-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, LW02mrJhsm+DDxPSyRJw4Fm+GoB4QIMMJmvlSPWIVZnbid7u97SdNVJ36w8J+tt8 phU7zAZzzSvwMXGMMwt9YA== 0000912057-97-010239.txt : 19970327 0000912057-97-010239.hdr.sgml : 19970327 ACCESSION NUMBER: 0000912057-97-010239 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970326 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: MIDWEST MEDICAL INSURANCE HOLDING CO CENTRAL INDEX KEY: 0000894353 STANDARD INDUSTRIAL CLASSIFICATION: SURETY INSURANCE [6351] IRS NUMBER: 411625287 STATE OF INCORPORATION: MN FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-21230 FILM NUMBER: 97563797 BUSINESS ADDRESS: STREET 1: 6600 FRANCE AVE SOUTH SUITE 245 CITY: MINNEAPOLIS STATE: MN ZIP: 55435-1891 BUSINESS PHONE: 6129225445 MAIL ADDRESS: STREET 1: 6600 FRANCES AVE SOUTH STE 245 CITY: MINNEAPOLIS STATE: MN ZIP: 554351891 10-K 1 10-K SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 FORM 10-K [X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 (Fee Required) For the Fiscal year ended December 31,1996 [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 (No Fee Required) For the transition period from __________to___________ Commission file number 0-21230 Midwest Medical Insurance Holding Company - ------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Minnesota 41-1625287 - -------------------------------------- --------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 6600 France Avenue So., Suite 245 Minneapolis, Minnesota 55435-1891 - ------------------------------------- --------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (612) 922-5445 Securities registered pursuant to Section 12(b) of the Act: NONE Securities registered pursuant to Section 12(g) of the Act: Title of Each Class Name of Each Exchange on Which Registered ------------------ ----------------------------------------- Class A Common Stock $.01 par value N/A Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. YES _X_ NO ___ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value (based on December 31, 1996 Net Redemption Value per share) of the voting stock held by non-affiliates of the registrant as of March 30, 1997 was $7,534,994. The number of shares outstanding of the issuer's classes of common stock, as of March 30, 1997: Class A Common Stock $.01 par Value - 118,209 shares Class B Common Stock $1,000 par value - 1 share DOCUMENTS INCORPORATED BY REFERENCE None. 1 PART I ITEM 1. BUSINESS BACKGROUND Midwest Medical Insurance Holding Company (MMIHC) is an insurance holding company organized under the laws of the State of Minnesota. Midwest Medical Insurance Company (MMIC) is a wholly-owned subsidiary of MMIHC and is MMIHC's primary operating asset. MMIC's primary business is selling and issuing policies of medical professional liability insurance to: (1) individual physicians, (2) partnerships or professional corporations comprised of physicians and (3) clinics. In addition, MMIC writes business liability insurance providing coverage for claims against a medical business entity resulting from acts by the employees who work for the entity, and office premises liability insurance providing coverage for claims arising out of the ownership, maintenance or use of office premises of the insured. MMIC originally was organized in 1980 under the auspices of the Minnesota Medical Association (the "MMA") to provide professional liability (malpractice) insurance to Minnesota physicians who are members of the MMA. The business was reorganized on November 30, 1988 into a stock insurance company (MMIC), wholly owned by a holding company (MMIHC), which could pursue other business opportunities. MMIHC has not engaged in any such activities to any material extent. The reorganization also was effected to give physicians a limited equity interest in their malpractice insurer while preserving MMIC's capital and surplus. As of July 1, 1993, the Iowa physician-owned malpractice insurer, Iowa Physicians Mutual Insurance Trust (IPMIT), was merged with and into MMIC. As of June 5, 1996, the Nebraska physician-owned malpractice insurer, Medical Liability Mutual Insurance Company of Nebraska (MLM) was merged with and into MMIC. MMIC now provides malpractice insurance to physicians and physician groups in Minnesota, Iowa, North Dakota, South Dakota, Nebraska, Illinois and Wisconsin on a claims-made basis. MMIC has had the sponsorship of the MMA since inception and also has the sponsorship of the Iowa Medical Society (IMS) and North Dakota Medical Association. Professional liability, general liability, and umbrella excess liability insurance is also available to hospitals, nursing homes and extended care facilities through MMIC. MMIC has no employees. Instead, MMIHC provides all management and administrative services to MMIC for a fee based upon the cost of providing services. For insurance operational expenses, a ten percent administrative surcharge is added. Hereafter, MMIHC and MMIC shall be collectively referred to as the Company unless the reference pertains to a specific entity. Further, due to the nature of the relationship between MMIHC and MMIC, the insurance operations of MMIC will be discussed as though they are the operations of the registrant. 2 ITEM 1. BUSINESS (CONTINUED) ELIGIBLE PHYSICIANS An individual physician must meet the following criteria in order to be eligible to obtain insurance coverage from MMIC: 1. An applicant must be licensed to practice medicine, surgery or osteopathy in Minnesota, Iowa, Nebraska, North Dakota, South Dakota, Nebraska, Illinois, or Wisconsin; 2. An applicant must conduct a majority of his or her practice in Minnesota, Iowa, Nebraska, North Dakota, South Dakota, Nebraska, Illinois or Wisconsin. ELIGIBLE GROUPS MMIC also provides professional liability insurance to entities including partnerships, professional corporations and other associations through which qualifying physicians practice medicine, surgery or osteopathy. A group must meet the following criteria in order to be eligible to be insured by MMIC: 1. The entity must have its principal place of business in Minnesota, Iowa, Nebraska, North Dakota, South Dakota, Nebraska, Illinois or Wisconsin; and 2. The group must demonstrate that all of the individual physicians practicing medicine, surgery or osteopathy on a full-time basis through such clinic are, or intend to be, insured by MMIC. ELIGIBLE HOSPITALS, NURSING HOMES AND OTHER EXTENDED CARE FACILITIES MMIC also provides professional liability, general liability and umbrella excess liability to hospitals, nursing homes and other extended care facilities which provide medical services to patients on more than an outpatient basis. A business must meet the following criteria in order to be eligible to be insured by MMIC: 1. The entity must have its principal place of business in Minnesota, Iowa, Nebraska, North Dakota, South Dakota, Illinois or Wisconsin; and 2. The facility must be a licensed hospital, nursing home, hospice or other extended care facility. 3 ITEM 1. BUSINESS (CONTINUED) POLICY FORMS MMIC offers a "claims-made" medical malpractice liability insurance policy. Under a claims-made policy, coverage is provided for claims asserted and reported to MMIC while the policy is in effect relating to occurrences which took place during the period in which the policyholder had coverage with MMIC. For purposes of policy coverage, a claim includes any lawsuit, allegation of liability or other notice of patient dissatisfaction with services performed that is communicated to MMIC as required by the policy. The policy also covers prior acts (i.e., claims first made during the policy period with respect to occurrences which took place prior to the date the insured initially secured coverage from MMIC) for physicians previously insured under a claims-made policy with another professional liability insurer. Prior acts coverage is not available from MMIC for physicians who have not been continuously insured prior to obtaining coverage from MMIC. MMIC also offers reporting endorsements ("tails") which provide coverage of subsequent claims (i.e., claims first made subsequent to the date the insured terminates basic insurance coverage with MMIC, but with respect to occurrences which took place while the insurance coverage was in effect prior to such termination date) made against its former insureds who have voluntarily terminated insurance coverage with MMIC. In the event of death, permanent disability, or retirement at age 55 or older after five years of coverage with MMIC, the reporting endorsement is provided at no additional premium. MMIC offers basic limits of coverage from $100,000 for each claim, subject to $300,000 annual aggregate, up to $5,000,000 for each claim, subject to $5,000,000 annual aggregate. Excess coverage above the basic limits is available from MMIC's reinsurers on a facultative basis. The basic office premises liability limits offered are $100,000 for each occurrence for bodily injury and $100,000 for each occurrence for property damage. Limits up to $1,000,000 for each occurrence are also available. The basic liability limits for coverage of employees and assistants cannot exceed the limits purchased by the insured physician or clinic. 4 ITEM 1. BUSINESS (CONTINUED) MARKETING AND DISTRIBUTION Marketing of MMIC policies in Minnesota, South Dakota, Nebraska, Illinois and Wisconsin is handled principally by MMIC through salaried marketing representatives. MMIC has also made marketing arrangements with a select group of large national brokers to assist MMIC in the production of large accounts and in the production of new coverages as they are developed. These brokers will work primarily in Minnesota. MMIC has appointed an exclusive independent agent in Iowa and in North Dakota in order to enhance marketing efforts there. MMIC does not believe that the loss of any exclusive agent would have a material adverse effect on its business because other agents are available and MMIC has the in-house capacity to market directly in any of these areas. MMIC approves all policies (and their terms) sold by agents prior to their becoming effective, and no commissions are earned by agents until such approval has been granted. Distribution of policies is handled through a processing system which MMIC has utilized for several years. Since most policies have a common expiration date, it is essential that MMIC's policy processing operations be highly efficient. MMIC consistently has been able to provide policy processing on a timely basis. REINSURANCE MMIC purchases reinsurance in order to reduce its liability on individual risks. A reinsurance transaction takes place when an insurance company transfers or "cedes" to another insurer a portion of its exposure on insurance it writes. The reinsurer assumes the exposure in return for a portion of the premium. The reinsurer's liability is limited to losses it assumes that are in excess of the portion retained by MMIC. However, in the event the reinsurer is unable or otherwise fails to pay, MMIC remains primarily liable for the loss. Historically, entering into reinsurance agreements permitted MMIC to issue policies having greater liability limits than otherwise would have been allowed under Minnesota insurance law, which prohibits an insurer from retaining a risk on any one claim that is greater than 10 percent of its surplus. As MMIC's surplus has grown, MMIC now utilizes reinsurance primarily to limit its risk on any single claim. Such limits of risk assumed by MMIC for physician coverage have increased from $150,000 in the first year of operations to $750,000 as of January 1, 1995. The single claim limit of risk assumed is $500,000 for hospital coverage. The reinsurer will pay losses in excess of the amount of risk retained by MMIC, not to exceed the limits of liability of the policies issued by MMIC. 5 ITEM 1. BUSINESS (CONTINUED) MMIC currently operates under an excess-of-loss reinsurance treaty with General Reinsurance Corporation of Stamford, Connecticut (85%) and Hanover Reinsurance Company of Hanover, Germany (15%), whereby the reinsurers insure against losses in excess of the of loss limit retained by MMIC. General Reinsurance Corporation is the largest reinsurer of medical professional liability in the United States and one of the largest in the world and has received the highest rating of A++ by A.M. Best & Company, Inc. Hanover Reinsurance Company is rated A+ by A.M. Best & Company, Inc. Coverage under the treaty was initially issued on October 1, 1986, and is continuous until canceled by either party. Previous reinsurance treaties, which remain in effect for pre-1986 incidents, were with various domestic and foreign reinsurers, all of whom have maintained their obligations to MMIC and appear to be financially sound. MMIC currently cedes about $7,200,000 of premium per year under the reinsurance treaty. INVESTMENTS MMIC's investment portfolio is under the direction of the Board of Directors acting through the Investment Committee. The Investment Committee establishes MMIC's investment policy which, in summary, is to assist in maintaining MMIC's financial stability through the preservation of assets and the maximizing of after-tax investment income. Adequate liquidity is maintained to assure that MMIC has the ability to meet its insurance operational requirements, in particular the payment of claims. MMIC employs outside investment managers who manage the portfolio on a discretionary basis consistent with the policies set by MMIC. In addition, the Investment Committee utilizes the services of a separate outside consultant who calculates performance measures and provides an independent opinion on the overall results being obtained by the investment managers. MMIC's investment portfolio consists primarily of fixed income instruments, including United States Government and governmental agency bonds and other public and municipal bonds. MMIC's investment policy permits the inclusion of equity securities of up to 15 percent of the portfolio. In accordance with this policy, equity securities currently comprised approximately 12.3 percent of the portfolio at December 31, 1995. Due to the 1996 increase in market values, with no new funds committed to equities, equities comprise 16.6% of the portfolio at December 31, 1996. RATING A.M. Best & Company, Inc. ("Best's"), publisher of BEST'S INSURANCE REPORTS, PROPERTY-CASUALTY, 1996 Edition, has assigned MMIC an "A", or excellent, rating in 1996. Best's ratings are based on an analysis of the financial condition and operation of an insurance company as compared with the industry in general. MMIHC believes that a favorable rating has a positive effect since customers and their advisors often review Best's ratings when selecting an insurer and are more apt to purchase insurance from a company with a positive rating because of the greater security and stability associated with a positive rating. A positive rating relates to the ability of an insurer to meet its insurance obligations and does not directly relate to the value of the insurer's securities. 