are classified as available-for-sale and are carried at fair value as of December 31, 1999 and 1998. As a result, the Company's fixed maturity investment portfolio is sensitive to interest rate changes. As of December 31, 1999, the fixed maturity portfolio had net unrealized losses of $19.5 million. As of December 31, 1998, the fixed maturity portfolio had net unrealized gains of $22.3 million. This change was due primarily to higher interest rates at year-end 1999 compared to year-end 1998. As of December 31, 1999, the fixed maturity portfolio had a weighted average modified duration of approximately 4.9 years. A one hundred basis point increase in market interest rates would decrease the value of this portfolio by approximately 4.9 percent, whereas a one hundred basis point decrease in market interest rates would increase the value of this portfolio by approximately 4.9 percent.
The unearned premium reserve increased $39.1 million, or 81.1%, to $87.3 million at December 31, 1999, from $48.2 million at December 31, 1998. This increase was due mainly to the acquisition of MEEMIC Holdings, which added $34.1 million. The remainder of the increase was due to an increase in the professional liability business written in 1999 compared to 1998.
The $18.6 million excess of assets acquired over cost and the minority interest of $23.8 million at December 31, 1999 were related to the acquisition of MEEMIC Holdings (see also Note 4 to the Company's consolidated financial statements.)
Professional liability net premiums written were $116.6 million for the year ended December 31, 1999, an increase of $15.4 million, or 15.2%, compared to net premiums written of $101.2 million for the year ended December 31, 1998. This increase was due to increased premium writings in the Company's existing markets of Florida, Illinois, Indiana, Michigan and Pennsylvania as well as business written in new states such as Kentucky and New Jersey. The most significant increase was in Florida because of eighteen month policies issued in 1997 as part of a plan to stagger Florida renewals more evenly throughout the year. The issuance of eighteen month policies in 1997 resulted in a one-time decrease in premiums written in 1998 because these
policies were not renewed until 1999. These increases were offset somewhat by continued price-based competition.
Professional liability policy acquisition and underwriting expenses were $24.4 million in both 1999 and 1998. As a percentage of premiums earned, the underwriting expense ratio improved to 21.6% during 1999, from 22.1% during 1998. Underwriting expenses for 1999 included $2.0 million of severance expenses associated with the resignation of three executives that joined Professionals Group from PPTF. Underwriting expenses for 1998 included $3.3 million of expenses associated with the closing of the PPTF merger.
Personal lines insurance incurred losses and loss adjustment expenses totaled $51.7 million for 1999, an increase of $23.7 million, or 84.6%, compared to $28.0 million for 1998 (pursuant to the then existing quota share reinsurance relationship with MEEMIC). The increase in incurred losses and loss adjustment expenses was due to the acquisition of MEEMIC Holdings. As a percentage of premiums earned, the personal lines insurance incurred loss and loss adjustment expense ratio decreased to 63.2% in 1999, compared to 65.6% in 1998. The personal lines insurance loss and loss adjustment expense ratio benefited from favorable weather conditions in both 1999 and 1998.
Net investment income, excluding net realized investment gains, was $41.1 million for 1999, an increase of $2.7 million, or 7.0%, compared to net investment income of $38.4 million for 1998. The increase reflects the addition of MEEMIC's investment portfolio as of July 1, 1999. The weighted average tax equivalent book yield of the fixed maturity portfolio was 7.0% and 6.9% as of December 31, 1999 and 1998, respectively. Net realized investment gains were $2.7 million and $4.8 million during 1999 and 1998, respectively. The significant amount of investment gains recorded in 1998 was attributable to the sale of a majority of the Company's common stock portfolio due to the Company's desire to maximize after-tax investment yield. Interest expense was $1.1 million and $1.3 million during 1999 and 1998, respectively. See "Liquidity and Capital Resources."
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997:
Professional liability net premiums written were $101.2 million for the year ended December 31, 1998, a decrease of $41.7 million, or 29.2%, compared to net premiums written of $142.9 million for the year ended December 31, 1997. This decrease was mainly due to the Florida policies issued in the last half of 1997 that had a term of eighteen months to convert policy renewal dates from a common renewal date of January 1st. Prior to 1997 all Florida policies were issued on a calendar year basis with all policies renewing January 1st of each year. The issuance of eighteen month policies in 1997 resulted in a one time increase in premiums written (and premiums due from policyholders) for 1997. An offsetting decrease in premiums written was expected in 1998 because these policies were not renewed until 1999.
