-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Kw0Ytv5gmRXPoE+QiigbgxCNM1ePeuyF7ZpDObJo1Ra++YPv2GcTzdJab934nab/ NPOkGyhsaAzfFtQESZ1gHA== 0001047469-99-012731.txt : 19990402 0001047469-99-012731.hdr.sgml : 19990402 ACCESSION NUMBER: 0001047469-99-012731 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990331 FILER: COMPANY DATA: COMPANY CONFORMED NAME: MIDWEST MEDICAL INSURANCE HOLDING CO CENTRAL INDEX KEY: 0000894353 STANDARD INDUSTRIAL CLASSIFICATION: SURETY INSURANCE [6351] IRS NUMBER: 411625287 STATE OF INCORPORATION: MN FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-21230 FILM NUMBER: 99580909 BUSINESS ADDRESS: STREET 1: 6600 FRANCE AVE SOUTH SUITE 245 CITY: MINNEAPOLIS STATE: MN ZIP: 55435-1891 BUSINESS PHONE: 6129225445 MAIL ADDRESS: STREET 1: 6600 FRANCES AVE SOUTH STE 245 CITY: MINNEAPOLIS STATE: MN ZIP: 554351891 10-K 1 FORM 10-K SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 FORM 10-K [ X ] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 (Fee Required) For the fiscal year ended December 31, 1998 [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 (No Fee Required) For the transition period from to --------------- ---------------- Commission file number 0-21230 ------- Midwest Medical Insurance Holding Company - -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Minnesota 41-1625287 - ---------------------------------------- ---------------------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 6600 France Avenue So., Suite 245 Minneapolis, Minnesota 55435-1891 - ---------------------------------------- ---------------------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (612) 922-5445 -------------- Securities registered pursuant to Section 12(b) of the Act: NONE Securities registered pursuant to Section 12(g) of the Act:
Title of Each Class Name of Each Exchange on Which Registered ------------------- ----------------------------------------- Class A Common Stock $.01 par value N/A
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. YES X NO --- --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value (based on December 31, 1998 Net Redemption Value per share) of the voting stock held by non-affiliates of the registrant as of March 30, 1999 was $8,062,838. The number of shares outstanding of the issuer's classes of common stock, as of March 30, 1999: Class A Common Stock $.01 par Value - 125,682 shares Class B Common Stock $1,000 par value - 1 share DOCUMENTS INCORPORATED BY REFERENCE None. 1 PART I ITEM 1. BUSINESS BACKGROUND Midwest Medical Insurance Holding Company (MMIHC) is an insurance holding company organized under the laws of the State of Minnesota. Midwest Medical Insurance Company (MMIC) is a wholly-owned subsidiary of MMIHC and is MMIHC's primary operating asset. MMIC's primary business is selling and issuing policies of medical professional liability insurance to: (1) individual physicians, (2) partnerships or professional corporations comprised of physicians, (3) clinics, (4) hospitals, and (5) health plans. In addition, MMIC writes business liability insurance providing coverage for claims against a medical business entity resulting from acts by the employees who work for the entity, and office premises liability insurance providing coverage for claims arising out of the ownership, maintenance or use of office premises of the insured. MMIC originally was organized in 1980 under the auspices of the Minnesota Medical Association (the "MMA") to provide professional liability (malpractice) insurance to Minnesota physicians who are members of the MMA. The business was reorganized on November 30, 1988 into a stock insurance company (MMIC), wholly owned by a holding company (MMIHC), which could pursue other business opportunities. MMIHC has not engaged in such activities to any material extent. The reorganization also was effected to give physicians a limited equity interest in their malpractice insurer while preserving MMIC's capital and surplus. As of July 1, 1993, the Iowa physician-owned malpractice insurer, Iowa Physicians Mutual Insurance Trust (IPMIT), was merged with and into MMIC. As of June 5, 1996, the Nebraska physician-owned malpractice insurer, Medical Liability Mutual Insurance Company of Nebraska (MLM) was merged with and into MMIC. MMIC now provides malpractice insurance to physicians and physician groups in Minnesota, Iowa, North Dakota, South Dakota, Nebraska, Illinois and Wisconsin on a claims-made basis. MMIC has had the sponsorship of the MMA since inception and also has the sponsorship of the Iowa Medical Society (IMS) and North Dakota Medical Association. Professional liability, general liability, and umbrella excess liability insurance is also available to hospitals, nursing homes and extended care facilities throughout MMIC's territory. MMIC has no employees. Instead, MMIHC provides all management and administrative services to MMIC for a fee based upon the cost of providing services. For insurance operational expenses, a ten percent administrative surcharge is added. During 1997, MMIHC formed Midwest Medical Solutions, Inc. (Solutions) as a business development company to strengthen and promote the independence and interdependencies of physicians, clinics and hospitals that MMIC serves. Business development opportunities being considered include practice enhancement, strategic consulting, and electronic processing and 2 ITEM 1. BUSINESS (CONTINUED) integration services and support. Solutions purchased the assets of MedPower Information Services, Inc. effective January 1, 1998. Solutions then contributed those assets to its newly formed, wholly-owned subsidiary, MedPower Information Resources, Inc. (MedPower). MedPower processes and electronically submits medical claims for over 100 healthcare providers in the Upper Midwest. MedPower also provides various information consulting and network support services. Together, Solutions and MedPower had assets of less than $3,000,000 at December 31, 1998 and revenues of less than $400,000 for the year ended December 31, 1998. Hereafter, MMIHC, MMIC, Solutions and MedPower shall be collectively referred to as the Company unless the reference pertains to a specific entity. Further, due to the nature of the relationship between MMIHC and MMIC, the insurance operations of MMIC will be discussed as though they are the operations of the registrant. ELIGIBLE PHYSICIANS An individual physician must meet the following criteria in order to be eligible to obtain insurance coverage from MMIC: 1. An applicant must be licensed to practice medicine, surgery or osteopathy in Minnesota, Iowa, Nebraska, North Dakota, South Dakota, Illinois, or Wisconsin; 2. An applicant must conduct a majority of his or her practice in Minnesota, Iowa, Nebraska, North Dakota, South Dakota, Illinois or Wisconsin. ELIGIBLE GROUPS MMIC also provides professional liability insurance to entities including partnerships, professional corporations and other associations through which qualifying physicians practice medicine, surgery or osteopathy. A group must meet the following criteria in order to be eligible to be insured by MMIC: 1. The entity must have its principal place of business in Minnesota, Iowa, Nebraska, North Dakota, South Dakota, 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 clinic are, or intend to be, insured by MMIC. 3 ITEM 1. BUSINESS (CONTINUED) ELIGIBLE HOSPITALS, NURSING HOMES AND OTHER EXTENDED CARE FACILITIES MMIC also provides professional liability, general liability and umbrella excess liability to hospitals, nursing homes and other extended care facilities which provide medical services to patients on more than an outpatient basis. A business must meet the following criteria in order to be eligible to be insured by MMIC: 1. The entity must have its principal place of business in Minnesota, Iowa, Nebraska, North Dakota, South Dakota, Illinois or Wisconsin; and 2. The facility must be a licensed hospital, nursing home, hospice or other extended care facility. POLICY FORMS MMIC offers a "claims-made" medical malpractice liability insurance policy. Under a claims-made policy, coverage is provided for claims asserted and reported to MMIC while the policy is in effect relating to occurrences which took place during the period in which the policyholder had coverage with MMIC. For purposes of policy coverage, a claim includes any lawsuit, allegation of liability or other notice of patient dissatisfaction with services performed that is communicated to MMIC as required by the policy. The policy also covers prior acts (i.e., claims first made during the policy period with respect to occurrences which took place prior to the date the insured initially secured coverage from MMIC) for physicians previously insured under a claims-made policy with another professional liability insurer. Prior acts coverage is not available from MMIC for physicians who have not been continuously insured prior to obtaining coverage from MMIC. MMIC also offers reporting endorsements ("tails") which provide coverage of subsequent claims (i.e., claims first made subsequent to the date the insured terminates basic insurance coverage with MMIC, but with respect to occurrences which took place while the insurance coverage was in effect prior to such termination date) made against its former insureds who have voluntarily terminated insurance coverage with MMIC. In the event of death, permanent disability, or retirement at age 55 or older after five years of continuous coverage with MMIC, the reporting endorsement is provided at no additional premium. MMIC 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 MMIC's reinsurers on a facultative basis. 4 ITEM 1. BUSINESS (CONTINUED) The basic office premises liability limits offered are $100,000 for each occurrence for bodily injury and $100,000 for each occurrence for property damage. Limits up to $1,000,000 for each occurrence are also available. The basic liability limits for coverage of employees and assistants cannot exceed the limits purchased by the insured physician or clinic. MARKETING AND DISTRIBUTION Marketing of MMIC policies in Minnesota, North Dakota, South Dakota, Nebraska, Illinois and Wisconsin is handled principally by MMIC through salaried marketing representatives. MMIC has also made marketing arrangements with a select group of large national brokers to assist MMIC in the production of large accounts and in the production of new coverages as they are developed. These brokers will work in all states. MMIC has appointed an exclusive independent agent in Iowa in order to enhance marketing efforts there. MMIC approves all policies (and their terms) sold by agents prior to their becoming effective, and no commissions are earned by agents until such approval has been granted. Distribution of policies is handled through a processing system which MMIC has utilized for several years. Since most policies have a common expiration date, it is essential that MMIC's policy processing operations be highly efficient. MMIC consistently has been able to provide policy processing on a timely basis. In 1998 the Company completed an implementation of an entirely new operating system which has expanded its capacity and efficiency. REINSURANCE MMIC purchases reinsurance in order to reduce its liability on individual risks. A reinsurance transaction takes place when an insurance company transfers or "cedes" to another insurer a portion of its exposure on insurance it writes. The reinsurer assumes the exposure in return for a portion of the premium. The reinsurer's liability is limited to losses it assumes that are in excess of the portion retained by MMIC. However, in the event the reinsurer is unable or otherwise fails to pay, MMIC remains primarily liable for the loss. Historically, entering into reinsurance agreements permitted MMIC to issue policies having greater liability limits than otherwise would have been allowed under Minnesota insurance law, which prohibits an insurer from retaining a risk on any one claim that is greater than 10 percent of its surplus. As MMIC's surplus has grown, MMIC now utilizes reinsurance primarily to limit its risk on any single claim. Such limits of risk assumed by MMIC for physician coverage have increased from $150,000 in the first year of operations to $750,000 currently. The single claim limit of risk assumed is $750,000 for hospital coverage. The reinsurer will pay losses in excess of the amount of risk retained by MMIC, not to exceed the limits of liability of the policies issued by MMIC. 5 ITEM 1. BUSINESS (CONTINUED) MMIC currently operates under an excess-of-loss reinsurance treaty with General Reinsurance Corporation of Stamford, Connecticut (80%), Hanover Reinsurance Company of Hanover, Germany (7%), Transatlantic Reinsurance Corp. (6.5%), and CNA Re, UK (6.5%), whereby the reinsurers insure against losses in excess of the loss limit retained by MMIC. General Reinsurance Corporation is the largest reinsurer of medical professional liability in the United States and one of the largest in the world and has received the highest rating of A++ by A.M. Best & Company, Inc. Hanover Reinsurance Company is rated A+; Transatlantic Re is rated A++; and CNA Re, UK is rated A by A.M. Best & Company, Inc. Coverage under the treaty was initially issued on January 1, 1998, and is continuous until canceled by either party. MMIC commuted the reinsurance treaties covering the period from October 1, 1986 through December 31, 1991. As a result, there is no longer any reinsurance coverage for those report years. As of December 31, 1998, there is one open case with $10,000 in loss reserves pertaining to those report years. Previous reinsurance treaties, which remain in effect for incidents prior to October 1, 1986, were with various domestic and foreign reinsurers, all of whom have maintained their obligations to MMIC and appear to be financially sound. MMIC currently cedes about $4,700,000 of premium per year under the reinsurance treaty. INVESTMENTS MMIC's investment portfolio is under the direction of the Board of Directors acting through the Investment Committee. The Investment Committee establishes MMIC's investment policy which, in summary, is to assist in maintaining MMIC's financial stability through the preservation of assets and the maximizing of pre-tax investment income. In 1997, the Committee changed the investment guidelines to maximize pre-tax income and to extend the duration of the fixed income investments. Adequate liquidity is maintained to assure that MMIC has the ability to meet its insurance operational requirements, in particular the payment of claims. MMIC employs outside investment managers who manage the portfolio on a discretionary basis consistent with the policies set by MMIC. In addition, the Investment Committee utilizes the services of a separate outside consultant who calculates performance measures and provides an independent opinion on the overall results being obtained by the investment managers. MMIC's investment portfolio consists primarily of investment grade fixed income instruments, including United States Government, governmental agency, and corporate bonds. Fixed income investments comprised approximately 62% of total invested assets at December 31, 1998 compared to 70% at December 31, 1997. MMIC's investment policy also permits the inclusion of equity securities. Equity securities comprised approximately 33% of total invested assets at December 31, 1998 compared to 20% at December 31, 1997. The increase in the proportion of equity securities was due to an increase in equity market values and a reallocation of $15,000,000 from fixed income investments to international equities in January 1998. The objectives of this reallocation were to further diversify the portfolio and maximize pre-tax total return. The remainder of MMIC's investment portfolio, 5% and 10% at December 31, 1998 and 1997, respectively, was invested in a real estate investment trust and short-term instruments. 6 ITEM 1. BUSINESS (CONTINUED) RATING A.M. Best & Company, Inc. ("Best's"), publisher of BEST'S INSURANCE REPORTS, PROPERTY-CASUALTY, 1997 Edition, has assigned MMIC an "A", or excellent, rating in 1998. This is the highest rating given 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. MMIHC believes that a favorable rating has a positive effect since customers and their advisors often review Best's ratings when selecting an insurer and are more apt to purchase insurance from a company with a positive rating because of the greater security and stability associated with a positive rating. A positive rating relates to the ability of an insurer to meet its insurance obligations and does not directly relate to the value of the insurer's securities. GOVERNMENT REGULATION MMIC is subject to governmental regulation in the states in which it conducts its business (Minnesota, Iowa, North Dakota, South Dakota, Nebraska, Illinois, and Wisconsin). Such regulation is conducted by state agencies having broad administrative power dealing with all aspects of MMIC's business, including policy terms, rates, dividends and retrospective premium credits to policyholders, and dividends to the parent corporation, MMIHC. Without prior approval from the Minnesota Commissioner of Commerce, annual dividends to MMIHC cannot exceed 10 percent of unassigned surplus of MMIC or the prior year's net income from operations of MMIC, whichever is greater. MMIC is also subject to statutes that require it to file periodic information with state regulatory authorities and is subject to periodic financial and business conduct examinations. MMIHC is also subject to statutes governing insurance holding company systems in Minnesota, which relate primarily to the acquisition of control of insurance companies directly or through a holding company. COMPETITION MMIC's major competitor in all states in which it conducts its business is The St. Paul Companies. The St. Paul Companies is a major national property-casualty insurance company, the largest writer of medical professional liability insurance in the United States, and is many times larger than MMIC. In addition to The St. Paul Companies, several other national companies have become active competitors in the last several years, including Medical Protective Insurance Company, CNA Insurance Company, Zurich Insurance Company, Fireman's Fund Insurance Company, and American Continental Insurance Company (commonly referred to as MMI). At this time they have achieved limited market penetration, but represent an increasing competitive pressure for the future. In addition several other physician-owned specialty carriers have entered the market, but have yet to be a significant factor in MMIC's area. Finally, in the mid-nineties several large self-insured hospitals in Minneapolis and Des Moines purchased 7 ITEM 1. BUSINESS (CONTINUED) MMIC insured clinics, and other physician practices were purchased by large, self-insured clinics such as the Mayo Clinic. In response to the consolidation occurring among healthcare providers, MMIC expanded its underwriting capability by partnering with its reinsurers to provide the types of coverages needed by larger healthcare organizations. MMIC is also the only carrier endorsed by local medical societies in Minnesota, Iowa and North Dakota and owned by its physician-insureds, which management believes gives MMIC a competitive advantage in marketing to physicians. The market for medical professional liability insurance is changing, especially with the dramatic changes proposed and occurring in the broader health care industry. Various changes in the market for medical professional liability insurance are possible as a result of developments such as practice consolidation and integration, physician-hospital organizations, various forms of managed health care, various forms of alliances between providers, proposals for enterprise liability, and many others. Management of MMIC believes it is developing new programs and products which will allow it to remain an industry leader as such change occurs, although no assurance can be given to that effect. EMPLOYEES As of December 31, 1998, MMIHC employed 82 persons, of whom 6 were executives, 52 were supervisory employees or specialists, and 24 were clerical employees. None of the employees of MMIHC is covered by a collective bargaining agreement and management believes that relations with employees are good. 8 ITEM 2. PROPERTIES MMIHC owns the following fixed assets, all of which are used in the conduct of its business:
NET BOOK VALUE DECEMBER 31, 1998 -------------- Office furniture and equipment $ 250,291 Leasehold improvements at leased premises, 6600 France Avenue South, Minneapolis, MN 37,819 Computer hardware 728,593 Computer system software 1,911,712 ---------- Total $2,928,415 ---------- ----------
The Company owns no real estate. MMIHC leases approximately 15,765 square feet of office space in Edina, Minnesota under a 10-year lease that expires in 2001, subject to the option for MMIHC to renew the lease for an additional five years after the original term. 4,060 square feet of office space is leased in West Des Moines, Iowa under a 10-year lease that expires in 2000, with an option for MMIHC to extend the term for an additional five years after the original term. An additional 1,249 square feet of office space is leased in Omaha, Nebraska under a three year lease that expires November 30, 2000. Solutions and MedPower operate out of a separate 3,149 square foot facility also located in Edina, Minnesota. This lease is set to expire in 2001. Annual rent expense was $501,032 for 1998 and $427,646 for 1997. 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 the Company's Class A or Class B Common Stock. Class A shares are issued only to insured individual physicians or individual physicians jointly with the legal entities in which they practice. The shares are restricted and cannot be sold to any person other than MMIHC and are subject to mandatory redemption at the time that the physician terminates his or her insurance coverage for any reason. (b) As of March 30, 1999, there were 125,682 shares of Class A Common Stock outstanding held by 3,496 physicians and 1 share of Class B Common Stock held by the Minnesota Medical Association. (c) MMIHC has never paid a shareholder dividend nor does it intend to within the foreseeable future. Without prior approval from the Minnesota Commissioner of Commerce, annual dividends to MMIHC from MMIC cannot exceed 10% of unassigned surplus of MMIC or the prior year's net income from operations of MMIC, whichever is greater. ITEM 6. SELECTED FINANCIAL DATA Following is the selected financial data of MMIHC for the five years ended December 31, 1998. This data should be read in conjunction with the consolidated financial statements and notes thereto appearing under Item 8 of this Form 10-K.