6 ITEM 1. BUSINESS (CONTINUED) GOVERNMENT REGULATION MMIC is subject to governmental regulation in the states in which it conducts its business (Minnesota, Iowa, North Dakota, South Dakota, Nebraska, Illinois, and Wisconsin). Such regulation is conducted by state agencies having broad administrative power dealing with all aspects of MMIC's business, including policy terms, rates, dividends and retrospective premium credits to policyholders, and dividends to the parent corporation, MMIHC. Without prior approval from the Minnesota Commissioner of Commerce, annual dividends to MMIHC cannot exceed 10 percent of unassigned surplus of MMIC or the prior year's net income from operations of MMIC, whichever is greater. MMIC is also subject to statutes that require it to file periodic information with state regulatory authorities and is subject to periodic financial and business conduct examinations. MMIHC is also subject to statutes governing insurance holding company systems in Minnesota, which relate primarily to the acquisition of control of insurance companies directly or through a holding company. COMPETITION MMIC's major competitor in all states in which it conducts its business is The St. Paul Companies. The St. Paul Companies is a major national property-casualty insurance company, the largest writer of medical professional liability insurance in the United States, and is many times larger than MMIC. In addition to The St. Paul Companies, several other national companies have become active competitors in the last several years, including Medical Protective Insurance Company, CNA Insurance Company, Zurich Insurance Company, and Fireman's Fund Insurance Company. At this time they have achieved limited market penetration, but represent an increasing competitive pressure for the future. In addition several other physician-owned specialty carriers have entered the market, but have yet to be a significant factor in MMIC's area. Finally, over the past three years several large self-insured hospitals in Minneapolis and Des Moines have purchased MMIC insured clinics, and other physician practices have been purchased by large, self-insured clinics such as the Mayo Clinic. This trend decreased significantly in 1996. The trends are causing a contraction in the available market for MMIC's primary malpractice insurance. MMIC is the only carrier endorsed by local medical societies in Minnesota, Iowa and North Dakota and owned by its physician-insureds, which management believes gives MMIC a competitive advantage in marketing to physicians. The market for medical professional liability insurance is changing, especially with the dramatic changes proposed and occurring in the broader health care industry. Various changes in the market for medical professional liability insurance are possible as a result of developments such as practice consolidation and integration, physician-hospital organizations, various forms of managed health care, various forms of alliances between providers, proposals for enterprise liability, and many others. Management of MMIC believes it is developing new programs and products which will allow it to remain an industry leader as such change occurs, although no assurance can be given to that effect. 7 ITEM 1. BUSINESS (CONTINUED) EMPLOYEES As of December 31, 1996, MMIHC employed 64 persons, of whom 5 were executives, 44 were supervisory employees or specialists, and 15 were clerical employees. None of the employees of MMIHC is covered by a collective bargaining agreement and management believes that relations with employees are good. 8 ITEM 2. PROPERTIES MMIHC owns the following fixed assets, all of which are used in the conduct of its business: NET BOOK VALUE DECEMBER 31, 1996 --------------- Office furniture and equipment $308,758 Leasehold improvements at leased premises, 6600 France Avenue South, Minneapolis, MN 35,127 Computer hardware 166,348 Computer system software 61,476 --------------- Total $571,709 --------------- --------------- The Company owns no real estate. MMIHC leases approximately 15,765 square feet of office space in Edina, Minnesota under a 10-year lease that expires in 2001, subject to the option for MMIHC to renew the lease for an additional five years after the original term. Four-thousand and sixty square feet of office space is leased in West Des Moines, Iowa under a 10-year lease that expires in 2000, with an option for MMIHC to extend the term for an additional five years after the original term. An additional 2,398 square feet of office space is leased in Omaha, Nebraska under a three year lease that expires November 30, 1997. Annual rent expense was $392,282 for 1996 and $379,699 for 1995. ITEM 3. LEGAL PROCEEDINGS The Company is not a party to any pending or threatened legal proceedings which could have a material adverse effect on its operations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS At a meeting held on February 14, 1996, MMIHC shareholders approved an amendment to eliminate from its Articles of Incorporation the requirement that only physicians who are members of their respective state medical societies may own MMIHC Class A Common Stock. This amendment was effective immediately as to Nebraska physicians, and is effective on January 1, 1997 as to physicians in all other states. 9 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS (a) There is no market for the Company's Class A or Class B Common Stock. Class A shares are issued only to insured individual physicians or individual physicians jointly with the legal entities in which they practice. The shares are restricted and cannot be sold to any person other than MMIHC and are subject to mandatory redemption at the time that the physician terminates his or her insurance coverage for any reason. (b) As of March 30, 1997, there were 118,209 shares of Class A Common stock outstanding held by 3,445 physicians and 1 share of Class B Common Stock held by the Minnesota Medical Association. (c) MMIHC has never paid a shareholder dividend nor does it intend to within the foreseeable future. Without prior approval from the Minnesota Commissioner of Commerce, annual dividends to MMIHC from MMIC cannot exceed 10% of unassigned surplus of MMIC or the prior year's net income from operations of MMIC, whichever is greater. ITEM 6. SELECTED FINANCIAL DATA Following is the selected financial data of MMIHC for the five years ended December 31, 1996. This data should be read in conjunction with the consolidated financial statements and notes thereto appearing under Item 8 of this Form 10-K. YEAR ENDED DECEMBER 31 OPERATIONS DATA 1996 (1) 1995 (1) 1994 (1) 1993 (1) 1992 (3) - -------------------------------------------------------------------------------- (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) Net premiums earned $32,046 $29,798 $26,246 $40,183 $36,317 Net investment and other income 14,840 14,191 11,509 14,773 14,859 ----------------------------------------------- Total revenue 46,886 43,989 37,755 54,956 51,176 Loss and loss adjustment expense 32,257 37,560 11,334 30,693 19,707 Other underwriting expenses 5,690 6,415 5,509 5,807 6,480 ----------------------------------------------- 37,947 43,975 16,843 36,500 26,187 ----------------------------------------------- Income before income taxes 8,939 14 20,912 18,456 24,989 Income taxes (benefit) 1,458 (1,711) 6,417 6,156 8,528 ----------------------------------------------- Net income $ 7,481 $ 1,725 $14,495 $12,300 $16,461 ----------------------------------------------- ----------------------------------------------- 10 ITEM 6. SELECTED FINANCIAL DATA (CONTINUED)
YEAR ENDED DECEMBER 31 1996 (1) 1995 (1) 1994 (1) 1993 (1) 1992 (3) ------------------------------------------------------ (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) Net income per common share and common share equivalent $58.33 $13.74 $114.84 $99.53 $142.20 Number of shares used in per share calculation 128,259 125,536(4) 126,222(4) 123,575(4) 115,758(4) Net income/total revenue 16.0% 3.9% 38.4% 22.4% 32.2% Return on average equity 6.5% 1.7% 15.8% 9.0% 12.9%
DECEMBER 31 FINANCIAL CONDITION 1996 (1) 1995 (1) 1994 (1) 1993 (2) 1992 (3) - ------------------------------------------------------------------------------- (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) ASSETS Fixed maturities at fair value $183,561 $182,817 $174,203 $ - $ - Fixed maturities at amortized cost - - - 181,526 164,878 Equity securities at fair value 38,001 28,311 19,782 19,580 17,782 Short-term investments 7,898 15,015 9,755 7,429 5,674 -------------------------------------------------- Total investments 229,460 226,143 203,740 208,535 188,334 Reinsurance recoverable 22,174 25,112 23,637 18,310 19,839 Other assets 10,359 13,329 19,100 16,335 15,954 -------------------------------------------------- Total assets $261,993 $264,584 $246,477 $243,180 $224,127 -------------------------------------------------- -------------------------------------------------- LIABILITIES Unpaid losses and loss adjustment expenses $110,037 $120,264 $110,967 $123,420 $118,171 Other liabilities 33,074 34,053 38,358 33,904 32,006 -------------------------------------------------- 143,111 154,317 149,325 157,324 150,177 REDEEMABLE STOCK Class A and Class B Common Stock at redemption value 7,604 6,975 7,712 7,605 7,230 111,278 103,292 89,440 78,251 66,720 -------------------------------------------------- OTHER SHAREHOLDERS' EQUITY Total liabilities, redeemable stock and shareholders' equity $261,993 $264,584 $246,477 $243,180 $224,127 -------------------------------------------------- --------------------------------------------------
11 ITEM 6. SELECTED FINANCIAL DATA (CONTINUED)
DECEMBER 31 1996 (1) 1995 (1) 1994 (1) 1993 (2) 1992 (2) ------------------------------------------------- (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) Midwest Medical Insurance Holding Company: Class A Common Shares issued and outstanding 118,209 116,251 116,855 115,230 110,333 Redemption value per share $64.33 $60.00 $66.00 $66.00 $65.53 Class A Common Shares redeemed 10,272 12,424 12,640 6,426 2,953 Amount paid to terminating policyholders upon redemption $ 608 $ 829 $ 840 $ 415 $ 233
_______________________________________ (1) Amounts derived from audited consolidated financial statements of MMIHC included in Item 8 of this Form 10-K. (2) Amounts derived from audited consolidated financial statements of MMIHC. (3) Amounts derived from post-pooling financial statements of MMIHC which have been audited as to combination only. (4) Includes pro forma shares computed to give retroactive effect to the merger of MMIHC/MMIC with MLM. See Note 2 to the consolidated financial statements included in Item 8 of this Form 10-K. 12 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS MANNER OF PRESENTATION The financial statements of MMIHC and MMIC are presented on a consolidated basis. In future references in this analysis, which should be read together with the 1996 consolidated financial statements and notes thereto appearing under Item 8 in this Form 10-K, MMIHC and MMIC are referred to collectively as the "Company". CAPITAL RESOURCES AND LIQUIDITY The majority of the Company's assets are invested in bonds, stocks and short-term instruments. These investments totaled $229,460,000 and $226,143,000 at December 31, 1996 and 1995, respectively, which represented 87.5% and 85.7% of total assets. The primary objective of the Company's investment policy is preservation of assets while securing the highest after-tax return consistent with asset conservation. The investment in U.S. Government bonds assists in assuring adequate liquidity for payment of losses. Stocks are carried at fair value on the balance sheet. The Company adopted SFAS No. 115 effective January 1, 1994. Fixed maturity investments are classified as available for sale by management and therefore, in accordance with SFAS No. 115, are also carried at fair value effective January 1, 1994. Prior to January 1, 1994, bonds were carried at the lower of aggregate amortized cost or market. Equity securities are also classified as available for sale. This caused no change in the accounting for these investments. See Note 1 of the notes to the consolidated financial statements for additional detail concerning the impact of adopting SFAS No. 115. Partially taxable state and other political subdivision bonds are utilized in the portfolio to reduce federal income taxes and to secure a higher after-tax return than fully taxable investments. The Company's cash flow from operations has been essentially breakeven for the years 1996, 1995 and 1994. Premium rates have remained level for several years causing cash receipts from operations to be relatively level. In addition, in recent years MMIC has returned substantial amounts of premiums to policyholders in the form of retrospective premium credits. Loss and operating expense payments during all three years have generally been met from current year's premium receipts with any excess cash allocated to the investment portfolio. The Company regularly analyzes loss liabilities to project cash flow required in future years. Bond maturities by year approximate this loss payment pattern. Since the overall portfolio is highly liquid, exact matching is not a goal. Maturities are selected to maximize total return rather than to achieve exact matching of liabilities. While operating cash flow was basically breakeven in 1996, 1995 and 1994, given the Company's December 31, 1996 shareholders' equity of $111,278,000, investments of $229,460,000 and gross loss liabilities of $110,037,000, the Company anticipates no cash flow problems in the near future. 13 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) The Company's bylaws require that MMIHC Class A Common Stock issued to MMIC policyholders be redeemed when a physician ceases to be insured by MMIC for any reason. The redemption value per share is calculated by dividing the net book value of the Company, excluding the net book value of MMIC (other shareholders' equity) from the calculation, by the number of MMIHC Class A Common Shares outstanding. More detail about the redeemable stock and the actual redemptions during the years 1996, 1995 and 1994 are found in Note 3 to the consolidated financial statements. This limited redemption value preserves the capital of MMIC as shareholders' equity. The consolidated statements of changes in other shareholders' equity found in the accompanying financial statements provide the details of additions to and reductions in other shareholders' equity. From time to time the Board of Directors of MMIC declares dividends payable to MMIHC to maintain the redemption value of the Company's Class A Common Stock. The $1,181,000 dividend declared in November 1994 and the $260,000 dividend in November 1995 were declared in accordance with that principle and paid in February of 1994 and 1995, respectively. In July 1996, a dividend of $327,000 was paid to MMIHC as required by a provision of the MMIC/MLM merger agreement. Per the merger agreement, the amount was sufficient to maintain the per share redemption value of MMIHC's Class A Common Stock at the same per share value immediately after the merger as immediately before the merger. 14 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) LOSS AND LOSS ADJUSTMENT EXPENSE RECONCILIATION OF LIABILITY FOR LOSS AND LOSS ADJUSTMENT EXPENSE (THOUSANDS OF DOLLARS)
1996 1995 1994 ------------------------------- Liability for loss and loss adjustment expense at beginning of year $ 96,424 $ 88,227 $105,589 Plus: Incurred loss and loss adjustment expense: Provision for current year 41,101 39,847 36,275 (Decrease) in provision for prior years (8,844) (2,287) (24,941) -------------------------------- Total incurred loss and loss adjustment expense 32,257 37,560 11,334 Less: Incurred loss and loss adjustment expense payments: Payment attributable to current year 4,885 2,484 3,445 Payment attributable to prior years 33,454 26,879 25,251 -------------------------------- Total payments 38,339 29,363 28,696 -------------------------------- Liability for loss and loss adjustment expense at end of year 90,342 96,424 88,227 Reinsurance recoverables on unpaid losses at end of year 19,695 23,840 22,740 -------------------------------- Liability for loss and loss adjustment expense, gross of reinsurance recoverables on unpaid losses at end of year $110,037 $120,264 $110,967 -------------------------------- --------------------------------
