We increased renewal premium rates an average of 11.7% in 2000 compared to premium rates for the same periods in 1999, reversing a trend of continued rate declines in prior years; and
Premium rates on renewal policies stabilized in the latter half of 1999 and we realized only slight pricing decreases. In 2000, we were able to increase premium rates on renewing policies an average of 11.7%. Our ability to increase rates in our markets is due to the following:
Reinsurance rates for workers’ compensation insurers have increased due to settlements related to Unicover reinsurance treaties, resulting in increased costs for workers’ compensation insurers; and
We expect that renewal premium rates will continue to increase into 2001. The ultimate increase is unknown at this time;
Interest Expense: We incurred interest charges on our $8.0 million Term Loan in 2000 and outstanding Senior Notes in 1999 and 1998.
Our primary sources of cash from operations are premiums collected and investment income. Our investment portfolio is also a source of liquidity, through the sale of readily marketable fixed maturity investments. Our primary cash requirements consist of payments for (i) reinsurance, (ii) claim and claim settlement expenses, (iii) policy acquisition costs, (iv) general and administrative expenses, (v) capital expenditures, (vi) income taxes, and (vii) debt service or principal repayment on our Term Loan. We have historically generated positive net cash from operations due, in part, to timing differences between the receipt of premiums and the payment of claim and claim settlement expenses. As we lowered our reinsurance retention levels to $25,000 in mid-1998, we decreased our current period cash flows as a result of “pre-funding” quarterly premiums under that agreement. We expect this reduction in cash flow will reverse itself in 2001 as we run-off the $25,000 to $300,000 excess of loss reinsurance policy and reimbursements for loss payments to claimants under this contract offset disbursements for premium payments. Cash generated is either invested in short-term cash and cash equivalents or longer term available-for-sale securities pending future payments for such expenses as indemnity, medical benefits and other operating expenses. Cash and cash equivalents consist of U.S. government securities acquired under repurchase agreements, tax-exempt municipal securities and corporate securities all with maturities of 90 days or less, with the remaining balances in cash and a money market fund that invests primarily in short-term government securities.
In March 1998, the National Association of Insurance Commissioners adopted the Codification of Statutory Accounting Principles (the Codification). The Codification is intended to standardize regulatory accounting and reporting to state insurance departments and is effective January 1, 2001. Statutory accounting principles, however, will continue to be established by individual state laws and permitted practices. The state of Minnesota requires adoption of the Codification for preparing statutory financial statements for financial periods occurring on or after January 1, 2001. We estimate that adoption of the Codification will increase our statutory capital and surplus by approximately $2.9 million on January 1, 2001.
Consolidated Statements of Shareholders’ Equity - Years Ended December 31, 2000, 1999 and 1998
As described in Note 5, the establishment of claim and claim settlement expense reserves is an inherently uncertain process.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company at December 31, 2000 and 1999, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States of America.
Available-for-Sale Investments: We intend to hold our available-for-sale investments to maturity, but may sell before maturity in response to income tax considerations, changes in interest rates, prepayment risk and funding sources or terms, or to address liquidity needs. Our available-for-sale investments are carried at fair value with changes in unrealized gains or losses, net of deferred taxes, reported as other comprehensive income or loss. The fair values of our investments are determined based upon quoted market prices as obtained through commercial pricing services or brokers who provide estimated fair values.
Effect of Recent Accounting Pronouncements - The Financial Accounting Standards Board has issued SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” which is effective January 1, 2001 (as amended by SFAS No. 137). SFAS No. 133 requires that all derivative instruments be recorded on the balance sheet at fair value. Changes in the fair value of derivative instruments are recorded each period in current earnings or other comprehensive income, depending on whether a derivative is designated as part of a hedge transaction, and if it is, the type of hedge transaction. We expect that adoption of the new standard will not affect our results of operations or financial position.
The weighted average fair value of options granted under the ESPP and 1994 Stock Plan during 2000, 1999 and 1998 is estimated at $2.24, $2.53 and $3.14, respectively, on the date of grant using the Black-Scholes option-pricing model with the following assumptions: no dividend yield; volatility of 64.6% in 2000, 64.3% in 1999 and 71.0% in 1998; risk-free interest rates ranging from 4.51% to 7.70%; and an expected life of 1 to 5 years.
Other Employee Benefit Plans - We maintained bonus plans in 2000, 1999 and 1998 under which all employees, including officers, were eligible for a bonus based, in part, on our operating results. These bonuses aggregated $951,000, $544,000 and $267,000 in 2000, 1999 and 1998, respectively.
Future minimum (base) rental payments required under the leases, as of December 31, 2000, are as follows (000’s):