YEAR ENDED DECEMBER 31 OPERATIONS DATA 1998(1) 1997(1) 1996(1) 1995(2) 1994(2) - ------------------------------------------------------------------------------------------------- (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) Net premiums earned $ 35,014 $ 32,916 $ 31,177 $ 29,798 $ 26,246 Net investment and other income 21,404 19,276 15,558 14,258 11,509 ----------------------------------------------------- Total revenue 56,418 52,192 46,735 44,056 37,755 Loss and loss adjustment expenses 37,494 31,834 32,257 37,560 11,334 Underwriting and other operating expenses 10,287 6,595 5,539 6,482 5,509 ----------------------------------------------------- 47,781 38,429 37,796 44,042 16,843 ----------------------------------------------------- Income before income taxes 8,637 13,763 8,939 14 20,912 Income taxes (benefit) 2,689 4,463 1,458 (1,711) 6,417 ----------------------------------------------------- Net income $ 5,948 $ 9,300 $ 7,481 $ 1,725 $ 14,495 ----------------------------------------------------- -----------------------------------------------------
10 ITEM 6. SELECTED FINANCIAL DATA (CONTINUED)
YEAR ENDED DECEMBER 31 1998(1) 1997(1) 1996(1) 1995(2) 1994(2) ----------------------------------------------------------------------------- (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) Net income per common share - assuming dilution $43.65 $70.23 $58.33 $13.74 $114.84 Number of shares used in per share calculation 136,251 132,427 128,259 125,536(3) 126,222(3) Net income/total revenue 10.5% 17.8% 16.0% 3.9% 38.4% Return on average equity 4.2% 7.4% 6.5% 1.7% 15.8%
DECEMBER 31 FINANCIAL CONDITION 1998(1) 1997(1) 1996(2) 1995(2) 1994(2) - ------------------------------------------------------------------------------------------ (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) ASSETS Fixed maturities at fair value $164,652 $171,975 $183,561 $182,817 $174,203 Equity securities at fair value 86,553 49,759 38,001 28,311 19,782 Short-term investments 3,556 13,909 7,898 15,015 9,755 Other 10,000 10,000 -- -- -- ---------------------------------------------------- Total investments 264,761 245,643 229,460 226,143 203,740 Reinsurance recoverable 16,499 19,117 22,174 25,112 23,637 Other assets 14,223 10,755 10,359 13,329 19,100 ---------------------------------------------------- Total assets $295,483 $275,515 $261,993 $264,584 $246,477 ---------------------------------------------------- ---------------------------------------------------- LIABILITIES Unpaid losses and loss adjustment expenses $110,964 $107,806 $110,037 $120,264 $110,967 Other liabilities 33,926 33,942 33,074 34,053 38,358 ---------------------------------------------------- 144,890 141,748 143,111 154,317 149,325 REDEEMABLE STOCK Class A and Class B Common Stock at redemption value 8,147 7,477 7,604 6,975 7,712 OTHER SHAREHOLDERS' EQUITY 142,446 126,290 111,278 103,292 89,440 ---------------------------------------------------- Total liabilities, redeemable stock and shareholders' equity $295,483 $275,515 $261,993 $264,584 $246,477 ---------------------------------------------------- ----------------------------------------------------
11 ITEM 6. SELECTED FINANCIAL DATA (CONTINUED)
DECEMBER 31 1998(1) 1997(1) 1996(1) 1995(2) 1994(2) ------------------------------------------------------- (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) Midwest Medical Insurance Holding Company: Class A Common Shares issued and outstanding 125,682 121,322 118,209 116,251(3) 116,855(3) Redemption value per share $64.81 $61.63 $64.33 $60.00 $66.00 Class A Common Shares redeemed 9,005 10,306 10,272 12,424 12,640 Amount paid to terminating policyholders upon redemption $ 523 $ 648 $ 608 $ 829 $ 840
_______________________________________ (1) Amounts derived from audited consolidated financial statements of MMIHC included in Item 8 of this Form 10-K. (2) Amounts derived from audited consolidated financial statements of MMIHC. (3) Includes pro forma shares computed to give retroactive effect to the merger of MMIHC/MMIC with MLM. See Note 1 to the consolidated financial statements included in Item 8 of this Form 10-K. 12 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS MANNER OF PRESENTATION The financial statements of MMIHC and its subsidiaries are presented on a consolidated basis. In future references in this analysis, which should be read together with the 1998 consolidated financial statements and notes thereto appearing under Item 8 in this Form 10-K, MMIHC and its subsidiaries are referred to collectively as the "Company." LIQUIDITY AND CAPITAL RESOURCES The majority of the Company's assets are invested in investment-grade bonds, stocks, a real estate investment trust and short-term instruments. These investments totaled $264,761,000 and $246,746,000 at December 31, 1998 and 1997, respectively, which represented 89.6% and 89.5% of total assets. The primary objectives of the Company's investment policy established by the Board's Investment Committee 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 carried at fair value. The real estate investment trust and short-term instruments are recorded at cost which approximates fair value. During 1997, the Company adopted a revised Investment Policy resulting in a portfolio restructuring designed to increase the pre-tax total return from investments. The benchmark total return goal set for the fixed portfolio manager was increased. This resulted in a turnover of most of the fixed income portfolio which included selling all municipal bonds. To further diversify the portfolio and maximize total return, the Company invested $10 million in a private placement real estate investment trust in September of 1997 and invested $15 million in international equities in January of 1998. These changes reflect the Company's strong financial position relative to the risk inherent in the amount of premium written. The Company's cash flow from operations decreased in 1998 versus 1997 and 1996. The 1998 cash flow from operations of $(9,605,000) was unfavorably impacted by premium adjustments paid to reinsurers on reinsurance contracts for prior years, less premium received in advance at the end of the year due to later billing of policies with January effective dates, and an increase in underwriting and other operating expenses. 1998 underwriting expenses increased primarily from additional staff needed to manage Company growth and added costs from the conversion to a new insurance company operating system. 1998 other operating expenses increased primarily from launching the operations of Solutions including the acquisition of MedPower. The positive cash flow from 1997 operations of $4,002,000 was primarily the result of a decrease in claim payments, whereas the negative cash flow from 1996 operations of $(2,072,000) was primarily driven by an increase in claim payments. 13 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Premium rates in general have remained stable with slight rate increases in regions where the Company has experienced unfavorable claim trends. Consequently, cash receipts from policyholder premiums have been relatively level. MMIC, however, has returned substantial amounts of premiums to policyholders in recent years in the form of retrospective premium credits. The retrospective premium credits have been paid to policyholders in the first quarter of each year. Loss and operating expense payments have generally been met from policyholder premium receipts with any excess cash allocated to the investment portfolio. The Company regularly analyzes loss liabilities to project the cash flow required in future years. Since the overall portfolio is highly liquid, exact matching of bond maturities and liabilities is not a goal. Bond maturities are primarily selected to maximize total return. The Company believes that its cash and investments combined with its internally generated funds will be sufficient to meet its present and reasonably foreseeable operating and capital requirements and will not need to borrow funds from external sources. The Company had no material capital expenditure commitments as of December 31, 1998. The Company's bylaws require that MMIHC Class A Common Stock issued to MMIC policyholders be redeemed when a physician ceases to be insured by MMIC for any reason. The redemption value per share is calculated by dividing the net book value of the Company, excluding the net book value of MMIC (other shareholders' equity) from the calculation, by the number of MMIHC Class A Common Shares outstanding. More details about the redeemable stock and the actual redemptions during the years 1998, 1997 and 1996 are found in Note 2 to the consolidated financial statements. This limited redemption value preserves the capital of MMIC which is separately disclosed as other shareholders' equity in the consolidated financial statements. The consolidated statements of changes in other shareholders' equity found in the accompanying consolidated financial statements provide the details of additions to and reductions in other shareholders' equity. From time to time the Board of Directors of MMIC declares dividends payable to MMIHC to maintain the redemption value of the Company's Class A Common Stock and to provide capital for new ventures entered into by Solutions. A $2,000,000 dividend was declared in September of 1998 and paid in November of 1998 for those reasons mentioned above. No dividends were declared or paid by MMIC to MMIHC in 1997. In July 1996, a dividend of $327,000 was paid to MMIHC as required by a provision of the MMIC/MLM merger agreement. Per the merger agreement, the amount was sufficient to maintain the per share redemption value of MMIHC's Class A Common Stock at the same per share value immediately after the merger as immediately before the merger. A $260,000 dividend was declared in November of 1995 and paid in February of 1996 primarily to maintain the redemption value of the Company's Class A Common Stock. 14 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) RESULTS OF OPERATIONS NET PREMIUMS EARNED increased $2,098,000 in 1998 from 1997. Although policyholder rates remained relatively level, new business generated approximately $1,263,000 of additional earned premium. The remaining increase 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, was reduced $2,550,000 on a net basis in 1998. This compares to a net reduction for those treaty years of $2,950,000 in 1997 resulting in a net DECREASE in premium between years of $400,000. 2. The Company negotiated lower rates on its 1998 reinsurance contract that reduced ceded premiums by $1,031,000 compared to 1997. This INCREASED 1998 net premiums earned. 3. In 1998, $789,000 was received from the commutation of a reinsurance treaty covering the 1991 year. Since no reinsurance commutation occurred in 1997, premiums INCREASED from 1997 to 1998 by $789,000. 4. Retrospective premium credits of $5,200,000 for Minnesota policyholders and $280,000 for North Dakota policyholders were recorded in 1998. The premium credits for 1997 were $5,000,000 for Minnesota policyholders only. The difference between years resulted in a $480,000 DECREASE in 1998 net premiums earned. Net premiums earned increased $1,749,000 in 1997 from 1996. Although policyholder rates remained relatively level for 1996 and 1997, an increase in the number of policyholders in 1997 resulted in additional earned premium of $500,000. The remaining increase 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, was reduced $2,950,000 in 1997 versus an increase of $925,000 in 1996. This resulted in a net INCREASE in premium between years of $3,875,000. 2. The Company recorded an increase of $1,171,000 in the Iowa Development Experience Liability account in 1997. A similar increase of $2,901,000 was recorded in 1996. While these increased liabilities both reduce premium, the difference in the amounts between years caused an INCREASE in net premiums earned from 1996 to 1997 of $1,730,000. 3. In 1996, $2,194,000 was received from the commutation of a reinsurance treaty covering the years 1989 and 1990. This increased 1996 premiums. Since there was no counterpart in 1997, premiums DECREASED $2,194,000 from 1996 to 1997. 15 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) 4. A number of other prior year reinsurance premium adjustments recorded in 1996 increased 1996 premiums by $2,143,000. With no counterpart in 1997, the difference between years DECREASED 1997 premiums by $2,143,000. NET INVESTMENT INCOME decreased $590,000 from 1997 to 1998 and $552,000 from 1996 to 1997. Although total invested assets has increased over the same time period, the fixed maturity component of invested assets has decreased due to the Company's efforts to maximize total return and diversify the portfolio as referred to earlier under the Liquidity and Capital Resources section. Since it is the largest contributor to the Company's investment income, the decrease in fixed maturity investments decreased investment income. Yields on fixed maturity investments also declined over the same time period further contributing to the decrease in investment income. REALIZED CAPITAL GAINS increased $2,465,000 to $8,949,000 in 1998 and increased $4,713,000 to $6,484,000 in 1997. During 1998, approximately $1,175,000 of net capital gains were realized through the allocation of $15,000,000 to international equities in January of 1998. The remaining $7,774,000 of 1998 net realized capital gains resulted from the management of the portfolio on a pre-tax total return basis within the parameters set by the Board's Investment Committee. During 1997, the fixed income portfolio was restructured to pursue the newly adopted pre-tax total return objective resulting in net realized capital gains of $4,916,000. An additional $1,568,000 of net capital gains were realized in 1997 in the normal course of managing the investment portfolio. 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 Board's Investment Committee. This policy was revised in 1997 as previously discussed under the Liquidity and Capital Resources section. The Investment Committee meets with outside investment managers approximately four times per year. 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 $37,494,000 for 1998 compared to $31,834,000 in 1997 and $32,257,000 in 1996. This results in an increase of 17.8 % between 1998 and 1997 versus a slight decrease of 1.3% between 1997 and 1996. As shown in Note 5 of the 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, was fairly stable for the years 1998, 1997 and 1996. Loss 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 5 of the consolidated financial statements, these evaluations resulted in a reduction in estimated liabilities applicable to prior years of $4,433,000, $8,352,000 and $8,844,000, respectively in 1998, 1997 and 1996. The less favorable development on prior years is the primary reason for the greater incurred loss and loss adjustment expenses in 1998. 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 1988 through 1998. This schedule is presented net of reinsurance which the Company believes best explains the development as it affects operating results. The Company has a conservative loss reserving policy which, when coupled with a moderation of malpractice insurance losses beginning approximately in 1986 for the Company and across the industry, has resulted in redundancies in liabilities greater than expected. The table indicates that the redundancy in loss liabilities, which develop as actual results become known, has significantly decreased from the high at December 31, 1990. 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)
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 ------------------------------------------------------------------------------------------------------- Liability for unpaid loss and loss adjustment expense $74,577 $89,630 $97,375 $100,167 $98,617 $105,589 $88,227 $96,424 $90,342 $89,394 $94,467 Cumulative amount of liability paid through: 1 year later 12,067 10,585 13,973 19,112 21,422 25,251 26,879 33,454 30,097 28,755 2 years later 19,043 21,890 28,643 32,798 37,498 42,685 46,925 53,132 44,562 3 years later 24,143 30,869 35,305 39,906 45,227 51,087 55,534 59,568 4 years later 26,241 35,015 37,624 42,752 46,226 53,594 57,129 5 years later 27,561 35,115 38,298 43,994 46,823 53,288 6 years later 27,695 35,187 39,505 44,370 46,810 7 years later 27,695 35,295 39,861 44,420 8 years later 27,695 35,295 39,862 9 years later 27,695 35,295 10 years later 27,695 Liability re-estimated as of: 1 year later 65,928 73,244 83,359 83,991 94,633 80,960 85,595 87,580 81,990 84,961 2 years later 51,379 62,056 64,876 74,883 69,490 75,364 76,365 79,665 76,542 3 years later 43,516 52,010 56,351 53,538 65,568 64,586 67,891 77,294 4 years later 35,753 44,582 42,075 52,833 56,426 57,851 65,794 5 years later 31,052 37,872 41,771 45,892 52,388 56,785 6 years later 29,052 37,617 39,519 43,760 53,014 7 years later 29,002 35,882 38,929 43,563 8 years later 28,724 35,882 38,929 9 years later 28,724 35,882 10 years later 28,724 Cumulative redundancy 45,853 53,748 58,446 56,604 45,603 48,804 22,433 19,130 13,800 4,433