The second to the last line on the preceding reconciliation reports the amount of reinsurance recoverables for unpaid losses which are included in the 1996, 1995 and 1994 balance sheet liability "Unpaid losses and loss adjustment expenses". Except for adding the reinsurance recoverables, the reconciliation is presented net of reinsurance which coincides with the manner of presentation of the income statements. 15 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) The current year's provision for loss and loss adjustment expense, which is based upon policyholder exposure, expected frequency of losses, and severity of losses, was fairly stable for 1996 and 1995. The 1994 current year provision was approximately $4,000,000 less than the 1996 and 1995 amounts primarily because the Company increased its retention from $500,000 per claim to $750,000 per claim effective January 1, 1995. The loss and loss adjustment expenses reflected in the consolidated financial statements, and shown in the Reconciliation of Liability for Loss and Loss Adjustment Expense as total incurred loss and loss adjustment expense, include adjustments of prior years' estimates. Incurred loss and loss adjustment expenses for 1996 and 1995 of $32,257,000 and $37,560,000, respectively, are significantly greater than the $11,334,000 in 1994. During 1994, the liability for loss and loss adjustment expenses was extensively reevaluated by management which resulted in a significant reduction, $24,941,000, in these liabilities for years prior to 1994. That reduction was supported by outside actuarial evaluation. There were smaller reversals of prior years' liabilities in 1996 and 1995. Following the 1994 extensive review and liability reduction, management does not expect prior year liability reductions of similar significance in future years. The schedule which follows summarizes the development of the liability for loss and loss adjustment expense from 1986 through 1996. This schedule is also presented net of reinsurance which the Company believes best explains the development as it affects operating results. The Company has a conservative loss reserving policy which, when coupled with a moderation of malpractice insurance losses which began in approximately 1986 for the Company and across the industry, has resulted in redundancies in liabilities larger than expected. The table indicates that the redundancy in loss liabilities, which developed when more actual results were known, has been significantly reduced from the high at December 31, 1990. Loss and loss adjustment expense liabilities have not been discounted in the Company's financial statements. 16 Development of Liability for Loss and Loss Adjustment Expense (THOUSANDS OF DOLLARS)
1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 ------------------------------------------------------------------------------------------------- Liability for unpaid loss and loss adjustment expense $45,105 $60,133 $74,577 $89,630 $97,375 $100,167 $98,617 $105,589 $88,227 $96,424 $90,342 Liability reestimated as of: 1 year later 41,123 53,358 65,928 73,244 83,359 83,991 94,633 80,960 85,595 87,589 2 years later 36,346 46,297 51,379 62,056 64,876 74,883 69,490 75,364 76,365 3 years later 30,325 35,881 43,516 52,010 56,351 53,538 65,568 64,586 4 years later 24,378 33,448 35,753 44,582 42,075 52,833 56,426 5 years later 24,767 30,345 31,052 37,872 41,771 45,892 6 years later 23,722 26,818 29,052 37,617 39,519 7 years later 22,379 26,613 29,002 35,882 8 years later 22,176 26,620 28,724 9 years later 22,179 26,611 10 years later 22,176 Cumulative redundancy 22,929 33,522 45,853 53,748 57,856 54,275 42,191 41,003 11,862 8,844 Cumulative amount of liability paid through: 1 year later 7,103 13,421 12,067 10,585 13,973 19,112 21,422 25,251 26,879 33,454 2 years later 16,443 19,787 19,043 21,890 28,643 32,798 37,498 42,685 46,925 3 years later 19,189 23,184 24,143 30,869 35,305 39,906 45,227 51,087 4 years later 20,817 25,238 26,241 35,015 37,624 42,752 46,226 5 years later 21,790 26,240 27,561 35,115 38,298 43,994 6 years later 21,902 26,555 27,660 35,187 39,505 7 years later 22,121 26,610 27,695 35,295 8 years later 22,176 26,610 27,695 9 years later 22,176 26,610 10 years later 22,176
17 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) RESULTS OF OPERATIONS NET PREMIUMS EARNED increased $2,248,000 in 1996 from 1995 while the number of insured policyholders and rate levels were relatively the same. The primary reasons for this increase are: 1. In 1996, $2,194,000 was received from the commutation of a reinsurance treaty covering the years 1989 and 1990. This increases 1996 net premiums. There was no similar item in 1995. 2. Several other reinsurance treaty adjustments involving prior years retrospective reinsurance treaties resulted in reducing 1996 reinsurance costs by $1,740,000, thereby increasing net premium earned. The years involved ranged from 1987-1995. Most of these treaties originated with IPMIT prior to its merger into MMIC on July 1, 1993. 3. Offsetting these two major reasons for the increase in 1996 net premiums was one significant item which caused a decrease. The Company recorded an increase of $2,901,000 in an Iowa development experience liability account in 1996. A similar increase of $646,000 was recorded in 1995. The difference between the 1996 and 1995 amounts decreased net premium $2,255,000. Under terms of the MMIC/IPMIT July 1, 1993 merger agreement, if the financial results for the years prior to 1993 are more favorable than expected at December 31, 1992, that favorable development must be returned to the prior IPMIT policyholders who renew coverage with MMIC. 18 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) NET PREMIUMS EARNED increased $3,552,000 in 1995 from 1994 even though policyholder rate levels remained the same and the number of policyholders insured also remained stable. The primary reasons for this increase are: 1. A $5,200,000 retrospective premium credit was declared in 1995 for Minnesota policyholders who were insured during 1992, 1993 and 1994 and renew with the Company on January 1, 1996. A similar premium credit of $6,000,000 was declared in 1994. The 1995 credit was lower by $800,000 and caused 1995 net premium to be higher by this amount. These premium credits were paid to policyholders in early March of 1995 and 1996, respectively. 2. The Company recorded an increase of $646,000 in an Iowa development experience liability account in 1995. Under terms of the MMIC/IPMIT July 1, 1993 merger agreement, if the financial results for years prior to 1993 are more favorable than expected at December 31, 1992, that favorable development must be returned to the prior IPMIT policyholders who renew coverage with MMIC. The establishment of this liability reduces earned premiums. A similar increase of $7,227,000 was recorded in 1994. The difference between 1995 and 1994 increased net premium from 1994 to 1995 by $6,581,000. 3. Offsetting the two major reasons for the increase in 1995 net premiums, which total $7,381,000, is one item which caused a decrease. In 1994, the Company reduced its estimated unearned premium liability for free death, disability and retirement reporting endorsements by $2,903,000 which increases net premium. A further small decrease in this liability, $310,000, was recorded in 1995. The difference, $2,593,000, causes 1995 net premium to be lower by that amount. INVESTMENT INCOME has remained level during the last three years. Invested assets as shown in the Balance Sheet at fair value increased by $3,317,000 from December 31, 1995 to December 31, 1996. On a cost basis, the amount of investments increased by $885,000. 19 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) REALIZED CAPITAL GAINS of $1,771,000 in 1996 and $1,646,000 in 1995 were due to active management of both the bond and equity sections of the portfolio. During 1994, the same investment management philosophy, preservation of assets while securing the highest total return possible, resulted in a net capital loss of $455,000. The Company employs two outside professional advisors to manage the portfolio, one to manage fixed income securities and a separate manager for equities. The managers operate within the Company's adopted investment policy. The Investment Committee meets with the outside managers approximately four times per year. OTHER UNDERWRITING EXPENSES decreased by $725,000 from 1995 to 1996. This decrease was primarily due to a reallocation of costs under the Company's amended management agreement for 1996 filed herein. In 1995 the majority of this expense was included in other underwriting expense. The increase from 1994 to 1995 was primarily due to a $520,000 reduction in reinsurance ceding commission received. The reduction occurred in connection with the Company increasing its retention from $500,000 per claim to $750,000 per claim and changing the method by which final reinsurance premium is determined for coverage up to $2,000,000 per claim. INCOME TAXES. In 1996 the Company's book net income before taxes was $8,939,000. Deductions from book income, primarily tax exempt interest income from municipal bonds reduces income subject to tax. This current year's tax based on taxable earnings was increased by a reduction in deferred taxes of $298,000 to arrive at the income tax charged to operations as shown in the financial statements. Deferred tax effects are provided whenever expense items are recorded in the accompanying financial statements in a time period different from those in the Company's tax returns. NET INCOME for the Company during the last three years totaled $23,701,000 which was added to retained earnings. As indicated in the discussion of loss and loss adjustment expenses, a significant portion of net income for these years resulted from the reversal of loss liabilities established in prior years. 20 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The consolidated financial statements of Midwest Medical Insurance Holding Company and Subsidiary are presented on pages 22 through 49 of this Annual Report on Form 10-K following. 21 Midwest Medical Insurance Holding Company and Subsidiaries Consolidated Financial Statements Years ended December 31, 1996, 1995 and 1994 CONTENTS
Report of Independent Auditors . . . . . . . . . . . . . . . . . . . . . . .23 Consolidated Financial Statements Consolidated Balance Sheets. . . . . . . . . . . . . . . . . . . . . . . . .24 Consolidated Statements of Income. . . . . . . . . . . . . . . . . . . . . .25 Consolidated Statements of Changes in Other Shareholders' Equity . . . . . .26 Consolidated Statements of Cash Flows. . . . . . . . . . . . . . . . . . . .28 Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . . 29
22 Report of Independent Auditors Board of Directors Midwest Medical Insurance Holding Company and Subsidiaries We have audited the accompanying consolidated balance sheets of Midwest Medical Insurance Holding Company and Subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of income, changes in other shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1996. Our audits also included the financial statement schedules listed in the index at Item 14(a). These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit 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. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Midwest Medical Insurance Holding Company and Subsidiaries at 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. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein. In 1994, as discussed in Note 1 to the financial statements, the Company changed its method of accounting for certain investments in debt and equity securities. /s/ Ernst & Young LLP Minneapolis, Minnesota January 31, 1997 23 Midwest Medical Insurance Holding Company and Subsidiaries Consolidated Balance Sheets (IN THOUSANDS, EXCEPT FOR SHARE AMOUNTS) DECEMBER 31 1996 1995 -------------------------- ASSETS Investments (NOTE 4): Fixed maturities at fair value (cost: 1996--$179,979; 1995--$174,544) $183,561 $182,817 Equity securities at fair value (cost: 1996--$20,237; 1995--$17,670) 38,001 28,311 Short-term 7,898 15,015 -------------------------- 229,460 226,143 Cash - 704 Accrued investment income 2,778 2,875 Reinsurance recoverable (NOTE 8) 22,174 25,112 Other assets 6,451 7,446 Deferred income taxes (NOTE 7) 1,130 2,304 -------------------------- Total assets $261,993 $264,584 -------------------------- -------------------------- LIABILITIES, REDEEMABLE STOCK AND OTHER SHAREHOLDERS' EQUITY Liabilities: Unpaid losses and loss adjustment expenses $110,037 $120,264 Unearned premiums 6,860 7,033 Retrospective premiums (NOTE 5) 10,838 10,864 Amounts due reinsurers 7,274 7,818 Other liabilities 8,102 8,338 -------------------------- Total liabilities 143,111 154,317 Redeemable stock (NOTES 3 AND 12): Class A Common Stock--authorized 300,000 shares, issued and outstanding 118,209 shares in 1996 and 116,251 shares in 1995 7,603 6,974 Class B Common Stock--authorized, issued and outstanding 1 share 1 1 -------------------------- 7,604 6,975 Other shareholders' equity (NOTES 3 AND 11) 111,278 103,292 -------------------------- Total liabilities, redeemable stock and other shareholders' equity $261,993 $264,584 -------------------------- -------------------------- SEE ACCOMPANYING NOTES. 24 Midwest Medical Insurance Holding Company and Subsidiaries Consolidated Statements of Income (IN THOUSANDS, EXCEPT FOR SHARE AND PER SHARE AMOUNTS) YEAR ENDED DECEMBER 31 1996 1995 1994 -------------------------------------- Revenues: Net premiums earned (NOTE 8) $32,046 $29,798 $26,246 Net investment income (NOTE 4) 12,212 12,211 11,995 Realized capital gains (losses) 1,771 1,646 (455) Other 857 334 (31) -------------------------------------- 46,886 43,989 37,755 Losses and expenses: Losses and loss adjustment expenses (NOTES 6 AND 8) 32,257 37,560 11,334 Other underwriting expenses 5,690 6,415 5,509 -------------------------------------- 37,947 43,975 16,843 -------------------------------------- Income before income taxes 8,939 14 20,912 Income taxes (benefit) (NOTE 7) 1,458 (1,711) 6,417 Net income $ 7,481 $ 1,725 $14,495 -------------------------------------- -------------------------------------- Income per common share and common share equivalent $ 58.33 $ 13.74 $114.84 -------------------------------------- -------------------------------------- Number of shares used in per share calculation 128,259 125,536 126,222 -------------------------------------- -------------------------------------- SEE ACCOMPANYING NOTES. 25 Midwest Medical Insurance Holding Company and Subsidiaries Consolidated Statements of Changes in Other Shareholders' Equity (IN THOUSANDS)
UNREALIZED APPRECIATION ON INVESTMENTS, PAID-IN RETAINED NET OF CAPITAL EARNINGS INCOME TAXES TOTAL -------------------------------------------------------------------------------------- Balance at December 31, 1993, as originally reported $12,770 $58,523 $ 2,690 $73,983 Adjustments for pooling of interests: Equity of Medical Liability Mutual Insurance Company 346 4,054 283 4,683 Pro forma distribution to holding company from subsidiary for assumed issuance of Class A Common Stock (415) - - (415) -------------------------------------------------------------------------------------- Balance at December 31, 1993, restated 12,701 62,577 2,973 78,251 Increase in unrealized appreciation, net of income tax, resulting from initial adoption of SFAS No. 115 (NOTE 1) - - 7,762 7,762 Net income - 14,495 - 14,495 Net loss of Midwest Medical Insurance Holding Company includable in Class A Common Stock redemption value - 487 - 487 Dividend declared by subsidiary payable to Midwest Medical Insurance Holding Company - (1,181) - (1,181) Decrease in unrealized appreciation, net of income tax - - (10,379) (10,379) Adjustment to pro forma distribution to holding company from subsidiary to reflect change in number of Class A common shares issued and net redemption value per share 33 - - 33 -------------------------------------------------------------------------------------- Balance at December 31, 1994 (carried forward) 12,734 76,378 356 89,468
26 Midwest Medical Insurance Holding Company and Subsidiaries Consolidated Statements of Changes in Other Shareholders' Equity (continued) (IN THOUSANDS)
UNREALIZED APPRECIATION ON INVESTMENTS, PAID-IN RETAINED NET OF CAPITAL EARNINGS INCOME TAXES TOTAL ---------------------------------------------- Balance at December 31, 1994 (brought forward) $12,734 $76,378 $ 356 $ 89,468 Net income - 1,725 - 1,725 Net loss of Midwest Medical Insurance Holding Company includable in Class A Common Stock redemption value - 387 - 387 Dividend declared by subsidiary payable to Midwest Medical Insurance Holding Company - (260) - (260) Increase in unrealized appreciation, net of income tax - - 11,936 11,936 Adjustment to pro forma combination of Midwest Medical Insurance Holding Company and Medical Liability Mutual Insurance Company - (26) 7 (19) Adjustment to pro forma distribution to holding company from subsidiary to reflect change in number of Class A common shares issued and net redemption value per share 55 - - 55 ---------------------------------------------- Balance at December 31, 1995 12,789 78,204 12,299 103,292 Net income - 7,481 - 7,481 Net income of Midwest Medical Insurance Holding Company includable in Class A Common Stock redemption value - (1,070) - (1,070) Increase in unrealized appreciation, net of income tax - - 1,575 1,575 ---------------------------------------------- Balance at December 31, 1996 $12,789 $84,615 $13,874 $111,278 ---------------------------------------------- ----------------------------------------------
