10-K 1 c68269e10-k.txt ANNUAL REPORT 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, 2001 | | 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 Identification No.) incorporation or organization) 7650 Edinborough Way, Suite 400 Minneapolis, Minnesota 55435-5978 ------------------------------- ------------------------------------ (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (952) 838-6700 -------------- 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 C Common Stock no 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 of the voting stock held by non-affiliates of the registrant as of March 15, 2002 was $-0-. The number of shares outstanding of the issuer's classes of common stock, as of March 15, 2002: Class B Common Stock, $1,000 par value - 1 share Class C Common Stock, no par value - 9,298 shares DOCUMENTS INCORPORATED BY REFERENCE None. PART I ITEM 1. BUSINESS BACKGROUND Midwest Medical Insurance Holding Company is a holding company organized under the laws of the State of Minnesota. Midwest Medical Insurance Company, Midwest Medical Solutions, Inc. and MMIHC Insurance Services, Inc. are wholly-owned subsidiaries of Midwest Holding. Midwest Holding and its subsidiaries are referred to collectively as the Company unless the reference pertains to a specific entity. The Company's principal business operation is Midwest Medical. Midwest Medical's primary business is selling and issuing policies of medical professional liability insurance to: (1) individual physicians, (2) partnerships or professional corporations composed of physicians, (3) clinics, (4) hospitals, and (5) health plans. Midwest Medical originally was organized in 1980 under the auspices of the Minnesota Medical Association to provide professional liability (malpractice) insurance to Minnesota physicians who were members of the Minnesota Medical Association. The business was reorganized on November 30, 1988 into a stock insurance company, Midwest Medical, wholly owned by a holding company, Midwest Holding, which could pursue other business opportunities. Another purpose of the reorganization was to give physicians a limited equity interest in their malpractice insurer while preserving Midwest Medical's capital and surplus. On July 1, 1993, the Iowa physician-owned malpractice insurer, Iowa Physicians Mutual Insurance Trust, was merged with and into Midwest Medical. On June 5, 1996, the Nebraska physician-owned malpractice insurer, Medical Liability Mutual Insurance Company of Nebraska, was merged with and into Midwest Medical. Midwest Medical 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. Midwest Medical has had the sponsorship of the Minnesota Medical Association since inception and also has the sponsorship of the Iowa Medical Society and the North Dakota Medical Association. Professional liability, general liability and umbrella excess liability insurance is also available to hospitals and other healthcare facilities throughout Midwest Medical's territory. During 1997, Midwest Holding formed Solutions as a business development company to strengthen and promote the independence and interdependencies of physicians, clinics and hospitals that Midwest Medical serves. Business development opportunities being pursued include practice enhancement, strategic consulting, and technology services and support. In January 1998, Solutions purchased the assets of MedPower Information Services, Inc. Solutions then contributed those assets to its newly formed, wholly-owned subsidiary, MedPower Information Resources, Inc. (MedPower). MedPower was subsequently sold effective July 31, 2001. MedPower processed and electronically submitted medical claims for over 100 healthcare providers in the Upper Midwest. 2 ITEM 1. BUSINESS (CONTINUED) Services was incorporated in 1995 and began active operations in January 1999 with the acquisition of a book of business from Johnson-McCann Benefits, Inc. Services is an insurance agency specializing in providing Upper Midwest clients with group insurance products such as health, dental, life, disability and workers' compensation. Midwest Holding provides management and administrative services to Midwest Medical and Solutions for a fee generally equal to the cost of services provided. Services operates independently with its own management and administrative staff and therefore does not have a management agreement with Midwest Holding. ELIGIBLE PHYSICIANS An individual physician must meet the following criteria in order to be eligible to obtain insurance coverage from Midwest Medical: 1. An applicant must be licensed to practice medicine, surgery or osteopathy in Minnesota, Iowa, North Dakota, South Dakota, Nebraska, Illinois or Wisconsin; 2. An applicant must conduct a majority of his or her practice in Minnesota, Iowa, North Dakota, South Dakota, Nebraska, Illinois or Wisconsin. ELIGIBLE GROUPS Midwest Medical 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 Midwest Medical: 1. The entity must have its principal place of business in Minnesota, Iowa, North Dakota, South Dakota, Nebraska, Illinois or Wisconsin; and 2. The group must demonstrate that a majority of the individual physicians practicing medicine, surgery or osteopathy on a full-time basis through such clinics are, or intend to be, insured by Midwest Medical. ELIGIBLE HOSPITALS AND OTHER HEALTHCARE FACILITIES Midwest Medical also provides professional liability, general liability and umbrella excess liability to hospitals and other healthcare facilities. 3 ITEM 1. BUSINESS (CONTINUED) A business must meet the following criteria in order to be eligible to be insured by Midwest Medical: 1. The entity must have its principal place of business in Minnesota, Iowa, North Dakota, South Dakota, Nebraska, Illinois or Wisconsin; and 2. The facility must be a licensed hospital or other healthcare facility. POLICY FORMS Midwest Medical offers a "claims-made" medical malpractice liability insurance policy. Under a claims-made policy, coverage is provided for claims asserted and reported to Midwest Medical while the policy is in effect relating to occurrences which took place during the period in which the policyholder had coverage with Midwest Medical. 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 Midwest Medical 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 Midwest Medical) for physicians previously insured under a claims-made policy with another professional liability insurer. Prior-acts coverage is not available from Midwest Medical for physicians who have not been continuously insured prior to obtaining coverage from Midwest Medical. Midwest Medical 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 Midwest Medical, 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 Midwest Medical. In the event of death, permanent disability or retirement at age 55 or older after five years of continuous coverage with Midwest Medical, the reporting endorsement is provided at no additional premium. Midwest Medical offers basic limits of coverage from $1,000,000 for each claim, subject to $3,000,000 annual aggregate, up to $12,000,000 for each claim, subject to $14,000,000 annual aggregate. Excess coverage above the basic limits is available from Midwest Medical's reinsurers on a facultative basis. MARKETING AND DISTRIBUTION Marketing of Midwest Medical policies is handled principally by Midwest Medical through salaried marketing representatives. Midwest Medical has also made marketing arrangements with a select group of agents to assist Midwest Medical in the production of large accounts and in the 4 ITEM 1. BUSINESS (CONTINUED) production of new coverages as they are developed. Midwest Medical 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 Midwest Medical updated in 1998. Since most policies have a common expiration date, it is essential that Midwest Medical's policy processing operations be highly efficient. Midwest Medical consistently has been able to provide policy processing on a timely basis. REINSURANCE Midwest Medical 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 Midwest Medical. However, in the event the reinsurer is unable or otherwise fails to pay, Midwest Medical remains primarily liable for the loss. Historically, entering into reinsurance agreements permitted Midwest Medical 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% of its surplus. As Midwest Medical's surplus has grown, Midwest Medical now utilizes reinsurance primarily to limit its risk on any single claim. Such limits of risk assumed by Midwest Medical for physician coverage have increased from $150,000 in the first year of operations to $1,000,000 currently. The reinsurer will pay losses in excess of the amount of risk retained by Midwest Medical, not to exceed the limits of liability of the policies issued by Midwest Medical. Midwest Medical's reinsurance contract in effect during 2001 provided a primary layer of coverage of $1,000,000 in excess of $1,000,000 of retention per insured. The premium ceded for this coverage was 8.75% of net written premium with a profit sharing provision that is determined after 3 years. For limits of liability greater than $2,000,000, Midwest Medical cedes all premium and exposure to the reinsurers and collects a ceding commission of 25%. The reinsurers, their participation percentages and their A.M. Best rating are listed below. - Hannover Reinsurance Company, (35%), A+ - Transatlantic Reinsurance Company, (35%), A+ - CNA Re, UK, (15.0%), A- - Gerling Global Reinsurance Corporation (15%), A 5 ITEM 1. BUSINESS (CONTINUED) Midwest Medical renewed its reinsurance agreement effective January 1, 2002. The premium ceded on the renewed reinsurance agreement increased to 9.75% of net written premium. The reinsurers on the 2002 agreement, their participation percentages and their A.M. Best rating are listed below: - Hannover Reinsurance Company, (40%), A+ - Transatlantic Reinsurance Company, (30%), A+ - Gerling Global Reinsurance Corporation of America, (20%), A - Lloyds syndicates, (10%), A- From 1992 through 2000, Midwest Medical utilized "swing-rated" treaty reinsurance contracts. Premium ceded is based upon the losses paid under the contract limited to a minimum and a maximum percentage of the underlying Midwest Medical subject premium. These treaties do not include a commutation clause, but rather develop over time as claims are settled. The paid losses on the 1998-2000 reinsurance contract have already triggered the maximum premium ceded limit and the 1992-1994 and 1995-1997 reinsurance contracts together have fewer than forty outstanding claims. Consequently, management believes that the potential for further significant premium ceded on these contract years is small. All reinsurance contracts have been commuted and no claims are outstanding for years prior to 1992. INVESTMENTS Midwest Medical's investment portfolio is under the direction of the Board of Directors acting through the Investment Committee. The Investment Committee establishes Midwest Medical's investment policy which, in summary, is to assist in maintaining Midwest Medical's financial stability through the preservation of assets and the maximizing of pre-tax investment income. Adequate liquidity is maintained to assure that Midwest Medical has the ability to meet its insurance operational requirements, in particular, the payment of claims. Midwest Medical employs outside investment managers who manage the portfolio on a discretionary basis consistent with the policies set by Midwest Medical. 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. Midwest Medical's investment portfolio consists primarily of investment-grade fixed income instruments, including United States Government, governmental agency and corporate bonds. Fixed income investments comprised approximately 57% of total invested assets at December 31, 2001 compared to 56% at December 31, 2000. Midwest Medical's investment policy also permits the inclusion of equity securities. Equity securities comprised approximately 26% of total invested assets at December 31, 2001 compared to 33% at December 31, 2000. The 6 ITEM 1. BUSINESS (CONTINUED) decrease in the proportion of equity securities was due to a decrease in equity market values and sales of equity securities to add to the existing real estate investment trust holding and to provide capital for other corporate purposes. The remainder of Midwest Medical's investment portfolio, 17% and 11% at December 31, 2001 and 2000, respectively, was invested in real estate investment trusts and short-term investments. RATING A.M. Best & Company, Inc., publisher of Best's Insurance Reports, Property-Casualty, 2000 Edition, has assigned Midwest Medical an "A", or excellent, rating in 2001. This is the highest rating currently assigned to any company that specializes in medical malpractice insurance. 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. Midwest Medical 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 it. 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. GOVERNMENT REGULATION Midwest Medical 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 Midwest Medical's business, including policy terms, rates, dividends and retrospective premium credits to policyholders, and dividends to the parent corporation, Midwest Holding. Without prior approval from the Minnesota Commissioner of Commerce, annual dividends to Midwest Holding cannot exceed 10% of policyholder surplus of Midwest Medical or the prior year's net income from operations of Midwest Medical, excluding realized capital gains, whichever is greater. Midwest Medical 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. Midwest Holding is also subject to statutes governing insurance holding company systems in Minnesota, which relate primarily to the acquisition or control of insurance companies directly or through a holding company. COMPETITION Midwest Medical's major competitor, The St. Paul Companies, recently announced that they are exiting the medical malpractice line of business. Another major competitor, PHICO, was placed in rehabilitation by the Pennsylvania Department of Insurance in early 2002. The only national company that remains active in Midwest Medical's market area is Medical Protective Insurance 7 ITEM 1. BUSINESS (CONTINUED) Company. In addition, PIC-Wisconsin, another physician-owned specialty carrier, has entered the market but has yet to be a significant factor in Midwest Medical's core states of Minnesota, Iowa, North Dakota, South Dakota and Nebraska. Midwest Medical 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 Midwest Medical a competitive advantage in marketing to physicians. EMPLOYEES As of December 31, 2001, Midwest Holding employed 101 persons, of whom ten were executives, 70 were supervisory employees or specialists and 21 were clerical employees. As of December 31, 2001, Services employed 13 persons, of whom one was an executive, nine were supervisory employees or specialists and three were clerical employees. No employees of Midwest Holding and Services are covered by a collective bargaining agreement and management believes that relations with employees are good. ITEM 2. PROPERTIES The Company owns the following fixed assets, all of which are used in the conduct of its business:
NET BOOK VALUE DECEMBER 31, 2001 -------------- Office furniture and equipment $ 484,000 Leasehold improvements at leased premises 207,000 Computer hardware 493,000 Computer system software 362,000 ---------- Total $1,546,000 ==========
Midwest Holding and its subsidiaries own no real estate. Midwest Holding leases office space in Edina, Minnesota with total square feet of 26,069 and a lease term of six years and two months that expires on November 30, 2005. Midwest Holding also leases 5,018 square feet of office space in West Des Moines, Iowa under a three-year lease that expires on August 31, 2003. Midwest Holding leases an additional 4,610 square feet of office space in Omaha, Nebraska under a five-year lease that expires January 31, 2007. Solutions entered a new five-year lease commencing December 2001 for 8,031 square feet of office space in Plymouth, Minnesota. This lease expires December 31, 2006. Services leases a separate 5,437 square foot facility located in Shoreview, Minnesota. This lease expires March 31, 2006. Annual rent expense was approximately $1,020,000 in 2001 and $895,000 in 2000. 8 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 There were no matters submitted to a vote of security holders. 9 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS (a) There is no market for Midwest Holding's Class B or Class C Common Stock. Class C 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 anyone other than Midwest Holding and are subject to mandatory redemption for no consideration at the time that the physician terminates their insurance coverage with Midwest Medical for any reason. (b) As of March 15, 2002, the Minnesota Medical Association held the 1 share of Class B Common Stock and 9,298 physicians held one share each of Class C Common Stock. (c) Midwest Holding 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 Midwest Holding from Midwest Medical cannot exceed 10% of policyholder surplus of Midwest Medical or the prior year's net income from operations of Midwest Medical excluding realized capital gains, whichever is greater. ITEM 6. SELECTED FINANCIAL DATA Following is the selected financial data of the Company for the five years ended December 31, 2001. This data should be read in conjunction with the audited consolidated financial statements and notes thereto appearing under Item 8 of this Form 10-K.