18 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) UNDERWRITING, ACQUISITION AND INSURANCE EXPENSES increased $1,189,000 from $5,509,000 in 1997 to $6,698,000 in 1998. Approximately $469,000 of the increase came from increases in variable expenses such as commissions and premium taxes that resulted from the greater premium volume. The remaining increase was largely due to additional staff needed to manage Company growth and added costs from the conversion to a new insurance company operating system. Underwriting, acquisition and insurance expenses increased $828,000 from 1996 to 1997. Approximately $425,000 of the increase was due to payments to state medical societies, for the first time in 1997, under license and endorsement agreements. The remaining increase reflected the increase in overall cost of operating the Company in 1997 with employee salaries and benefits being the largest component. OTHER OPERATING EXPENSES increased $2,503,000 from $1,086,000 in 1997 to $3,589,000 in 1998. Approximately $2,344,000 of the increase was from operating two new, non-insurance companies, Solutions and MedPower. Both Solutions and MedPower began active operations as of the beginning of 1998 as described in Item 1 of this Form 10-K. The remaining increase resulted primarily from added costs of operating the holding company. Other operating expenses increased $228,000 from $858,000 in 1996 to $1,086,000 in 1997. Approximately $131,000 of the increase was from researching and forming the new business development company that became Solutions. The remaining increase resulted primarily from additional stock issuance expenses. INCOME BEFORE INCOME TAXES decreased to $8,637,000 in 1998 compared to $13,763,000 in 1997. The decrease resulted primarily from less favorable development on loss liabilities estimated in prior years and added expenses from operating two non-insurance companies newly formed at the beginning of 1998. Income before income taxes increased to $13,763,000 in 1997 from $8,939,000 in 1996 primarily from the reversal of loss liabilities established in prior years and additional net realized capital gains from the repositioning of the investment portfolio. INCOME TAXES decreased to $2,689,000 for 1998 compared to $4,463,000 for 1997. The effective tax rates for 1998 and 1997 were 31.1% and 32.4%, respectively. The principal factor in the decline in the effective tax rate was a recovery of prior taxes recorded in 1998. Income taxes increased to $4,463,000 for 1997 compared to $1,458,000 for 1996. The effective tax rates for 1997 and 1996 were 32.4% and 16.3%, respectively. The increase in the effective tax rate for 1997 was primarily due to a reduction in tax-exempt investment income due to the 1997 repositioning of the investment portfolio that eliminated tax-exempt municipal bonds. A 1997 payment of prior year taxes and tax-exempt life insurance proceeds received in 1996 also contributed to the increase in the effective tax rate in 1997. 19 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) NET INCOME realized by the Company was $5,948,000 for 1998 compared to $9,300,000 for 1997 because of the factors discussed above. Basic net income per share decreased to $48.36 for 1998 from $77.79 per share for 1997. Diluted net income per share decreased to $43.65 for 1998 from $70.23 per share for 1997. Also due to the factors discussed above, the Company realized net income of $9,300,000 for 1997 compared to net income of $7,481,000 for 1996. Basic net income per share increased to $77.79 for 1997 from $64.45 per share for 1996. Diluted net income per share increased to $70.23 for 1997 from $58.33 per share for 1996. YEAR 2000 ISSUE The Year 2000 issue is the result of computer programs being written using two digits rather than four to define the applicable year. Any of the Company's computer programs that have time sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculation causing disruptions of operations, including, among other things, a temporary inability to process transactions, send billings, or engage in similar normal business activities. A Year 2000 Task Force was formed in early 1998 consisting of members of senior and departmental management to evaluate and monitor the Year 2000 issue, identify the causes and consequences to the Company, and develop courses of action including contingency plans as deemed necessary. The Year 2000 Task Force assessment includes the following key areas: internal computer hardware and software, significant business partners and vendors and insurance policy exposure. An evaluation of the Year 2000 readiness of all significant internal computer hardware and software applications and devices was completed in the latter part of 1998. The evaluation identified three pieces of network hardware and one subsidiary operating system that were not Year 2000 compliant. The three pieces of network hardware did not impact time sensitive operations and therefore did not pose any significant Year 2000 risk to the Company. The operating system used by the MedPower subsidiary is in the process of being converted to a new, Year 2000 compliant platform. The new operating system is expected to be fully operational by June 1999 with a total conversion cost estimated at $250,000. The conversion was approximately 60% completed and had expenditures of approximately $150,000 as of the date of this Form 10-K filing. As a result of the above evaluation, management believes that the Year 2000 issue has been adequately addressed with respect to internal use hardware and software. 20 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) A Year 2000 compliance inquiry was prepared and mailed in early October of 1998 to all of the Company's key business partners and service vendors. Responses are being evaluated and follow-up will be performed during 1999 as appropriate. No assurances, however, can be given that the systems of other companies on which the Company's operations rely will become Year 2000 compliant in a timely manner, or that the failure by a third party to become Year 2000 compliant would not have a material adverse effect on the company. A multi-departmental team consisting of claims, risk management and underwriting management studied and carefully assessed the exposure that might exist in the policies issued by MMIC. The majority of the exposure is related to medical equipment that contains computer chips and may be affected by the Year 2000 bug. This is primarily an exposure for the products liability carrier. All hospital insureds have been surveyed to monitor their compliance to MMIC guidelines on medical equipment. All current hospital insureds are in compliance. At this point, no coverage change or exclusion has been enacted for the medical malpractice professional liability policy. A Year 2000 exclusion became effective January 1, 1999 on all premises and general liability policies issued by MMIC. This exclusion will continue through the 2000 policy year. MMIC has communicated its Year 2000 exposure preparedness to its reinsurers and they fully support the plan as developed. While MMIC feels confident in the completeness of its due diligence on Year 2000 exposure, it is not yet possible to determine whether Year 2000 claims will be made against these policies or if such claims will be held to have merit and what potential financial impact may result. Although the Company expects to complete its Year 2000 remediation in 1999, there are risks if its efforts are delayed or fail. A delay or failure in remedying a Year 2000 issue, caused by internal computer hardware or software errors or failures, or by key business partners and service vendors who fail to become Year 2000 compliant could, in a worst case, interrupt the Company's business. Depending upon the extent and duration of the business interruption resulting from non-compliance issues, such interruption could have a material adverse effect on the Company's business, financial condition, and results of operations. Although the Company believes the likelihood is remote based on the due diligence performed as described previously, the potential does exist in a worst case scenario for claims to be made by MMIC policyholders for Year 2000 failures they experience. Depending on whether such claims are deemed to have merit and to the extent and amount these claims are awarded compensation, such claims could have a material adverse effect on the Company's business, financial condition, and results of operations. 21 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) The Year 2000 Task Force has developed contingency plans for the Company with the exception of the MedPower subsidiary which is in the process of developing a separate contingency plan. MedPower's contingency plan is expected to be completed by June 1999. If the Company encounters Year 2000 problems with respect to internal computer hardware and software, core functions can be processed manually until the problems are remedied. If unanticipated Year 2000 problems occur with key service vendors, essential services can be handled manually or through other vendors until the problems are resolved. The Year 2000 Task Force will be evaluating the need to test backup manual systems and identify alternative key service vendors. In the event Year 2000 claims are made on policies written by MMIC, the Company believes these claims will be without merit and will vigorously defend its position. Although the Company believes its contingency plans will be adequate, no assurances can be given that such plans will address all risks that may actually arise. The anticipated completion dates for Year 2000 compliance and the Company's contingency plans and the cost estimates for the completion of Year 2000 modifications are based on management's best estimates utilizing current data regarding available resources, coordination with third parties and other relevant factors and information about systems conversion. No assurances, however, can be given that these estimates will be achieved and actual results may differ from those anticipated. Readers are reminded that forward-looking statements contained in this description of the Company's treatment of the Year 2000 issue should be read in conjunction with the Company's following disclosures under the heading "Cautionary Note Regarding Forward-Looking Statements." 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 important factors that could cause actual results to differ materially from those indicated in such statements. These factors include but are not limited to: i. the impact of changing market conditions on the Company's business strategy; ii. the effects of increased competition on pricing, coverage terms, retention of customers and ability to attract new customers; iii. greater severity or frequency of the types of losses that the Company insure; 22 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) iv. faster or more adverse loss development experience than that on which the Company based its underwriting, reserving, and investment practices; v. developments in global financial markets which could adversely affect the performance of the Company's investment portfolio; vi. litigation, regulatory or tax developments which could adversely affect the Company's business; vii. risks associated with the introduction of new products and services; viii. dependence on key personnel; ix. the impact of mergers and acquisitions; and x. failure of the Company or significant third parties to achieve Year 2000 compliance or material expense incurred in connection with such compliance. The facts set forth above should be considered in connection with any forward-looking statement contained in this Form 10-K. The important 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 forgoing list of important 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 above. ITEM 7a. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK Market risk is the risk of loss that may occur when fluctuations in interest and 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 and equity price risk on its investment in equity securities. As disclosed previously, the Company's fixed maturity and equity investments are classified as available for sale and are managed to preserve assets, maximize pre-tax total return, and assure adequate liquidity to meet the funding needs of the Company. Under the current investment policy, management does not use derivative instruments to manage exposure to either interest rate risk or equity price risk. Professional outside investment managers adjust portfolio characteristics, such as sector and average life, based on their outlook of market conditions within the parameters set by the Company's investment policy as approved by the Investment Committee of the Board of Directors. 23 ITEM 7a. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK (CONTINUED) Based on the effective duration of the fixed maturity investment portfolio as of December 31, 1998, 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 $8,500,000. Based primarily on past annual performance relative to the Standard & Poors 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 $10,000,000 at December 31, 1998. The Company believes that there would be no material effect on its net income and cash flows in either scenario. 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. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The consolidated financial statements of Midwest Medical Insurance Holding Company and Subsidiaries are presented on the following pages 25 through 53 of this Annual Report on Form 10-K. 24 Midwest Medical Insurance Holding Company and Subsidiaries Consolidated Financial Statements Years ended December 31, 1998, 1997 and 1996 CONTENTS Report of Independent Auditors . . . . . . . . . . . . . . . . . . . . . . 26 Consolidated Financial Statements Consolidated Balance Sheets. . . . . . . . . . . . . . . . . . . . . . . . 27 Consolidated Statements of Income. . . . . . . . . . . . . . . . . . . . . 28 Consolidated Statements of Changes in Other Shareholders' Equity . . . . . 29 Consolidated Statements of Cash Flows. . . . . . . . . . . . . . . . . . . 30 Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . . 31
25 Report of Independent Auditors Board of Directors Midwest Medical Insurance Holding Company and Subsidiaries We have audited the accompanying consolidated balance sheets of Midwest Medical Insurance Holding Company and Subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of income, changes in other shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1998. Our audits also included the financial statement schedules listed in the index at Item 14(a). These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Midwest Medical Insurance Holding Company and Subsidiaries at December 31, 1998 and 1997, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth herein. /s/ ERNST & YOUNG LLP Minneapolis, Minnesota February 1, 1999 26 Midwest Medical Insurance Holding Company and Subsidiaries Consolidated Balance Sheets (IN THOUSANDS, EXCEPT FOR SHARE AMOUNTS)
