Our insurance subsidiaries are also subject to assessment by the financial guaranty associations in the states in which they conduct business for the provision of funds necessary for the settlement of covered claims under certain policies of insolvent insurers. Generally, these associations can assess member insurers on the basis of written premiums in their particular states. In addition to standard assessments, the Florida and Missouri legislatures may also levy special assessments to settle claims caused by certain catastrophic losses. We would be assessed on the basis of premiums written. During 2001, a special assessment was levied on First Professionals and APAC that totaled $0.9 million. No special assessments were made in 2003 or 2002. In addition, we could be subject to additional assessments in the future as a result of damages caused by catastrophic losses, such as a hurricane.
AFP also has two subsidiaries, FPIC Intermediaries (“FPIC Intermediaries”) and Group Data Corporation (“Group Data”). FPIC Intermediaries acts as a reinsurance co-broker and intermediary for our insurance subsidiaries. Group Data acts as a co-agent and co-broker for our internal insurance needs and for the purchase of structured settlements from time to time for settled MPL claims for PRI. The reciprocal management segment also includes FPIC’s 80% owned subsidiary Professional Medical Administrators (“PMA”), which acts as co-broker, intermediary and manager of reinsurance programs for PRI’s program business in Pennsylvania, whereby PRI assumes the premiums and risks insured. PRI also owns 10% of PMA and until August 2003, our subsidiary, First Professionals acted as the fronting carrier for PRI for the program business managed on its behalf by PMA. Since then, PRI has used an outside carrier to act as its fronting carrier.
PRI, as an MPL insurer, is subject to many of the same types of risks as those of our insurance subsidiaries and MPL companies generally. These risks include, but are not limited to, rate adequacy, adverse loss experience, and the effects of changes in market interest rates that it can earn on invested assets. PRI files information about its rates annually with the New York State Insurance Department. PRI implemented an 8.5% rate increase effective July 1, 2003 following several years of level rates. Growth at PRI is also subject to surplus constraints; however, as a reciprocal, PRI is able to operate with lower surplus and at higher leverage ratios than non-reciprocals such as our insurance subsidiaries. PRI’s policyholders’ surplus exceeds the minimum amount required under New York insurance laws and regulations. New York insurance laws and regulations do not impose risk-adjusted capital requirements. Further, as allowed under New York insurance laws, PRI has requested and received permission from the NYSID to follow the permitted practice of discounting its loss and LAE reserves.
Ceded written premiums under the Hannover Re agreement were $84.3 million and $85.5 million for the years ended December 31, 2003 and 2002, respectively. Thus, while the Hannover Re agreement did have a significant impact on the change in net premiums earned and our underwriting results between 2003 and 2002, it did not have a significant impact on the overall change in net premiums written between 2002 and 2003.
The Hannover Re net account quota share reinsurance cession resulted in improvements to our net underwriting margin of $5.8 million in 2003 and $3.6 million in 2002 ($3.5 million and $2.2 million, respectively after income taxes). The agreement resulted in an increase in our insurance segment’s total income from operations before income taxes and cumulative effect of accounting change of $1.3 million ($0.8 million after income taxes) for the year 2003 and $2.5 million ($1.6 million after income taxes) in 2002 (excluding the effects of net investment income we earned on funds withheld.) Finance charges associated with the Hannover Re agreement are included in other expenses and were $4.5 million in 2003 and $1.1 million in 2002. The increase in these charges was due to growth in the funds withheld account under the agreement.
Management fees earned by AFP are classified with claims administration and management fees in our statements of income. They are comprised entirely of management fees from PRI and the increase for the years ended December 31, 2003 and 2002 are due to the corresponding increase in the direct premiums written by PRI. In accordance with the management agreement between AFP and PRI, AFP receives a management fee equal to 13% of PRI’s direct premiums written, with an adjustment for expected return premiums.
Our TPA segment represents the business of our subsidiary EMI. Financial and selected other data for our TPA segment for the years ended December 31, 2003, 2002, and 2001 is summarized in the table below. Dollar amounts are in thousands.
The decline in commission income earned for the period ended December 31, 2003 is the result of a change in contract terms with a major client. The contract was changed from receiving commission income based on a percentage of premiums to a fixed fee for service basis.
Other expenses for the year ended December 31, 2003 decreased primarily due to ceasing the amortization of goodwill in accordance with the adoption of FAS 142, as described above. In addition, the year 2001 results include a restructuring charge of approximately $0.6 million, before income taxes, in connection with the disposition of the Brokerage Services, Inc. division of EMI in Albuquerque, New Mexico, which did not recur in 2002. We sold the division’s assets and cancelled its service agreements with self-insured customers. Certain other contracts were retained and are serviced by our Jacksonville, Florida division. The 2001 restructuring activity was a continuation of our consolidation of the TPA operations and concluded the restructuring activities of the Albuquerque division that began during 2000.