SEE ACCOMPANYING NOTES. 27 Midwest Medical Insurance Holding Company and Subsidiaries Consolidated Statements of Cash Flows (IN THOUSANDS)
YEAR ENDED DECEMBER 31 1996 1995 1994 ---------------------------------- OPERATING ACTIVITIES Net income $ 7,481 $ 1,725 $14,495 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Decrease (increase) in accrued investment income 97 (50) (76) Decrease (increase) in reinsurance recoverable 2,938 (1,475) (5,324) Decrease (increase) in other assets 1,015 (1,898) (1,690) Deferred tax provision 298 482 426 (Decrease) increase in unpaid losses and loss adjustment expenses (10,227) 9,297 (12,454) Decrease in unearned premiums (173) (281) (3,917) (Decrease) increase in retrospective premiums (26) (3,171) 11,255 Decrease in amounts due reinsurers (544) (1,287) (1,316) (Decrease) increase in other liabilities (236) 469 (1,359) Accretion of bond discount, net of premium amortization (1,080) (1,087) (1,160) Realized capital (gains) losses (1,771) (1,646) 455 Compensation expense for vested Class A common shares 156 193 310 ---------------------------------- (2,072) 1,271 (355) INVESTING ACTIVITIES Purchases of fixed maturity investments and equity securities (75,684) (56,345) (51,445) Sales of fixed maturity investments and equity securities 54,293 52,545 44,616 Calls and maturities of fixed maturity investments 16,250 7,535 10,859 Net sales (purchases) of short-term investments 7,117 (5,261) (2,326) ---------------------------------- 1,976 (1,526) 1,704 FINANCING ACTIVITIES Redemption of Class A Common Stock (608) (829) (840) ---------------------------------- (Decrease) increase in cash (704) (1,084) 509 Cash at beginning of year 704 1,788 1,279 ---------------------------------- Cash at end of year $ - $ 704 $ 1,788 ---------------------------------- ----------------------------------
SEE ACCOMPANYING NOTES. 28 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements December 31, 1996 1. ACCOUNTING POLICIES ORGANIZATION AND OPERATIONS The Minnesota Medical Insurance Exchange (Exchange) began operations in October 1980 as a reciprocal or inter-insurance exchange organized under Chapter 71A of the Minnesota Statutes. Minnesota Medical Management, Inc. (MMMI) was the Exchange's attorney-in-fact and was responsible for management of the Exchange. On November 30, 1988, the Exchange was reorganized into a stock insurance company, Midwest Medical Insurance Company (MMIC), under the statutes of the State of Minnesota. Concurrently, MMMI merged with the Midwest Medical Insurance Holding Company (MMIHC) which then acquired all outstanding shares of the reorganized stock company. Effective July 1, 1993, MMIC merged with Iowa Physicians Mutual Insurance Trust (IPMIT), a physician-owned professional liability insurance company providing insurance coverage to Iowa physicians. As provided for in the agreement and plan of merger, IPMIT was merged into MMIC. The merger was accounted for as a pooling-of-interests and, accordingly, the consolidated financial statements include the combined financial position and results of operations of MMIHC and IPMIT for all periods presented. During 1995, MMIHC formed MMIHC Services, Inc. to provide agency services for the distribution of complementary insurance products and services to physicians, clinics and hospitals. Effective June 5, 1996, MMIC merged with Medical Liability Mutual Insurance Company of Nebraska (MLM), a physician-owned professional liability insurance company providing insurance coverage to Nebraska physicians. As provided for in the agreement and plan of merger, MLM was merged into MMIC. The merger was accounted for as a pooling-of-interests and, accordingly, the consolidated financial statements include the combined financial position and results of operations of MMIHC and MLM for all periods presented (see Note 2). 29 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 1. ACCOUNTING POLICIES (CONTINUED) The holding company provides management and administrative services to the insurance company for a fee generally equal to the cost of services provided plus ten percent. The insurance company provides professional liability insurance to physicians in Minnesota, Iowa, Nebraska, North Dakota and South Dakota. Insurance policies issued by MMIC are on a "claims made" basis and provide coverage for the policyholder for claims first made against the policyholder and reported to MMIC during the policy period for claims which occurred on or after the retroactive date stated in the policy. MMIC provides, upon payment of an additional premium, a reporting endorsement which extends the period in which claims otherwise covered by the "claims made" policy may be reported to MMIC. In the event of death or permanent disability of a policyholder, the reporting endorsement is issued without additional premium. Upon retirement, as defined in the policy, a policyholder with at least five years of consecutive coverage with MMIC is eligible for a credit toward the additional premium for the reporting endorsement. Prior acts coverage may be purchased by policyholders who were previously insured under a "claims made" policy with another professional liability insurer for an additional premium at the option of the insured in lieu of purchasing reporting endorsement coverage from the previous insurer. PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of MMIHC and its wholly-owned subsidiaries, MMIC and MMIHC Services, Inc. All transactions between MMIHC and its subsidiaries have been eliminated in consolidation with the exception of the distribution of capital to MMIHC by MMIC in the form of dividends. From time to time the Board of Directors of MMIC may declare dividends payable to MMIHC in lieu of adjusting the management fee rate. Hereafter, MMIHC, MMIC and MMIHC Services, Inc. shall be collectively referred to as the Company unless the reference pertains to a specific entity. 30 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 1. ACCOUNTING POLICIES (CONTINUED) BASIS OF PRESENTATION The consolidated financial statements have been presented in conformity with generally accepted accounting principles, which differ in certain respects from statutory accounting practices followed by MMIC in reporting to the Department of Commerce of the State of Minnesota (see Note 11). USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, as well as disclosure of contingent assets and liabilities at the date of the financial statements. Actual results could differ from those estimates. INVESTMENTS The Company manages its investment portfolio to achieve its long-term investment objective of providing for the financial stability of the Company through preservation of assets and maximization of total portfolio return. Although management believes the Company has the ability to hold its fixed maturity investment portfolio to maturity, these investments are classified as "available for sale" as management may take advantage of opportunities to increase total return through sales of selected securities in response to changing market conditions. On January 1, 1994, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity Securities". Consistent with management's classification of its investments in debt and equity securities as available for sale, such investments are carried at fair value with unrealized holding gains and losses reflected as a separate component of equity, net of applicable deferred taxes. As a result of the initial adoption of SFAS No. 115, the balance of redeemable stock and other shareholders' equity increased by $8,000 and $7,762,000, respectively, on January 1, 1994. 31 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 1. ACCOUNTING POLICIES (CONTINUED) Prior to January 1, 1994, fixed maturity investments were carried at the lower of aggregate amortized cost or market. Unrealized losses on the fixed maturity portfolio are recorded as a component of equity, net of applicable deferred taxes. Equity securities are recorded at market. Unrealized gains and losses are reported as a component of equity, net of applicable deferred taxes. Fair values are based on quoted market prices, where available. For fixed maturity investments not actively traded, fair values are estimated using values obtained from independent pricing services. Short-term investments are principally money market funds backed by U.S. government securities and are recorded at cost which approximates fair value. Realized gains and losses on sales of investments are reported on a pre-tax basis as a component of income and are determined on the specific identification basis. LOSSES AND LOSS ADJUSTMENT EXPENSES The liability for losses and loss adjustment expenses represents an estimate of the ultimate cost of all such amounts which are unpaid at the balance sheet dates. The liability is based on both case-by-case estimates and statistical analysis and projections using the historical loss experience of MMIC, and gives effect to estimates of trends in claim severity and frequency. These estimates are continually reviewed and, as adjustments become necessary, such adjustments are included in current operations. MMIC believes that the estimate of the liability for losses and loss adjustment expenses is reasonable. PREMIUMS Premiums received are recorded as earned ratably over the lives of the policies to which they apply. A portion of premiums received is deferred to recognize the Company's obligation to provide reporting endorsement coverage without additional premium upon the death, disability or retirement of policyholders. This amount is recorded as an unearned premium reserve and represents the actuarially determined present value of future benefits to be provided less the present value of future revenues to be received. 32 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 1. ACCOUNTING POLICIES (CONTINUED) The Company has a retro premium program whereby physicians may receive credits against future premiums based upon loss experience of the Company. Amounts to be returned under the program are accrued when approved by the Board of Directors and reflected as a reduction in net premium earned. REINSURANCE The Company cedes reinsurance in order to reduce its liability on individual risks and to enable it to write business at limits it otherwise would be unable to accept. All reinsurance contracts are excess-of-loss contracts which indemnify the Company for losses in excess of a stated retention limit up to the policy limits. Reinsurance receivables and recoverables and prepaid reinsurance premiums are reported as assets and reserve liabilities are reported gross of reinsurance credits. UNDERWRITING EXPENSES Underwriting costs are expensed when incurred. Due to the nature of its operations, MMIC does not pay significant amounts in commissions. INCOME TAXES The Company uses the asset and liability method of accounting for income taxes. Deferred income tax assets or liabilities are recognized for the temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and amounts used for income tax purposes. EARNINGS PER SHARE Earnings per share is computed using weighted average issued and outstanding Class A common shares as well as Class A common share equivalents. All earned but unissued shares of Class A Common Stock (see Note 3) are considered common share equivalents for purposes of the earnings per share computation. 33 MIDWEST MEDICAL INSURANCE HOLDING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 1. ACCOUNTING POLICIES (CONTINUED) RECLASSIFICATIONS Certain amounts in the prior years' financial statements have been reclassified to conform with the 1996 presentation. 2. BUSINESS COMBINATION Effective June 5, 1996, MLM policyholders received, in exchange for their ownership interests, 5,447 shares of MMIHC Class A Common Shares which was computed by dividing the December 31, 1995 GAAP basis capital and surplus of MLM by the net book value per share of MMIHC. These shares were distributed to the MLM policyholders ratably in proportion to their ownership of shares of MLM Common Stock. To maintain the net redemption value of the Class A Common Shares (see Note 3), a dividend in the amount of $327,000 was paid by MMIC to MMIHC at the time of the merger. Net premiums earned, losses and loss adjustment expenses and net income for the individual entities for the period ended December 31, 1995 were as follows (in thousands): MMIHC MLM ADJUSTMENTS COMBINED ---------------------------------------- Net premium earned $27,981 $1,817 $ - $29,798 Losses and loss adjustment expenses 35,472 2,088 - 37,560 Net income 1,425 (172) 472 1,725 In order to restate the components of shareholders' equity and determine the restated income per common share and common share equivalent, management computed the number of shares that would have been issued to MLM policyholders as of December 31, 1995, 1994 and 1993 as if the effective date of the merger had been as of those dates, respectively. Following is that computation (dollars in thousands, except for share and per share amounts). DECEMBER 31 1995 1994 1993 ---------------------------- Redeemable stock and other shareholders' equity of MMIHC and subsidiaries $104,667 $92,365 $81,173 Divided by MMIHC Class A Common Shares outstanding 110,804 111,067 108,945 ---------------------------- Net book value per share $944.61 $831.62 $745.08 ---------------------------- ---------------------------- 34 MIDWEST MEDICAL INSURANCE HOLDING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 2. BUSINESS COMBINATION (CONTINUED) DECEMBER 31 1995 1994 1993 ---------------------------- Capital and surplus of MLM $5,145 $4,814 $4,683 Divided by MMIHC net book value per share $944.61 $831.62 $745.08 ---------------------------- Shares to be issued to MLM policyholders 5,447 5,788 6,285 Multiplied by net redemption value of MMIHC Class A Shares $60.00 $66.00 $66.00 ---------------------------- Dividend from MMIC to MMIHC to maintain pre-merger net redemption value $327 $382 $415 ---------------------------- ---------------------------- A provision of the agreement and plan of merger requires that any favorable development of certain pre-merger liabilities of MLM be paid to the former MLM policyholders who remain active MMIC insureds as of the date of payment through a retrospective premium credit. The agreement further stipulates that any amounts due under this provision must be settled no later than June 5, 2001. As of December 31, 1996, there has been no favorable development and therefore there is no accrual related to this provision. 3. REDEEMABLE STOCK Effective November 30, 1988, MMIC policyholders earn Class A Common Shares for each month of service pursuant to a stock allocation formula based on underwriting risk classification. Shares earned by new policyholders are not issued until the end of five years of continuous coverage under an MMIC policy (the vesting date). The Company does not record any amounts related to unissued Class A Common Shares. At the vesting date, the issued shares are recorded at the then current redemption value (see Note 12). The Company accounts for these shares by increasing Common Stock by the par value ($.01 per share) of the newly issued shares, increasing paid-in capital by the excess of the redemption value over par and charging stock compensation expense for the full redemption value. Once vested, policyholders will continue to earn shares for each month they remain insured with MMIC according to the stock allocation formula. The Company accounts for additional shares issued to vested policyholders by increasing Common Stock for the par value of the shares and decreasing retained earnings by the same amount. 35 MIDWEST MEDICAL INSURANCE HOLDING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 3. REDEEMABLE STOCK (CONTINUED) MMIC policyholders whose initial effective date was on or before the November 30, 1988 reorganization, IPMIT policyholders whose initial effective date was on or before December 31, 1992 and MLM policyholders whose initial effective date was on or before December 31, 1995 became fully vested upon initial receipt of their shares without regard to their length of coverage. These policyholders will continue to earn and receive additional Class A shares for each month they remain insured with MMIC. The Company accounts for these shares similar to additional shares issued to other fully vested shareholders. In accordance with the Articles of Incorporation and By-laws of MMIHC, only active policyholders of MMIC may own shares of Class A Common Stock of MMIHC. At each meeting of the shareholders, every Class A shareholder having the right to vote shall be entitled to one vote, either in person or by proxy, regardless of the number of Class A shares held by the individual. Class A shareholders are required to redeem their shares with MMIHC upon termination as policyholders of MMIC. The net redemption value (NRV) of the shares is equal to the net book value of MMIHC, excluding the amount of net book value that is attributable to MMIC, divided by the number of outstanding Class A Common Shares of MMIHC at the semi-annual valuation dates of June 30 and December 31 of each year. The amount paid upon redemption is the redemption value determined at the most recent semi-annual valuation. MMIHC has issued one share of Class B voting stock which carries with it the right to elect the Board of Directors of MMIHC. The voting rights are currently exercised by the Minnesota Medical Association and the Iowa Medical Society. A majority of the Class A shareholders may at any time, by a two-thirds vote, elect to redeem the Class B share at cost. The schedule which follows has been restated for the merger of MMIC with MLM. The schedule was further restated in that redemption of shares due to policyholder termination has been changed for all periods to reclassify a pro rata portion of each redemption to paid-in capital with the remainder to retained earnings. As originally presented in prior years, each redemption was charged entirely to retained earnings. 36 MIDWEST MEDICAL INSURANCE HOLDING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 3. REDEEMABLE STOCK (CONTINUED) Following is the detail of changes in redeemable stock for the three years ended December 31, 1996 (in thousands, except for share and per share amounts):