DECEMBER 31 1998 1997 ----------------------- ASSETS Investments: Fixed maturities at fair value (cost: 1998--$161,430; 1997--$170,590) $164,652 $171,975 Equity securities at fair value (cost: 1998--$41,907 1997--$21,576) 86,553 50,862 Short-term 3,556 13,909 Other 10,000 10,000 ----------------------- 264,761 246,746 Cash 647 2,378 Accrued investment income 1,739 2,341 Reinsurance recoverable 16,499 19,117 Amounts due from reinsurers 3,191 - Other assets 8,646 4,933 ----------------------- Total assets $295,483 $275,515 ----------------------- ----------------------- LIABILITIES, REDEEMABLE STOCK AND OTHER SHAREHOLDERS' EQUITY Liabilities: Unpaid losses and loss adjustment expenses $110,964 $107,806 Unearned premiums 8,173 6,072 Retrospective premiums 8,543 9,905 Deferred income taxes 10,966 3,592 Amounts due reinsurers - 2,984 Other liabilities 6,244 11,389 ----------------------- Total liabilities 144,890 141,748 Redeemable stock: Class A Common Stock--authorized 300,000 shares, issued and outstanding 125,682 shares in 1998 and 121,322 shares in 1997 8,146 7,476 Class B Common Stock--authorized, issued and outstanding 1 share 1 1 ----------------------- 8,147 7,477 Other shareholders' equity 142,446 126,290 ----------------------- Total liabilities, redeemable stock and other shareholders' equity $295,483 $275,515 ----------------------- -----------------------
SEE ACCOMPANYING NOTES. 27 Midwest Medical Insurance Holding Company and Subsidiaries Consolidated Statements of Income (IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
YEAR ENDED DECEMBER 31 1998 1997 1996 ------------------------------------- Revenues: Net premiums earned $35,014 $32,916 $31,177 Net investment income 10,919 11,509 12,061 Realized capital gains 8,949 6,484 1,771 Other 1,536 1,283 1,726 ------------------------------------- 56,418 52,192 46,735 Losses and expenses: Losses and loss adjustment expenses 37,494 31,834 32,257 Underwriting, acquisition and insurance expenses 6,698 5,509 4,681 Other operating expenses 3,589 1,086 858 ------------------------------------- 47,781 38,429 37,796 ------------------------------------- Income before income taxes 8,637 13,763 8,939 Income taxes 2,689 4,463 1,458 ------------------------------------- Net income $5,948 $9,300 $7,481 ------------------------------------- ------------------------------------- Income per common share $48.36 $77.79 $64.45 ------------------------------------- ------------------------------------- Income per common share--assuming dilution $43.65 $70.23 $58.33 ------------------------------------- -------------------------------------
SEE ACCOMPANYING NOTES. 28 Midwest Medical Insurance Holding Company and Subsidiaries Consolidated Statements of Changes in Other Shareholders' Equity (IN THOUSANDS)
ACCUMULATED OTHER PAID-IN RETAINED COMPREHENSIVE TOTAL CAPITAL EARNINGS INCOME ------------------------------------------------------- Balance at December 31, 1995 $103,292 $12,789 $78,204 $12,299 Comprehensive income: Net income 7,481 - 7,481 - Other comprehensive income: Unrealized gains on securities net of $1,468 in taxes 2,726 - - 2,726 Reclassification adjustment for gains included in net income net of $620 in taxes (1,151) - - (1,151) -------- Total comprehensive income 9,056 Net income of non-insurance entities includable in Class A Common Stock redemption value (1,070) - (1,070) - ----------------------------------------------------- Balance at December 31, 1996 111,278 12,789 84,615 13,874 Comprehensive income: Net income 9,300 - 9,300 - Other comprehensive income: Unrealized gains on securities net of $5,491 in taxes 10,199 - - 10,199 Reclassification adjustment for gains included in net income net of $2,269 in taxes (4,215) - - (4,215) -------- Total comprehensive income 15,284 Net income of non-insurance entities includable in Class A Common Stock redemption value (272) - (272) - ----------------------------------------------------- Balance at December 31, 1997 126,290 12,789 93,643 19,858 Comprehensive income: Net income 5,948 - 5,948 - Other comprehensive income: Unrealized gains on securities net of $9,111 in taxes 16,921 - - 16,921 Reclassification adjustment for gains included in net income net of $3,132 in taxes (5,817) - - (5,817) -------- Total comprehensive income 17,052 Dividend paid by Midwest Medical Insurance Company to Midwest Medical Insurance Holding Company (2,000) - (2,000) - Net loss of non-insurance entities includable in Class A Common Stock redemption value 1,104 - 1,104 - ----------------------------------------------------- Balance at December 31, 1998 $142,446 $12,789 $98,695 $30,962 ----------------------------------------------------- -----------------------------------------------------
SEE ACCOMPANYING NOTES. 29 Midwest Medical Insurance Holding Company and Subsidiaries Consolidated Statements of Cash Flows (IN THOUSANDS)
YEAR ENDED DECEMBER 31 1998 1997 1996 --------------------------------------- OPERATING ACTIVITIES Net income $ 5,948 $ 9,300 $ 7,481 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Decrease in accrued investment income 602 437 97 Decrease in reinsurance recoverable 2,618 3,057 2,938 Increase in amounts due from reinsurers (3,191) - - (Increase) decrease in other assets (3,713) 1,518 1,015 Deferred tax provision 1,354 1,494 298 Increase (decrease) in unpaid losses and loss adjustment expenses 3,158 (2,231) (10,227) Increase (decrease) in unearned premiums 2,101 (788) (173) Decrease in retrospective premiums (1,362) (933) (26) Decrease in amounts due reinsurers (2,984) (4,290) (544) (Decrease) increase in other liabilities (5,145) 3,287 (236) Accretion of bond discount, net of premium amortization (266) (618) (1,080) Realized capital gains (8,949) (6,484) (1,771) Compensation expense for vested Class A common shares 224 253 156 --------------------------------------- (9,605) 4,002 (2,072) INVESTING ACTIVITIES Purchases of fixed maturity investments and equity securities (401,922) (311,947) (75,684) Sales of fixed maturity investments and equity securities 398,717 316,982 54,293 Calls and maturities of fixed maturity investments 1,250 - 16,250 Net sales (purchases) of short-term investments 6,502 (6,011) 7,117 Capitalization of Midwest Medical Solutions, Inc. 3,850 - - --------------------------------------- 8,397 (976) 1,976 FINANCING ACTIVITIES Redemption of Class A Common Stock (523) (648) (608) --------------------------------------- (Decrease) increase in cash (1,731) 2,378 (704) Cash at beginning of year 2,378 - 704 --------------------------------------- Cash at end of year $ 647 $ 2,378 $ - --------------------------------------- ---------------------------------------
SEE ACCOMPANYING NOTES. 30 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements December 31, 1998 1. ACCOUNTING POLICIES ORGANIZATION AND OPERATIONS The Minnesota Medical Insurance Exchange (Exchange) began operations in October 1980 as a reciprocal or inter-insurance exchange organized under Chapter 71A of the Minnesota Statutes. Minnesota Medical Management, Inc. (MMMI) was the Exchange's attorney-in-fact and was responsible for management of the Exchange. On November 30, 1988, the Exchange was reorganized into a stock insurance company, Midwest Medical Insurance Company (MMIC), under the statutes of the State of Minnesota. Concurrently, MMMI merged with the Midwest Medical Insurance Holding Company (MMIHC) which then acquired all outstanding shares of the reorganized stock company. Effective July 1, 1993, MMIC merged with Iowa Physicians Mutual Insurance Trust (IPMIT), a physician-owned professional liability insurance company providing insurance coverage to Iowa physicians. As provided for in the agreement and plan of merger, IPMIT was merged into MMIC. The merger was accounted for as a pooling-of-interests. During 1995, MMIHC formed MMIHC Insurance Services, Inc. (Services) to provide agency services for the distribution of complementary insurance products and services to physicians, clinics and hospitals. Effective June 5, 1996, MMIC merged with Medical Liability Mutual Insurance Company of Nebraska (MLM), a physician-owned professional liability insurance company providing insurance coverage to Nebraska physicians. As provided for in the agreement and plan of merger, MLM was merged into MMIC. The merger was accounted for as a pooling-of-interests and, accordingly, the consolidated financial statements include the combined financial position and results of operations of MMIHC and MLM for all periods presented. During 1997, MMIHC formed Midwest Medical Solutions, Inc. (Solutions) as a business development company to strengthen and promote the independence and interdependencies of physicians, clinics and hospitals that MMIC serves. Business development opportunities being pursued include practice enhancement, strategic consulting, and electronic processing and integration services and support. 31 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 1. ACCOUNTING POLICIES (CONTINUED) Effective January 1, 1998, Solutions purchased the assets and operations of MedPower Information Resources, Inc. (MedPower). MedPower processes and electronically submits medical claims for a network of over 100 provider entities. MedPower also provides various information consulting and network support services. MMIHC provides management and administrative services to MMIC for a fee generally equal to the cost of services provided plus ten percent. The insurance company provides professional liability insurance to physicians, clinics, hospitals and healthcare systems in Minnesota, Iowa, Nebraska, Wisconsin, Illinois, North Dakota and South Dakota. Insurance policies issued by MMIC are on a "claims made" basis and provide coverage for the policyholder for claims first made against the policyholder and reported to MMIC during the policy period for claims which occurred on or after the retroactive date stated in the policy. MMIC provides, upon payment of an additional premium, a reporting endorsement which extends the period in which claims otherwise covered by the "claims made" policy may be reported to MMIC. In the event of death or permanent disability of a policyholder, the reporting endorsement is issued without additional premium. Upon retirement, as defined in the policy, a policyholder with at least five years of consecutive coverage with MMIC is eligible for a credit toward the additional premium for the reporting endorsement. Prior acts coverage may be purchased by policyholders who were previously insured under a "claims made" policy with another professional liability insurer for an additional premium at the option of the insured in lieu of purchasing reporting endorsement coverage from the previous insurer. PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of MMIHC and its wholly-owned subsidiaries, MMIC, Services, and Solutions, which includes Solution's wholly-owned subsidiary, MedPower. All transactions between MMIHC and its subsidiaries have been eliminated in consolidation with the exception of the distribution of capital to MMIHC by MMIC in the form of dividends. 32 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 1. ACCOUNTING POLICIES (CONTINUED) Hereafter, MMIHC, MMIC, Services, Solutions and MedPower shall be collectively referred to as the Company unless the reference pertains to a specific entity. BASIS OF PRESENTATION The consolidated financial statements have been presented in conformity with generally accepted accounting principles, which differ in certain respects from statutory accounting practices followed by MMIC in reporting to the Department of Commerce of the State of Minnesota (see Note 10). COMPREHENSIVE INCOME As of January 1, 1998, the Company adopted Statement 130, REPORTING COMPREHENSIVE INCOME. Statement 130 establishes new rules for the reporting and display of comprehensive income and its components; however, the adoption of this Statement had no impact on the Company's net income or shareholders' equity. Statement 130 requires unrealized gains or losses on the Company's available-for-sale securities, which prior to adoption were reported separately in shareholders' equity, to be included in other comprehensive income. Prior year financial statements have been reclassified to conform to the requirements of Statement 130. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, as well as disclosure of contingent assets and liabilities at the date of the financial statements. Actual results could differ from those estimates. 33 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 1. ACCOUNTING POLICIES (CONTINUED) 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 backed by U.S. government securities and are recorded at cost which approximates fair value. Other investments are less than twenty percent equity interests in non-traded real estate investment trusts and are recorded at cost. 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. 34 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 1. ACCOUNTING POLICIES (CONTINUED) 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 MMIC, and gives effect to estimates of trends in claim severity and frequency. These estimates are continually reviewed and, as adjustments become necessary, such adjustments are included in current operations. MMIC believes that the estimate of the liability for losses and loss adjustment expenses is reasonable. PREMIUMS Premiums received are recorded as earned ratably over the lives of the policies to which they apply. A portion of premiums received is deferred to recognize MMIC'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. MMIC has a retro premium program whereby physicians may receive credits against future premiums based upon loss experience of MMIC. Amounts to be returned under the program are accrued when approved by the Board of Directors and reflected as a reduction in net premiums earned. REINSURANCE MMIC cedes reinsurance in order to reduce its liability on individual risks and to enable it to write business at limits it otherwise would be unable to accept. All reinsurance contracts are excess-of-loss contracts which indemnify MMIC for losses in excess of a stated retention limit up to the policy limits. Reinsurance receivables and recoverables and prepaid reinsurance premiums are reported as assets and reserve liabilities are reported gross of reinsurance credits. 35 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. Due to the nature of its operations, MMIC does not pay significant amounts in commissions. 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. EARNINGS PER SHARE Basic earnings per share (EPS) is computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding for the year. Diluted EPS reflects the potential dilution that could occur if earned but unissued shares of Class A common stock were issued. RECLASSIFICATIONS Certain amounts in the prior years' financial statements have been reclassified to conform with the current year presentation. 2. REDEEMABLE STOCK Effective November 30, 1988, MMIC policyholders earn Class A Common Shares for each month of service pursuant to a stock allocation formula based on underwriting risk classification. Shares earned by new policyholders are not issued until the end of five years of continuous coverage under an MMIC policy (the vesting date). The Company does not record any amounts related to unissued Class A Common Shares. At the vesting date, the issued shares are recorded at the then current redemption value (see Note 12). 36 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 2. REDEEMABLE STOCK (CONTINUED) The Company accounts for these shares by increasing Common Stock by the par value ($.01 per share) of the newly issued shares, increasing paid-in capital by the excess of the redemption value over par and charging stock compensation expense for the full redemption value. Once vested, policyholders will continue to earn shares for each month they remain insured with MMIC according to the stock allocation formula. The Company accounts for additional shares issued to vested policyholders by increasing Common Stock for the par value of the shares and decreasing retained earnings by the same amount. MMIC policyholders whose initial effective date was on or before the November 30, 1988 reorganization, IPMIT policyholders whose initial effective date was on or before December 31, 1992 and MLM policyholders whose initial effective date was on or before December 31, 1995 became fully vested upon initial receipt of their shares without regard to their length of coverage. These policyholders will continue to earn and receive additional Class A shares for each month they remain insured with MMIC. The Company accounts for these shares similar to additional shares issued to other fully vested shareholders. In accordance with the Articles of Incorporation and By-laws of MMIHC, only active policyholders of MMIC may own shares of Class A Common Stock of MMIHC. At each meeting of the shareholders, every Class A shareholder having the right to vote shall be entitled to one vote, either in person or by proxy, regardless of the number of Class A shares held by the individual. Class A shareholders are required to redeem their shares with MMIHC upon termination as policyholders of MMIC. The net redemption value (NRV) of the shares is equal to the net book value of MMIHC, excluding the amount of net book value that is attributable to MMIC, divided by the number of outstanding Class A Common Shares of MMIHC at the semi-annual valuation dates of June 30 and December 31 of each year. The amount paid upon redemption is the redemption value determined at the most recent semi-annual valuation. MMIHC has issued one share of Class B voting stock which carries with it the right to elect the Board of Directors of MMIHC. The voting rights are currently exercised by the Minnesota Medical Association and the Iowa Medical Society. A majority of the Class A shareholders may at any time, by a two-thirds vote, elect to redeem the Class B share at cost. 37 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 2. REDEEMABLE STOCK (CONTINUED) Following is the detail of changes in redeemable stock for each of the three years in the period ended December 31, 1998 (in thousands, except for share and per share amounts):