During 1998 and 1997, the Company endeavored to balance its need for rate adjustments with the goal of maintaining market share in a very competitive professional liability environment. Although the Company endeavored to offset lower premiums charged through selective underwriting practices, there can be no assurance that these practices will be successful in the long run.
Reinsurance experience refunds were $3.1 million and $4.2 million in 1998 and 1997, respectively. Through 1995, reinsurance agreements on the Florida business included profit sharing provisions whereby premiums were refunded to the Company after an established period of time if they exceeded actual losses incurred plus an allowance for expenses. Interest income also accrued on excess premiums paid. In prior years, the amount of profit recognized in income was based on ultimate loss projections established by the Company's independent actuary. Reinsurance profits were paid to the Company when losses developed favorably. During 1998, reinsurance contracts covering claims prior to 1991 were commuted. Therefore, any deferred reinsurance profits from these contracts were recognized in 1998.
Professional liability insurance incurred losses and loss adjustment expenses (including the increase in reserve for extended reporting period claims) totaled $144.1 million in 1998, an increase of $30.7 million, or 27.1%, compared to $113.4 million in 1997. The increase was primarily due to unusually high loss costs during 1998, including a $25.6 million increase to loss reserves to reflect actuarial estimates and the application of the Company's reserving practices to the Florida book of business as well as a $9.5 million excess limits verdict on one Florida claim. As a percentage of premiums earned, the professional liability insurance incurred loss and loss adjustment expense ratio (including the increase in reserve for extended reporting period claims, but excluding the reserve charges) improved to 96.7% in 1998, compared to 101.3% in 1997. The decrease in the professional liability loss and loss adjustment expense ratio was mainly attributable to favorable development of prior years' loss reserves related to the Company's book of business in the Midwest.
Professional liability policy acquisition and underwriting expenses were $24.4 million in 1998, an increase of $8.0 million, or 48.7%, compared to policy acquisition and underwriting expenses of $16.4 million in 1997. As a percentage of premiums earned, the underwriting expense ratio increased to 22.1% during 1998, from 14.7% during 1997. Underwriting expenses for 1998 included $3.3 million of expenses associated with the closing of the PPTF merger. Underwriting expenses during 1998 also included $1.2 million of additional compensation expense recognized on stock grants issued to directors and management of PPTF, as contemplated by the merger agreement. In addition, 1997 expenses included a one-time premium tax refund which reduced 1997 underwriting expenses by $2.6 million.
Personal lines net premiums assumed (written and earned) from MEEMIC were $42.7 million in 1998, an increase of $22.6 million, or 112.2%, compared to net premiums assumed (written and earned) of $20.1 million in 1997 (the quota share reinsurance relationship with MEEMIC was not in force during the first six months of 1997.)
$4.8 million and $3.9 million during 1998 and 1997, respectively. Interest expense was $1.3 million and $1.1 million during 1998 and 1997, respectively. See "Liquidity and Capital Resources."
The Company recorded a $6.1 million tax benefit during 1998, due to the pretax loss generated from the reserve charges, compared to $7.8 million in federal income tax expense in 1997. The Company's effective federal income tax (benefit) rate was (65.5%) in 1998 compared to 25.9% in 1997. The large amount of tax exempt income in relation to the small pretax loss has caused the unusually high effective tax (benefit) rate in 1998.
The payment of losses, loss adjustment expenses and operating expenses in the ordinary course of business represents the Company's principal need for liquid funds. Payments for losses and loss adjustment expenses are distributed fairly evenly throughout the year. Payments for reinsurance are generally made within thirty days subsequent to the end of each quarter, with adjustments made after each reinsurance year. Historically, cash used to pay for these items has been provided by operations. In 1997, the Company used a portion of its cash flow from operations to fund its purchase of a new home office facility, including furniture and equipment, for $7.1 million. As of December 31, 1999, no material commitments for capital expenditures existed, and management believes the Company's present liquidity, together with its expected cash flow from operations, will be sufficient to fund its commitments for capital expenditures.