UNREALIZED APPRECIATION (DEPRECIATION) CLASS A COMMON STOCK CLASS B MMIHC MMIHC ON INVESTMENTS, -------------------- COMMON PAID-IN RETAINED NET OF INCOME SHARES AMOUNT STOCK CAPITAL EARNINGS TAXES TOTAL ---------------------------------------------------------------------------------- Balance at January 1, 1994, as originally reported with redemptions reclassified 108,945 $1 $1 $3,380 $3,808 $- $7,190 Pro forma issuance of shares to MLM policyholders as if the merger with MMIC became effective on January 1, 1994 (NOTE 2) 6,285 415 415 ---------------------------------------------------------------------------------- Balance at January 1, 1994, restated 115,230 1 1 3,795 3,808 - 7,605 Unrealized appreciation, net of income tax, resulting from initial adoption of SFAS No. 115 (NOTE 1) 8 8 Redemption of shares due to policyholder terminations by effective date: January 1, 1994 to June 30, 1994; NRV of $66.00 (7,974) (247) (279) (526) July 1, 1994 to December 31, 1994; NRV of $67.04 (4,666) (1) (148) (165) (314) Issuance of shares to vested policyholders 10,140 1 (1) - Initial issuance of shares to policyholders upon vesting 4,622 310 310 Dividend receivable from Midwest Medical Insurance Company 1,181 1,181 Net loss of Midwest Medical Insurance Holding Company includable in Class A Common Stock redemption value (487) (487) Change in unrealized appreciation, net of income tax (32) (32) Adjustment to pro forma issuance of shares to MLM policyholders to adjust effective date to December 31, 1994 (497) (33) (33) ---------------------------------------------------------------------------------- Balance at December 31, 1994 (carried forward) 116,855 1 1 4,858 2,876 (24) 7,712
37 MIDWEST MEDICAL INSURANCE HOLDING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 3. REDEEMABLE STOCK (CONTINUED)
UNREALIZED APPRECIATION (DEPRECIATION) CLASS A COMMON STOCK CLASS B MMIHC MMIHC ON INVESTMENTS, -------------------- COMMON PAID-IN RETAINED NET OF INCOME SHARES AMOUNT STOCK CAPITAL EARNINGS TAXES TOTAL ---------------------------------------------------------------------------------- Balance at December 31, 1994 (brought forward) 116,855 $1 $1 $4,858 $2,876 $(24) $7,712 Redemption of shares due to policyholder terminations by effective date: January 1, 1995 to June 30, 1995; NRV of $66.00 (8,017) (323) (207) (530) July 1, 1995 to December 31, 1995; NRV of $67.65 (4,407) (1) (181) (117) (299) Issuance of shares to vested policyholders 9,271 1 (1) - Initial issuance of shares to policyholders upon vesting 2,890 193 193 Dividend receivable from Midwest Medical Insurance Company 260 260 Net loss of Midwest Medical Insurance Holding Company includable in Class A Common Stock redemption value (387) (387) Change in unrealized appreciation, net of income tax 81 81 Adjustment to pro forma issuance of shares to MLM policyholders to adjust effective date to December 31, 1995 (341) (55) (55) ---------------------------------------------------------------------------------- Balance at December 31, 1995 116,251 1 1 4,752 2,164 57 6,975 Redemption of shares due to policyholder terminations by effective date: January 1, 1996 to June 30, 1996; NRV of $60.00 (6,277) (1) (259) (117) (377) July 1, 1996 to December 31, 1996; NRV of $57.84 (3,995) (159) (72) (231) Issuance of shares to vested policyholders 9,540 1 (1) - Initial issuance of shares to policyholders upon vesting 2,690 156 156 Net income of Midwest Medical Insurance Holding Company includable in Class A Common Stock redemption value 1,070 1,070 Change in unrealized appreciation, net of income tax 11 11 ---------------------------------------------------------------------------------- Balance at December 31, 1996 118,209 $1 $1 $4,490 $3,044 $68 $7,604 ---------------------------------------------------------------------------------- ----------------------------------------------------------------------------------
38 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 4. INVESTMENTS Components of net investment income are summarized as follows (in thousands): 1996 1995 1994 -------------------------------- Fixed maturities $11,561 $11,716 $11,953 Equity securities 380 338 288 Short-term investments 904 923 487 -------------------------------- 12,845 12,977 12,728 Investment expenses (633) (766) (733) -------------------------------- $12,212 $12,211 $11,995 -------------------------------- -------------------------------- The cost (amortized cost for fixed maturities) and fair value of available for sale investments are as follows (in thousands): DECEMBER 31, 1996 ----------------------------------------------- GROSS GROSS UNREALIZED UNREALIZED MARKET COST GAINS LOSSES VALUE ----------------------------------------------- Fixed maturities: MMIHC: Industrial and other $ 1,031 $ 4 $ (2) $ 1,033 MMIC: United States Government 92,365 2,075 (797) 93,643 State and other political subdivisions 57,968 1,885 (45) 59,808 Industrial and other 28,615 648 (186) 29,077 ----------------------------------------------- Total $179,979 $ 4,612 $(1,030) $183,561 ----------------------------------------------- ----------------------------------------------- Equity securities $ 20,237 $ 18,183 $ (419) $ 38,001 ----------------------------------------------- ----------------------------------------------- 39 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 4. INVESTMENTS (CONTINUED) DECEMBER 31, 1995 --------------------------------------------------- GROSS GROSS UNREALIZED UNREALIZED MARKET COST GAINS LOSSES VALUE --------------------------------------------------- Fixed maturities: MMIHC: Industrial and other $ 847 $ 4 $ - $ 851 MMIC: United States Government 96,826 4,933 (179) 101,580 State and other political subdivisions 64,894 2,795 (41) 67,648 Industrial and other 11,977 761 - 12,738 --------------------------------------------------- Total $174,544 $ 8,493 $ (220) $182,817 --------------------------------------------------- --------------------------------------------------- Equity securities $ 17,670 $ 10,825 $ (184) $ 28,311 --------------------------------------------------- --------------------------------------------------- The components of the unrealized appreciation on available for sale securities as of December 31 are as follows (in thousands): 1996 1995 --------------------------------------------- MMIHC MMIC MMIHC MMIC --------------------------------------------- Fixed maturities: Gross unrealized gain $4 $ 4,608 $4 $ 8,489 Gross unrealized losses (2) (1,028) - (220) Equity securities: Gross unrealized gains - 18,183 - 10,825 Gross unrealized losses - (419) - (184) --------------------------------------------- 2 21,344 4 18,910 Deferred income taxes - (7,470) - (6,611) --------------------------------------------- $2 $13,874 $4 $12,299 --------------------------------------------- --------------------------------------------- 40 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 4. INVESTMENTS (CONTINUED) In addition to the unrealized gains and losses per the above schedule, MMIHC has unrealized gains on certain investments in mutual funds. The mutual fund assets are classified as other assets in the consolidated balance sheet and are held to coordinate with the Supplemental Executive Retirement Plan obligation (Note 10). At December 31, 1996 and 1995, respectively, gross unrealized gains related to these assets were $103,000 and $84,000. Deferred taxes related to these unrealized gains were $37,000 and $31,000, respectively. The amortized cost and market value of fixed maturities at December 31, 1996, by contractual maturity, are shown below (in thousands). Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. AMORTIZED MARKET COST VALUE ----------------------------- Due in one year or less $ 7,477 $ 7,514 Due after one year through five years 79,456 81,736 Due after five years through ten years 65,380 66,576 Due after ten years 27,666 27,735 ----------------------------- $ 179,979 $ 183,561 ----------------------------- ----------------------------- Proceeds from sales of available for sale investments and the related gross realized gains and losses are as follows (in thousands): GROSS GROSS PROCEEDS REALIZED REALIZED FROM SALES GAINS LOSSES -------------------------------------- Year ended December 31, 1996: Fixed maturities $46,735 $ 803 $(214) Equity securities 7,558 1,347 (165) Year ended December 31, 1995: Fixed maturities 43,387 1,012 (254) Equity securities 9,158 1,356 (468) Year ended December 31, 1994: Fixed maturities 37,647 509 (652) Equity securities 6,969 472 (784) 41 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 4. INVESTMENTS (CONTINUED) Net unrealized appreciation of fixed maturities (decreased) increased by $(4,691,000), $11,630 and $(15,610,000) and net unrealized appreciation of equity securities increased by $7,123,000, $6,078,000 and $232,000 for the years ended December 31, 1996, 1995 and 1994, respectively. 5. RETROSPECTIVE PREMIUMS The components of retrospective premiums at December 31 are as follows (in thousands): 1996 1995 ------------------------------- Retrospective premium credits declared: Minnesota policyholders $ 4,603 $ 5,200 Iowa policyholders active at date of merger and renewing in 1995 2,500 2,300 Favorable development on pre-merger IPMIT liabilities not yet approved for credit 3,735 3,364 ------------------------------- $ 10,838 $ 10,864 ------------------------------- ------------------------------- A provision of the agreement and plan of merger between IPMIT and the Company requires that any favorable development of certain pre-merger liabilities of IPMIT be paid to the former IPMIT policyholders who remain active MMIC insureds as of the date of payment through a retrospective premium credit. The agreement further stipulates that any amounts due under this provision must be settled no later than December 31, 1998. Actual payments of $2,330,000 and $3,017,000 were made to former IPMIT policyholders in 1996 and 1995, respectively. Actual retrospective premium credits applied to Minnesota policyholder accounts in 1996 and 1995 were $5,198,000 and $6,076,000, respectively. 42 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 6. UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES The reconciliation of the liability for unpaid losses and loss adjustment expenses is as follows (in thousands): 1996 1995 1994 --------------------------------------- Balance as of January 1, net of reinsurance recoverables $ 96,424 $ 88,227 $105,589 Incurred related to: Current year 41,101 39,847 36,275 Prior years (8,844) (2,287) (24,941) --------------------------------------- Total incurred 32,257 37,560 11,334 Paid related to: Current year 4,885 2,484 3,445 Prior years 33,454 26,879 25,251 --------------------------------------- Total paid 38,339 29,363 28,696 --------------------------------------- Balance as of December 31, net of reinsurance recoverables 90,342 96,424 88,227 Reinsurance recoverables at December 31 19,695 23,840 22,740 --------------------------------------- Balance as of December 31, gross $110,037 $120,264 $110,967 --------------------------------------- --------------------------------------- The Company continually evaluates emerging trends in the development of loss liabilities including the trends related to the pre-merger IPMIT business. Based on this analysis, management periodically adjusts their estimates of ultimate losses. See Note 5 regarding retrospective premium credits paid and accrued. 43 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 7. INCOME TAXES Components of income taxes are as follows (in thousands): 1996 1995 1994 --------------------------------------- Current provision (benefit) $1,160 $(2,193) $5,991 Deferred tax provision 298 482 426 --------------------------------------- $1,458 $(1,711) $6,417 --------------------------------------- --------------------------------------- The Company's income taxes differ from the federal statutory rate applied to income before tax as follows (in thousands): 1996 1995 1994 --------------------------------------- Income before tax at the federal statutory rate of 35% $3,129 $ 5 $7,319 Tax-exempt income (net of proration adjustment) (1,452) (1,090) (1,104) State income taxes, net of federal tax benefit 50 (42) 603 Proceeds on life insurance (368) - - Benefit for prior year income taxes - (660) (316) Other 99 76 (85) --------------------------------------- $1,458 $(1,711) $6,417 --------------------------------------- --------------------------------------- The deferred income tax (benefit) provision includes the following differences between financial and income tax reporting (in thousands): 1996 1995 1994 --------------------------------------- Discounting of post-1986 unpaid losses and loss adjustment expenses $1,190 $232 $1,540 Liabilities not currently deductible (274) 481 (1,571) Unearned premiums 6 22 277 Alternative minimum tax carryforwards (496) - - Other (128) (253) 180 --------------------------------------- $ 298 $482 $ 426 --------------------------------------- --------------------------------------- 44 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 7. INCOME TAXES (CONTINUED) The Company made income tax payments of $3,260,000, $832,000 and $8,065,000, in 1996, 1995 and 1994, respectively. The components of the net deferred income tax asset as of December 31 are as follows (in thousands): 1996 1995 ------------------------- Deferred tax assets: Unpaid losses and loss adjustment expenses $5,319 $6,509 Liabilities not currently deductible 2,311 2,037 Unearned premiums 534 540 Alternative minimum tax credit 496 - Other 510 442 ------------------------- 9,170 9,528 Deferred tax liabilities: Unrealized gains (7,507) (6,642) Other (533) (582) ------------------------- (8,040) (7,224) ------------------------- $1,130 $2,304 ------------------------- ------------------------- Management has determined that no valuation allowances were necessary for unrealizable portions of deferred tax assets. This was supported primarily through the presence of taxable income in carryback years and reversals of existing temporary differences which provide taxable income in future years. A portion of the deferred tax assets was supported through reliance on available tax planning strategies which could be implemented at no cost. 8. REINSURANCE To reduce overall risk, including exposure to large losses, the Company participates in various reinsurance programs. MMIC would only become liable for losses in excess of stipulated amounts in the event that any reinsuring company were unable to meet its obligations under the existing agreement. Management is not aware of any such default at December 31, 1996. Reinsurance recoverables on paid and unpaid losses of $17,485,000 and $18,967,000 are associated with a single reinsurer at December 31, 1996 and 1995, respectively. 