YEAR ENDED DECEMBER 31 OPERATIONS DATA 2001(1) 2000(1) 1999(1) 1998(2) 1997(2) ------------------------------------------------------------------------------------------------------------------------ (Amounts in thousands, except percentage data) Net premiums earned $ 50,097 $41,344 $46,583 $35,014 $32,916 Net investment and other income 21,549 26,765 20,583 21,015 19,276 ------------------------------------------------------------------------- Total revenue 71,646 68,109 67,166 56,029 52,192 Loss and loss adjustment expenses 58,299 39,587 41,468 37,494 31,834 Policyholder dividends 4,050 8,108 10,175 -- -- Underwriting and other operating expenses 15,745 14,392 11,604 8,861 6,595 ------------------------------------------------------------------------- 78,094 62,087 63,247 46,355 38,429 ------------------------------------------------------------------------- (Loss) income from continuing operations before tax (6,448) 6,022 3,919 9,674 13,763 Income tax (benefit) expense (2,222) 437 1,281 3,052 4,463 ------------------------------------------------------------------------- (Loss) income from continuing operations after tax $ (4,226) $ 5,585 $ 2,638 $ 6,622 $ 9,300 =========================================================================
10 ITEM 6. SELECTED FINANCIAL DATA (CONTINUED)
YEAR ENDED DECEMBER 31 2001(1) 2000(1) 1999(1) 1998(2) 1997(2) ------------------------------------------------------------------------------------------------------------------------ (Amounts in thousands, except percentage data) (Loss) income from continuing operations after tax/total revenue (5.9)% 8.2% 3.9% 11.8% 17.8% Return on average equity (3.4)% 3.7% 1.2% 4.4% 7.8%
DECEMBER 31 FINANCIAL CONDITION 2001(1) 2000(1) 1999(2) 1998(2) 1997(2) ------------------------------------------------------------------------------------------------------------------------ (Amounts in thousands) ASSETS Fixed maturities at fair value $140,436 $146,516 $153,950 $164,652 $171,975 Equity securities at fair value 63,700 86,418 104,898 86,553 49,759 Short-term investments 21,541 19,587 9,128 3,556 13,909 Other 21,616 10,915 10,000 10,000 10,000 ------------------------------------------------------------------------- Total investments 247,293 263,436 277,976 264,761 245,643 Reinsurance recoverable on paid and unpaid losses 14,528 18,833 19,285 16,499 19,117 Other assets 25,584 19,472 22,915 14,223 10,755 ------------------------------------------------------------------------- Total assets $287,405 $301,741 $320,176 $295,483 $275,515 ========================================================================= LIABILITIES Unpaid losses and loss adjustment expenses $118,574 $118,478 $119,141 $110,964 $107,806 Other liabilities 41,944 42,665 53,234 42,072 41,418 ------------------------------------------------------------------------- 160,518 161,143 172,375 153,036 149,224 SHAREHOLDERS' EQUITY 126,887 140,598 147,801 142,447 126,291 ------------------------------------------------------------------------- Total liabilities and shareholders' equity $287,405 $301,741 $320,176 $295,483 $275,515 =========================================================================
-------------------------------------------------------------------------------- (1) Amounts derived from audited consolidated financial statements of Midwest Holding included in Item 8 of this Form 10-K. (2) Amounts derived from audited consolidated financial statements of Midwest Holding. 11 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS MANNER OF PRESENTATION The financial statements of Midwest Holding and its subsidiaries are presented on a consolidated basis. In future references in this analysis, which should be read together with the 2001 audited consolidated financial statements and notes thereto appearing under Item 8 of this Form 10-K, Midwest Holding and its subsidiaries are referred to collectively as the Company unless the reference pertains to a specific entity. LIQUIDITY AND CAPITAL RESOURCES The majority of the Company's assets are invested in investment-grade bonds, common stocks, real estate investment trusts and short-term investments. These investments totaled $247,293,000 and $263,436,000 at December 31, 2001 and 2000, respectively, which represented 86.0% and 87.3% of total assets. The Investment Committee of the Board of Directors establishes the Company's investment policy. The main objectives of the current investment policy are the preservation of assets, maximizing pre-tax total portfolio return, and assuring adequate liquidity to meet operational requirements primarily the payment of insurance claims. Fixed maturity investments and equity securities are classified as available for sale and therefore are carried at fair value. The real estate investment trusts are recorded at appraised value and short-term investments are recorded at cost which approximates fair value. In January 2001, the Company purchased an additional $10,000,000 of the real estate investment trusts (REIT) bringing its ownership interest to approximately 7% of the total REIT shares outstanding. The purchase used proceeds from sales of equity securities and was made to capture the current attractive yield on the REIT, approximately 8.5%, and to reduce the Company's portfolio allocation to equities to a level more consistent with the rest of the medical malpractice insurance industry. The Company believes that this will also help to reduce the volatility in the market value of the total investment portfolio. The Company's cash flow from operations was $(8,829,000) in 2001 versus $1,544,000 in 2000 and $2,187,000 in 1999. The 2001 cash flow from operations was unfavorably impacted by an increase in claim payments, policyholder dividend payments and premium adjustments paid to reinsurers on reinsurance contracts for prior years. These negative cash flows were partially offset by an increase in premium volume. The 2000 cash flow from operations was favorably impacted by premium adjustments received from reinsurers on reinsurance contracts for prior years and federal tax refunds received from the Internal Revenue Service for the 1992 to 1996 tax years. These positive cash flows were partially offset by the payment of policyholder dividends. The 1999 cash flow from operations was favorably impacted by premium adjustments received from reinsurers on reinsurance contracts for prior years and greater premium received at the end of 1999 due to earlier billing of policies with January 2000 effective dates. 12 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Increases in new business and premium rates drove greater cash receipts from policyholder premiums in 2001. The increase in new business opportunities is primarily the result of the easing of competitive pressures in Midwest Medical's markets. Two main competitors, The St. Paul Companies and PHICO, have recently exited from the medical malpractice insurance marketplace and other competitors are generally raising rates aggressively or exiting certain segments of the medical malpractice market. Increasing reinsurance costs and claims severity has caused and will likely continue to cause Midwest Medical to raise premium rates in the near term. Midwest Medical, however, has generally not had to raise rates to the same degree as other insurers in many parts of the United States medical malpractice insurance market. Over $65,000,000 of premium has been returned to policyholders since 1993 through policyholder dividends or retrospective premium credits. The policyholder dividend program replaced the retrospective premium credit program beginning in 1999. Policyholder dividends are generally paid in four equal installments in February, May, August and November of the year following their declaration by the Board of Directors. As discussed under the reinsurance section of Item 1 of this Form 10-K, the renewal of Midwest Medical's reinsurance agreement resulted in a rate change effective January 1, 2002. The flat, ceded premium rate increased to 9.75% from 8.75%. Although the terrorist attacks of September 11 did not impact the Company directly, the losses suffered by Midwest Medical's reinsurance partners were a factor in the reinsurance rate increase. The rate change coupled with anticipated new business will result in greater reinsurance costs for Midwest Medical in 2002. In the past, loss and operating expense payments have generally been met from policyholder premium receipts with any excess cash invested. In 2001, operating cash needs primarily from claim payments exceeded premium receipts requiring approximately $8,800,000 of cash from the investment portfolio. Premium receipts are expected to once again cover loss and operating expenses in 2002 due to the recent increase in premium volume and rates. Management regularly analyzes loss liabilities to project the cash flow required in future years. Since the overall investment portfolio is highly liquid, exact matching of bond maturities and loss liabilities is not a goal. Bond maturities are primarily selected to maximize total return. The Company believes that its cash and investments combined with internally generated funds will be sufficient to meet its present and reasonably foreseeable operating and capital requirements. Consequently, borrowing funds from external sources is not anticipated. The Company does, however, maintain a $5,000,000 secured line of credit with its bank in the event of an urgent cash need. The Company had no material capital expenditure commitments as of December 31, 2001. 13 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) During 2000, Midwest Holding completed a stock restructure that exchanged and redeemed all outstanding Class A Common Shares. Under the terms of the stock restructure, Class A shareholders received $66 for each Class A share owned, plus one Class C share. The stock restructure paid approximately $9,541,000 to Class A shareholders for the redemption of their Class A shares. An $8,500,000 loan from Midwest Medical to Midwest Holding largely funded these payments. Midwest Medical primarily used proceeds from sales of domestic equity securities to provide the loan. The loan was a non-interest bearing note and was retired in May 2001 by Midwest Holding through a dividend received from Midwest Medical. More details about the stock restructure, Class A and Class C Common Stock are found in Note 3 to the audited consolidated financial statements. Periodically, the Board of Directors of Midwest Medical declares dividends payable to Midwest Holding to provide capital for holding company and non-insurance business operations including new business ventures. In 2001, a dividend from Midwest Medical was also used by Midwest Holding to retire an $8,500,000 loan used to fund stock restructure payments in 2000. Midwest Medical declared and paid dividends to Midwest Holding of $11,400,000, $3,000,000 and $2,050,000 in 2001, 2000 and 1999, respectively. The increases and decreases in shareholders' equity are described in the consolidated statements of changes in shareholders' equity found in the accompanying audited consolidated financial statements. RESULTS OF OPERATIONS Net premiums earned increased $8,753,000 in 2001 from 2000. The increase was the result of the following significant factors: 1. New 2001 business increased earned premium by approximately $7,785,000. 2. Rate increases and granting fewer premium discounts increased earned premium by approximately $3,400,000 in 2001. 3. Premiums from reporting endorsements that provide policyholder tail coverage increased earned premium by approximately $1,686,000 in 2001. 4. The estimated reinsurance premium applicable to the treaty years 1992-1994 and 1995-1997, which is based in part on reinsured claims experience, increased $3,125,000 in 2001. This compares to an increase for those treaty years of $634,000 in 2000 resulting in a net decrease in premium between years of $2,491,000. 5. Due primarily to the increase in premiums written, current year reinsurance costs were $1,685,000 greater in 2001 compared to 2000. This decreased 2001 net premiums earned. 14 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Net premiums earned decreased $5,239,000 in 2000 from 1999. The decrease was the result of the following significant factors: 1. The estimated reinsurance premium applicable to the treaty years 1992-1994 and 1995-1997, which is based in part on reinsured claims experience, increased $634,000 on a net basis in 2000. This compares to a net reduction for those treaty years of $5,920,000 in 1999 resulting in a net decrease in premium between years of $6,554,000. 2. New 2000 business increased earned premium by approximately $2,600,000. 3. Due primarily to the new reinsurance program for fraud and abuse provided at no additional cost to Midwest Medical policyholders, current year reinsurance costs were $968,000 greater in 2000 compared to 1999. This decreased 2000 net premiums earned. Net investment income increased $101,000 in 2001 from 2000 and increased $1,290,000 in 2000 from 1999. The pick-up in yield from the additional purchase of the REIT and lower investment expenses due to the drop in market values of equity securities caused the increase in net investment income in 2001. This was partially offset by lower yields on bonds and short-term investments due to the drop in interest rates during 2001. Increasing yields on bonds and short-term investments from the upward movement in interest rates during 1999 and 2000 primarily caused the increase in net investment income in 2000. Also contributing to the increase were proceeds from the sales of equity securities used to pay Class A shareholders for stock restructure redemptions. The proceeds earned interest while held in short-term investments until stock restructure payments were made. Realized capital gains decreased $3,931,000 to $6,571,000 in 2001 and increased $3,282,000 to $10,502,000 in 2000. During 2001, sales of equity securities realized $6,752,000 of net capital gains while sales of bonds realized $(181,000) of net capital losses. Approximately $3,000,000 of the net realized capital gains on equity securities resulted from the sale of common stocks in the first quarter to fund the additional REIT purchase of $10,000,000. All other 2001 realized capital gains and losses resulted from the management of the portfolio on a pre-tax total return basis. During 2000, sales of equity securities realized $12,245,000 of net capital gains while sales of bonds realized $(1,743,000) of net capital losses. Approximately $7,000,000 of the net realized capital gains on equity securities resulted from the sale of appreciated technology common stocks in the first quarter as holdings in the technology sector were trimmed in order to maintain appropriate portfolio diversification. Another $3,000,000 of net realized capital gains resulted from sales of equity securities in the latter part of 2000 to fund stock restructure redemption payments to Class A shareholders. All other 2000 realized capital gains and losses resulted from the management of the portfolio on a pre-tax total return basis. 