The Credit Agreement contains a covenant which prohibits the payment of cash dividends on Professionals Group's common stock (except for cash paid in lieu of fractional shares related to stock dividends declared). Additional covenants also require the Company to, among other things, maintain total consolidated stockholders' equity of at least $80.0 million plus 50% of the preceding fiscal year's consolidated net income, maintain a ratio of debt to equity of not more than 0.5:1 and maintain a fixed charges coverage ratio and an interest coverage ratio (as defined in the Credit Agreement) of not less than 1.5:1 and 2.5:1, respectively. The Company was in compliance with, or has received waivers of, all required covenants as of December 31, 1999.
The ability of Professionals Group to fund its operations and to pay dividends on its common stock will be dependent upon its receipt of dividends, loans or advances from its insurance company subsidiaries (particularly ProNational). The ability of those subsidiaries to pay dividends is subject to regulatory restrictions. Generally, these restrictions limit the amount of dividends such subsidiaries can pay to their
respective parent in any 12-month period to the greater of statutory net income for the preceding year (excluding realized gains and losses on sales of investments), or ten percent of policyholders' surplus as of the end of the preceding year. As of January 1, 2000, approximately $23.0 million of dividends could be paid by Professionals Group's direct insurance subsidiaries without prior regulatory approval. In 1999, 1998 and 1997, Professionals Group's insurance subsidiaries paid cash dividends aggregating $12.0 million, $12.3 million and $4.7 million, respectively, to Professionals Group. There can be no assurance as to any future dividends by Professionals Group or any of its subsidiaries (see also Note 11 to the Company's consolidated financial statements).
On July 1, 1998, Professionals Group consummated its merger with Physicians Protective Trust Fund, a medical malpractice self-insurance trust fund located in Coral Gables, Florida ("PPTF"). Pursuant to the merger agreement, Professionals Group issued 4,087,525 shares of Professionals Group common stock to the eligible members of PPTF and paid cash of approximately $67,000 in lieu of fractional shares. Additionally, 30,594 shares (representing 20% of the 153,000 total shares to be issued over a period of five years) of Professionals Group common stock were issued to directors and management of PPTF, as contemplated by the merger agreement (see also Note 4 to the Company's consolidated financial statements.)
The primary effects of inflation on the Company are considered in estimating reserves for unpaid losses and loss adjustment expenses and in the premium rate-making process. The actual effects of inflation on the Company's results of operations cannot be accurately known until claims are ultimately settled. However, based on actual results to date, the Company believes that loss and loss adjustment expense reserves and the Company's rate-making process make adequate provision for the effects of inflation.
The Company has completed an assessment of its computerized information systems across its entire operation and has determined that all significant systems are Year 2000 compliant. To date, ProNational has incurred approximately $0.5 million in connection with its efforts to become Year 2000 compliant. All of such costs have been expensed as incurred. In 1999, MEEMIC has incurred approximately $1.0 million ($3.0 million in total) for the purchase of new computerized information and communication systems. Neither ProNational or MEEMIC anticipates incurring additional costs related to the Year 2000. The Company has received written assurances from the third party vendors of such equipment and software, that such items are Year 2000 compliant. The Company has also conducted Year 2000 investigation and testing with its major third party vendors' software and hardware and determined that all significant hardware and software is Year 2000 compliant. While the Company believes that Year 2000 compliance issues have been reasonably addressed, both internally and externally, no assurances can be given that all entities with whom the Company does business will be Year 2000 compliant. The foregoing disclosure contains information regarding Year 2000 readiness which constitutes a "Year 2000 Readiness Disclosure" as defined in the Year 2000 Readiness Disclosure Act.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
Professionals Group, Inc. (Professionals Group) is an insurance holding company incorporated under Michigan law on January 31, 1996. Professionals Group owns all of the issued and outstanding common stock of ProNational Insurance Company (ProNational), a Michigan-domiciled property and casualty insurance company which primarily provides professional liability insurance coverages and services to health care providers. ProNational owns 100% of ProNational Casualty Company (ProNational Casualty), an inactive Illinois-domiciled property and casualty insurance company. ProNational also owns 77% of MEEMIC Holdings, Inc. (MEEMIC Holdings) which provides personal auto and homeowners coverages to teachers and other educational employees through MEEMIC Insurance Company (MEEMIC), a Michigan-domiciled property and casualty insurance company. Professionals Group and subsidiaries are collectively referred to as "the Company."
