At December 31, 2001, we established a $14.5 million valuation allowance against deferred tax assets resulting in a corresponding increase in income tax expense. This valuation allowance decreased to $6.6 million at December 31, 2002. The $7.9 million decrease in the valuation allowance favorably affected our income tax expense in 2002. See further discussion under “Income Taxes.”
We expect that our B- A.M. Best rating and the final runoff of in force premiums in our Massachusetts and Missouri regions will put downward pressure on premiums in force in 2003. Premium rates are expected to be relatively flat on new and renewing policies as we filed our rates at the high end in each region in which we operate in 2002, leaving little room to further increase rates in 2003. Premium rate increases realized in 2002 will continue to favorably affect profitability on each account in 2003 as we earn more premium on those policies. We expect to further improve our agency relationships in 2003 resulting in new business increases primarily in our Minnesota and Michigan regions. Overall, we expect premiums in force to increase only slightly;
Claim costs continued to reflect increasing medical and indemnity costs in accident year 2002 as compared to accident year 2001 resulting from inflationary pressures.
We reduced and renegotiated lease costs for our Corporate and Minnesota office space and expect that related office expenses will decrease in 2003.
Operating cash flows consist of the deficit or excess of premiums collected over claim and claim settlement expenses paid reduced by payments for reinsurance premiums as well as other operating expenses paid. Investment cash flows consist of income on existing investments and proceeds from sales and maturities of investments. Prior to 1999, we generated positive net cash flows from operations due, in part, to timing differences between the receipt of premiums and the payment of claim and claim settlement expenses. These net cash flows decreased significantly in 2001, 2000 and 1999 as we focused on closing old claims by paying earlier to close those claims. Combined with relatively flat premiums in force in 1998, 1999 and 2000 and decreasing premiums since that time, our cash flows from differences in timing have decreased. Additionally, 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 reinsurance premiums under that agreement. Reinsurance reimbursements from our $25,000 to $300,000 excess of loss reinsurance agreement offset similar payments to claimants for those years in 2002. Our investment portfolio decreased $7.8 million to $81.4 million at December 31, 2002 from $89.2 million at December 31, 2001, as a result of these factors. The cash balance at December 31, 2002 included $28.8 million received from St. Paul Re from terminating the
Our independent actuary provides management with an opinion regarding the acceptable range for adequate statutory reserves based on generally accepted actuarial guidelines. We record our net reserves by considering a range of estimates bounded by the high and low point of the range. Within that range, we record our best estimate. We focus in our decision process on improving our financial strength ratings and expect to remain a market for workers’ compensation insurance in all market conditions. In 2002,we established recorded reserves in the upper half of the actuary’s range. The ultimate actual liability may be higher or lower than reserves established.
We ceded Minnesota claims in excess of $350,000, $330,000 and $310,000 per occurrence during 2002, 2001 and 2000, respectively, to the Minnesota Workers’ Compensation Reinsurance Association (WCRA). In our non-Minnesota states, our per-incident exposure was $300,000 in 2002, 2001 and 2000. We purchased this non-Minnesota coverage from a single reinsurer.