15 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) The Company employs three outside professional advisors to manage the portfolio: one to manage investment-grade fixed income securities, one to manage large-cap domestic equities, and one to manage international equities. The managers operate within the Company's adopted investment policy as approved by the Investment Committee of the Board of Directors. The Investment Committee meets with outside investment managers approximately four times per year. Future levels of realized capital gains or losses are difficult to predict as investment managers purchase and sell securities in response to changing market conditions and investment policy guidelines. Other revenues decreased $1,386,000 from $4,023,000 in 2000 to $2,637,000 in 2001. Most of this decrease is due to the $1,716,000 recorded by Midwest Medical in 2000 for interest on federal tax refunds. Also contributing to the decrease is the elimination of finance charges on 2001 premium billings to Midwest Medical policyholders. Finance charges of $556,000 were included in other revenues for 2000. Offsetting these decreases were a $691,000 increase in Solutions' revenues primarily from technology consulting and a $479,000 increase in Services' revenues primarily from commission income earned on new accounts Other revenues increased $1,610,000 from $2,413,000 in 1999 to $4,023,000 in 2000. Interest on federal tax refunds of $1,716,000 recorded by Midwest Medical in 2000 primarily caused the increase. Revenues from the new information technology consulting division of Solutions also contributed to the increase. A decrease in income from Midwest Holding's officer life insurance policies partially offset the above increases. Losses and loss adjustment expenses are the costs associated with the settlement of insurance claims and are the Company's principal expense. Incurred loss and loss adjustment expenses were $58,299,000 in 2001 compared to $39,587,000 in 2000 and $41,468,000 in 1999. This resulted in an increase of 47.3% in 2001 versus a decrease of 4.5% in 2000. As shown in Note 6 to the audited consolidated financial statements, 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, increased by $10,664,000 in 2001 compared to $1,521,000 in 2000. The significant increase in 2001 was primarily driven by additional policyholder exposure from the increase in premium volume and the increase in Midwest Medical's retention from $750,000 to $1,000,000 per insured for the primary layer of coverage. Also, a conservative loss position was taken since a significant portion of the increase in premium volume came from newer business lines, such as large, healthcare systems and hospitals. Losses and loss adjustment expenses also include adjustments of prior years' estimates. These adjustments to the liability for loss and loss adjustment expense are evaluated by management and supported by an outside actuarial review performed at the conclusion of the year. As shown in Note 6 of the audited consolidated financial statements, these evaluations resulted in a small increase of $172,000 in 2001 in the estimated liabilities applicable to prior years versus a reduction of $7,876,000 in 2000. The less favorable development on prior years resulted primarily from an increase in claims severity. 16 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) The following schedule summarizes the development of the liability for loss and loss adjustment expense from 1991 through 2001. This schedule is presented net of reinsurance, which the Company believes best explains the development as it affects operating results. Midwest Medical has a conservative loss reserving policy that when coupled with a decline in medical malpractice insurance claim frequency since the early 1990's has generally resulted in redundancies in the liability for losses and loss adjustment expenses. The table indicates that the redundancy in loss liabilities, which develop as actual results become known, has significantly decreased since 1991. Downward competitive pressure on premium rates during the latter portion of the 1990's coupled with increasing claims severity have been major contributors to the decrease in redundancies. Loss and loss adjustment expense liabilities have not been discounted in the Company's financial statements. 17 Development of Liability for Loss and Loss Adjustment Expense (Thousands of Dollars)
1991 1992 1993 1994 1995 1996 ----------------------------------------------------------------------------- Liability for unpaid loss and loss adjustment expense $100,167 $98,617 $105,589 $88,227 $96,424 $90,342 Cumulative amount of liability paid through: 1 year later 19,112 21,422 25,251 26,879 33,454 30,097 2 years later 32,798 37,498 42,685 46,925 53,132 44,562 3 years later 39,906 45,227 51,087 55,534 59,568 54,411 4 years later 42,752 46,226 53,594 57,129 63,915 60,708 5 years later 43,994 46,823 53,288 58,856 67,291 63,990 6 years later 44,370 46,810 54,709 60,701 68,032 7 years later 44,420 47,218 55,281 61,293 8 years later 44,634 47,249 55,568 9 years later 44,646 47,262 10 years later 44,659 Liability re-estimated as of: 1 year later 83,991 94,633 80,960 85,595 87,580 81,990 2 years later 74,883 69,490 75,364 76,365 79,665 76,542 3 years later 53,538 65,568 64,586 67,891 77,294 70,228 4 years later 52,833 56,426 57,851 65,794 73,979 65,691 5 years later 45,892 52,388 56,785 63,958 70,601 67,566 6 years later 44,370 53,014 55,358 63,037 70,916 7 years later 44,420 52,469 55,790 62,377 8 years later 44,634 52,342 55,568 9 years later 44,646 52,355 10 years later 44,659 Redundancy (deficiency) 55,508 46,262 50,021 25,850 25,508 22,776
1997 1998 1999 2000 2001 ---------------------------------------------------------------- Liability for unpaid loss and loss adjustment expense $89,394 $94,467 $99,894 $ 100,264 $104,870 Cumulative amount of liability paid through: 1 year later 28,755 33,787 35,891 50,829 2 years later 48,437 54,319 69,753 3 years later 60,582 71,162 4 years later 68,726 5 years later 6 years later 7 years later 8 years later 9 years later 10 years later Liability re-estimated as of: 1 year later 84,961 89,992 92,022 100,436 2 years later 78,679 85,205 96,752 3 years later 74,909 85,512 4 years later 75,096 5 years later 6 years later 7 years later 8 years later 9 years later 10 years later Redundancy (deficiency) 14,298 8,955 3,142 (172)
18 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Policyholder dividends of $4,050,000 were declared by the Board of Directors of Midwest Medical in 2001 and will be paid to physician and clinic policyholders in 2002. Policyholder dividends of $8,108,000 and $10,175,000 were declared in 2000 and 1999, respectively, and were paid to physician, clinic and hospital policyholders the following year. The $4,050,000 policyholder dividend declared in 2001 will be awarded proportionately based on annual premiums for physician and clinic policyholders that were insured by Midwest Medical in 1997 and remain insured throughout 2002. The dividend will be paid in four equal installments in February, May, August and November of 2002. The decrease in policyholder dividends is primarily due to less favorable loss experience on the 1997 coverage year on which the 2001 policyholder dividend was based. Policyholder dividends represent a return of prior years' profits that were greater than anticipated due to favorable claims and investment experience. Underwriting, acquisition and insurance expenses increased $1,274,000 from $7,570,000 in 2000 to $8,844,000 in 2001. Greater premium volume drove a $1,179,000 increase in commission payments and a $399,000 increase in premium taxes. These increases were partially offset by greater ceding commissions earned by Midwest Medical of approximately $243,000 resulting from the increase in premiums ceded to the treaty reinsurance contract for the current year. Underwriting, acquisition and insurance expenses increased $373,000 from $7,197,000 in 1999 to $7,570,000 in 2000. Less ceding commissions earned by Midwest Medical due to a decline in the premiums ceded to the treaty reinsurance contract for the current year drove approximately $216,000 of the increase. Greater commissions paid in 2000 due to enhanced agent incentives contributed an additional $215,000. These increases were partially offset by lower premium taxes. Lower written premium volume in 2000 and the $10,175,000 of policyholder dividends paid during the year, which is deductible for premium tax purposes, caused the decline in premium taxes. Other operating expenses increased $79,000 from $6,822,000 in 2000 to $6,901,000 in 2001. Additional staff for Solutions' technology consulting and practice management software initiatives and greater commissions paid to Services' producers from new business primarily drove the increase. This was partially offset by the decrease in stock restructure expenses, which were all incurred in 2000 by Midwest Holding. Other operating expenses increased $2,415,000 from $4,407,000 in 1999 to $6,822,000 in 2000. The stock restructure of Midwest Holding caused an additional $1,057,000 of compensation expense to be recognized in 2000 for the vesting of all previously unvested Class A shares. Legal and accounting fees related to the restructure contributed another $201,000. The remaining increase was largely from greater salary and benefit expenses incurred by Midwest Holding, Services and Solutions primarily to service additional business volume. 19 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Loss from continuing operations before income taxes was $(6,448,000) in 2001 compared to income of $6,022,000 in 2000. The decrease resulted primarily from greater loss liabilities estimated for the current year, less favorable development on prior years' loss liabilities and lower realized capital gains. This was partially offset by an increase in net premiums earned and lower policyholder dividends. Income in 2000 also benefited from some non-recurring items such as the realized capital gains recorded on sales of domestic equity securities to fund the stock restructure as well as interest on federal tax refunds. Income from continuing operations before income taxes increased to $6,022,000 in 2000 compared to $3,919,000 in 1999. Greater realized capital gains from sales of domestic equity securities to maintain appropriate portfolio diversification and to fund the stock restructure primarily drove the increase. Interest on federal tax refunds, favorable development on prior years' loss liabilities and lower policyholder dividends also contributed to the increase. This was partially offset by lower net premiums earned and an increase in other operating expenses. Income taxes decreased $2,659,000 resulting in an income tax benefit of $(2,222,000) for 2001 compared to an income tax expense of $437,000 for 2000. The effective tax rates for 2001 and 2000 were 34.5% and 7.3%, respectively. The principal factor in the increase in the effective tax rate was a recovery of prior year taxes recorded in 2000. The tax recovery in 2000 was primarily due to federal tax refunds received by Midwest Medical from the Internal Revenue Service for the 1992 to 1996 tax years. Income taxes decreased $844,000 to $437,000 for 2000 compared to $1,281,000 for 1999. The effective tax rates for 2000 and 1999 were 7.3% and 32.7%, respectively. The principal factor in the decrease in the effective tax rate was a greater recovery of prior year taxes recorded in 2000 compared to 1999. Discontinued operations represent the impact of the sale of MedPower effective July 31, 2001. The Company decided to sell MedPower as continued strong competition in the electronic medical claims processing marketplace diminished the prospect of generating sufficient revenues for MedPower to earn a profit. The Company incurred a loss net of tax of $(135,000) on the 2001 operation of MedPower through July 31 and recorded a loss net of tax of $(240,000) on the sale. Further information regarding MedPower and its sale is found in Notes 1 and 2 to the audited consolidated financial statements. Net (loss) income recorded by the Company decreased $(9,887,000) to a net loss of $(4,601,000) in 2001 and increased $3,550,000 to net income of $5,286,000 in 2000 due to the factors discussed above. 20 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS Statements other than historical information contained in this Form 10-K are considered to be "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Act of 1934, as amended. All forward-looking statements address matters that involve risks and uncertainties. Accordingly, in addition to the factors discussed in this Form 10-K, there are or will be other significant factors that could cause actual results to differ materially from those indicated in such statements. These factors include but are not limited to: 1. the impact of changing market conditions on the Company's business strategy; 2. the effects of increased competition on pricing, coverage terms, retention of customers and ability to attract new customers; 3. greater severity or frequency of the types of losses that the Company insures; 4. faster or more adverse loss development experience than that on which the Company based its underwriting, reserving and investment practices; 5. developments in global financial markets which could adversely affect the performance of the Company's investment portfolio; 6. litigation, regulatory or tax developments which could adversely affect the Company's business; 7. risks associated with the introduction of new products and services; 8. dependence on key personnel; and 9. the impact of mergers and acquisitions. The above factors should be considered in connection with any forward-looking statement contained in this Form 10-K. The significant factors that could affect such forward-looking statements are subject to change, and the Company does not intend to update any forward-looking statement or the above list of significant factors. By this cautionary note, the Company intends to avail itself of the safe harbor from liability with respect to forward-looking statements provided by Section 27A and Section 21E referred to previously. 21 ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK Market risk is the risk of loss that may occur when fluctuations in interest and foreign currency exchange rates and equity and commodity prices change the value of a financial instrument. Both derivative and nonderivative financial instruments have market risk. The Company is primarily exposed to interest rate risk on its investment in fixed maturities, equity price risk on its investment in equity securities and foreign currency exchange rate risk on its investment in international equity securities. Professional outside investment firms manage the Company's investment portfolios according to the objectives and parameters set by the Company's investment policy as approved by the Investment Committee of the Board of Directors. Under the current investment policy, the only derivative instrument the Company may use is covered call options. A call option gives the purchaser a right to buy a stock at a specified price within a specified time. The Company's domestic equity investment manager may write call options on equity securities the Company owns (a "covered" call option) to manage exposure to equity price risk and enhance investment returns. No covered call options were written or outstanding in 2001 or 2000. Based on the effective duration of the fixed maturity investment portfolio, an abrupt 100 basis point increase in interest rates along the entire interest rate yield curve would adversely affect the fair value of fixed maturity investments by approximately $5,800,000 at December 31, 2001 compared to $6,500,000 at December 31, 2000. Based primarily on past annual performance relative to the Standard & Poor's 500 Market Index (S&P 500), an abrupt ten percent decrease in the S&P 500 would adversely affect the fair value of equity securities by approximately $7,800,000 at December 31, 2001 compared to $10,400,000 at December 31, 2000. A hypothetical ten percent weakening of all foreign currencies relative to the U.S. dollar would adversely affect the fair value of the Company's investment in international equity securities by approximately $1,800,000 at December 31, 2001 compared to $2,000,000 at December 31, 2000. The Company believes that there would be no material effect on its net income and cash flows in any of the above scenarios. This effect on net income and cash flows does not consider the possible effects a change in economic activity could have in such an environment. Investors, customers, regulators and legislators could respond to these fluctuations in ways the Company cannot foresee. Because the Company cannot be certain what specific actions would be taken and their effects, the above sensitivity analyses assume no significant changes in the Company's financial structure. 22 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The audited consolidated financial statements of Midwest Medical Insurance Holding Company and Subsidiaries are presented on the following pages 24 through 53 of this Annual Report on Form 10-K. 23 Midwest Medical Insurance Holding Company and Subsidiaries Consolidated Financial Statements Years Ended December 31, 2001, 2000 and 1999 CONTENTS Report of Independent Auditors............................................ 24 Consolidated Financial Statements Consolidated Balance Sheets............................................... 25 Consolidated Statements of Income......................................... 26 Consolidated Statements of Changes in Shareholders' Equity................ 27 Consolidated Statements of Cash Flows..................................... 28 Notes to Consolidated Financial Statements................................ 29