ACCUMULATED CLASS A COMMON STOCK CLASS B MMIHC MMIHC OTHER -------------------- COMMON PAID-IN RETAINED COMPREHENSIVE TOTAL SHARES AMOUNT STOCK CAPITAL EARNINGS INCOME ------------------------------------------------------------------------- Balance at December 31, 1995 $6,975 116,251 $ 1 $1 $4,752 $2,164 $ 57 Comprehensive income: Net income of non-insurance entities includable in Class A Common Stock redemption value 1,070 - - - - 1,070 - Other comprehensive income: Unrealized gains on securities net of $6 in taxes 11 - - - - - 11 ------ Total comprehensive income 1,081 Redemption of shares due to policyholder terminations by effective date: January 1, 1996 to June 30, 1996; NRV of $60.00 (377) (6,277) (1) - (259) (117) - July 1, 1996 to December 31, 1996; NRV of $57.84 (231) (3,995) - - (159) (72) - Issuance of shares to vested policyholders - 9,540 1 - - (1) - Initial issuance of shares to policyholders upon vesting 156 2,690 - - 156 - - ---------------------------------------------------------------------- Balance at December 31, 1996 (CARRIED FORWARD) 7,604 118,209 1 1 4,490 3,044 68
38 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 2. REDEEMABLE STOCK (CONTINUED)
ACCUMULATED CLASS A COMMON STOCK CLASS B MMIHC MMIHC OTHER -------------------- COMMON PAID-IN RETAINED COMPREHENSIVE TOTAL SHARES AMOUNT STOCK CAPITAL EARNINGS INCOME ------------------------------------------------------------------------- Balance at December 31, 1996 (BROUGHT FORWARD) $7,604 118,209 $ 1 $1 $4,490 $3,044 $ 68 Comprehensive income: Net income of non-insurance entities includable in Class A Common Stock redemption value 272 - - - - 272 - Other comprehensive income: Unrealized gains on securities net of $6 in taxes 11 - - - - - 11 ------ Total comprehensive income 283 Redemption of shares due to policyholder terminations by effective date: January 1, 1997 to June 30, 1997; NRV of $64.33 (278) (4,363) - - (165) (113) - July 1, 1997 to December 31, 1997; NRV of $62.12 (370) (5,943) (1) - (220) (149) - Issuance of shares to vested policyholders - 9,406 1 - - (1) - Initial issuance of shares to policyholders upon vesting 253 4,013 - - 253 - - Other (15) - - - - (15) - ------------------------------------------------------------------------ Balance at December 31, 1997 (CARRIED FORWARD) 7,477 121,322 1 1 4,358 3,038 79
39 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 2. REDEEMABLE STOCK (CONTINUED)
ACCUMULATED CLASS A COMMON STOCK CLASS B MMIHC MMIHC OTHER -------------------- COMMON PAID-IN RETAINED COMPREHENSIVE TOTAL SHARES AMOUNT STOCK CAPITAL EARNINGS INCOME ------------------------------------------------------------------------- Balance at December 31, 1997 (BROUGHT FORWARD) $ 7,477 121,322 $ 1 $1 $4,358 $ 3,038 $ 79 Comprehensive income: Net loss of non-insurance entities includable in Class A Common Stock redemption value (1,104) - - - - (1,104) - Other comprehensive income: Unrealized gains on securities net of $39 in taxes 73 - - - - - 73 ------- Total comprehensive income (1,031) Redemption of shares due to policyholder terminations by effective date: January 1, 1998 to June 30, 1998; NRV of $61.63 (251) (4,070) - - (147) (104) - July 1, 1998 to December 31, 1998; NRV of $54.70 (272) (4,935) (1) - (160) (111) - Issuance of shares to vested policyholders - 9,437 1 - - (1) - Initial issuance of shares to policyholders upon vesting 224 3,928 - - 224 - - Dividend from MMIC 2,000 - - - 2,000 - - ------------------------------------------------------------------------ Balance at December 31, 1998 $ 8,147 125,682 $ 1 $1 $6,275 $ 1,718 $152 ------------------------------------------------------------------------ ------------------------------------------------------------------------
40 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 3. INVESTMENTS Components of net investment income are summarized as follows (in thousands):
1998 1997 1996 --------------------------------- Fixed maturities $ 9,340 $10,901 $11,561 Equity securities 820 523 380 Short-term investments 926 939 904 Other investments 855 - - --------------------------------- 11,941 12,363 12,845 Investment expenses (1,022) (854) (784) --------------------------------- $10,919 $11,509 $12,061 --------------------------------- ---------------------------------
The cost (amortized cost for fixed maturities) and fair value of available for sale investments are as follows (in thousands):
DECEMBER 31, 1998 ----------------------------------------------- GROSS GROSS UNREALIZED UNREALIZED MARKET COST GAINS LOSSES VALUE ----------------------------------------------- Fixed maturities: MMIC: United States Government $110,729 $ 2,729 $ (70) $113,388 Public utilities 1,609 5 - 1,614 Industrial and other 49,092 651 (93) 49,650 ----------------------------------------------- Total $161,430 $ 3,385 $(163) $164,652 ----------------------------------------------- ----------------------------------------------- Equity securities: MMIHC $ 520 $ 234 $ - $ 754 MMIC 41,387 45,297 (885) 85,799 ----------------------------------------------- Total $ 41,907 $ 45,531 $(885) $ 86,553 ----------------------------------------------- -----------------------------------------------
41 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 3. INVESTMENTS (CONTINUED)
DECEMBER 31, 1997 ----------------------------------------------- GROSS GROSS UNREALIZED UNREALIZED MARKET COST GAINS LOSSES VALUE ----------------------------------------------- Fixed maturities: MMIHC: United States Government $ 1,255 $ - $ - $ 1,255 Industrial and other 53 - - 53 MMIC: United States Government 97,234 801 (36) 97,999 State and other political subdivisions 32,991 383 - 33,374 Industrial and other 39,057 257 (20) 39,294 ----------------------------------------------- Total $170,590 $ 1,441 $(56) $171,975 ----------------------------------------------- ----------------------------------------------- Equity securities: MMIHC $ 981 $ 122 $ - $ 1,103 MMIC 20,595 29,164 - 49,759 ----------------------------------------------- Total $ 21,576 $ 29,286 $ - $ 50,862 ----------------------------------------------- -----------------------------------------------
The components of the unrealized appreciation on available for sale securities as of December 31 are as follows (in thousands):
1998 1997 ----------------- ----------------- MMIHC MMIC MMIHC MMIC ----------------- ----------------- Fixed maturities: Gross unrealized gains $ - $ 3,385 $ - $ 1,441 Gross unrealized losses - (163) - (56) Equity securities: Gross unrealized gains 234 45,297 122 29,164 Gross unrealized losses - (885) - - ----------------- ----------------- 234 47,634 122 30,549 Deferred income taxes (82) (16,672) (43) (10,691) ----------------- ----------------- $ 152 $ 30,962 $ 79 $ 19,858 ----------------- ----------------- ----------------- -----------------
42 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 3. INVESTMENTS (CONTINUED) The amortized cost and market value of fixed maturities at December 31, 1998, by contractual maturity, are shown below (in thousands). Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
AMORTIZED MARKET COST VALUE ------------------------ Due in one year or less $ 6,192 $ 6,221 Due after one year through five years 40,322 40,982 Due after five years through ten years 27,671 28,309 Due after ten years 87,245 89,140 ------------------------ $161,430 $164,652 ------------------------ ------------------------
Proceeds from sales of available for sale investments and the related gross realized gains and losses are as follows (in thousands):
GROSS GROSS PROCEEDS REALIZED REALIZED FROM SALES GAINS LOSSES -------------------------------- Year ended December 31, 1998: Fixed maturities $382,048 $3,600 $(769) Equity securities 16,669 6,404 (286) Year ended December 31, 1997: Fixed maturities 310,235 5,806 (884) Equity securities 6,747 2,109 (547) Year ended December 31, 1996: Fixed maturities 46,735 803 (214) Equity securities 7,558 1,347 (165)
Net unrealized appreciation of fixed maturities increased (decreased) by $1,837,000, $(2,197,000) and $(4,691,000) and net unrealized appreciation of equity securities increased by $15,360,000, $11,417,000 and $7,140,000 for the years ended December 31, 1998, 1997 and 1996, respectively. 43 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 4. RETROSPECTIVE PREMIUMS The components of retrospective premiums at December 31 are as follows (in thousands):
1998 1997 ------------------- Retrospective premium credits declared: Minnesota policyholders $5,200 $5,000 North Dakota policyholders 280 - Iowa policyholders active at date of merger and renewing in 1999 and 1998 3,063 3,100 Favorable development on pre-merger IPMIT liabilities not yet approved for credit - 1,805 ------------------- $8,543 $9,905 ------------------- -------------------
A provision of the agreement and plan of merger between IPMIT and the Company requires that any favorable development of certain pre-merger liabilities of IPMIT be paid to the former IPMIT policyholders who remain active MMIC insureds as of the date of payment through a retrospective premium credit. The agreement further stipulates that any amounts due under this provision must be finalized using financial information available as of December 31, 1998. Final amounts due under this provision will be paid to physician insureds in early 1999. Actual payments of $3,073,000 and $2,501,000 were made to former IPMIT policyholders in 1998 and 1997, respectively. Actual retrospective premium payments made to Minnesota policyholders' accounts in 1998 and 1997 were $5,008,000 and $4,803,000, respectively. A provision of the agreement and plan of merger between MLM and the Company requires that any favorable development of certain pre-merger liabilities of MLM be paid to the former MLM policyholders who remain active MMIC insureds as of the date of payment through a retrospective premium credit. The agreement further stipulates that any amounts due under this provision must be settled no later than June 5, 2001. As of December 31, 1998, there has been no favorable development and therefore there is no accrual related to this provision. 44 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 5. UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES The reconciliation of the liability for unpaid losses and loss adjustment expenses is as follows (in thousands):
1998 1997 1996 -------------------------------------- Balance as of January 1, net of reinsurance recoverables $ 89,394 $ 90,342 $ 96,424 Incurred related to: Current year 41,927 40,186 41,101 Prior years (4,433) (8,352) (8,844) -------------------------------------- Total incurred 37,494 31,834 32,257 Paid related to: Current year 3,666 2,685 4,885 Prior years 28,755 30,097 33,454 -------------------------------------- Total paid 32,421 32,782 38,339 -------------------------------------- Balance as of December 31, net of reinsurance recoverables 94,467 89,394 90,342 Reinsurance recoverables at December 31 16,497 18,412 19,695 -------------------------------------- Balance as of December 31, gross $110,964 $107,806 $110,037 -------------------------------------- --------------------------------------
The Company continually evaluates emerging trends in the development of loss liabilities including the trends related to the pre-merger IPMIT and MLM business. Based on this analysis, management periodically adjusts their estimates of ultimate losses. See Note 4 regarding retrospective premium credits paid and accrued. 45 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 6. INCOME TAXES Components of income taxes are as follows (in thousands):
1998 1997 1996 --------------------- Current provision $1,335 $2,969 $1,160 Deferred tax provision 1,354 1,494 298 --------------------- $2,689 $4,463 $1,458 --------------------- ---------------------
The Company's income taxes differ from the federal statutory rate applied to income before tax as follows (in thousands):
1998 1997 1996 --------------------------------------- Income before tax at the federal statutory rate of 35% $ 3,023 $ 4,817 $ 3,129 Tax-exempt income (net of proration adjustment) - (775) (1,374) Dividends received deductions (net of proration adjustment) (99) (89) (78) State income taxes, net of federal tax benefit 37 198 50 Payment of prior year taxes - 300 - Recovery of prior year taxes (267) - - Proceeds on life insurance - - (368) Other (5) 12 99 --------------------------------------- $ 2,689 $ 4,463 $ 1,458 --------------------------------------- ---------------------------------------
46 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 6. INCOME TAXES (CONTINUED) The deferred income tax provision includes the following differences between financial and income tax reporting (in thousands):
1998 1997 1996 ------------------------------------- Discounting of post-1986 unpaid losses and loss adjustment expenses $ 842 $ 323 $1,190 Liabilities not currently deductible 596 636 (274) Unearned premiums (151) 57 6 Utilization of alternative minimum tax carryforwards - 496 - Alternative minimum tax carryforwards - - (496) Other 67 (18) (128) ------------------------------------- $1,354 $1,494 $ 298 ------------------------------------- -------------------------------------
The Company made income tax payments of $3,041,000, $1,518,000 and $3,260,000 in 1998, 1997 and 1996, respectively. The components of the net deferred income tax (liability) asset as of December 31 are as follows (in thousands):
1998 1997 ------------------------ Deferred tax assets: Unpaid losses and loss adjustment expenses $ 4,154 $ 4,996 Liabilities not currently deductible 1,079 1,675 Unearned premiums 628 477 Other 550 552 ------------------------ 6,411 7,700 Deferred tax liabilities: Unrealized gains (16,754) (10,734) Other (623) (558) ------------------------ (17,377) (11,292) ------------------------ $(10,966) $(3,592) ------------------------ ------------------------