Available for sale securities are recorded at fair value. Unrealized gains and losses, net of the related income tax effect, on available for sale securities are excluded from income and recorded as other comprehensive income.
A decline in the fair value of an available for sale security below cost that is deemed other than temporary results in a charge to income, resulting in the establishment of a new cost basis for the security. All declines in fair values of the Company's investment securities in 1999, 1998 or 1997 were deemed to be temporary.
Insurance premium income is recognized on a monthly pro rata basis over the respective terms of the policies in force, and unearned premiums represent the portion of premiums written which is applicable to the unexpired terms of the policies in force.
Through 1995, reinsurance agreements on the Company's Florida business included profit sharing provisions whereby premiums were refunded to the Company after an established period of time if they exceeded actual losses incurred plus an allowance for expenses. Interest income also accrued on excess premiums paid. In prior years, the amount of profit recognized in income was based on ultimate loss projections established by the Company's independent actuary. Reinsurance profits were recognized by the Company when losses developed favorably. During 1998, the 1991 and prior reinsurance contracts were commuted and deferred reinsurance profits thereon were recognized.
Property and equipment, consisting of real estate, data processing equipment and furniture and fixtures, are recorded at cost, net of accumulated depreciation. Depreciation is computed on the straight-line method over periods ranging from 4 to 25 years. Maintenance, repairs and minor renewals are charged to expense as incurred.
Intangible assets are comprised mainly of goodwill, which represents the excess of cost over the fair value of assets acquired, and the cost of a purchased book of business. Intangible assets are being amortized on a straight-line basis over ten years. The carrying value of intangible assets is periodically reviewed by the Company based on the expected future undiscounted operating cash flows of the related item. Based upon its most recent analysis, the Company believes that no material impairment of intangible assets exists at December 31, 1999.
Restricted cash is an amount required to be deposited in escrow for the appeal process of a specific case being litigated and decided upon in arbitration.
These unaudited pro forma results have been prepared for comparative purposes only and do not purport to be indicative of the results of operations which would have actually resulted had this acquisition occurred on January 1, 1998, or of future results of operations of the Company.
The amortized cost and estimated fair value of fixed maturities at December 31, 1999, by contractual maturity, are shown below. Expected maturities on certain corporate and mortgage-backed securities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
At December 31, 1999, amounts related to reinsurance balances and prepaid reinsurance premiums follow:
Professionals Group, together with certain subsidiaries, files a consolidated Federal income tax return. MEEMIC Holdings, together with its subsidiaries, files its own consolidated Federal income tax return. Income tax expense for both Professionals Group and MEEMIC Holdings is computed under the liability method, whereby deferred income taxes reflect the estimated future tax effects of temporary differences between the carrying value of assets and liabilities for financial reporting purposes and those for income tax purposes.
Actual Federal income taxes (benefit) vary from amounts computed by applying the current Federal income tax rate of 34% for 1999, 1998 and 1997 to income or loss before Federal income taxes (benefit). The reasons for these differences, and the tax effects thereof, are as follows:
The Credit Agreement contains a covenant which prohibits the payment of cash dividends on Professionals Group's common stock (except for cash paid in lieu of fractional shares related to stock dividends declared). Additional covenants also require the Company to, among other things, maintain total consolidated shareholders' equity of at least $80.0 million plus 50% of the preceding fiscal year's consolidated net income, maintain a ratio of debt to equity of not more than 0.5:1 and maintain a fixed charges coverage ratio and an interest coverage ratio (as defined by the Credit Agreement) of not less than 1.5:1 and 2.5:1, respectively. The Company was in compliance with, or has received waivers of, all required covenants as of December 31, 1999.
Approximately $914.9 million of consolidated assets represents assets of the Company's insurance operations that are subject to regulation and may not be transferred to Professionals Group in the form of dividends, loans or advances. The amount of dividends that Professionals Group's insurance subsidiaries can pay to Professionals Group 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 policyholders' surplus as of the preceding year end. As of January 1, 2000, approximately $22,966,000 could be paid by Professionals Group's insurance subsidiaries without prior regulatory approval. In 1999, 1998 and 1997, Professionals Group's insurance subsidiaries paid dividends of $12,000,000, $12,316,000 and $4,717,049, respectively.