45 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 8. REINSURANCE (CONTINUED) MMIC is authorized to issue policies with limits not to exceed $5,000,000 for each claim and $5,000,000 in the aggregate under each policy in any one policy year. Limits in excess of $5,000,000 for each claim and $5,000,000 annual aggregate are available to physicians and clinics through reinsurance handled by MMIC. The Company generally retains the first $750,000 of each claim and reinsures the remainder. In years prior to 1995, retention levels for a portion of MMIC's business varied from $200,000 to $500,000. Total ceded reinsurance premiums, before the effects of treaty commutations, for the years ended December 31, 1996, 1995 and 1994 were $6,416,000, $7,544,000 and $8,704,000, respectively. Loss and loss adjustment expenses incurred are net of applicable reinsurance of $2,459,000, $7,873,000 and $8,025,000 for the years ended December 31, 1996, 1995 and 1994, respectively. In 1996, the Company commuted reinsurance treaties covering the period January 1, 1989 through December 31, 1990. Net premiums recovered as a result of these commutations of $2,194,000 have been included in net premiums earned in 1996. 9. OTHER COMMITMENTS In the normal course of claim settlement, MMIC negotiates structured settlements including the purchase of annuities from life insurance companies with an A+ rating from A.M. Best (an industry rating organization) at the date of issue and a minimum of $100 million in surplus. These annuities guarantee a stream of payments to the claimant holding the annuity. The majority of these settlements have been assigned to the life insurance company which releases MMIC from any future contractual liability to the claimant. MMIC and its reinsurers could only become liable for ultimate settlement of those claims which have not been assigned. At December 31, 1996 and 1995, respectively, non-assigned structured settlements guaranteed $5,926,000 and $4,087,000 of payments under annuity contracts for which MMIC and its reinsurers paid $3,208,000 and $1,833,000. In the event that the insurance company issuing the annuity was unable to meet its obligation under the terms provided, MMIC would be liable for the ultimate settlement. 46 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 10. BENEFIT PLANS The Company has a non-contributory defined contribution pension plan covering substantially all employees. Contributions to the plan are based upon each covered employee's salary. The Company also sponsors a 401(k) plan covering substantially all employees and provides a fifty percent match on employee contributions subject to certain limitations. Total contributions charged to expense for the years ended December 31, 1996, 1995 and 1994 were $371,000, $294,000 and $283,000, respectively. The Company provides an unfunded Supplemental Executive Retirement Plan (SERP) which is a non-qualified, defined benefit retirement plan covering certain Company officers. Benefits are based upon years of service and compensation. Although the plan is technically unfunded, the Company has purchased life insurance contracts for each officer, the cash value of which is designed to coordinate with the projected benefit payments under the SERP. The cash value of these contracts is included in other assets. The net periodic pension cost for this plan was $323,000, $292,000 and $266,000 for the years ended December 31, 1996, 1995 and 1994, respectively. The liability recognized in the consolidated balance sheets at December 31, 1996 and 1995 related to this plan was $1,909,000 and $1,643,000, respectively. The Company also provides medical benefits to retirees through a defined benefit post-retirement plan which covers substantially all employees. The net periodic post-retirement benefit cost for the years ended December 31, 1996, 1995 and 1994 was $30,000, $25,000 and $38,000, respectively. As of December 31, 1996 and 1995, the net post-retirement benefit plan asset recognized in the consolidated balance sheets was $12,000 and $116,000, respectively. The plan is funded through contributions to mutual funds. 47 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 11. RECONCILIATION WITH STATUTORY ACCOUNTING PRINCIPLES The following is a reconciliation of net income and shareholders' equity under generally accepted accounting principles with that reported for MMIC on a statutory basis (in thousands): Net Income
YEAR ENDED DECEMBER 31 1996 1995 1994 ---------------------------- As reported under generally accepted accounting principles $7,481 $1,725 $14,495 MMIHC (income) loss (1,070) 387 487 ----------------------------- On the basis of generally accepted accounting principles, MMIC only 6,411 2,112 14,982 Additions (deductions): Deferred income taxes 445 442 524 Other 123 (215) - ----------------------------- On the basis of statutory accounting principles $6,979 $2,339 $15,506 ----------------------------- -----------------------------
Shareholders' Equity
DECEMBER 31 1996 1995 1994 ---------------------------------- As reported under generally accepted accounting principles $111,278 $103,292 $89,468 Additions (deductions): Deferred income taxes (590) (2,015) (8,875) Unrealized (gain) loss on fixed maturities (3,580) (8,269) 3,771 Pro forma equity distributed to MMIHC in connection with pooling - 327 382 Other (41) (14) 157 ---------------------------------- On the basis of statutory accounting principles $107,067 $ 93,321 $84,903 ---------------------------------- ----------------------------------
48 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 11. RECONCILIATION WITH STATUTORY ACCOUNTING PRINCIPLES (CONTINUED) The equity of MMIHC, exclusive of the carrying value of its investment in MMIC, is subject to redemption and therefore reported outside of shareholders' equity under the caption redeemable stock. As a result, consolidated other shareholders' equity as reported on the balance sheets represents equity of MMIC only under generally accepted accounting principles. Under Minnesota insurance statutes, MMIC is required to maintain statutory surplus in excess of ten times its per occurrence reinsurance retention limit. The minimum level is $7,500,000 for 1996 and 1995. 12. NET REDEMPTION VALUE The net redemption value per share of the Class A common shares was as follows: CLASS A NET REDEMPTION MMIHC COMMON SHARES VALUE PER NET EQUITY OUTSTANDING SHARE --------------------------------------------- (000'S) December 31, 1992 $7,230 110,333* $65.53 ---------- ---------- ---------- ---------- December 31, 1993 $7,605 115,230* $66.00 ---------- ---------- ---------- ---------- December 31, 1994 $7,712 116,855* $66.00 ---------- ---------- ---------- ---------- December 31, 1995 $6,975 116,251* $60.00 ---------- ---------- ---------- ---------- December 31, 1996 $7,604 118,209* $64.33 ---------- ---------- ---------- ---------- * Includes pro forma shares related to merger. 49 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 50 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT DIRECTORS The names and ages of the directors of MMIHC and MMIC, the year each first became a director, and the number of Class A Common Shares owned by each as of December 31, 1996, are as follows: CLASS A COMMON DIRECTOR PRINCIPAL SHARES NAME AGE SINCE OCCUPATION OWNED - ------------------------------------------------------------------------------- Michael Abrams 35 1996 Exec V.P. Iowa Medical Society - John R. Balfanz, M.D. 51 1995 Physician 12 Gail P. Bender 49 1996 Physician 20 James R. Bishop, M.D. 50 1994 Physician - David P. Bounk 50 1995 President and CEO - E. Duane Engstrom, M.D. Secretary 65 1986 Family Physician 33 William W. Eversman, M. 58 1993 Physician 51 Roger L. Frerichs, M.D. 57 1988 Surgeon 80 Richard Geier, Jr., M.D. 56 1995 Physician - Anthony C. Jaspers, M.D. 49 1996 Physician 47 Wayne F. Leebaw, M.D. 53 1994 Physician 22 Steven A. McCue, M.D. 55 1995 Physician 113 Harold W. Miller, M.D. 49 1996 Physician 25 Anton S. Nesse, M.D. 58 1989 Radiologist 51 Mark D. Odlund, M.D. 44 1996 Physician 75 G. William Orr, M.D. 61 1996 Physician 43 Norman Rinderknecht, M.D.62 1993 Physician 87 Paul S. Sanders, M.D. 52 1984 CEO-MN Medical Assoc. - Richard D. Schmidt, M.D. 53 1990 Physician 139 Mark B. Siegel, M.D. 49 1989 Surgeon 64 Andrew J. K. Smith, M.D. 54 1990 Neurological Surgeon 181 G. David Spoelhof, M.D. 43 1989 Physician 43 R. Bruce Trimble, M.D. Vice Chair of Board 56 1993 Physician 20 The Bylaws of MMIHC provide that MMIHC's Board of Directors shall include the following: (1) up to 20 physicians divided into three classes and elected for staggered three-year terms; (2) for as long as the Class B Common Share is outstanding, the Chief Executive Officer of the MMA and the Executive Vice President of the IMS, both of whom shall be ex-officio directors;(3) the President of MMIHC as an ex-officiodirector; and (4) such additional ex-officio and 51 ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT (CONTINUED) advisory members as the Board of Directors may determine. At least two-thirds of the voting members of the Board of Directors must be physician directors. All physician directors must be members of a state medical association and insured by MMIC. The MMA, which has the exclusive right to elect directors, has agreed to elect the directors nominated by a committee of the Board of Directors. The Bylaws of MMIC provide that the directors of MMIHC shall also serve as the directors of MMIC, with the exception of any outside directors of MMIHC. Outside directors are persons who are not policyholders of MMIC or members of any state medical society. There are currently no outside directors of MMIHC so the Boards of MMIHC and MMIC are identical at this time. Pursuant to the merger with IPMIT, the Bylaws of MMIHC were amended to provide for the election of directors who are members of the IMS in a number, when compared to the total number of directors, which is proportionate to the number of Iowa insureds compared to the total number of MMIC insureds, subject to a minimum of two Iowa directors, one of whom shall be the Executive Vice President of the IMS, for as long as the Class B Common Share is outstanding. The MMA has placed the Class B Voting Share in a voting trust which requires the trustee to vote the share for the election of the Iowa directors nominated by the IMS. Directors serve until their successors are elected and qualified, or until their prior resignation, removal, death or disqualification. As of December 31, 1996, the directors of MMIHC, as a group, owned 1,106 Class A Common Shares or 1.0 percent of the total Class A Common Shares outstanding as of such date. No executive officer owned any Class A Common Shares as of such date. All of the directors have been principally engaged in the practice of medicine for more than five years, except for Dr. Sanders who has been the Executive Vice President of the MMA since 1990, Michael Abrams who has been the Executive Vice President of the Iowa Medical Society beginning in 1996 and David P. Bounk who has been the President and CEO of MMIHC since 1991. Prior to 1990, Dr. Sanders was principally engaged in the practice of medicine. Prior to 1996 Michael Abrams was Director, Government Relations of the Indiana Medical Association for nine years. The Chairman of the Board of Directors (currently Dr. Smith) is paid an annual fee of $31,500. All members of the Board of Directors currently are paid $750 for each meeting of the Board of Directors they attend. In addition, members of the Executive Committee currently are paid $750 for each meeting of the Executive Committee they attend, and committee chairmen are paid $600 for each meeting of the standing committee they chair. Other members of standing committees currently are paid between $300 and $500, depending upon distance traveled, for each committee meeting they attend. 52 ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT (CONTINUED) EXECUTIVE OFFICERS The names, ages and positions of the executive officers of MMIHC and MMIC are as follows:
PERIOD OF POSITION SERVICE AS PRINCIPAL NAME AGE WITH COMPANY AN OFFICER OCCUPATION - ------------------------------------------------------------------------------- David P. Bounk 50 President and 8/1/90 to date President and Chief Executive Chief Executive Officer Officer Merlin R. Bretzman 62 Vice President- 1986 to date Vice President- Finance and Finance and Treasurer Treasurer Jack L. Kleven 50 Vice President- 1986 to date Vice President- Claims Claims Elizabeth S. Lincoln 43 Vice President- 1990 to date Vice President- Risk Management Risk Management Michael Rutz 43 Vice President- 5/15/95 to date Vice President- Underwriting Underwriting
Mr. Bounk has over 28 years experience in the insurance industry and joined MMIHC and MMIC as President and Chief Executive Officer in August 1990. From July 1982 through July 1990, he was Executive Vice President and Chief Operating Officer of Missouri Medical Insurance Company, a corporation providing malpractice insurance to physicians in Missouri. Mr. Bounk has an MBA degree in finance. Mr. Bounk has an employment agreement which continues until December 31, 1995 and then renews for successive calendar-year terms unless it is terminated by either party at least 60 days prior to any renewal date. The agreement provides that Mr. Bounk's base salary will be adjusted annually by the Executive Committee. If the agreement is terminated by MMIHC for cause or by Mr. Bounk voluntarily, he is entitled to receive his base salary for 30 days thereafter. If the agreement is terminated by MMIHC without cause, Mr. Bounk is entitled to receive his base salary for six months thereafter, plus one additional month for each year of service, subject to a 53 ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT (CONTINUED) maximum of 12 additional months, and then only until he commences new employment or self-employment. The agreement also prohibits Mr. Bounk from competing with MMIHC for one year following his termination of employment. Effective January 1, 1997, the Company entered into termination agreements with the executive officers. These agreements provide a severance package to these executives in the event of termination of employment without cause. Mr. Bretzman has over 39 years experience in the insurance industry, including 23 years with Blue Cross/Blue Shield of Minnesota prior to joining the Exchange (MMIC's predecessor) in 1983. He has been in his current position since March 1986. He has a BA degree in accounting. Mr. Kleven has over 24 years experience in medical malpractice claims adjusting and management. He joined the Exchange in 1983, and has held his current position since March 1986. Prior to joining the Exchange, he was a liability manager at The St. Paul Companies for six years. He has a BS degree in business. Ms. Lincoln has over 14 years experience in medical professional liability risk management. She joined the Exchange in 1982, and has held her current position since January 1990. She has a law degree. Mr. Rutz has over 18 years experience in the insurance industry, including 10 years in medical malpractice. From June 1986 through April 1994, he was Senior Regional Underwriting Manager with St. Paul Fire and Marine Insurance Company. From May 1994 through April 1995, he was Vice President with Alexander and Alexander, insurance brokers. He joined the Company in May 1995 as Vice President-Underwriting. He has a BS degree in resource management. Officers serve until their successors are appointed by the Board of Directors, or until their prior resignation, removal or death. BENEFICIAL OWNERSHIP REPORTING Section 16 of the Securities Exchange Act of 1934 requires officers and directors of reporting companies to file reports disclosing ownership of, and transactions in, securities of the Company. During 1996, required forms were not filed for the new directors. This failure was cured by filings made after the end of the year. 54 ITEM 11. EXECUTIVE COMPENSATION SUMMARY COMPENSATION TABLE The following table summarizes compensation paid by MMIHC to its five most highly compensated executive officers for services rendered in all capacities during the last three years.