47 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 6. INCOME TAXES (CONTINUED) Management has determined that no valuation allowances were necessary for unrealizable portions of deferred tax assets. This was supported primarily through the presence of taxable income in carryback years and reversals of existing temporary differences which provide taxable income in future years. A portion of the deferred tax assets was supported through reliance on available tax planning strategies which could be implemented at no cost. 7. REINSURANCE To reduce overall risk, including exposure to large losses, the Company participates in various reinsurance programs. MMIC would only become liable for losses in excess of stipulated amounts in the event that any reinsuring company were unable to meet its obligations under the existing agreement. Management is not aware of any such default at December 31, 1998. Reinsurance recoverables on paid and unpaid losses of $16,277,000 and $16,141,000 are associated with a single reinsurer, General Reinsurance Corporation, at December 31, 1998 and 1997, respectively. MMIC 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 MMIC. The Company generally retains the first $750,000 of each claim and reinsures the remainder through a treaty under which premiums are subject to adjustment based on experience. Total ceded reinsurance premiums, before the effects of treaty commutations, for the years ended December 31, 1998, 1997 and 1996 were $3,104,000, $3,329,000 and $6,416,000, respectively. Loss and loss adjustment expenses incurred are net of applicable reinsurance of $2,240,000, $2,455,000 and $2,459,000 for the years ended December 31, 1998, 1997 and 1996, respectively. In 1998, the Company commuted reinsurance treaties covering the period January 1, 1991 through December 31, 1991. Net premiums recovered as a result of these commutations of $789,000 have been included in net premiums earned in 1998. In 1996, the Company commuted reinsurance treaties covering the period January 1, 1989 through December 31, 1990. Net premiums recovered as a result of these commutations of $2,194,000 have been included in net premiums earned in 1996. 48 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 8. OTHER COMMITMENTS In the normal course of claim settlement, MMIC negotiates structured settlements including the purchase of annuities from life insurance companies with an A+ rating from A.M. Best (an industry rating organization) at the date of issue and a minimum of $100 million in surplus. These annuities guarantee a stream of payments to the claimant holding the annuity. The majority of these settlements have been assigned to the life insurance company which releases MMIC from any future contractual liability to the claimant. MMIC and its reinsurers could only become liable for ultimate settlement of those claims which have not been assigned. At December 31, 1998 and 1997, respectively, non-assigned structured settlements guaranteed $5,820,000 and $12,299,000 of payments under annuity contracts for which MMIC and its reinsurers paid $2,627,000 and $4,726,000. In the event that the insurance company issuing the annuity was unable to meet its obligation under the terms provided, MMIC would be liable for the ultimate settlement. 9. BENEFIT PLANS The Company has a non-contributory defined contribution pension plan covering substantially all employees. Contributions to the plan are based upon each covered employee's salary. The Company also sponsors a 401(k) plan covering substantially all employees and provides a fifty percent match on employee contributions subject to certain limitations. Total contributions charged to expense for the years ended December 31, 1998, 1997 and 1996 were $521,000, $393,000 and $371,000, respectively. The Company provides an unfunded Supplemental Executive Retirement Plan (SERP) which is a non-qualified, defined benefit retirement plan covering certain Company officers. Benefits are based upon years of service and compensation. Although the plan is technically unfunded, the Company 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 $404,000, $363,000 and $323,000 for the years ended December 31, 1998, 1997 and 1996, respectively. The liability recognized in the consolidated balance sheets at December 31, 1998 and 1997 related to this plan was $2,439,000 and $2,192,000, respectively. 49 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 9. BENEFIT PLANS (CONTINUED) The Company also provides medical benefits to retirees through a defined benefit post-retirement plan which covers substantially all employees. The net periodic post-retirement benefit cost for the years ended December 31, 1998, 1997 and 1996 was $41,000, $27,000 and $30,000, respectively. As of December 31, 1998 the plan was fully funded. As of December 31, 1997, the net post-retirement benefit plan liability was $4,000. 10. RECONCILIATION WITH STATUTORY ACCOUNTING PRINCIPLES The following is a reconciliation of net income and shareholders' equity under generally accepted accounting principles with that reported for MMIC on a statutory basis (in thousands): Net Income
YEAR ENDED DECEMBER 31 1998 1997 1996 ------------------------------------ As reported under generally accepted accounting principles $5,948 $ 9,300 $ 7,481 (Income) loss of non-insurance entities 1,104 (272) (1,070) ------------------------------------ On the basis of generally accepted accounting principles, MMIC only 7,052 9,028 6,411 Additions (deductions): Deferred income taxes 1,390 1,525 445 Other - - 123 ------------------------------------ On the basis of statutory accounting principles $8,442 $10,553 $6,979 ------------------------------------ ------------------------------------
50 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 10. RECONCILIATION WITH STATUTORY ACCOUNTING PRINCIPLES (CONTINUED) Shareholders' Equity
DECEMBER 31 1998 1997 1996 --------------------------------- As reported under generally accepted accounting principles $142,446 $126,290 $111,278 Additions (deductions): Deferred income taxes 11,526 4,158 (590) Unrealized (gain) loss on fixed maturities (3,222) (1,385) (3,580) Other (34) (3) (41) --------------------------------- On the basis of statutory accounting principles $150,716 $129,060 $107,067 --------------------------------- ---------------------------------
The equity of MMIHC, exclusive of the carrying value of its investment in MMIC, is subject to redemption and therefore reported outside of shareholders' equity under the caption redeemable stock. As a result, consolidated other shareholders' equity as reported on the balance sheets represents equity of MMIC only under generally accepted accounting principles. Under Minnesota insurance statutes, MMIC is required to maintain statutory surplus in excess of ten times its per occurrence reinsurance retention limit. The minimum level is $7,500,000 for 1998 and 1997. 51 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 11. EARNINGS PER SHARE The following table sets forth the computation of basic and diluted earnings per share (in thousands, except for share and per share amounts):
1998 1997 1996 -------------------------------- Numerator for basic and dilutive earnings per share available to common shareholders $5,948 $9,300 $7,481 -------------------------------- -------------------------------- Denominator: Denominator for basic earnings per share--weighted average shares 123,004 119,554 116,071 Effect of dilutive securities: Unvested shares 13,247 12,873 12,188 -------------------------------- Denominator for dilutive earnings per share--adjusted weighted-average shares and assumed conversions 136,251 132,427 128,259 -------------------------------- -------------------------------- Basic earnings per share $48.36 $77.79 $64.45 -------------------------------- -------------------------------- Diluted earnings per share $43.65 $70.23 $58.33 -------------------------------- --------------------------------
52 Midwest Medical Insurance Holding Company and Subsidiaries Notes to Consolidated Financial Statements (continued) 12. NET REDEMPTION VALUE The net redemption value per share of the Class A common shares was as follows:
CLASS A NET REDEMPTION MMIHC COMMON SHARES VALUE PER NET EQUITY OUTSTANDING SHARE ----------------------------------------- (000S) December 31, 1994 $7,712 116,855* $66.00 ------ ------ ------ ------ December 31, 1995 $6,975 116,251* $60.00 ------ ------ ------ ------ December 31, 1996 $7,604 118,209 $64.33 ------ ------ ------ ------ December 31, 1997 $7,477 121,322 $61.63 ------ ------ ------ ------ December 31, 1998 $8,147 125,682 $64.81 ------ ------ ------ ------
* Includes pro forma shares related to merger. 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 MMIHC and MMIC, the year each first became a director, and the number of Class A Common Shares owned by each as of December 31, 1998, are as follows:
CLASS A COMMON DIRECTOR PRINCIPAL SHARES NAME AGE SINCE OCCUPATION OWNED - ----------------------------------------------------------------------------------------- Michael Abrams 37 1996 Exec V.P. Iowa Medical Society - John R. Balfanz, M.D. 53 1995 Physician 15 Gail P. Bender 51 1996 Physician 23 James R. Bishop, M.D. 57 1994 Physician - David P. Bounk 52 1995 President and CEO - Roger L. Frerichs, M.D. 59 1988 Surgeon 88 Richard Geier, Jr., M.D. 58 1995 Physician 24 Anthony C. Jaspers, M.D. 51 1996 Physician 52 Russel J. Kuzel, M.D. 46 1997 Physician 27 Wayne F. Leebaw, M.D. 55 1994 Physician 25 Steven A. McCue, M.D. 57 1995 Physician 126 William J. McMillan, Jr. M.D. 51 1997 Physician 70 Harold W. Miller, M.D. 51 1996 Physician 27 Anton S. Nesse, M.D. 60 1989 Radiologist 54 Mark D. Odlund, M.D. 46 1996 Physician 88 G. William Orr, M.D. 63 1996 Physician 56 Norman Rinderknecht, M.D. 64 1993 Physician 97 Paul S. Sanders, M.D. 54 1984 CEO-MN Medical Assoc. - Richard D. Schmidt, M.D. Secretary 55 1990 Physician 152 Judith F. Shank, M.D. 56 1999 Physician 15 Andrew J. K. Smith, M.D. Chairman of Board 56 1990 Neurological Surgeon 199 G. David Spoelhof, M.D. 45 1989 Physician 48 Tom D. Throckmorton, M.D. 53 1997 Physician 72 R. Bruce Trimble, M.D. Vice Chair of Board 58 1993 Physician 23
The Bylaws of MMIHC provide that MMIHC's Board of Directors shall include the following: (1) up to 20 physicians divided into three classes and elected for staggered three-year terms; (2) for as long as the Class B Common Share is outstanding, the Chief Executive Officer of the MMA and the Executive Vice President of the IMS, both of whom shall be ex-officio directors; (3) the President of MMIHC as an ex-officio director; and (4) such additional ex-officio and 55 ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT (CONTINUED) advisory members as the Board of Directors may determine. At least two-thirds of the voting members of the Board of Directors must be physician directors. All physician directors must be members of a state medical association and insured by MMIC. The MMA, which has the exclusive right to elect directors, has agreed to elect the directors nominated by a committee of the Board of Directors. The Bylaws of MMIC provide that the directors of MMIHC shall also serve as the directors of MMIC, with the exception of any outside directors of MMIHC. Outside directors are persons who are not policyholders of MMIC or members of any state medical society. There are currently no outside directors of MMIHC so the Boards of MMIHC and MMIC are identical at this time. Pursuant to the merger with IPMIT, the Bylaws of MMIHC were amended to provide for the election of directors who are members of the IMS in a number, when compared to the total number of directors, which is proportionate to the number of Iowa insureds compared to the total number of MMIC insureds, subject to a minimum of two Iowa directors, one of whom shall be the Executive Vice President of the IMS, for as long as the Class B Common Share is outstanding. The MMA has placed the Class B Voting Share in a voting trust which requires the trustee to vote the share for the election of the Iowa directors nominated by the IMS. Directors serve until their successors are elected and qualified, or until their prior resignation, removal, death or disqualification. As of December 31, 1998, the directors of MMIHC, as a group, owned 1,283 Class A Common Shares or 1.0 percent of the total Class A Common Shares outstanding as of such date. No executive officer owned any Class A Common Shares as of such date. All of the directors have been principally engaged in the practice of medicine for more than five years, except for Dr. Sanders who has been the Executive Vice President of the MMA since 1990, Michael Abrams who has been the Executive Vice President of the Iowa Medical Society beginning in 1996 and David P. Bounk who has been the President and CEO of MMIHC since 1991. Prior to 1990, Dr. Sanders was principally engaged in the practice of medicine. Prior to 1996 Michael Abrams was Director, Government Relations of the Indiana Medical Association for nine years. The Chairman of the Board of Directors (currently Dr. Smith) is paid an annual fee of $38,528. All members of the Board of Directors currently are paid $750 for each meeting of the Board of Directors they attend. In addition, members of the Executive Committee currently are paid $750 for each meeting of the Executive Committee they attend, and committee chairmen are paid $600 for each meeting of the standing committee they chair. Other members of standing committees currently are paid between $300 and $500, depending upon distance traveled, for each committee meeting they attend. 56 ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT (CONTINUED) EXECUTIVE OFFICERS The names, ages and positions of the executive officers of MMIHC and MMIC are as follows:
PERIOD OF SERVICE POSITION AS PRINCIPAL NAME AGE WITH COMPANY AN OFFICER OCCUPATION - ------------------------------------------------------------------------------------------ David P. Bounk 52 President and Chief 8/1/90 to date President and Chief Executive Officer Executive Officer Niles A. Cole 37 Vice President-Finance 1998 to date Vice President-Finance and Treasurer and Treasurer Jack L. Kleven 52 Senior Vice President 1986 to date Senior Vice President and Chief Operating and Chief Operating Officer Officer Elizabeth S. Lincoln 45 Vice President-Law and 1990 to date Vice President-Law and Health Policy Health Policy Gerald M. O'Connell 44 Vice President - 1998 to date Vice President - Marketing Marketing Michael G. Rutz 45 Vice President- 5/15/95 to date Vice President- Underwriting Underwriting
Mr. Bounk has over 30 years experience in the insurance industry and joined MMIHC and MMIC as President and Chief Executive Officer in August 1990. From July 1982 through July 1990, he was Executive Vice President and Chief Operating Officer of Missouri Medical Insurance Company, a corporation providing malpractice insurance to physicians in Missouri. Mr. Bounk has an MBA degree in finance. Mr. Bounk has an employment agreement which 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 MMIHC for cause or by Mr. Bounk voluntarily, he is entitled to receive his base salary for 30 days thereafter. If the agreement is terminated by MMIHC without cause, Mr. Bounk is entitled to receive his base salary for six months thereafter, plus one additional month for each year of service, subject to a maximum of 12 additional 57 ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT (CONTINUED) months, and then only until he commences new employment or self-employment. The agreement also prohibits Mr. Bounk from competing with MMIHC for one year following his termination of employment. Effective January 1, 1997, the Company entered into termination agreements with the executive officers. These agreements provide a severance package to these executives in the event of termination of employment without cause. Mr. Cole has over 15 years experience in the insurance industry, including 6 years with Washington State Physician's Insurance Association. He has been in his current position since March 1998. He has BS degrees in accounting and finance. Mr. Kleven has over 25 years experience in medical malpractice claims adjusting and management. He joined the Exchange in 1983, and was Vice President, Claims since March 1986. He was promoted to Chief Operating Officer on January 1, 1998. Prior to joining the Exchange, he was a liability manager at The St. Paul Companies for six years. He has a BS degree in business. Ms. Lincoln has over 15 years experience in medical professional liability risk management. She joined the 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. Mr. Rutz has over 20 years experience in the insurance industry, including 10 years in medical malpractice. From June 1986 through April 1994, he was Senior Regional Underwriting Manager with St. Paul Fire and Marine Insurance Company. From May 1994 through April 1995, he was Vice President with Alexander and Alexander, insurance brokers. He joined the Company in May 1995 as Vice President-Underwriting. He has a BS degree in resource management. Mr. O'Connell has over 22 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 the Company in October 1996. He has a BS in Agriculture Business Management with an emphasis in Insurance. Officers serve until their successors are appointed by the Board of Directors, or until their prior resignation, removal or death. 58 ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT (CONTINUED) 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 1998, 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. ITEM 11. EXECUTIVE COMPENSATION SUMMARY COMPENSATION TABLE The following table summarizes compensation paid by MMIHC to its five most highly compensated executive officers for services rendered in all capacities during the last three years.