24 Report of Independent Auditors The 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 (the Company) as of December 31, 2001 and 2000 and the related consolidated statements of income, changes in shareholders' equity and cash flows for each of the three years in the period ended December 31, 2001. Our audits also included the financial statements and 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 auditing standards generally accepted in the United States. 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, 2001 and 2000 and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States. 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. /s/ Ernst & Young LLP February 1, 2002 25 Midwest Medical Insurance Holding Company and Subsidiaries Consolidated Balance Sheets (In Thousands, Except for Share Amounts)
DECEMBER 31 2001 2000 ---------------------- ASSETS Investments: Fixed maturities at fair value (cost: 2001 - $137,844; 2000 - $148,832) $140,436 $146,516 Equity securities at fair value (cost: 2001 - $46,432; 2000 - $49,739) 63,700 86,418 Short-term 21,541 19,587 Other 21,616 10,915 ---------------------- 247,293 263,436 Cash 1,018 976 Accrued investment income 2,219 2,286 Premiums receivable 9,844 6,214 Reinsurance recoverable on paid and unpaid losses 14,528 18,833 Amounts due from reinsurers 1,657 1,390 Other assets 10,846 8,606 ---------------------- Total assets $287,405 $301,741 ====================== LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Unpaid losses and loss adjustment expenses $118,574 $118,478 Unearned premiums 15,489 12,050 Policyholder dividends 4,050 8,108 Deferred income taxes 1,664 6,635 Amounts due to reinsurers 6,775 5,248 Other liabilities 13,966 10,624 ---------------------- Total liabilities 160,518 161,143 Shareholders' equity: Class B Common Stock - authorized, issued and outstanding, 1 share 1 1 Class C Common Stock - authorized, 300,000 shares; issued and outstanding, 9,298 shares in 2001 and 7,961 shares in 2000; no par value -- -- Paid-in capital 12,789 12,789 Retained earnings 99,923 104,524 Net unrealized appreciation of investments 14,174 23,284 ---------------------- 126,887 140,598 ---------------------- Total liabilities and shareholders' equity $287,405 $301,741 ======================
See accompanying notes. 26 Midwest Medical Insurance Holding Company and Subsidiaries Consolidated Statements of Income (In Thousands)
YEAR ENDED DECEMBER 31 2001 2000 1999 -------------------------------------- Revenues: Net premiums earned $ 50,097 $ 41,344 $ 46,583 Net investment income 12,341 12,240 10,950 Realized capital gains 6,571 10,502 7,220 Other 2,637 4,023 2,413 -------------------------------------- 71,646 68,109 67,166 Losses and expenses: Losses and loss adjustment expenses 58,299 39,587 41,468 Policyholder dividends 4,050 8,108 10,175 Underwriting, acquisition and insurance expenses 8,844 7,570 7,197 Other operating expenses 6,901 6,822 4,407 -------------------------------------- 78,094 62,087 63,247 -------------------------------------- (Loss) income from continuing operations before tax (6,448) 6,022 3,919 Income tax (benefit) expense (2,222) 437 1,281 -------------------------------------- (Loss) income from continuing operations after tax (4,226) 5,585 2,638 Discontinued operations: Loss from discontinued operations, net of tax (135) (299) (902) Loss on disposal, net of tax (240) -- -- -------------------------------------- Net (loss) income $ (4,601) $ 5,286 $ 1,736 ======================================
See accompanying notes. 27 Midwest Medical Insurance Holding Company and Subsidiaries Consolidated Statements of Changes in Shareholders' Equity (In Thousands)
ACCUMULATED OTHER CLASS B PAID-IN RETAINED COMPREHENSIVE TOTAL COMMON STOCK CAPITAL EARNINGS INCOME ----------------------------------------------------------------------- Balance at December 31, 1998 $ 142,447 $ 1 $ 12,789 $ 98,695 $ 30,962 Comprehensive income: Net income 1,736 -- -- 1,736 -- Other comprehensive income: Unrealized gains on securities, net of $3,708 in taxes 8,600 -- -- -- 8,600 Reclassification adjustment for gains included in net income, net of $2,394 in taxes (4,646) -- -- -- (4,646) --------- Total comprehensive income 5,690 Dividend paid by Midwest Medical Insurance Company to Midwest Medical Insurance Holding Company (2,050) -- -- (2,050) -- Net loss of non-insurance entities includable in Class A Common Stock redemption value 1,714 -- -- 1,714 -- ----------------------------------------------------------------------- Balance at December 31, 1999 147,801 1 12,789 100,095 34,916 Reclassification of equity components related to stock restructure 172 -- -- -- 172 Comprehensive income (loss): Net income 5,286 -- -- 5,286 -- Other comprehensive income (loss): Unrealized losses on securities, net of $2,515 in tax benefits (4,873) -- -- -- (4,873) Reclassification adjustment for gains included in net income, net of $3,571 in taxes (6,931) -- -- -- (6,931) --------- Total comprehensive income (loss) (6,518) Dividend paid by Midwest Medical Insurance Company to Midwest Medical Insurance Holding Company (3,000) -- -- (3,000) -- Net loss of non-insurance entities includable in Class A Common Stock redemption value 3,496 -- -- 3,496 -- Excess of tender price over redemption value related to stock restructure (1,353) -- -- (1,353) -- ----------------------------------------------------------------------- Balance at December 31, 2000 140,598 1 12,789 104,524 23,284 Comprehensive income (loss): Net loss (4,601) -- -- (4,601) -- Other comprehensive income (loss): Unrealized losses on securities, net of $2,459 in tax benefits (4,773) -- -- -- (4,773) Reclassification adjustment for gains included in net income, net of $2,234 in taxes (4,337) -- -- -- (4,337) --------- Total comprehensive income (loss) (13,711) ----------------------------------------------------------------------- Balance at December 31, 2001 $ 126,887 $ 1 $ 12,789 $ 99,923 $ 14,174 =======================================================================
See accompanying notes. 28 Midwest Medical Insurance Holding Company and Subsidiaries Consolidated Statements of Cash Flows (In Thousands)
YEAR ENDED DECEMBER 31 2001 2000 1999 ----------------------------------------- OPERATING ACTIVITIES Net (loss) income $ (4,601) $ 5,286 $ 1,736 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Decrease (increase) in accrued investment income 67 31 (578) (Increase) decrease in premiums receivable (3,630) 929 (5,120) Decrease (increase) in reinsurance recoverable 4,305 452 (2,786) (Increase) decrease in amounts due from reinsurers (267) 2,443 (642) Increase in other assets (2,240) (805) (1,178) Deferred tax provision (278) 516 (90) Increase (decrease) in unpaid losses and loss adjustment expenses 96 (663) 8,177 Increase (decrease) in unearned premiums 3,439 (747) 4,624 (Decrease) increase in policyholder dividends (4,058) (2,067) 10,175 Decrease in retrospective premiums -- -- (8,543) Increase in amounts due to reinsurers 1,527 5,248 -- Increase in other liabilities 3,342 365 4,015 Premium amortization, net of accretion of bond discount 40 (253) (636) Realized capital gains (6,571) (10,502) (7,220) Compensation expense for vested Class A Common Shares -- 1,311 253 ----------------------------------------- (8,829) 1,544 2,187 INVESTING ACTIVITIES Purchases of fixed maturity investments and equity securities (118,633) (106,361) (171,139) Purchase of other investments (10,000) -- -- Sales of fixed maturity investments and equity securities 136,098 120,049 174,651 Calls and maturities of fixed maturity investments 3,360 4,180 2,000 Net purchases of short-term investments (1,954) (10,459) (5,572) ----------------------------------------- 8,871 7,409 (60) FINANCING ACTIVITIES Redemption of Class A Common Shares -- (9,798) (953) ----------------------------------------- Increase (decrease) in cash 42 (845) 1,174 Cash at beginning of year 976 1,821 647 ----------------------------------------- Cash at end of year $ 1,018 $ 976 $ 1,821 =========================================
See accompanying notes. 29 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements December 31, 2001 1. ACCOUNTING POLICIES ORGANIZATION AND OPERATIONS The Company's consolidated financial statements include the accounts of Midwest Medical Insurance Holding Company (Midwest Holding) and its wholly owned subsidiaries, Midwest Medical Insurance Company (Midwest Medical), MMIHC Insurance Services, Inc. (Services) and Midwest Medical Solutions, Inc. (Solutions). All transactions between Midwest Holding and its subsidiaries have been eliminated in consolidation, with the exception of the distribution of capital to Midwest Holding by Midwest Medical in the form of dividends for periods prior to 2001. Hereafter, Midwest Holding, Midwest Medical, Services and Solutions shall be collectively referred to as the Company unless the reference pertains to a specific entity. The Company, through its subsidiary Midwest Medical and its predecessors, has been providing professional liability insurance to physicians in the Midwest since October 1980. The current structure of the Company is the result of a reorganization in 1988 followed by two business combinations with other insurers. In 1993, the Company merged with Iowa Physicians Mutual Insurance Trust. In 1996, the Company merged with Medical Liability Mutual Insurance Company of Nebraska. Each combination was accounted for as a pooling-of-interests. During 1997, the Company formed Solutions as a business development company to strengthen and promote the independence and interdependencies of physicians, clinics and hospitals that the Company serves. Business development opportunities being pursued include practice enhancement, strategic consulting and technology services and support. In January 1998, Solutions purchased the assets of MedPower Information Services, Inc. Solutions then contributed those assets to its newly formed, wholly-owned subsidiary, Medpower Information Resources, Inc. MedPower was subsequently sold effective July 31, 2001. MedPower processed and electronically submitted medical claims for a network of over 100 provider entities (See Note 2). 30 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 1. ACCOUNTING POLICIES (CONTINUED) Services was incorporated in 1995 and began active operations in January 1999 with the acquisition of a book of business from Johnson-McCann Benefits, Inc. Services is an insurance agency specializing in providing clients with group insurance products such as health, dental, life, disability and workers' compensation. Midwest Holding provides management and administrative services to Midwest Medical and Solutions for a fee generally equal to the cost of services provided. Services operates independently with its own management and administrative staff and therefore does not have a management agreement with Midwest Holding. Midwest Medical provides professional liability insurance to physicians, clinics, hospitals and healthcare systems in Minnesota, Iowa, Nebraska, North Dakota, South Dakota, Wisconsin and Illinois. Insurance policies issued by Midwest Medical are on a "claims made" basis and provide coverage for the policyholder for claims first made against the policyholder and reported to Midwest Medical during the policy period for claims which occurred on or after the retroactive date stated in the policy. Midwest Medical 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 Midwest Medical. 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 Midwest Medical 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. BASIS OF PRESENTATION The consolidated financial statements have been presented in conformity with accounting principles generally accepted in the United States, which differ in certain respects from statutory accounting practices followed by Midwest Medical in reporting to the Minnesota Department of Commerce (see Note 11). 31 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 1. ACCOUNTING POLICIES (CONTINUED) USE OF ESTIMATES The preparation of financial statements in conformity with accounting principles generally accepted in the United States 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. Consistent with management's classification of its investment 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 component of other comprehensive income, 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 and commercial paper with maturities of less than one year. Short-term investments are recorded at cost, which approximates fair value. Other investments are less than 20% equity interests in non-traded real estate investment trusts and are recorded at appraised 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. 32 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 1. ACCOUNTING POLICIES (CONTINUED) When evidence indicates a decline, which is other than temporary, in the underlying value or earning power of individual investments, such investments are written down to fair value by a charge to income. LOSSES AND LOSS ADJUSTMENT EXPENSES The liability for unpaid 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 Midwest Medical 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. Midwest Medical 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 Midwest Medical'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. POLICYHOLDER DIVIDENDS Midwest Medical implemented a policyholder dividend program in 1999. Policyholder dividends are accrued when approved by the Board of Directors and are recorded as a separate component of losses and expenses in the consolidated statements of income. REINSURANCE Midwest Medical 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. Reinsurance contracts are principally excess-of-loss contracts, which indemnify Midwest Medical for losses in excess of a stated retention limit up to the policy limits. 