CASH COMPENSATION NAME OF INDIVIDUAL CAPACITIES IN ----------------- ALL OTHER OR NUMBER IN GROUP WHICH SERVED SALARY BONUS COMPENSATION(A) - ------------------------------------------ ------------------------------------- David P. Bounk President and Chief 1996 $170,080 $51,024 $17,687 Executive Officer 1995 162,760 47,200 22,620 1994 153,540 53,062 22,012 Merlin R. Bretzman Vice President-Finance 1996 133,240 39,972 18,478 and Treasurer 1995 127,500 36,975 19,899 1994 122,160 40,148 19,351 Jack L. Kleven Vice President-Claims 1996 132,420 39,796 17,384 1995 126,720 36,749 18,512 1994 121,716 40,015 18,112 Elizabeth S. Lincoln Vice President-Risk 1996 97,020 29,106 14,319 Management 1995 88,690 25,720 13,677 1994 78,240 26,972 12,159 Michael G. Rutz Vice President- 1996 108,680 32,604 14,980 Underwriting 1995 65,000 7,250 8,658 (A) Includes employer contributions to qualified retirement plans and the term and cash surrender value of supplemental life insurance premiums.
MMIHC also maintains a Supplemental Executive Retirement Plan ("SERP") which provides an annual retirement benefit for an executive officer who retires at age 65 with 20 years of service of 65% (70% for the Chief Executive Officer) of the officer's final average salary. Benefits are reduced for years of service less than 20 and retirement prior to age 65. The annual benefit payable under the SERP is reduced by 50% of the officer's primary Social Security benefit and 55 ITEM 11. EXECUTIVE COMPENSATION (CONTINUED) by the annual benefit (expressed in the form of an annuity) of the officer's accrued benefits under MMIHC's current money purchase pension plan and a predecessor plan. The estimated annual benefits payable upon retirement at normal retirement age for the executive officers in the Summary Compensation table are as follows: Mr. Bounk--$133,300; Mr. Bretzman--$69,500; Mr. Kleven--$66,200; Ms. Lincoln--$51,800; and Mr. Rutz--$71,600. The estimated annual retirement benefits were calculated assuming salary increases of six percent per year, discounted four percent per year for future inflation to express the estimated benefits in today's dollars. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The response to this item is contained in Item 10. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS None. 56 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a)(1) The following consolidated financial statements of Midwest Medical Insurance Holding Company, Inc. for the year ended December 31, 1996 are included in this annual report (Form 10-K) in Item 8: Report of Independent Auditors Consolidated Balance Sheets as of December 31, 1996 and 1995 Consolidated Statements of Income for the years ended December 31, 1996, 1995 and 1994 Consolidated Statements of Changes in Other Shareholders' Equity for the years ended December 31, 1996, 1995 and 1994 Consolidated Statements of Cash Flows for the years ended December 31, 1996, 1995 and 1994 Notes to Consolidated Financial Statements (a)(2) The following consolidated financial statement schedules of Midwest Medical Insurance Holding Company, Inc. required by Item 14(d) are included in a separate section of this report: II Condensed Financial Information of Registrant IV Reinsurance VI Supplemental Information Concerning Property/Casualty Insurance Operations All other schedules to the consolidated financial statements required by Article 7 of Regulation S-X are not required under the related instructions or are inapplicable and therefore have been omitted. (a)(3) LISTING OF EXHIBITS The Exhibits required to be a part of this report are listed in the Index to Exhibits which follows the financial statement schedules. (b) REPORTS ON FORM 8-K No reports on Form 8-K were filed during the fourth quarter of 1996. 57 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Midwest Medical Insurance Holding Company ----------------------------------------- (Registrant) By: /s/ David P. Bounk March 20, 1997 ------------------ -------------- David P. Bounk Date President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
/s/ David P. Bounk - ------------------------------- Principal Executive Officer March 20, 1997 David P. Bounk /s/ Merlin R. Bretzman - ------------------------------- Principal Financial Officer and March 20, 1997 Merlin R. Bretzman Principal Accounting Officer * - ------------------------------ Director, Chairman of the Board March 20, 1997 Andrew J.K. Smith, M.D. * - ------------------------------ Director March 20, 1997 Michael Abrams, M.D. * - ------------------------------ Director March 20, 1997 John R. Balfanz, M.D. * - ------------------------------ Director March 20, 1997 Gail P. Bender, M.D. 58 * - ------------------------------ Director March 20, 1997 James R. Bishop, M.D. * - ------------------------------ Director, Secretary March 20, 1997 E. Duane Engstrom, M.D. * - ------------------------------ Director March 20, 1997 William E. Eversman, M.D. * - ------------------------------ Director March 20, 1997 Roger L. Frerichs, M.D. * - ------------------------------ Director March 20, 1997 Richard Geier, Jr., M.D. * - ------------------------------ Director March 20, 1997 Anthony C. Jaspers, M.D. * - ------------------------------ Director March 20, 1997 Wayne F. Leebaw, M.D. * - ------------------------------ Director March 20, 1997 Steven A. McCue, M.D. * - ------------------------------ Director March 20, 1997 Harold W. Miller, M.D. - - - ------------------------------ Director March 20, 1997 Anton S. Nesse, M.D. - - - ------------------------------ Director March 20, 1997 Mark D. Odlund, M.D. - - - ------------------------------ Director March 20, 1997 G. William Orr, M.D. 59 * - ------------------------------ Director March 20, 1997 Norman Rinderknecht, M.D. * - ------------------------------ Director March 20, 1997 Paul S. Sanders, M.D. * - ------------------------------ Director March 20, 1997 Richard D. Schmidt, M.D. * - ------------------------------ Director March 20, 1997 Mark B. Siegel, M.D. * - ------------------------------ Director March 20, 1997 G. David Spoelhof, M.D. * - ------------------------------ Director, Vice Chairman March 20, 1997 R. Bruce Trimble, M.D. * By: /s/ David P Bounk March 20, 1997 ------------------------- David P. Bounk pursuant to power of attorney * David P. Bounk, on his own behalf and pursuant to Powers of Attorney, dated prior to the date hereof, attested by the officers and directors listed above and filed with the Securities and Exchange Commission, by signing his name hereto does hereby sign and execute this Report of Midwest Medical Insurance Holding Company on behalf of each of the officers and directors named above, in the capacities in which the name of each appears above. The above persons signing as directors constitute a majority of the directors.
60 Midwest Medical Insurance Holding Company and Subsidiaries (Parent Company) Schedule II--Condensed Financial Information of Registrant Balance Sheets DECEMBER 31 1996 1995 ------------------------------ (IN THOUSANDS) ASSETS Fixed maturities $ 1,032 $ 851 Short-term investments 4,183 5,521 Investment in subsidiary 111,278 103,292 Accrued investment income 45 57 Dividend receivable - 587 Other 5,399 3,787 ------------------------------ Total assets $121,937 $114,095 ------------------------------ ------------------------------ LIABILITIES, REDEEMABLE STOCK AND OTHER SHAREHOLDERS' EQUITY LIABILITIES Accounts payable $ 22 $ 986 Accrued expenses and other liabilities 3,033 2,842 ------------------------------ 3,055 3,828 REDEEMABLE STOCK Class A Common Stock 7,603 6,674 Class B Common Stock 1 1 ------------------------------ 7,604 6,975 OTHER SHAREHOLDERS' EQUITY Additional paid-in capital 12,789 12,789 Retained earnings, comprised of undistributed earnings of subsidiary 84,615 78,204 Unrealized appreciation on investments, net of income taxes 13,874 12,299 ------------------------------ 111,27 103,292 ------------------------------ $121,93 $114,095 ------------------------------ ------------------------------ SEE ACCOMPANYING NOTE. 61 Midwest Medical Insurance Holding Company and Subsidiaries (Parent Company) Schedule II--Condensed Financial Information of Registrant (continued) Statements of Income YEAR ENDED DECEMBER 31 1996 1995 1994 ------------------------------- (IN THOUSANDS) REVENUES Management fee from subsidiary $8,706 $5,405 $ 4,931 Investment income 726 704 238 Other income (loss) 4 17 (49) ------------------------------- 9,436 6,126 5,120 EXPENSES Operating and administrative 8,357 6,783 5,968 ------------------------------- Income (loss) before income taxes and other items 1,079 (657) (848) Income tax expense (benefit) 9 (270) (361) ------------------------------- Income (loss) before equity in undis- tributed income of subsidiary 1,070 (387) (487) Equity in undistributed income of subsidiary 6,411 2,112 14,982 ------------------------------- Net income $7,481 $1,725 $14,495 ------------------------------- ------------------------------- SEE ACCOMPANYING NOTE. 62 Midwest Medical Insurance Holding Company and Subsidiaries (Parent Company) Schedule II--Condensed Financial Information of Registrant (continued) Statements of Cash Flows YEAR ENDED DECEMBER 31 1996 1995 1994 ------------------------------------- (IN THOUSANDS) Net cash (used in) provided by operating activities $ (877) $ 1,184 $ (155) INVESTING ACTIVITIES Purchase of fixed maturities (20,469) (670) (2,200) Sales of fixed maturities 20,289 1,833 3,642 Calls and maturities of fixed maturities - 240 - Sales purchases of short-term investments, net 1,338 (1,758) (447) FINANCING ACTIVITIES Redemption of Class A Common Stock (608) (829) (840) Dividend from MMIC in connection with merger 327 - - ------------------------------------- Decrease in cash - - - Cash at beginning of year - - - ------------------------------------- Cash at end of year $ - $ - $ - ------------------------------------- ------------------------------------- SEE ACCOMPANYING NOTE. 63 Midwest Medical Insurance Holding Company and Subsidiaries (Parent Company) Schedule II--Condensed Financial Information of Registrant (continued) Note to Condensed Financial Statements December 31, 1996 The accompanying condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto of Midwest Medical Insurance Holding Company and Subsidiaries. See Note 3 to the consolidated financial statements of Midwest Medical Insurance Holding Company and Subsidiaries for a description of the redeemable stock. 64 Midwest Medical Insurance Holding Company and Subsidiaries Schedule IV--Reinsurance
COL. A COL. B COL. C COL. D COL. E COL. F - ---------------------------------------------------------------------------------------------------------- PERCENTAGE OF CEDED TO ASSUMED AMOUNT GROSS OTHER FROM OTHER NET ASSUMED AMOUNT COMPANIES COMPANIES AMOUNT TO NET - --------------------------------------------------------------------------------------------------------- (IN THOUSANDS) Year ended December 31, 1996: Insurance premiums: Property/casualty insurance $34,875 $2,829 $ - $32,046 N/A Year ended December 31, 1995: Insurance premiums: Property/casualty insurance 37,342 7,544 - 29,798 N/A Year ended December 31, 1994: Insurance premiums: Property/casualty insurance 34,950 8,704 - 26,246 N/A
NOTE TO SCHEDULE IV: Ceded premiums for the years ended December 31, 1996, 1995 and 1994 are net of reductions (additions) in ceded premiums related to swing rated reinsurance treaties of $748,000, $(260,000), and $(346,000), respectively. Ceded premiums in 1996 are also net of proceeds from commutations of reinsurance covering the period January 1, 1987 through December 31, 1990 of $2,194,000. 65 Midwest Medical Insurance Holding Company and Subsidiaries Schedule VI--Supplemental Information Concerning Property/Casualty Insurance Operations
DECEMBER 31 YEAR ENDED DECEMBER 31 ------------------------------------------------------------------------------------------------------------------------ COL. A COL. B COL. C COL. D COL. E COL. F COL. G COL. H COL. I COL. J COL. K - ----------------------------------------------------------------------------------------------------------------------------------- LOSSES AND LOSS ADJUSTMENT EXPENSES RESERVES FOR INCURRED RELATED TO AMORTIZATION PAID DEFERRED UNPAID LOSSES DISCOUNT, --------------------- OF DEFERRED LOSSES AFFILIATION POLICY AND LOSS IF ANY, NET (1) (2) POLICY AND LOSS WITH ACQUISITION ADJUSTMENT DEDUCTED IN UNEARNED EARNED INVESTMENT CURRENT PRIOR ACQUISITION ADJUSTMENT PREMIUMS REGISTRANT COSTS EXPENSES COLUMN C PREMIUMS PREMIUM INCOME YEAR YEAR COSTS EXPENSES WRITTEN - ----------------------------------------------------------------------------------------------------------------------------------- (IN THOUSANDS) Consolidated property/ casualty entities 1996 N/A $110,037 N/A $6,860 $32,046 $12,212 $41,101 $ (8,844) N/A $38,339 $32,036 1995 N/A 120,264 N/A 7,033 29,798 12,211 39,847 (2,287) N/A 29,363 35,519 1994 N/A 110,967 N/A 7,314 26,246 11,995 36,275 (24,941) N/A 28,696 28,462
66 ANNUAL REPORT ON FORM 10-K ITEM 14(a)(3) AND 14(c) EXHIBITS Midwest Medical Insurance Holding Company Index to Exhibits
REGULATION S-K EXHIBIT TABLE SEQUENTIAL ITEM REFERENCE PAGE NO. - --------------------------------------------------------------------------------------------- Restated Articles of Incorporation of the registrant (Form S-4, Exhibit 3C). 3A.(1) Bylaws of the registrant (Form S-4, Exhibit 3D). 3B.(1) Voting Trust Agreement. 9.(1) Governance Agreement between the registrant and the 10A.(1) Minnesota Medical Association, holder of the registrant's Class B Common Share, dated November 30,1988. Lease for office space between the registrant and Lexington 10B.(1) Property Fund, L.P. Limited Partnership, dated March 26, 1991. Management Agreement between the registrant and 10C.(4) 69 Midwest Medical Insurance Company, dated November 30, 1988, as amended January 1, 1990, January 1, 1991, and January 1, 1996. Agency Agreement with Vaaler Insurance, Inc. pursuant 10D.(1) to which Vaaler acts as agent of the registrant in North Dakota, dated April 21, 1989. Agreement of Reinsurance between Midwest Medical 10F.(1) Insurance Company and General Reinsurance Corporation, dated March 3, 1992. Letter Employment Agreement between the registrant and 10G.(2) David P. Bounk, President and Chief Executive Officer of the registrant and Midwest Medical Insurance Company, dated January 1, 1993.