CASH COMPENSATION NAME OF INDIVIDUAL CAPACITIES IN --------------------- ALL OTHER OR NUMBER IN GROUP WHICH SERVED SALARY BONUS COMPENSATION(a) - ------------------------------------------------- --------------------------------------- David P. Bounk President and Chief 1998 $200,187 $85,830 $32,272 Executive Officer 1997 187,088 56,126 20,963 1996 170,080 51,024 17,687 Jack L. Kleven Senior Vice President and 1998 167,716 61,636 30,847 Chief Operating Officer 1997 145,840 43,752 17,193 1996 132,420 39,796 17,384 Elizabeth S. Lincoln Vice President-Law 1998 108,015 33,080 29,242 and Health Policy 1997 102,871 30,861 13,286 1996 97,020 29,106 14,319 Gerald M. O'Connell Vice President-Marketing 1998 109,000 34,749 21,739 1997 95,077 11,530 17,850 1996 24,900 2,423 4,608 Michael G. Rutz Vice President- 1998 119,816 36,694 31,406 Underwriting 1997 114,110 34,233 14,113 1996 108,680 32,604 14,980
(a) Includes employer contributions to qualified retirement plans and the term and cash surrender value of supplemental life insurance premiums. 59 ITEM 11. EXECUTIVE COMPENSATION (CONTINUED) MMIHC also maintains a Supplemental Executive Retirement Plan ("SERP") which provides an annual retirement benefit for an executive officer who retires at age 62 with 10 years of service of 70% of the officer's final average salary. Benefits are reduced for years of service less than 10 and retirement prior to age 62. The annual benefit payable under the SERP 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 MMIHC's current money purchase pension plan and a predecessor plan. The estimated annual benefits payable upon retirement at normal retirement age for the executive officers in the Summary Compensation table are as follows: Mr. Bounk--$201,500; Mr. Kleven--$125,900; Ms. Lincoln--$82,000; Mr. Rutz--$147,100 and Mr. O'Connell--$96,400. The estimated annual retirement benefits were calculated assuming salary increases of five percent per year, discounted four percent per year for future inflation to express the estimated benefits in today's dollars. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The response to this item is contained in Item 10. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS None. 60 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a)(1) The following consolidated financial statements of Midwest Medical Insurance Holding Company, Inc. for the year ended December 31, 1998 are included in this annual report (Form 10-K) in Item 8: Report of Independent Auditors Consolidated Balance Sheets as of December 31, 1998 and 1997 Consolidated Statements of Income for the years ended December 31, 1998, 1997 and 1996 Consolidated Statements of Changes in Other Shareholders' Equity for the years ended December 31, 1998, 1997 and 1996 Consolidated Statements of Cash Flows for the years ended December 31, 1998, 1997 and 1996 Notes to Consolidated Financial Statements (a)(2) The following consolidated financial statement schedules of Midwest Medical Insurance Holding Company, Inc. required by Item 14(d) are included in a separate section of this report: II Condensed Financial Information of Registrant IV Reinsurance VI Supplemental Information Concerning Property/Casualty Insurance Operations All other schedules to the consolidated financial statements required by Article 7 of Regulation S-X are not required under the related instructions or are inapplicable and therefore have been omitted. (a)(3) LISTING OF EXHIBITS The Exhibits required to be a part of this report are listed in the Index to Exhibits which follows the Financial Statement Schedules. (b) REPORTS ON FORM 8-K No reports on Form 8-K were filed during the fourth quarter of 1998. 61 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 19, 1999 -------------------------------------- -------------- 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 19, 1999 - ---------------------------- David P. Bounk /s/ Niles Cole Principal Financial Officer and March 19, 1999 - ---------------------------- Principal Accounting Officer Niles Cole * Director, Chairman of the Board March 19, 1999 - ---------------------------- Andrew J.K. Smith, M.D. * Director March 19, 1999 - ---------------------------- Michael Abrams * Director March 19, 1999 - ---------------------------- John R. Balfanz, M.D. * Director March 19, 1999 - ---------------------------- Gail P. Bender, M.D. 62 * Director March 19, 1999 - ---------------------------- James R. Bishop, M.D. * Director March 19, 1999 - ---------------------------- Roger L. Frerichs, M.D. * Director March 19, 1999 - ---------------------------- Richard Geier, Jr., M.D. * Director March 19, 1999 - ---------------------------- Anthony C. Jaspers, M.D. - ---------------------------- Director March 19, 1999 Russel J. Kuzel, M.D. * Director March 19, 1999 - ---------------------------- Wayne F. Leebaw, M.D. * Director March 19, 1999 - ---------------------------- Steven A. McCue, M.D. * Director March 19, 1999 - ---------------------------- William J. McMillan, Jr. M.D. * Director March 19, 1999 - ---------------------------- Harold W. Miller, M.D. * Director March 19, 1999 - ---------------------------- Anton S. Nesse, M.D. * Director March 19, 1999 - ---------------------------- Mark D. Odlund, M.D. 63 * Director March 19, 1999 - ---------------------------- G. William Orr, M.D. * Director March 19, 1999 - ---------------------------- Norman Rinderknecht, M.D. * Director March 19, 1999 - ---------------------------- Paul S. Sanders, M.D. * Director, Secretary March 19, 1999 - ---------------------------- Richard D. Schmidt, M.D. * Director March 19, 1999 - ---------------------------- Judith F. Shank, M.D. * Director March 19, 1999 - ---------------------------- G. David Spoelhof, M.D. * Director March 19, 1999 - ---------------------------- Tom D. Throckmorton, M.D. * Director, Vice Chairman March 19, 1999 - ---------------------------- R. Bruce Trimble, M.D. * By: /s/ David P Bounk March 19, 1999 ---------------------------- 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. 64 Midwest Medical Insurance Holding Company and Subsidiaries (Parent Company) Schedule II--Condensed Financial Information of Registrant Balance Sheets
DECEMBER 31 1998 1997 ----------------------- (IN THOUSANDS) ASSETS Fixed maturities $ - $ 1,308 Short-term investments 1,310 2,730 Investment in subsidiaries 145,032 126,290 Accrued investment income - 40 Other 8,385 6,881 ----------------------- Total assets $154,727 $137,249 ----------------------- ----------------------- LIABILITIES, REDEEMABLE STOCK AND OTHER SHAREHOLDERS' EQUITY LIABILITIES Accounts payable $ 43 $ 111 Accrued expenses and other liabilities 4,091 3,371 ----------------------- 4,134 3,482 REDEEMABLE STOCK Class A Common Stock 8,146 7,476 Class B Common Stock 1 1 ----------------------- 8,147 7,477 OTHER SHAREHOLDERS' EQUITY Additional paid-in capital 12,789 12,789 Retained earnings, comprised of undistributed earnings of subsidiaries 98,695 93,643 Unrealized appreciation on investments, net of income taxes 30,962 19,858 ----------------------- 142,446 126,290 ----------------------- Total liabilities, redeemable stock and other shareholders' equity $154,727 $137,249 ----------------------- -----------------------
SEE ACCOMPANYING NOTE. 65 Midwest Medical Insurance Holding Company and Subsidiaries (Parent Company) Schedule II--Condensed Financial Information of Registrant (continued) Statements of Income
YEAR ENDED DECEMBER 31 1998 1997 1996 ------------------------------------- (IN THOUSANDS) REVENUES Management fee from subsidiaries $14,038 $9,901 $8,706 Investment income 489 64 726 Other income 7 2 4 ------------------------------------- 14,534 9,967 9,436 EXPENSES Operating and administrative 14,267 9,535 8,357 ------------------------------------- Income before income taxes and other items 267 432 1,079 Income tax expense 104 162 9 ------------------------------------- Income before equity in undistributed income of subsidiaries 163 270 1,070 Equity in undistributed income of subsidiaries 5,785 9,030 6,411 ------------------------------------- Net income $ 5,948 $9,300 $7,481 ------------------------------------- -------------------------------------
SEE ACCOMPANYING NOTE. 66 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 1998 1997 1996 --------------------------------------- (IN THOUSANDS) Net cash (used in) provided by operating activities $ (366) $ (527) $ (877) INVESTING ACTIVITIES Purchase of fixed maturities (21,758) (38,979) (20,469) Sales of fixed maturities 22,826 38,701 20,289 Calls and maturities of fixed maturities 250 - - Sales of short-term investments, net 1,420 1,453 1,338 Capitalization of Solutions (3,850) - - FINANCING ACTIVITIES Redemption of Class A Common Stock (522) (648) (608) Dividend from MMIC 2,000 - 327 --------------------------------------- Increase in cash - - - Cash at beginning of year - - - --------------------------------------- Cash at end of year $ - $ - $ - --------------------------------------- ---------------------------------------
SEE ACCOMPANYING NOTE. 67 Midwest Medical Insurance Holding Company and Subsidiaries (Parent Company) Schedule II--Condensed Financial Information of Registrant (continued) Note to Condensed Financial Statements December 31, 1998 The accompanying condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto of Midwest Medical Insurance Holding Company and Subsidiaries. See Note 2 to the consolidated financial statements of Midwest Medical Insurance Holding Company and Subsidiaries for a description of the redeemable stock. 68 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, 1998: Insurance premiums: Property/casualty insurance $37,518 $2,601 $97 $35,014 0.3% Year ended December 31, 1997: Insurance premiums: Property/casualty insurance 36,511 3,595 - 32,916 N/A Year ended December 31, 1996: Insurance premiums: Property/casualty insurance 34,006 2,829 - 31,177 N/A
NOTE TO SCHEDULE IV: Ceded premiums for the years ended December 31, 1998, 1997 and 1996 are net of reductions (additions) in ceded premiums related to swing rated reinsurance treaties of $2,550,000, $(3,688,000), and $748,000 respectively. Ceded premiums in 1996 are also net of proceeds from commutations of reinsurance covering the period January 1, 1989 through December 31, 1990 of $2,194,000. Ceded premiums in 1998 are also net of proceeds from commutations of reinsurance covering the period January 1, 1991 through December 31, 1991 of $789,000. 69 Midwest Medical Insurance Holding Company and Subsidiaries Schedule VI--Supplemental Information Concerning Property/ Casualty Insurance Operations
DECEMBER 31 YEAR ENDED DECEMBER 31 - ----------------------------------------------------------- ---------------------------------------------------------------------- COL. A COL. B COL. C COL. D COL. E COL. F COL. G COL. H COL. I COL. J COL. K - ----------------------------------------------------------- ---------------------------------------------------------------------- LOSSES AND LOSS ADJUSTMENT EXPENSES RESERVES FOR INCURRED RELATED TO AMORTIZATION PAID DEFERRED UNPAID LOSSES DISCOUNT, ------------------ OF DEFERRED LOSSES AFFILIATION POLICY AND LOSS IF ANY, NET (1) (2) POLICY AND LOSS WITH ACQUISITION ADJUSTMENT DEDUCTED IN UNEARNED EARNED INVESTMENT CURRENT PRIOR ACQUISITION ADJUSTMENT PREMIUMS REGISTRANT COSTS EXPENSES COLUMN C PREMIUMS PREMIUMS INCOME YEAR YEAR COSTS EXPENSES WRITTEN - ----------------------------------------------------------------------------------------------------------------------------------- (IN THOUSANDS) Consolidated property/ casualty entities 1998 N/A $110,964 N/A $8,173 $35,014 $10,919 $41,927 $(4,433) N/A $32,421 $39,431 1997 N/A 107,806 N/A 6,072 32,916 11,509 40,186 (8,352) N/A 32,782 35,722 1996 N/A 110,037 N/A 6,860 31,177 12,061 41,101 (8,844) N/A 38,339 31,167
70 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 3A.(1) (Form S-4, Exhibit 3C). Bylaws of the registrant (Form S-4, Exhibit 3D). 3B.(1) Voting Trust Agreement. 9.(1) Governance Agreement between the registrant and the 10A.(1) Minnesota Medical Association, holder of the registrant's Class B Common Share, dated November 30, 1988. Lease for office space between the registrant and 10B.(1) Lexington Property Fund, L.P. Limited Partnership, dated March 26, 1991. Management Agreement between the registrant and Midwest 10C.(4) Medical Insurance Company, dated November 30, 1988, as amended January 1, 1990, January 1, 1991, and January 1, 1996. Agency Agreement with Vaaler Insurance, Inc. pursuant 10D.(1) to which Vaaler acts as agent of the registrant in North Dakota, dated April 21, 1989. Agreement of Reinsurance between Midwest Medical 10E.(5) Insurance Company and General Reinsurance Corporation, effective January 1, 1998. Letter of Employment Agreement between the registrant 10F.(2) and David P. Bounk, President and Chief Executive Officer of the registrant and Midwest Medical Insurance Company, dated January 1, 1993.