33 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 1. ACCOUNTING POLICIES (CONTINUED) ACQUISITION COSTS Acquisition costs are expensed when incurred. As most of its premium is written without the use of intermediaries, Midwest Medical does not pay significant amounts in commissions. OTHER REVENUES Other revenues consist primarily of Services' commission income from insurance carriers and Solutions' technology consulting and software sales and support to healthcare providers. Generally, such revenues are earned as the related services and products are provided or performed. INCOME TAXES The Company files a consolidated tax return with its subsidiaries. Income tax expense is allocated to the subsidiaries based upon separate company taxable income under a tax-sharing agreement. 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. RECLASSIFICATIONS Certain amounts in the prior years' financial statements have been reclassified to conform with the current year presentation. 2. DISCONTINUED OPERATIONS As mentioned in Note 1, the Company sold all of the capital stock of MedPower to ClaimLynx, Inc. effective July 31, 2001. Proceeds from the sale were $150,000. The Company recorded a $240,000 loss on the sale, net of an income tax benefit of $124,000. No significant assets or liabilities of MedPower remain as of December 31, 2001. The Company's consolidated statements of income separately disclose, as discontinued operations, the operating results and sale of MedPower, net of tax. Prior periods have been restated accordingly. 34 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 3. CAPITAL STRUCTURE Effective November 30, 1988, Midwest Medical policyholders earned Class A Common Shares for each month of service pursuant to a stock allocation formula based on underwriting risk classification. Shares earned by new policyholders were not issued until the end of five years of continuous coverage under a Midwest Medical policy (the vesting date). At the vesting date, the issued shares were recorded at the then current redemption value. Midwest Holding accounted for these shares by increasing common stock by the par value ($.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 continued to earn shares for each month they remained insured with Midwest Medical according to the stock allocation formula. Midwest Holding accounted 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. In accordance with the Articles of Incorporation and By-laws of Midwest Holding, only active policyholders of Midwest Medical owned shares of Class A Common Stock of Midwest Holding. At each meeting of the shareholders, every Class A shareholder having the right to vote was 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 were required to redeem their shares with Midwest Holding upon termination as policyholders of Midwest Medical. The net redemption value (NRV) of the shares was equal to the net book value of Midwest Holding, excluding the amount of net book value that was attributable to Midwest Medical, divided by the number of outstanding Class A Common Shares of Midwest Holding at the semi-annual valuation dates of June 30 and December 31 of each year. The amount paid upon redemption was the redemption value determined at the most recent semi-annual valuation. The Board of Directors of Midwest Holding approved a tender offer for the exchange and redemption of substantially all Class A shares owned by Class A shareholders of record on April 30, 2000. Pursuant to the offer, Class A shareholders who tendered their shares received $66 for each Class A share owned, plus one Class C share. The tender offer was conducted from May 2000 until closing effective July 31, 2000. Remaining shares outstanding after closing of the tender offer were subsequently acquired pursuant to 35 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 3. CAPITAL STRUCTURE (CONTINUED) individual offers under identical terms. All outstanding Class A Common Shares of Midwest Holding were exchanged and redeemed as of December 31, 2000. During 2000, payments of $9,541,000 were made to Class A shareholders for stock redemptions related to these offers. Like the Class A shares, Class C shares are not publicly or privately traded. The Class C shares provide all shareholders with the same voting rights as the Class A shares. Class C shareholders, however, do not accrue additional shares and the Class C shares have no redemption value. Issuance of Class C shares are not subject to any vesting requirements. In the event of a liquidation, sale, or similar transaction, Class C shareholders would participate in the proceeds according to a distribution formula developed by the Board of Directors. This formula takes into account the underwriting risk classification and years of coverage of each shareholder. As this is the same distribution formula that was previously applicable to Class A shares, Class C shareholders retained the same percentage ownership after the exchange as they had before the exchange. Class C shares are returned to Midwest Holding upon termination of the shareholder's insurance coverage with Midwest Medical. Midwest Holding has issued one share of Class B voting stock that carries with it the right to elect the Board of Directors of Midwest Holding. The Minnesota Medical Association and the Iowa Medical Society currently exercise the voting rights. A majority of the Class C shareholders may at any time, by a two-thirds vote, elect to redeem the Class B share at cost. 36 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 3. CAPITAL STRUCTURE (CONTINUED) Following is the detail of changes in redeemable stock for each of the two years in the period ended December 31, 2000:
MIDWEST MIDWEST ACCUMULATED CLASS A COMMON STOCK HOLDING HOLDING OTHER -------------------- PAID-IN RETAINED COMPREHENSIVE TOTAL SHARES AMOUNT CAPITAL EARNINGS INCOME ------------------------------------------------------------------------ (In Thousands, Except for Share and Per Share Amounts) Balance at January 1, 1999 $ 8,146 125,682 $ 1 $ 6,275 $ 1,718 $152 Comprehensive income: Net loss of non-insurance entities includable in Class A Common Stock redemption value (1,714) -- -- -- (1,714) -- Other comprehensive income: Unrealized gains on securities, net of $11 in taxes 20 -- -- -- -- 20 ------- Total comprehensive income (1,694) Redemption of shares due to policyholder terminations by effective date: January 1, 1999 to June 30, 1999; NRV of $64.81 (504) (7,784) -- (341) (163) -- July 1, 1999 to December 31, 1999; NRV of $60.10 (450) (7,240) (1) (304) (145) -- Issuance of shares to vested policyholders 1 8,702 1 -- -- -- Initial issuance of shares to policyholders upon vesting 253 4,149 -- 253 -- -- Dividends from Midwest Medical 2,050 -- -- 2,050 -- -- ------------------------------------------------------------------------ Balance at December 31, 1999 (carried forward) 7,802 123,509 1 7,933 (304) 172
37 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 3. CAPITAL STRUCTURE (CONTINUED)
MIDWEST MIDWEST ACCUMULATED CLASS A COMMON STOCK HOLDING HOLDING OTHER -------------------- PAID-IN RETAINED COMPREHENSIVE TOTAL SHARES AMOUNT CAPITAL EARNINGS INCOME ------------------------------------------------------------------------ (In Thousands, Except for Share and Per Share Amounts) Balance at December 31, 1999 (brought forward) $ 7,802 123,509 $ 1 $ 7,933 $ (304) $ 172 Reclassification of equity components related to stock restructure (172) -- -- -- -- (172) Comprehensive income: Net loss of non-insurance entities includable in Class A Common Stock redemption value (3,496) -- -- -- (3,496) -- Redemption of shares due to policyholder terminations by effective date: January 1, 2000 to April 30, 2000; NRV of $63.18 (257) (4,125) -- (257) -- -- Issuance of shares to vested policyholders -- 5,272 -- -- -- -- Initial issuance of shares to policyholders upon vesting 1,311 19,896 -- 1,311 -- -- Redemption of shares related to stock restructure (9,541) (144,552) (1) (9,540) -- -- Dividends from Midwest Medical 3,000 -- -- 3,000 -- -- Excess of tender price over redemption value related to stock restructure 1,353 -- -- (2,447) 3,800 -- ------------------------------------------------------------------------ Balance at December 31, 2000 $ -- -- $-- $ -- $ -- $ -- ========================================================================
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:
2001 2000 1999 -------------------------------------- (In Thousands) Fixed maturities $ 10,001 $ 10,722 $ 9,836 Equity securities 996 878 870 Short-term investments 925 1,002 505 Other investments 1,482 857 854 -------------------------------------- 13,404 13,459 12,065 Investment expenses (1,063) (1,219) (1,115) -------------------------------------- $ 12,341 $ 12,240 $ 10,950 ======================================
The cost (amortized cost for fixed maturities) and fair value of available for sale investments are as follows:
DECEMBER 31, 2001 ------------------------------------------------- GROSS GROSS UNREALIZED UNREALIZED MARKET COST GAINS LOSSES VALUE ------------------------------------------------- (In Thousands) Fixed maturities: United States Government $ 44,859 $ 583 $ (29) $ 45,413 Public utilities 1,451 -- (157) 1,294 Industrial and other 91,534 2,915 (720) 93,729 ------------------------------------------------- Total $137,844 $ 3,498 $ (906) $140,436 ================================================= Equity securities: Common stock: Banks, trusts and insurance companies $ 3,792 $ 3,910 $ (77) $ 7,625 Industrial, miscellaneous and other 42,640 17,117 (3,682) 56,075 ------------------------------------------------- Total $ 46,432 $21,027 $(3,759) $ 63,700 ================================================= Other long-term investments: Real estate investment trusts $ 20,000 $ 1,616 $ -- $ 21,616 =================================================
39 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 4. INVESTMENTS (CONTINUED)
DECEMBER 31, 2000 ------------------------------------------------- GROSS GROSS UNREALIZED UNREALIZED MARKET COST GAINS LOSSES VALUE ------------------------------------------------- (In Thousands) Fixed maturities: United States Government $ 59,756 $ 549 $ (493) $ 59,812 Public utilities 1,451 -- (219) 1,232 Industrial and other 87,625 1,225 (3,378) 85,472 ------------------------------------------------- Total $148,832 $ 1,774 $(4,090) $146,516 ================================================= Equity securities: Common stock: Banks, trusts and insurance companies $ 4,383 $ 4,556 $ -- $ 8,939 Industrial, miscellaneous and other 45,356 37,155 (5,032) 77,479 ------------------------------------------------- Total $ 49,739 $41,711 $(5,032) $ 86,418 ================================================= Other long-term investments: Real estate investment trusts $ 10,000 $ 915 $ -- $ 10,915 =================================================
The components of the unrealized appreciation on available for sale securities as of December 31 are as follows:
2001 2000 ----------------------- (In Thousands) Fixed maturities: Gross unrealized gains $ 3,498 $ 1,774 Gross unrealized losses (906) (4,090) Equity securities: Gross unrealized gains 21,027 41,711 Gross unrealized losses (3,759) (5,032) Other long-term investments: Gross unrealized gains 1,616 915 ----------------------- 21,476 35,278 Deferred income taxes (7,302) (11,994) ----------------------- $ 14,174 $ 23,284 =======================
40 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 4. INVESTMENTS (CONTINUED) The amortized cost and market value of fixed maturities at December 31, 2001, by contractual maturity, are shown below. 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 ---------------------- (In Thousands) Due in one year or less $ 1,696 $ 1,701 Due after one year through five years 14,334 15,135 Due after five years through ten years 51,120 52,134 Due after ten years 70,694 71,466 ---------------------- $137,844 $140,436 ======================
Proceeds from sales of available for sale investments and the related gross realized gains and losses are as follows:
PROCEEDS FROM GROSS REALIZED GROSS REALIZED SALES GAINS LOSSES ----------------------------------------------------- (In Thousands) Year ended December 31, 2001: Fixed maturities $ 98,700 $ 1,244 $(1,428) Equity securities 37,398 12,477 (5,722) Year ended December 31, 2000: Fixed maturities 70,372 364 (2,107) Equity securities 49,677 17,817 (5,572) Year ended December 31, 1999: Fixed maturities 154,388 608 (3,700) Equity securities 20,263 11,292 (980)
41 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 4. INVESTMENTS (CONTINUED) Net unrealized appreciation of fixed maturities increased (decreased) by $4,908,000, $3,198,000 and $(8,736,000) and net unrealized appreciation of equity securities (decreased) increased by $(19,411,000), $(22,003,000) and $14,036,000 for the years ended December 31, 2001, 2000 and 1999, respectively. Net unrealized appreciation of other long-term investments increased by $701,000 and $915,000 for the years ended December 31, 2001 and 2000, respectively, as a result of independent appraisals of the non-traded real estate investment trusts. 5. POLICYHOLDER DIVIDENDS AND RETROSPECTIVE PREMIUMS In 1999, Midwest Medical instituted a policyholder dividend program that replaced the previous retrospective premium credit program for physicians. To implement the program, Midwest Medical issued participating policy endorsements to all active physician, clinic and hospital accounts during 1999 and 2000. Participating policies represented approximately 96% of total premiums in force and premium income at December 31, 2001 and December 31, 2000. Dividends declared for the years ended December 31 are as follows:
2001 2000 1999 ------------------------------- (In Thousands) Physicians and clinics $4,050 $8,000 $10,100 Hospitals -- 108 75 ------------------------------- Total $4,050 $8,108 $10,175 ===============================
Dividends are generated from unanticipated profits on prior coverage years. Declared dividends are allocated to policyholders proportionately based on current year written premium. To receive a dividend, a policyholder is required to have been insured in the applicable coverage year and remain insured throughout the year the dividend is paid. Declared dividends are generally paid in quarterly installments in the year following declaration. 42 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 5. POLICYHOLDER DIVIDENDS AND RETROSPECTIVE PREMIUMS (CONTINUED) Prior to 1999, Midwest Medical had a retrospective premium program whereby physicians may have received credits against future premiums based upon the loss experience of Midwest Medical. Amounts returned under the program were accrued when approved by the Board of Directors and reflected as a reduction in net premiums earned. Payments under the program were generally made in the year following approval by the Board of Directors. Retrospective premium payments of $5,802,000 were made to Minnesota and North Dakota policyholders in 1999. A provision of the agreement and plan of merger between Iowa Physicians and Midwest Medical required that any favorable development of certain pre-merger liabilities of Iowa Physicians be paid to the former Iowa Physicians policyholders who remain active Midwest Medical insureds as of the date of payment through a retrospective premium credit. This agreement stipulated that any amounts due under this provision be finalized using financial information as of December 31, 1998. During 1999, final payments of $3,058,000 were made to former Iowa Physicians policyholders under the terms of the agreement. A provision of the agreement and plan of merger between Medical Liability Mutual and Midwest Medical required that any favorable development of certain pre-merger liabilities of Medical Liability Mutual be paid to the former Medical Liability Mutual policyholders who remain active Midwest Medical insureds as of the date of payment through a retrospective premium credit. The agreement stipulated that any amounts due under this provision must be settled no later than June 5, 2001. No payments were made related to this provision. 43 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:
2001 2000 ---------------------- (In Thousands) Balance as of January 1, net of reinsurance recoverables $100,264 $ 99,894 Incurred related to: Current year 58,127 47,463 Prior years 172 (7,876) ---------------------- Total incurred 58,299 39,587 Paid related to: Current year 2,849 3,331 Prior years 50,844 35,886 ---------------------- Total paid 53,693 39,217 ---------------------- Balance as of December 31, net of reinsurance recoverables 104,870 100,264 Reinsurance recoverables at December 31 13,704 18,214 ---------------------- Balance as of December 31, gross $118,574 $118,478 ======================
Midwest Medical continually evaluates emerging trends in the development of loss liabilities. Based on this analysis, management periodically adjusts their estimates of ultimate losses. 7. SEGMENT INFORMATION The Company is organized into four legal entity business segments consisting of Midwest Holding, Midwest Medical, Services and Solutions. The business and accounting policies of the reportable segments are described in Note 1 to the consolidated financial statements. Management evaluates the performance of each business segment based primarily on profit or loss from operations. With the exception of foreign stocks and bonds held as investments by Midwest Medical, all business transactions are conducted in the United States. The following financial information summarizes the results of operations and total assets reported by the four business segments for the years ended 2001, 2000 and 1999. 44 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 7. SEGMENT INFORMATION (CONTINUED)
2001 --------------------------------------------------------------------------------------------- MIDWEST MIDWEST HOLDING MEDICAL SERVICES SOLUTIONS ELIMINATIONS (1) CONSOLIDATED --------------------------------------------------------------------------------------------- (In Thousands) Revenues: External customers $ -- $ 50,097 $ 2,196 $ 836 $ -- $ 53,129 Intersegment 15,206 -- -- 135 (15,341) -- Net investment income (401) 12,289 8 19 426 12,341 Other (2) 75 6,527 -- -- (426) 6,176 --------------------------------------------------------------------------------------------- 14,880 68,913 2,204 990 (15,341) 71,646 Total expenses 16,416 71,193 2,531 3,295 (15,341) 78,094 --------------------------------------------------------------------------------------------- (Loss) from continuing operations before tax (1,536) (2,280) (327) (2,305) -- (6,448) Income tax benefit (475) (857) (106) (784) -- (2,222) --------------------------------------------------------------------------------------------- Loss from continuing operations after tax $ (1,061) $ (1,423) $ (221) $ (1,521) $ -- $ (4,226) ============================================================================================= Total assets $ 132,163 $ 286,878 $ 3,083 $ 1,663 $(136,382) $ 287,405 =============================================================================================
(1) Intersegment eliminations for revenues and expenses are primarily for management and administrative services provided by Midwest Holding. Eliminations for assets consist primarily of investments in wholly-owned subsidiaries, intersegment receivables for management fees and reclassifications between assets and liabilities primarily for taxes. (2) Other revenues consist primarily of net realized capital gains. 45 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 7. SEGMENT INFORMATION (CONTINUED)
2000 --------------------------------------------------------------------------------------------- MIDWEST MIDWEST HOLDING MEDICAL SERVICES SOLUTIONS ELIMINATIONS (1) CONSOLIDATED --------------------------------------------------------------------------------------------- (In Thousands) Revenues: External customers $ -- $ 41,900 $ 1,717 $ 266 $ -- $ 43,883 Intersegment 15,372 -- -- 14 (15,386) -- Net investment income (1,138) 12,166 9 15 1,188 12,240 Other (2) 214 12,006 -- -- (234) 11,986 --------------------------------------------------------------------------------------------- 14,448 66,072 1,726 295 (14,432) 68,109 Total expenses 17,306 55,264 1,836 2,113 (14,432) 62,087 --------------------------------------------------------------------------------------------- (Loss) income from continuing operations before tax (2,858) 10,808 (110) (1,818) -- 6,022 Income tax (benefit) expense (939) 2,026 (32) (618) -- 437 --------------------------------------------------------------------------------------------- (Loss) income from continuing operations after tax $ (1,919) $ 8,782 $ (78) $ (1,200) $ -- $ 5,585 ============================================================================================= Total assets $ 154,133 $304,932 $ 2,192 $ 2,116 $(161,632) $301,741 =============================================================================================
(1) Intersegment eliminations for revenues and expenses are primarily for management, administrative and investment services provided by Midwest Holding. Eliminations for assets consist primarily of investments in wholly-owned subsidiaries, intersegment receivables for management fees and reclassifications between assets and liabilities for taxes. (2) Other revenues consist primarily of net realized capital gains and interest received on federal income tax refunds. 46 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 7. SEGMENT INFORMATION (CONTINUED)
1999 --------------------------------------------------------------------------------------------- MIDWEST MIDWEST HOLDING MEDICAL SERVICES SOLUTIONS ELIMINATIONS (1) CONSOLIDATED --------------------------------------------------------------------------------------------- (In Thousands) Revenues: External customers $ -- $ 47,181 $1,661 $ -- $ -- $ 48,842 Intersegment 16,273 -- -- -- (16,273) -- Net investment income (696) 10,780 21 17 828 10,950 Other (2) 185 7,041 -- -- 148 7,374 --------------------------------------------------------------------------------------------- 15,762 65,002 1,682 17 (15,297) 67,166 Total expenses 15,584 59,904 1,648 1,408 (15,297) 63,247 --------------------------------------------------------------------------------------------- Income (loss) from continuing operations before tax 178 5,098 34 (1,391) -- 3,919 Income tax expense (benefit) 91 1,648 15 (473) -- 1,281 --------------------------------------------------------------------------------------------- Income (loss) from continuing operations after tax $ 87 $ 3,450 $ 19 $ (918) $ -- $ 2,638 ============================================================================================= Total assets $ 160,848 $311,367 $1,634 $ 1,539 $(155,212) $320,176 =============================================================================================
(1) Intersegment eliminations for revenues and expenses are primarily for management, administrative and investment services provided by Midwest Holding. Eliminations for assets consist primarily of investments in wholly-owned subsidiaries, intersegment receivables for management fees and reclassifications between assets and liabilities for taxes and reinsurance. (2) Other revenues consist primarily of net realized capital gains. 47 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 8. INCOME TAXES Components of income taxes are as follows:
2001 2000 1999 ------------------------------------------------------ (In Thousands) Current provision $(1,944) $ (79) $1,371 Deferred tax provision (278) 516 (90) ------------------------------------------------------ $(2,222) $ 437 $1,281 ======================================================
The Company's income taxes differ from the federal statutory rate applied to income before tax as follows:
2001 2000 1999 ------------------------------------------------------ (In Thousands) Income before tax at the federal statutory rate of 34% $(2,192) $ 2,048 $1,333 Dividends received deductions (net of proration adjustment) (66) (77) (81) State income taxes, net of federal tax benefit 11 155 86 Benefit for prior year income taxes - (1,697) (59) Other 25 8 2 ------------------------------------------------------ $(2,222) $ 437 $1,281 ======================================================
The deferred income tax provision includes the following differences between financial and income tax reporting:
2001 2000 1999 ------------------------------------------------------ (In Thousands) Discounting of post-1986 unpaid losses and loss adjustment expenses $ 204 $ 290 $ 167 Liabilities not currently deductible (250) 12 (121) Unearned and advanced premiums (422) 87 (256) Investment income not currently taxable 183 34 156 Other 7 93 (36) ------------------------------------------------------ $ (278) $ 516 $ (90) ======================================================
48 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 8. INCOME TAXES (CONTINUED) The Company made income tax payments of $655,000, $2,298,000 and $1,751,000 in 2001, 2000 and 1999, respectively. The components of the net deferred income tax (liability) asset as of December 31 are as follows:
2001 2000 ------------------------------------ (In Thousands) Deferred tax assets: Unpaid losses and loss adjustment expenses $ 3,496 $ 3,700 Liabilities not currently deductible 1,438 1,188 Unearned and advanced premiums 1,219 797 Other 623 587 ------------------------------------ 6,776 6,272 Deferred tax liabilities: Unrealized gains (7,302) (11,994) Other (1,138) (913) ------------------------------------ (8,440) (12,907) ------------------------------------ $(1,664) $ (6,635) ====================================
9. REINSURANCE To reduce overall risk, including exposure to large losses, Midwest Medical participates in various reinsurance programs. Midwest Medical would only become liable for losses in excess of its retention limits 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, 2001. Midwest Medical evaluates the financial condition of its reinsurers and monitors concentration of credit risk arising from similar geographic regions, activities or economic characteristics of the reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. Reinsurance recoverables on paid and unpaid losses of $8,167,000 and $15,117,000 are associated with a single reinsurer, General Reinsurance Corporation, at December 31, 2001 and 2000, respectively. Midwest Medical also holds collateral under related reinsurance agreements in the form of letters of credit totaling $4,399,000 that can be drawn upon in the event the applicable reinsuring company is unable to pay its obligation to Midwest Medical. 49 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 9. REINSURANCE (CONTINUED) Midwest Medical is authorized to issue policies with limits not to exceed $12,000,000 for each claim and $14,000,000 in the aggregate under each policy in any one policy year. Limits in excess of $12,000,000 for each claim and $14,000,000 annual aggregate are available to physicians and clinics through reinsurance placed on a facultative basis by Midwest Medical. Midwest Medical generally retains the first $1,000,000 of each claim and reinsures the remainder through a treaty under which premiums are based on a flat rate and could be subject to adjustment through a profit-sharing provision. For the years 1995 through 2000, Midwest Medical generally retained the first $750,000 of each claim and reinsured the remainder through a treaty under which premiums are subject to adjustment based on experience. The effect of reinsurance on premiums written and earned for 2001, 2000 and 1999 is as follows:
2001 2000 1999 ---------------------------- ---------------------------- ------------------------------ WRITTEN EARNED WRITTEN EARNED WRITTEN EARNED ---------------------------- ---------------------------- ------------------------------ (In Thousands) (In Thousands) (In Thousands) Current Year: Direct $65,556 $62,160 $48,554 $49,302 $51,672 $47,048 Assumed 116 71 76 76 48 48 Ceded (9,353) (9,085) (7,217) (7,400) (7,817) (6,433) ---------------------------- ---------------------------- ------------------------------ 56,319 53,146 41,413 41,978 43,903 40,663 Prior Years: Ceded (3,049) (3,049) (634) (634) 5,920 5,920 ---------------------------- ---------------------------- ------------------------------ Net $53,270 $50,097 $40,779 $41,344 $49,823 $46,583 ============================ ============================ ==============================
Loss and loss adjustment expenses incurred are net of applicable reinsurance of $5,452,000, $5,315,000 and $5,204,000 for the years ended December 31, 2001, 2000 and 1999, respectively. 10. BENEFIT PLANS Substantially all employees of Midwest Holding are covered by a non-contributory defined contribution pension plan. Contributions to the plan are based upon each covered employee's salary. Substantially all employees at Midwest Holding are also covered by a 401(k) plan that provides a 50% match on employee contributions subject to certain limitations. Total contributions charged to expense for the years ended December 31, 2001, 2000 and 1999 were $717,000, $583,000 and $581,000, respectively. 50 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 10. BENEFIT PLANS (CONTINUED) Midwest Holding provides an unfunded Supplemental Executive Retirement Plan (SERP) which is a non-qualified, defined benefit retirement plan covering certain Midwest Holding officers. Benefits are based upon years of service and compensation. Although the plan is technically unfunded, Midwest Holding invests in specified assets which are designed to coordinate with the projected obligation under the SERP. The net periodic pension cost for this plan was $636,000, $574,000 and $441,000 for the years ended December 31, 2001, 2000 and 1999, respectively. The liability recognized in the consolidated balance sheets at December 31, 2001 and 2000 related to this plan was $3,561,000 and $3,101,000, respectively. Midwest Holding 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, 2001, 2000 and 1999 was $38,000, $36,000 and $23,000, respectively. As of December 31, 2000 and 1999, the net post-retirement benefit plan liability was $86,000 and $51,000, respectively. 11. RECONCILIATION WITH STATUTORY ACCOUNTING PRINCIPLES The National Association of Insurance Commissioners (NAIC) revised the Accounting Practices and Procedures Manual in a process referred to as Codification. The revised manual became effective January 1, 2001. Midwest Medical's domiciliary state of Minnesota adopted the provisions of the revised manual. The revised manual has changed, to some extent, prescribed statutory accounting practices and resulted in changes to the accounting practices that Midwest Medical used to prepare its statutory-basis financial statements. Although the implementation of Codification had a negative impact on Midwest Medical's statutory-basis capital and surplus primarily from the recording of a net deferred tax liability, management believes Midwest Medical remains in compliance with all regulatory and contractual obligations. Accounting principles generally accepted in the United States differ in certain respects from the accounting practices prescribed or permitted by insurance regulatory authorities (statutory basis). 51 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 11. RECONCILIATION WITH STATUTORY ACCOUNTING PRINCIPLES (CONTINUED) The following is a reconciliation of net (loss) income and shareholders' equity under US GAAP with that reported for Midwest Medical on a statutory basis:
NET (LOSS) INCOME YEAR ENDED DECEMBER 31 ------------------------------------------------- 2001 2000 1999 ------------------------------------------------- (In Thousands) On the basis of US GAAP, Midwest Medical only $(1,423) $8,782 $3,450 Additions: Deferred income taxes 92 836 37 ------------------------------------------------- On the basis of statutory accounting principles $(1,331) $9,618 $3,487 =================================================
SHAREHOLDERS' EQUITY DECEMBER 31 ------------------------------------------------- 2001 2000 1999 ------------------------------------------------- (In Thousands) On the basis of US GAAP, Midwest Medical only $120,018 $141,935 $147,800 Additions (deductions): Deferred income taxes 881 7,714 12,878 Unrealized (gain) loss on fixed maturities (2,592) 2,316 5,514 Non-admitted assets (275) (11,564) (1,000) Prescribed market value differences 95 (16) (253) Other -- 1 (179) ------------------------------------------------- On the basis of statutory accounting principles $118,127 $140,386 $164,760 =================================================
Under Minnesota insurance statutes, Midwest Medical is required to maintain statutory surplus in excess of ten times its per risk reinsurance retention limit. Since Midwest Medical limited its retention to $1,000,000 on any single risk, the minimum statutory surplus level was $10,000,000 for 2001. 52 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 11. RECONCILIATION WITH STATUTORY ACCOUNTING PRINCIPLES (CONTINUED) Dividends that exceed the greater of 10% of Midwest Medical's prior year-end policyholder surplus or Midwest Medical's prior year net income excluding realized capital gains are considered extraordinary under Minnesota insurance statutes. Payment of extraordinary dividends is subject to the approval of the Commissioner of the Minnesota Department of Commerce. At December 31, 2001, the maximum dividend that may be paid by Midwest Medical in 2002 without regulatory approval is approximately $11,813,000. Cash dividends paid to Midwest Holding by Midwest Medical in 2001, 2000 and 1999 were $11,400,000, $3,000,000 and $2,050,000, respectively. 53 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 54 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT DIRECTORS The names and ages of the directors of Midwest Holding, the year each first became a director and the number of Class C Common Shares owned by each as of December 31, 2001 are as follows:
CLASS C COMMON DIRECTOR PRINCIPAL SHARES NAME AGE SINCE OCCUPATION OWNED -------------------------------------------------------------------------------------------------------------------- Michael D. Abrams 40 1996 Exec V.P. Iowa Medical Society -- John R. Balfanz, M.D. 56 1995 Physician 1 Mark A. Barnhill, D.O. 55 2001 Physician 1 Gail P. Bender, M.D. 54 1996 Physician 1 James R. Bishop, M.D. 60 1994 Physician 1 David P. Bounk 55 1995 President/CEO - Midwest Holding -- Terence P. Cahill, M.D. 45 2000 Physician 1 Peter J. Daly, M.D. 42 2001 Physician 1 G. Richard Geier, Jr., M.D. Vice Chairman 61 1995 Physician 1 Anthony C. Jaspers, M.D. 54 1996 Physician 1 Jack L. Kleven 55 1999 President/CEO - Midwest Medical -- Russel J. Kuzel, M.D. 49 1997 Physician 1 Wayne F. Leebaw, M.D. Secretary 58 1994 Physician 1 Mark O. Liaboe, M.D. 48 1999 Physician 1 Patricia J. Lindholm, M.D. 45 2000 Physician 1 Steven A. McCue, M.D. 60 1995 Physician 1 Roger H. Meyer, M.D. 63 2000 Physician 1 Harold W. Miller, M.D. 54 1996 Physician 1 Mark D. Odlund, M.D. 49 1996 Physician 1 Paul S. Sanders, M.D. 57 1984 CEO-MN Medical Assoc. -- Andrew J. K. Smith, M.D. Chairman of Board 59 1990 Neurological Surgeon -- Thomas M. Tedford, M.D. 45 2001 Physician 1 Tom D. Throckmorton, M.D. 56 1997 Physician 1 R. Bruce Trimble, M.D. 61 1993 Physician 1
55 ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT (CONTINUED) The Bylaws of Midwest Holding provide that Midwest Holding'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 Minnesota Medical Association and the Executive Vice President of the Iowa Medical Society, both of whom shall be ex-officio directors; (3) the President of Midwest Holding and the President of Midwest Medical as ex-officio directors; and (4) such additional ex-officio and 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 Midwest Medical. The Minnesota Medical Association, 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 Midwest Medical provide that the directors of Midwest Holding shall also serve as the directors of Midwest Medical, with the exception of any outside directors of Midwest Holding. Outside directors are persons who are not policyholders of Midwest Medical or members of any state medical society. There are currently no outside directors of Midwest Holding so the Boards of Midwest Holding and Midwest Medical are identical. Pursuant to the merger with Iowa Physician's, the Bylaws of Midwest Holding were amended to provide for the election of directors who are members of the Iowa Medical Society 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 Midwest Medical insureds, subject to a minimum of two Iowa directors, one of whom shall be the Executive Vice President of the Iowa Medical Society, for as long as the Class B Common Share is outstanding. The Minnesota Medical Association 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 Iowa Medical Society. Directors serve until their successors are elected and qualified, or until their prior resignation, removal, death or disqualification. As of December 31, 2001, the directors of Midwest Holding, as a group, owned 19 Class C Common Shares or less than 1.0 percent of the total Class C Common Shares outstanding as of that date. No executive officer owned any Class C Common Shares as of that date. All of the directors have been principally engaged in the practice of medicine for more than five years except for Dr. Paul S. Sanders, who has been the President of the Minnesota Medical Association since 1990, Michael D. Abrams, who has been the Executive Vice President of the Iowa Medical Society since 1996, David P. Bounk, who has been the President and CEO of Midwest Holding since 1990, and Jack L. Kleven, who has been the COO and President of Midwest Medical since 1999. Prior to 1990, Dr. Sanders was principally engaged in the practice of medicine. Prior to 1996, Mr. Abrams was Director, Government Relations of the Indiana Medical Association for nine years. 56 ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT (CONTINUED) The Chairman of the Board of Directors (currently Dr. Smith) is paid an annual fee of $56,805. All members of the Board of Directors currently are paid $1,250 for each meeting of the Board of Directors they attend. In addition, members of the Executive Committee currently are paid $1,250 for each meeting of the Executive Committee they attend, and committee chairmen are paid $1,000 for each meeting of the standing committee they chair. Other members of standing committees currently are paid between $500 and $800, depending upon distance traveled, for each committee meeting they attend. EXECUTIVE OFFICERS The names, ages and positions of the executive officers of Midwest Holding and Midwest Medical are as follows:
PERIOD OF SERVICE POSITION AS PRINCIPAL NAME AGE WITH COMPANY AN OFFICER OCCUPATION --------------------------------------------------------------------------------------------------------------------- David P. Bounk 55 President and Chief Executive 1990 to date President and Chief Executive Officer - Midwest Holding Officer - Midwest Holding Niles A. Cole 40 Vice President - Finance, 1998 to date Vice President - Finance, Treasurer and Chief Financial Treasurer and Chief Financial Officer Officer Jack L. Kleven 55 President - Midwest Medical 1986 to date President - Midwest Medical and Chief Operating Officer and Chief Operating Officer Thomas H. Lee 58 Vice President - Information 1999 to date Vice President - Information Systems Systems Elizabeth S. Lincoln 48 Vice President - Law and 1990 to date Vice President - Law and Health Policy Health Policy Debra L. McBride 47 Vice President - Risk 2000 to date Vice President - Risk Management Management Gerald M. O'Connell 47 Vice President - Sales and 1998 to date Vice President - Sales and Marketing Marketing Jerry A. Zeitlin 51 Vice President - Claims 1999 to date Vice President - Claims
Mr. Bounk has over 30 years' experience in the insurance industry and joined Midwest Holding and Midwest Medical 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 M.B.A. degree in finance. 57 ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT (CONTINUED) Mr. Bounk has an employment agreement which renews annually 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 Midwest Holding 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 Midwest Holding 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 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 Midwest Holding for one year following his termination of employment. Effective January 1, 1997, Midwest Holding 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. Cole has over 18 years' experience in the insurance industry, including six years as Vice President and Controller of Washington State Physician's Insurance Association. He has been in his current position since March 1998. He has B.S. degrees in accounting and finance. Mr. Kleven has over 27 years' experience in medical malpractice claims adjusting and management. He joined the Insurance Exchange in 1983, and was Vice President, Claims since March 1986. He was promoted to Chief Operating Officer on January 1, 1998. He was promoted to President of Midwest Medical effective September 1, 1999. Prior to joining the Insurance Exchange, he was a liability manager at The St. Paul Companies for six years. He has a B.S. degree in business. Mr. Lee has over 27 years' experience in the insurance industry. Prior to joining Midwest Holding in 1998 he owned an insurance related technology consulting business. From 1971 to 1989, he was Senior Vice President - Administration of American Hardware Mutual Insurance Company. He has B.A. degrees in mathematics and statistics. Ms. Lincoln has over 18 years' experience in medical professional liability risk management. She joined the Insurance Exchange in 1982, and was Vice President, Risk Management since January 1990. She transferred to Vice President - Law and Health Policy effective January 1, 1998. She has a law degree. Ms. McBride has over 14 years' experience in the insurance industry. Prior to joining Midwest Holding in 1994, she served as a trial attorney specializing in insurance defense. She has a B.A. degree in nursing and a law degree. 58 ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT (CONTINUED) Mr. O'Connell has over 25 years in the medical malpractice segment of the insurance industry. From 1977 to 1995, he was with St. Paul Fire and Marine Insurance Company, holding various marketing and underwriting management positions. He joined Midwest Holding in October 1996. He has a B.S. in agriculture business management with an emphasis in insurance. Mr. Zeitlin has over 28 years of claims experience in the property-casualty insurance industry. Prior to joining Midwest Holding in 1993, he was Liability Supervisor for The St. Paul Companies from 1979 to 1993. He has a B.S. degree in liberal arts. 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 2001, required Forms 3 were not filed for the new directors and officers. This failure was cured by filings of Forms 5 made after the end of the year. 59 ITEM 11. EXECUTIVE COMPENSATION SUMMARY COMPENSATION TABLE The following table summarizes compensation paid by Midwest Holding 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 2001 $254,023 $102,356 $33,944 Executive Officer - 2000 239,406 96,560 34,826 Midwest Holding 1999 213,981 85,830 34,348 Jack L. Kleven President - Midwest 2001 210,869 72,830 35,354 Medical and Chief 2000 198,702 68,694 33,886 Operating Officer 1999 177,624 61,636 32,066 Gerald M. O'Connell Vice President - Sales and 2001 135,897 39,266 33,990 Marketing 2000 130,570 37,575 30,156 1999 117,196 34,749 29,864 Thomas H. Lee Vice President - 2001 127,042 36,687 31,709 Information Services 2000 122,042 27,147 28,347 1999 106,594 15,000 18,275 Elizabeth S. Lincoln Vice President - Law and 2001 124,353 35,949 32,946 Health Policy 2000 118,976 34,237 28,061 1999 113,332 33,080 26,826
(a) Includes employer contributions to qualified retirement plans and car allowances Midwest Holding also maintains a Supplemental Executive Retirement Plan which provides an annual retirement benefit for an executive officer who retires at age 62 with ten years of service of 70% (55% for new officers after 1997) of the officer's final average salary. Benefits are reduced for retirement prior to age 62. The annual benefit payable under the plan is reduced by 50% of the officer's primary Social Security benefit and by the annual benefit (expressed in the form of an annuity) of the officer's accrued benefits under Midwest Holding's current money purchase pension plan and a predecessor plan. The estimated annual benefits payable upon 60 ITEM 11. EXECUTIVE COMPENSATION (CONTINUED) retirement at normal retirement age for the executive officers in the Summary Compensation Table are as follows: Mr. Bounk-$252,279; Mr. Kleven-$157,426; Mr. O'Connell-$100,534; Mr. Lee-$75,955 and Ms. Lincoln-$93,907. The estimated annual retirement benefits were calculated assuming salary increases of 5% per year, discounted 4% 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. 61 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 for the year ended December 31, 2001 are included in this annual report (Form 10-K) in Item 8: Report of Independent Auditors Consolidated Balance Sheets as of December 31, 2001 and 2000 Consolidated Statements of Income for the years ended December 31, 2001, 2000 and 1999 Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 2001, 2000 and 1999 Consolidated Statements of Cash Flows for the years ended December 31, 2001, 2000 and 1999 Notes to Consolidated Financial Statements (a)(2) The following consolidated financial statement schedules of Midwest Medical Insurance Holding Company 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 2001. 62 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 15, 2002 -------------------------------------- ---------------- 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 15, 2002 ------------------------------- David P. Bounk /s/ Niles Cole Principal Financial Officer and March 15, 2002 ------------------------------- Principal Accounting Officer Niles Cole * Director, Chairman of the Board March 15, 2002 ------------------------------- Andrew J. K. Smith, M.D. * Director March 15, 2002 ------------------------------- Michael D. Abrams * Director March 15, 2002 ------------------------------- John R. Balfanz, M.D. * Director March 15, 2002 ------------------------------- Mark A. Barnhill, D.O.