67 Index to Exhibits (continued)
REGULATION S-K EXHIBIT TABLE SEQUENTIAL ITEM REFERENCE PAGE NO. - --------------------------------------------------------------------------------------------- Executive Bonus Plan of the registrant. 10H.(1) Supplemental Executive Retirement Plan of the registrant. 10I.(1) Reinsurance Agreement pursuant to which commutation for the 10J.(1) period October 1, 1986 to December 31, 1987 occurred. Financial (catastrophic) reinsurance agreement in effect 10K.(1) during 1990 and 1991 policy periods. Plan and Agreement of Merger, without exhibits. 10L.(1) Agency Agreement with IMS Services pursuant to which IMS 10M.(3) Services acts as agent of the registrant in Iowa, dated July 1, 1993 Subsidiaries of the registrant. 22.(1) Powers of Attorney. 24.(4)
_________________________________ (1) Filed with the Company's Registration Statement on Form S-4, as amended, SEC File No. 33-55062 and incorporated herein by reference. (2) Filed with the Company's Registration Statement Form S-1 SEC File No. 33-70182 and incorporated herein by reference. (3) Filed with 1993 Annual Report on Form 10-K. (4) Filed with this Annual Report on Form 10-K. 68 EX-10.C 2 EXHIBIT 10C Amended and Restated Management Agreement 1996 THIS AMENDED AND RESTATED MANAGEMENT AGREEMENT, made and entered into as of this first day of January, 1996 by and between Midwest Medical Insurance Company (the "Company"), a Minnesota stock insurance corporation, and Midwest Medical Insurance Holding Company (the "Company"), a Minnesota corporation. WITNESSETH: WHEREAS, by Management Agreement dated November 30, 1988, at the request of the Company, the Manager has managed the business of the Company, provided certain other management services and provided facilities for the conduct of the Company's business; and WHEREAS, the parties desire to continue such relationship, amend certain provisions of the Management Agreement, and restate such agreement and its various amendments by this Amended and Restated Management Agreement ("Management Agreement"); NOW, therefore, in consideration of the mutual promises set forth below, the parties agree and contract as follows: 1. APPOINTMENT OF MANAGER The Company hereby confirms the appointment of the Manager to be the exclusive manager of the business of the Company, pursuant to the terms and conditions of this Management Agreement. 2. GENERAL POWERS The Manager agrees to perform or provide for the performance of the services hereinafter specified for the management of the Company in an efficient manner in strict accordance with the law, applicable requirements of governmental and non governmental regulatory and supervisory authorities, and generally accepted insurance, accounting, actuarial and business practices consistent with the financial well-being and general welfare of the Company and its insureds. The Manager agrees to procure and maintain any and all licenses that may be necessary in connection with performance of its duties under this Agreement, including, without limitation, insurance brokers' and salesmen's license. 3. SERVICES The Manager agrees to perform or provide for the performance of the following services, unless otherwise stated, at its expense, on behalf of the Company: 69 (a) to provide general administration and management of the day-to-day insurance business of the Company including, without limitation, the production, underwriting and servicing of insurance and claims; (b) to solicit, receive and accept or reject applications for insurance to be issued by the Company and to investigate and pass upon the desirability of the risks involved in the applications for insurance; and in such connection to provide marketing and sales services, as reasonably necessary; (c) to provide advice and recommendations concerning the strategic directions and business plans of the Company and to bring to its attention for appropriate action opportunities for the pursuit of the business plan of the Company, as it is approved and modified from time to time; (d) to underwrite, classify, rate and issue policies and binders of insurance and reinsurance for the Company; (e) to establish and maintain for, and as the property of, the Company complete and accurate records of all insurance policies written by the Company; (f) to solicit, collect, receive, and account for all insurance premiums paid, and to deposit all of said insurance premiums in a bank or banks to the account of the Company as soon as practicable; to maintain said premium accounts in accordance with applicable law; (g) to invest or cause the investment of such funds in accordance with legal requirements and the advice or instructions of any investment advisor or advisors selected by the Company upon the recommendation of the Manager and to monitor and supervise the performance of any such investment advisor on behalf of the Company and its Board of Directors and Investment Committee; (h) to establish and maintain for, and as the property of, the Company all financial and business records required by law and by sound and accepted insurance and business practices; to prepare for the Company all reports required by governmental and non governmental regulatory and supervisory authorities, including insurance reports and income tax returns; (i) to procure such reinsurance, automatic or facultative, required by law and by sound and accepted insurance and business practices; to keep the necessary records for, and as the property of, the Company in connection with such reinsurance; (j) to provide and equip appropriate and adequate offices for the business of the Company; to furnish all equipment, stationery, forms, printing and supplies for the conduct of functions required to be performed under this Agreement by the Manager; 70 (k) to provide and maintain an adequate claims service and facilities for the handling of all claims against the Company and for the payment thereof on behalf of the Company; to recover promptly for the Company all reinsurance due on claims paid; (l) to prepare mailings, advertisements, newsletters and other promotional material for the Company; (m) to make all required filings with the Commissioner of Commerce of the State of Minnesota and any other governmental agencies and authorities having jurisdiction over the Company including income taxing authorities; and (n) to do any and all other things reasonably necessary to carry out the foregoing. Operating costs, including all of its general and overhead expenses and third party expenses and reimbursements, incurred by the Manager to provide the services to the Company as described in this paragraph 3, shall be allocated between Manager, the Company and other in accordance with generally accepted cost accounting principles consistently applied and reimbursed as provided in paragraph 5 ("Allocated Costs"). Such method of allocation shall be reflected on a schedule which Manager shall maintain and update, from time to time, as appropriate to reflect materially changed circumstances. Certain third party fees and charges which are direct obligations of the Company shall be paid by it in the first instance, including but not limited to items in paragraph 7. 4. EXTRAORDINARY SERVICES Manager agrees to provide such special, or extraordinary, services as may be requested by Company from time to time and which are outside the scope of the services described in paragraph 3, such as services in connection with the acquisition of other companies or businesses. At the time such services are provided the Company and Manager shall agree on the basis and amount of additional consideration or reimbursement, including any incentive compensation, as shall be payable with respect to any such extraordinary services. 5. REIMBURSEMENT AND FEES (a) In consideration of all services to be provided under Article 3, the Company shall pay promptly upon receipt of invoice all Allocated Costs plus 10% thereof as a service fee; provided, however, that the following costs incurred by Manager on behalf of Company, included in Allocated Costs, shall be paid without service fee: i) All board of director and board committee fees and expenses of the Boards of both the Manager and the Company. ii) Directors and Officers liability insurance of the Company. iii) Legal, audit, consulting and other third party expenses incurred directly and specifically for the Company which shall not be considered to be part of Allocated Costs. 71 (b) The Company shall pay promptly upon receipt of invoice all costs, fees and additional consideration as is agreed upon between the parties under paragraph 4 with respect to Extraordinary Services. Payment shall be made on the first business day of each month based on Manager's estimate of amounts which will be payable to it hereunder with respect to such month on a cash basis modified to include accruals out of the ordinary and, with respect to December of each year, anticipated year end accruals. Such monthly payments shall include a true-up or adjustment factor to reflect actual results of the previous month and annually, shall be trued-up and adjusted within 60 days after year's end to reflect actual accrued expenses and obligations incurred during the previous year. Upon termination of this Agreement, such payments shall be trued-up and adjusted within 60 days after the last day of the month in which such termination occurred to reflect actual accrued expenses and obligations hereunder through the date of termination. 6. FEDERAL INCOME TAXES Federal income taxes incurred by either the Manager or the Company shall be shared in accordance with the separate Tax Sharing Agreement between the parties dated July 5, 1989 and are excluded from the Management Agreement. 7. DIRECT EXPENSES It is agreed that certain expenses, to be agreed upon from time to time, but to include the following, are direct expenses of the Company and shall be paid directly by the Company: (a) Agents commissions. (b) Premium taxes. (c) Guarantee fund assessments. (d) Insurance Department licenses and fees. (e) Donations approved by the Company's Board of Directors. (f) Costs of legislative monitoring. (g) Reinsurance commissions received by the Company from its reinsurance. (h) Company membership dues and insurance federation dues. (i) Endorsement and licensing fees. 8. RESPONSIBILITY The Manager shall remain fully responsible for the proper performance of any functions which it delegates to agents or independent contractors as permitted elsewhere in this Agreement. 72 The Manager assumes no responsibility hereunder other than to render the services called for, in good faith, and shall not be responsible for any actions of the Company, or its Board of Directors, in following or declining to follow the advise or recommendations of the Manager. 9. NON-INTERFERENCE Upon any termination of this Management Agreement, Manager agrees to turn over to Company all of its property and records, and to cooperate with the transition of the Company to other management services, provided that it receive its reasonable costs incurred in providing such transitional services, plus ten percent (10%). In the event of any such termination, Company agrees not to solicit the employment or services of employees of Manager, without its prior written consent, nor retain such employment or service within one year of the effective date of the termination of this Management Agreement. 10. TERM AND TERMINATION (a) Upon execution, this Agreement shall be effective for an indefinite term and shall continue unless terminated by either party at the end of any calendar year by written notice to the other given at least 180 days prior to the effective date of termination. (b) Notwithstanding the provisions of paragraph 8(a), either party may terminate this Agreement as hereinafter provided: (1) Effective immediately upon written notice to the other party in the event of fraud or dishonesty by the other party, provided that such notice shall be given as soon as practicable after discovery of such fraud or dishonesty. (2) Effective immediately upon written notice to the other party upon the final judicial determination of the insolvency or bankruptcy of the other party provided that such notice shall be given as soon as practicable after discovery of such fraud or dishonesty. (3) Upon at least one full month's notice effective the last day of any month because of the material breach by the other party of its obligations under this Agreement, provided that such notice shall be given as soon as practicable after discovery of such breach and that the other party fails to remedy such breach within the notice period provided. (4) Upon at least one full month's notice effective the last day of any month upon the merger of Company with another entity or upon the change in controlling ownership of Company by Manager. 73 (c) Upon termination of this Agreement the Manager shall deliver to the Company or its successor in interest all property, records and information of every kind concerning the affairs of the Company in the possession, custody, or control of the Manager and the parties shall make all payments required in paragraphs 4 and 5. (d) After the effective date of termination of this Agreement for any reason, the Company shall bear the cost of both allocated and unallocated loss adjustment expense for all claims open at the date of termination or reported after the date of termination and the Manager shall not be responsible for any such expense after the date of termination. (e) In the event that either party gives such notice of termination, the Company shall have the right, during the period preceding the termination date, to make any and all arrangements necessary or desirable in its discretion to provide for personnel and facilities for the performance of the services performed under this Agreement by the Manager, and the Manager will cooperate with the Company toward the end that there will be an orderly transfer of management service functions in respect of the Company's business from the Manager to the Company or its designee. 11. DAMAGES FOR BREACH No provision of this Agreement shall preclude either party from recovering damages, if any, sustained by reason of any conduct in breach of the terms hereof. 12. REGULATORY COMPLIANCE The Manager agrees and acknowledges that it shall cooperate in all respects with the relationship between the Company and the various governmental agencies having jurisdiction over it and its activities and agrees to make available to such agencies during normal business hours and upon reasonable request any and all records maintained by it for the Company under this Agreement. 13. ARBITRATION (a) In the event any dispute or difference of opinion arises under or with respect to this Agreement, the controversy shall be submitted to arbitration. Each party shall select on arbitrator, and the two arbitrators so selected shall select a third arbitrator before the entry into arbitration. Each of the arbitrators shall be persons having no less than five (5) years' experience in executive position with casualty insurance companies transacting substantial business. (b) The arbitrators may use their discretion in conducting the arbitration proceedings and are relieved of all judicial formalities except that they shall allow the parties an opportunity to be heard after reasonable notice before reaching any decision. 74 (c) Each party shall bear the expense of its own arbitrator and shall jointly and equally bear with the other the expense of the third arbitrator and of the arbitration. Any such arbitration shall take place in the greater Minneapolis-St. Paul area at a mutually acceptable location. MIDWEST MEDICAL INSURANCE HOLDING COMPANY By /s/ Andrew J.K. Smith ------------------------------------- Andrew J.K. Smith, M.D., Chairman By /s/ David Bounk ------------------------------------- David Bounk, President and CEO MIDWEST MEDICAL INSURANCE COMPANY By /s/ Andrew J.K. Smith ------------------------------------- Andrew J.K. Smith, M.D., Chairman By /s/ David Bounk ------------------------------------- David Bounk, President and CEO 75 EX-27 3 EXHIBIT 27 FDS
7 YEAR YEAR DEC-31-1996 DEC-31-1995 JAN-01-1996 JAN-01-1995 DEC-31-1996 DEC-31-1995 183,561 182,817 0 0 0 0 38,001 28,311 0 0 0 0 221,562 211,128 7,898 15,719 2,479 945 0 0 261,993 264,584 110,037 120,264 6,860 7,033 0 0 10,838 10,864 0 0 0 0 0 0 7,604 6,975 111,278 103,292 261,993 264,584 32,046 29,798 12,212 12,211 1,771 1,646 857 334 32,257 37,560 0 0 5,690 6,415 8,939 14 1,458 (1,711) 7,481 1,725 0 0 0 0 0 0 7,481 1,725 58.33 13.74 58.33 13.74 96,424 88,227 41,101 39,847 (8,844) (2,287) 4,885 2,484 33,454 26,879 90,342 96,424 8,844 2,632
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