On November 15, 1999, the Company declared a 10% stock dividend, issued on December 13, 1999 to shareholders of record as of November 29, 1999. All per-share information in the accompanying consolidated financial statements has been adjusted to give retroactive effect to this stock dividend.
Professionals Group also established the 1996 Non-Employee Directors Stock Option Plan (the "Directors Plan"), under which, subject to adjustment, non-qualified options for 50,000 shares of Professionals Group's common stock may be granted to non-employee directors (maximum of 5,000 shares to one individual) of Professionals Group. Options are granted at the market price of Professionals Group's common stock on the date of grant. Options become exercisable one year from the date of grant and expire seven years from the date of grant.
Holdings' common stock on the date of grant. These options vest and become exercisable over five years beginning one year from the date of grant, and expire ten years from the date of grant.
For all three option plans, no charges to operations are recorded with respect to authorization, grant or exercise of options and proceeds received upon exercise are credited to shareholders' equity.
Options outstanding as of December 31, 1999 under the Incentive Plan consisted of the following:
Option information regarding the Directors Plan for the years ending December 31, 1999, 1998 and 1997 follows:
Options outstanding as of December 31, 1999 under the Directors Plan consisted of the following:
The fair value of options at date of grant for the Incentive Plan and the Directors Plan was estimated using the Black-Scholes option pricing model with the following weighted average assumptions used for grants in 1999, 1998 and 1997: dividend yield of 0%; expected volatility of 35.4%, 35.6% and 35.7%; risk-free interest rate of 5.90% and 6.29% for the Incentive Plan (1999 and 1997 only); risk free interest rate of 6.01%, 5.69% and 6.62% for the Directors Plan; expected lives of 10 years and 9 years for the Incentive Plan (1999 and 1997 only); and expected lives of 7 years for the Directors Plan.
The proforma effect on net income for 1999, 1998 and 1997 is not representative of the proforma effect on net income for future years because additional stock option awards could be made in future years.
ProNational, MEEMIC and ProNational Casualty are required to file financial statements prepared in accordance with SAP prescribed or permitted by Michigan and Illinois with their respective domiciliary states. The only material statutory accounting methods utilized by ProNational that are permitted rather than prescribed are the discounting of its loss reserves through December 31, 1997 and recording the merger transaction with PPTF as a "pooling of interests" business combination for statutory reporting, which did not provide explicit guidance on the accounting for this transaction. The impact of the permitted practice of discounting loss reserves was to increase the statutory policyholders' surplus of ProNational by approximately $10,658,000 at December 31, 1997. ProNational eliminated the practice of discounting loss reserves for SAP reporting during 1998. As a result of applying "pooling of interests" accounting to the statutory financial statements, all prior periods have been restated to reflect the combined operations of ProNational and PPTF. MEEMIC and ProNational Casualty do not utilize any permitted accounting practices.
We have audited the accompanying consolidated balance sheets of Professionals Group, Inc. (formerly Professionals Insurance Company Management Group) and subsidiaries (the Company) as of December 31, 1998, and the related consolidated statements of operations, comprehensive income, shareholders' equity and cash flows for each of the years in the two year period ended December 31, 1998. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule as of December 31, 1998 and for each of the years in the two year period ended December 31, 1998. These consolidated financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform our 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. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
On July 1, 1999, Michigan Educational Employees Mutual Insurance Company completed its conversion to a stock insurance company and changed its name to MEEMIC Insurance Company (MEEMIC). MEEMIC became a wholly owned subsidiary of MEEMIC Holdings, Inc. (MEEMIC Holdings), a publicly traded Michigan business corporation. As part of MEEMIC's conversion, ProNational acquired 77% of the outstanding common stock of MEEMIC Holdings. This acquisition was accounted for as a purchase business combination. Beginning July 1, 1999, the financial results of MEEMIC Holdings have been consolidated into the financial results of Professionals Group. See also Note 4 to Professionals Group and subsidiaries consolidated financial statements.