63 * Director March 15, 2002 ------------------------------- Gail P. Bender, M.D. * Director March 15, 2002 ------------------------------- James R. Bishop, M.D. * Director March 15, 2002 ------------------------------- Terence P. Cahill, M.D. * Director March 15, 2002 ------------------------------- Peter J. Daly, M.D. * Director, Vice Chairman March 15, 2002 ------------------------------- G. Richard Geier, Jr., M.D. * Director March 15, 2002 ------------------------------- Anthony C. Jaspers, M.D. * Director March 15, 2002 ------------------------------- Jack L. Kleven * Director March 15, 2002 ------------------------------- Russel J. Kuzel, M.D. * Director, Secretary March 15, 2002 ------------------------------- Wayne F. Leebaw, M.D. * Director March 15, 2002 ------------------------------- Mark O. Liaboe, M.D. * Director March 15, 2002 ------------------------------- Patricia J. Lindholm, M.D. * Director March 15, 2002 ------------------------------- Steven A. McCue, M.D.
64 * Director March 15, 2002 ------------------------------- Roger H. Meyer, M.D. * Director March 15, 2002 ------------------------------- Harold W. Miller, M.D. * Director March 15, 2002 ------------------------------- Mark D. Odland, M.D. * Director March 15, 2002 ------------------------------- Paul S. Sanders, M.D. * Director March 15, 2002 ------------------------------- Thomas M. Tedford, M.D. * Director March 15, 2002 ------------------------------- Tom D. Throckmorton, M.D. * Director March 15, 2002 ------------------------------- R. Bruce Trimble, M.D. * By: /s/ David P Bounk March 15, 2002 ----------------------------------- 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. 65 Midwest Medical Insurance Holding Company and Subsidiaries (Parent Company) Schedule II - Condensed Financial Information of Registrant Balance Sheets
DECEMBER 31 2001 2000 ------------------------------------ (In Thousands) ASSETS Short-term investments $ 443 $ 171 Cash (18) 8 Investment in subsidiaries 124,158 145,793 Other 7,580 8,161 ------------------------------------ Total assets $ 132,163 $ 154,133 ==================================== LIABILITIES AND SHAREHOLDERS' EQUITY LIABILITIES Accrued expenses and other liabilities $ 5,276 $ 5,035 Note payable to Midwest Medical -- 8,500 ------------------------------------ 5,276 13,535 SHAREHOLDERS' EQUITY Class B Common Stock 1 1 Class C Common Stock -- -- Additional paid-in capital 12,789 12,789 Retained earnings, comprised of undistributed earnings of subsidiaries 99,923 104,524 Unrealized appreciation on investments, net of income taxes 14,174 23,284 ------------------------------------ 126,887 140,598 ------------------------------------ Total liabilities and shareholders' equity $ 132,163 $ 154,133 ====================================
See accompanying note. 66 Midwest Medical Insurance Holding Company and Subsidiaries (Parent Company) Schedule II - Condensed Financial Information of Registrant (continued) Statements of Income
YEAR ENDED DECEMBER 31 2001 2000 1999 ------------------------------------------------- (In Thousands) REVENUES Management fee from subsidiaries $15,206 $ 15,372 $16,273 Net investment income (401) (1,138) (696) Realized capital gains 28 213 179 Other income 47 1 6 ------------------------------------------------- 14,880 14,448 15,762 EXPENSES Compensation expense for vested Class A Common Shares -- 1,311 253 Other operating and administrative 16,416 15,995 15,331 ------------------------------------------------- 16,416 17,306 15,584 ------------------------------------------------- (Loss) income from continuing operations before tax and other items (1,536) (2,858) 178 Income tax (benefit) expense (475) (939) 91 ------------------------------------------------- (Loss) income from continuing operations before equity in undistributed (loss) income of subsidiaries (1,061) (1,919) 87 Equity in undistributed (loss) income of subsidiaries (3,165) 7,504 2,551 ------------------------------------------------- (Loss) income from continuing operations after tax and other items (4,226) 5,585 2,638 Discontinued operations: Loss from discontinued operations, net of tax (135) (299) (902) Loss on disposal, net of tax (240) -- -- ------------------------------------------------- Net (loss) income $(4,601) $ 5,286 $ 1,736 =================================================
See accompanying note. 67 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 2001 2000 1999 ------------------------------------------------- (In Thousands) Net cash (used in) provided by operating activities $ (254) $ (136) $ 856 INVESTING ACTIVITIES Net (purchases) sales of short-term investments (272) 936 203 Capitalization of Services (900) (700) (1,500) Capitalization of Solutions (1,500) (1,800) (650) FINANCING ACTIVITIES Redemption of Class A Common Shares -- (9,798) (953) Note payable to Midwest Medical (8,500) 8,500 -- Dividends from Midwest Medical 11,400 3,000 2,050 ------------------------------------------------- (Decrease) increase in cash (26) 2 6 Cash at beginning of year 8 6 -- ------------------------------------------------- Cash at end of year $ (18) $ 8 $ 6 =================================================
See accompanying note. 68 Midwest Medical Insurance Holding Company and Subsidiaries (Parent Company) Schedule II - Condensed Financial Information of Registrant (continued) Note to Condensed Financial Statements December 31, 2001 The accompanying condensed financial information of registrant should be read in conjunction with the audited consolidated financial statements and notes thereto of Midwest Medical Insurance Holding Company and Subsidiaries. See Note 3 to the audited consolidated financial statements of Midwest Medical Insurance Holding Company and Subsidiaries for a description of the stock restructure completed in 2000. Midwest Holding received $8,500,000 in 2000 from Midwest Medical through a non-interest-bearing note. The proceeds from the note were used to redeem Class A shares under the stock restructure completed during 2000. The note was retired in 2001. Certain amounts in the prior year's condensed financial information of registrant have been reclassified or restated to conform to the current year presentation. 69 Midwest Medical Insurance Holding Company and Subsidiaries Schedule IV--Reinsurance
COL. A COL. B COL. C COL. D COL. E COL. F -------------------------------------------------------------------------------------------------------------------- PERCENTAGE CEDED TO ASSUMED OF AMOUNT GROSS OTHER FROM OTHER NET ASSUMED TO AMOUNT COMPANIES COMPANIES AMOUNT NET -------------------------------------------------------------------------------------------------------------------- (In Thousands) Year ended December 31, 2001: Insurance premiums: Property/casualty insurance $62,160 $12,134 $71 $50,097 0.1% Year ended December 31, 2000: Insurance premiums: Property/casualty insurance 49,302 8,034 76 41,344 0.2% Year ended December 31, 1999: Insurance premiums: Property/casualty insurance 47,048 513 48 46,583 0.1%
NOTE TO SCHEDULE IV: Ceded premiums for the years ended December 31, 2001, 2000 and 1999 are net of (additions) reductions in ceded premiums related to swing-rated reinsurance treaties of $(3,049,000), $(1,300,000) and $5,205,000, respectively. Ceded premiums in 2000 and 1999 are also net of proceeds from contingent commission on reinsurance covering the period January 1, 1992 through December 31, 1994 of $666,000 and $715,000, respectively. 70 Midwest Medical Insurance Holding Company and Subsidiaries Schedule VI--Supplemental Information Concerning Property/Casualty Insurance Operations
DECEMBER 31 ------------------------------------------------------- COL. A COL. B COL. C COL. D COL. E ------------------------------------------------------------------------------- RESERVES FOR DEFERRED UNPAID LOSSES DISCOUNT, AFFILIATION POLICY AND LOSS IF ANY, WITH ACQUISITION ADJUSTMENT DEDUCTED IN UNEARNED REGISTRANT COSTS EXPENSES COLUMN C PREMIUMS ------------------------------------------------------------------------------- (In Thousands) Consolidated property/ casualty entities 2001 N/A $118,574 N/A $15,489 2000 N/A 118,478 N/A 12,050 1999 N/A 119,141 N/A 12,797
YEAR ENDED DECEMBER 31 --------------------------------------------------------------------------------------------- COL. A COL. F COL. G COL. H COL. I COL. J COL. K ----------------------------------------------------------------------------------------------------------------- LOSSES AND LOSS ADJUSTMENT EXPENSES INCURRED RELATED TO AMORTIZATION PAID ------------------- OF DEFERRED LOSSES AFFILIATION NET (1) (2) POLICY AND LOSS WITH EARNED INVESTMENT CURRENT PRIOR ACQUISITION ADJUSTMENT PREMIUMS REGISTRANT PREMIUMS INCOME YEAR YEAR COSTS EXPENSES WRITTEN -------------------- ----------------------- --------------------------------------------------------------------- Consolidated property/ casualty entities 2001 $50,097 $12,289 $58,127 $ 172 N/A $53,693 $65,556 2000 41,344 12,166 47,463 (7,876) N/A 39,217 48,554 1999 46,583 10,886 45,942 (4,474) N/A 36,041 51,672
71 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, as amended. 3A.(1)(5) Bylaws of the registrant. 3B.(1) Certificate of Designation for Class C Common Stock. 4.(5) Voting Trust Agreement. 9.(1) Governance Agreement between the registrant and the Minnesota Medical Association, holder of the registrant's Class B Common Share, dated November 30, 1988. 10A.(1) Lease for office space between registrant and Centennial Lakes IV, L.L.C., dated July 30, 1999. 10B.(3) Amended and Restated Management Agreement between the registrant and Midwest Medical Insurance Company, dated January 1, 2000. 10C.(4) Healthcare Liability Excess of Loss Reinsurance Contract issued to Midwest Medical Insurance Company, effective January 1, 2001 10D.(6) Letter of Employment Agreement between the registrant and David P. Bounk, President and Chief Executive Officer of the registrant and Midwest Medical Insurance Company, dated January 1, 1993. 10E.(2)
72 Index to Exhibits (continued)
REGULATION S-K EXHIBIT TABLE SEQUENTIAL ITEM REFERENCE PAGE NO. ----------------------------------------------------------------------------------------------------------- 1999 Officers Short-term Incentive Plan of the registrant. 10F.(3) Supplemental Executive Retirement Plan of the registrant. 10G.(1) Amended and Restated Endorsement Agreement between Midwest Medical Insurance Company and Iowa Medical Society, dated January 1, 1999. 10H.(3) Subsidiaries of the registrant. 21.(6) Power of attorney. 24.(6)
------- (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 1999 Annual Report on Form 10-K and incorporated herein by reference. (4) Filed with 2000 Annual Report on Form 10-K and incorporated herein by reference. (5) Filed with Schedule TO SEC File No. 005-58917 on April 26, 2000, as amended, and incorporated herein by reference. (6) Filed with this Annual Report on Form 10-K. 73