The implied range of reasonable loss and LAE reserves, net of reinsurance, estimated by FPIC as of December 31, 2003, was $276.4 million to $321.2 million. Our consolidated loss and LAE reserves, net of reinsurance, were $298.8 million in aggregate as of December 31, 2003, which represents management’s best estimate and was approximately equal to our in-house actuary’s point estimate within his range. Our independent actuary has also tested the loss and LAE reserves of each of our individual insurance subsidiaries as of December 31, 2003 and has issued his reports thereon, which have been filed with the Florida and Missouri insurance departments.
Issuance costs for all three offerings in the aggregate amount of approximately $1.4 million were capitalized and will be amortized over their respective stated maturity periods of thirty years. In addition, hedge agreements were purchased that effectively place floors and caps on the three-month LIBOR floating interest of approximately 1.0% to 1.20% and 4.40% to 4.65%, respectively, on notional principal corresponding with the principal amounts of each offering, for 5 years. These instruments will effectively serve to hedge our total floating interest rate borrowing costs under the securities to within a range of 4.85% to 8.6% for five years and until such time that we have the right to call the securities. The initial costs of the hedge instruments acquired for this purpose of $1.1 million, in aggregate, have been capitalized and will be amortized over their respective five year maturity periods.
Dividends from Subsidiaries. Shareholder dividends available from our insurance subsidiaries are subject to certain limitations imposed by Florida and Missouri laws. As of December 31, 2003, the insurance subsidiaries are permitted, within insurance regulatory guidelines, to pay FPIC dividends of approximately $13.4 million during 2004 without prior regulatory approval.
In April 2003, the Financial Accounting Standards Board (“FASB”) issued FAS 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” FAS 149 (1) clarifies under what circumstances a contract with an initial net investment meets the characteristic of a derivative discussed in paragraph 6(b) of FAS 133, (2) clarifies when a derivative contains a financing component, (3) amends the definition of an underlying derivative to conform it to language used in FASB Interpretation 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, and (4) amends certain other existing pronouncements. FAS 149 became effective for contracts and hedging relationships entered into or modified after June 30, 2003, with certain exceptions. All provisions of FAS 149 are to be applied prospectively. We have reviewed FAS 149 and complied with the reporting requirements therein for the period ended December 31, 2003. Adopting the provisions of FAS 149 did not have a significant impact on our consolidated financial statements.
Other invested assets ((Includes related party amounts of $788 and $7,398) Note 22)
Premiums receivable, net ((Includes related party amounts of $8,608 and $7,023) Note 22)
Medical professional liability (“MPL”) and legal professional liability (“LPL”) insurance is primarily written in Florida and Missouri. FPIC is also licensed to write insurance in Alabama, Arizona, Arkansas, Delaware, Georgia, Illinois, Indiana, Kansas, Kentucky, Maine, Maryland, Michigan, Minnesota, Mississippi, Montana, Nevada, North Carolina, Ohio, Oregon, Pennsylvania, South Carolina, Tennessee, Texas, Utah, Virginia, Washington and West Virginia.
As required by FAS 142, we completed annual impairment testing of our remaining goodwill as of December 31, 2003 and 2002 during the first quarters of 2004 and 2003, respectively, including obtaining reports from independent valuation consultants. Based on the results of such testing, we determined that the fair value of the goodwill exceeded the carrying value and that no impairment exists.
interest at three-month LIBOR plus 4.2% (5.37% at December 31, 2003).
The following tables set forth the status of our two defined benefit plans and SERP combined for the years ending December 31, 2003 and 2002, respectively.
For the years ended December 31, 2003, 2002 and 2001, the statutory net income or loss for FPIC’s insurance subsidiaries was as follows:
Management Agreement with APAM and Consulting Group of APA, Inc. (“CGA”)
Fronting fee income earned $ (2,020 ) (803 ) (356 )
The excess of loss reinsurance treaty between First Professionals and PRI related to losses of $0.25 million in excess of $0.5 million and the reinsurance treaty in which First Professionals reinsures PRI for policies with limits of $1.0 million in excess of $1.3 million both contain clauses under which PRI has the option to commute each such agreement. During the fourth quarter of 2001, the 1999 treaty relating to losses of $0.25 million in excess of $0.5 million was commuted. During the first quarter of 2002, the 2000 treaty relating to losses of $0.25 million in excess of $0.5 million was commuted. The commutations eliminated all of First Professionals’ present and future liabilities under the treaty in exchange for the return by First Professionals of all but the minimum contract premium to PRI. As a result of these commutations, First Professionals reported approximately $9.0 million and $9.3 million during the 4th quarter of 2001 and 1st quarter of 2002, respectively, of paid losses and LAE with a corresponding reduction in reserves. There was no net income effect from these commutations, due to the prior accrual of such charges.