71 Index to Exhibits (continued)
REGULATION S-K EXHIBIT TABLE SEQUENTIAL ITEM REFERENCE PAGE NO. - ----------------------------------------------------------------------------------- 1998 Officers Short-term Incentive Plan of the registrant. 10G.(5) Supplemental Executive Retirement Plan of the registrant. 10H.(1) Plan and Agreement of Merger, without exhibits. 10I.(1) Agency Agreement with IMS Services pursuant to which IMS 10J.(3) Services acts as agent of the registrant in Iowa, dated July 1, 1993 Subsidiaries of the registrant. 21.(5) Power of attorney. 24.(5) Financial Data Schedule 27.(5)
- -------------------------- (1) Filed with the Company's Registration Statement on Form S-4, as amended, SEC File No. 33-55062 and incorporated herein by reference. (2) Filed with the Company's Registration Statement Form S-1 SEC File No. 33-70182 and incorporated herein by reference. (3) Filed with 1993 Annual Report on Form 10-K. (4) Filed with 1996 Annual Report on Form 10-K. (5) Filed with this Annual Report on Form 10-K. 72 EX-10.E 2 EXHIBIT 10.E - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- MEDICAL PROFESSIONAL LIABILITY EXCESS OF LOSS REINSURANCE CONTRACT EFFECTIVE: JANUARY 1, 1998 issued to Midwest Medical Insurance Company Minneapolis, Minnesota (HEREINAFTER REFERRED TO AS THE "Company") by The Subscribing Reinsurer(s) Executing the Interests and Liabilities Agreement(s) Attached Hereto (HEREINAFTER REFERRED TO AS THE "Reinsurer") Article I - Classes of Business Reinsured A. By this Contract the Reinsurer agrees to reinsure the excess liability which may accrue to the Company under its policies, contracts and binders of insurance or reinsurance (hereinafter called "policies") issued or renewed on or after the effective date hereof, and classified by the Company as follows: 1. Professional Liability business as respects physicians, surgeons, dentists and ancillary health care professionals written on a claims made basis; 2. General Liability business as respects physicians, surgeons, dentists and ancillary health care professional entities written on an occurrence basis; and 3. Primary and Umbrella Excess Health Care Systems Professional Liability, General Liability and Employee Benefits Liability business providing both claims made and occurrence basis coverages and issued to health care facilities, it being understood that the combination of the Company's primary and umbrella/excess policies issued to any one health care facility shall be considered one policy. It is further understood that the umbrella excess business covered hereunder shall be written in excess of the following primary coverages: - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Page 1 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- a. Professional and General Liability insurance with minimum limits of liability of $1,000,000 as respects each claim or each occurrence (as applicable) and in the aggregate; b. Automobile Liability insurance with minimum limits of liability of $500,000 as respects each accident, combined single limit; c. Employers Liability insurance written under Workers' Compensation and Employers Liability policies with minimum limits of liability of $100,000 as respects each accident bodily injury by accident, $500,000 as respects policy limit bodily injury by disease, and $100,000 as respects each employee bodily injury by disease. in accordance with the Company original policies and subject to the terms, conditions and limitations hereinafter set forth. B. The Company may issue prior acts and extended reporting coverage in accordance with its original policies. Any claim under extended reporting coverage shall be deemed to have been reported on the day the original policy expired or was canceled. Premium, if any, for such extended reporting coverage period shall be considered fully earned by the Reinsurer on the last full day the original policy was in force. ARTICLE II - COMMENCEMENT AND TERMINATION A. This Contract shall become effective on January 1, 1998, with respect to losses occurring under policies allocated to underwriting years commencing on or after that date (or, as respects policies written on a claims made basis, claims made against and/or reported to the Company on or after that date), and shall continue in force thereafter until terminated. B. Either party may terminate this Contract on any December 31 by giving the other party not less than 90 days prior written notice. C. Unless the Company elects that the Reinsurer have no liability for losses arising out of occurrences with dates of loss after the effective date of termination, and so notifies the Reinsurer prior to or as promptly as possible after the effective date of termination, reinsurance hereunder on business in force on the effective date of termination shall remain in full force and effect until expiration, cancellation or next premium anniversary of such business, whichever first occurs, but in no event beyond 12 months following the effective date of termination. D. "Underwriting year" as used herein shall mean the period from January 1, 1998 through December 31, 1998, and each subsequent 12-month period shall be a separate underwriting year. All premiums and losses from policies allocated to an underwriting year shall be credited or charged, respectively, to such underwriting year, regardless of the date said - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- Page 2 - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- premiums earn or such losses occur. It is understood that a policy will be allocated to the underwriting year which is in effect as of: 1. As respects all new policies, the effective date of such policies; 2. As respects renewals of one year or less term policies, the renewal date of such policies; 3. As respects continuous or greater than one year term policies, the premium anniversary date of such policies. Such policies shall remain in the same underwriting year, as originally allocated, until the next renewal date or premium anniversary date, at which time such policies shall be reallocated to the underwriting year in effect as of such date as provided in subparagraphs 2 and 3 above. ARTICLE III - TERRITORY This Contract shall be worldwide in its geographical scope. ARTICLE IV - EXCLUSIONS A. This Contract does not apply to and specifically excludes the following: 1. Reinsurance assumed by the Company under obligatory reinsurance agreements, except agency reinsurance where the policies involved are to be reunderwritten in accordance with the underwriting standards of the Company and reissued as Company policies at the next anniversary or expiration date or reinsurance of "fronting carriers," including Genesis Indemnity Insurance Company, where the policies involved are underwritten, rated and administered by the Company. 2. Business written by the Company above self-insured retentions (SIRs). 3. Nuclear risks as defined in the "Nuclear Incident Exclusion Clause - Liability - Reinsurance" attached to and forming part of this Contract. However, this exclusion shall not apply to nuclear exposures emanating from health care facilities. 4. Liability as a member, subscriber or reinsurer of any pool, syndicate or association. 5. All liability of the Company arising by contract, operation of law, or otherwise, from its participation or membership, whether voluntary or involuntary, in any insolvency fund. "Insolvency fund" includes any guaranty fund, insolvency fund, plan, pool, association, fund or other arrangement, however denominated, established or governed, - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- Page 3 - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- which provides for any assessment of or payment or assumption by the Company of part or all of any claim, debt, charge, fee or other obligation of an insurer, or its successors or assigns, which has been declared by any competent authority to be insolvent, or which is otherwise deemed unable to meet any claims, debt, charge, fee or other obligation in whole or in part. 6. Loss or damage caused by or resulting from war, invasion, hostilities, acts of foreign enemies, civil war, rebellion, insurrection, military or usurped power, or martial law or confiscation by order of any government or public authority, but this exclusion shall not apply to loss or damage covered under a standard policy with a standard War Exclusion Clause. 7. Pollution under any General Liability policy written by the Company which does not contain the pollution exclusion set forth in ISO Commercial General Liability Coverage Form CG 00 01 (Ed. 11/88) or as subsequently amended; however, this exclusion does not apply to any risk located in a jurisdiction which has not approved the Insurance Services Office exclusion or where other regulatory constraints prohibit the Company from implementing such exclusion. If the Company elects to implement an exclusion different from that of ISO, such exclusion will be deemed a suitable substitute provided the Company has submitted the wording to the Reinsurers and received the Reinsurers' prior approval. 8. Business written on a co-indemnity basis. 9. Directors and Officers liability and managed care liability. 10. Any business obtained through Company merger or acquisition unless submitted to the Reinsurer for special acceptance and accepted by the Reinsurer. B. Business falling within the scope of one or more of the exclusions set forth in paragraph A may be submitted to the Reinsurer for special acceptance and, if accepted by the Reinsurer, shall be subject to all the terms of this Contract except as modified by the special acceptance. ARTICLE V - RETENTION AND LIMIT A. COVERAGE A: The Company shall retain and be liable for the first $750,000 of ultimate net loss as respects each insured, each occurrence. The Reinsurer shall then be liable for the amount by which such ultimate net loss exceeds the Company's retention, but the liability of the Reinsurer shall not exceed $1,250,000 as respects each insured, each occurrence. B. COVERAGE B: The Company shall retain and be liable for the first amount of ultimate net loss as follows: - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- Page 4 - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- 1. As respects policies with primary limits of $2,000,000 each occurrence and $4,000,000 in the aggregate, $2,000,000 each insured, each occurrence and $4,000,000 in the aggregate; 2. As respects policies with primary limits of $2,000,000 each occurrence and in the aggregate, $2,000,000 each insured, each occurrence and in the aggregate. The Reinsurer shall then be liable for the amount by which such ultimate net loss exceeds the Company's retention, but the liability of the Reinsurer shall not exceed $10,000,000 as respects each insured, each occurrence and in the aggregate, where applicable. C. COVERAGE C: The Company shall retain and be liable for the first $1,125,000 of ultimate net loss arising out of each loss event. The Reinsurer shall then be liable for the amount by which such ultimate net loss exceeds the Company's retention, but the liability of the Reinsurer shall not exceed $5,000,000 as respects any one loss event. It is understood that recoveries under individual facultative reinsurance and under Coverages A and B of this Article shall inure to the benefit of Coverage C. D. COVERAGE D: The Company shall retain and be liable for the first $750,000 of the following as respects any one loss event: 1. The Company's initial retention of ultimate net loss under Coverage A above; and then 2. Any loss in excess of policy limits and/or extra contractual obligations (as defined in Article VI). The Reinsurer shall then be liable for the amount of loss in excess of policy limits and/or extra contractual obligations which exceeds the Company's retention, but the liability of the Reinsurer shall not exceed $5,000,000 as respects loss in excess of policy limits and/or extra contractual obligations arising out of any one loss event. E. As respects Coverages C and D, the maximum amount recoverable on a combined basis shall be $5,000,000 as respects any one loss event. ARTICLE VI - DEFINITIONS A. "Ultimate net loss" as used herein is defined as the sum or sums (including deductibles of $250,000 or less paid by the Company or the insured and any loss adjustment expense, as hereinafter defined, which reduces the Company's limit of liability under the policy involved) paid or payable by the Company in settlement of claims and in satisfaction of judgments rendered on account of such claims, after deduction of all salvage, all recoveries and all claims on inuring insurance or reinsurance, whether collectible or not. Nothing - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- Page 5 - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- herein shall be construed to mean that losses under this Contract are not recoverable until the Company's ultimate net loss has been ascertained. B. "Loss in excess of policy limits" and "extra contractual obligations" as used herein shall be defined as follows: 1. "Loss in excess of policy limits" shall mean 90.0% of any amount paid or payable by the Company in excess of its policy limits, but otherwise within the terms of its policy, as a result of an action against it by its insured or its insured's assignee to recover damages the insured is legally obligated to pay to a third party claimant because of the Company's alleged or actual negligence or bad faith in rejecting a settlement within policy limits, or in discharging its duty to defend or prepare the defense in the trial of an action against its insured, or in discharging its duty to prepare or prosecute an appeal consequent upon such an action. 2. "Extra contractual obligations" shall mean 90.0% of any punitive, exemplary, compensatory or consequential damages, other than loss in excess of policy limits, paid or payable by the Company as a result of an action against it by its insured, its insured's assignee or a third party claimant, which action alleges negligence or bad faith on the part of the Company in handling a claim under a policy subject to this Contract. An extra contractual obligation shall be deemed to have occurred on the same date as the loss covered or alleged to be covered under the policy. Notwithstanding anything stated herein, this Contract shall not apply to any loss in excess of policy limits or any extra contractual obligation incurred by the Company as a result of any fraudulent and/or criminal act by any officer or director or employee of the Company acting individually or collectively or in collusion with any individual or corporation or any other organization or party involved in the presentation, defense or settlement of any claim covered hereunder. C. "Insured" as used herein shall mean any party or parties provided with a separate policy limit by the Company. D. "Occurrence" shall have the same meaning as the term occurrence, claim, medical incident, wrongful act or such similar term, as applicable, under the Company's policy forms. E. The term "Event" shall mean each accident, occurrence, medical incident, wrongful act or series of accidents, occurrences, medical incidents or wrongful acts arising out of one event, whether involving one or several of the Company's policies or insureds. All bodily injury or property damage arising out of continuous or repeated exposure to substantially the same general conditions shall be considered as arising out of one event, whether involving one or several of the Company's policies or insureds. The date of event shall be deemed to be the following: - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- Page 6 - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- 1. As respects a loss involving one or more coverages written on an occurrence basis, the date on which bodily injury or property damage occurs. 2. As respects a loss involving one or more coverages written on a claims-made basis, the date when the claim is first made in accordance with the policy terms, and any related claims reported subsequent to such date shall be included in such loss. However, if the claim is first made during an extended reporting period, the date of Event shall be deemed to be the last day of the policy period. 3. As respects a loss involving one or more coverages written on an occurrence basis and one or more coverages written on a claims-made basis, the date on which bodily injury or property damage occurs, and any related claims reported subsequent to such date shall be included in such loss whether they are covered under occurrence or claims-made policies. F. "Loss adjustment expense" as used herein shall mean expenses assignable to the appraisal, adjustment, settlement, litigation, investigation, defense and/or appeal of specific claims, regardless of how such expenses are classified for statutory reporting purposes. Loss adjustment expense shall include, but not be limited to interest on judgments, legal expenses, costs incurred in connection with coverage questions and legal actions connected thereto and declaratory judgment expense, as outlined below, but shall not include other salaries and expenses of the Company's employees or office and normal overhead expenses. G. "Declaratory judgment expense" as used herein shall mean all court costs, attorney's fees and expense incurred by the Company during the underwriting year in contesting insurance coverage on policies reinsured hereunder and shall be further limited as follows: 1. Expenses associated with unsuccessful actions shall constitute loss adjustment expense; 2. Expenses associated with successful or compromised actions shall be recoverable at 80.0%, and shall be subject to a $75,000 deductible per action, which shall be retained by the Company. Declaratory judgment expenses shall be deemed to have occurred on the same date as the loss covered or alleged to be covered under the policy. It is understood and agreed the maximum reinsurance recovery, as respects all declaratory judgment expense arising out of all business reinsured hereunder, shall be limited to $1,000,000 for each underwriting year. ARTICLE VII - CLAIMS AND LOSS ADJUSTMENT EXPENSE A. Whenever a claim is reserved by the Company for an amount greater than 66.0% of its retention hereunder and/or whenever a claim appears likely to result in a claim under this - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- Page 7 - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- Contract, the Company shall notify the Reinsurer. All cases of serious injury which, regardless of considerations of liability or coverage, might result in a claim under this Contract, shall be reported to the Reinsurer, including but not limited to the following: 1. Brain injury with significant cognitive, behavioral or physical residual damages; 2. Quadriplegia or paraplegia including Cauda Equina Syndrome; 3. Fatalities or significantly diminished life expectancy of wage earners or women with minor children; 4. Significant burns (i.e., third degree burns over 33.0% of body surface area or second degree burns over 66.0% of body surface area), including over-exposure to radiation; 5. Any other serious injury which, in the judgment of the Company, might involve the Reinsurer; 6. Any action alleging extra contractual obligations against the Company; 7. Any declaratory judgment action brought by or against the Company. The Company will provide quarterly updates on reported claims to the Reinsurer in bordereau format. The Reinsurer shall have the right to participate, at its own expense, in the defense or control of any claim or suit or proceeding involving this reinsurance. B. All claim settlements made by the Company, provided they are within the terms of this Contract, shall be binding upon the Reinsurer, and the Reinsurer agrees to pay all amounts for which it may be liable immediately upon receipt of reasonable evidence of the amount paid by the Company. C. In the event of loss hereunder, loss adjustment expense incurred by the Company in connection therewith which does not reduce the Company's limit of liability under the policy involved shall be shared by the Company and the Reinsurer in the proportion the ultimate net loss paid or payable by the Reinsurer bears to the total loss paid or payable by the Company, prior to any reinsurance recoveries, but after deduction of all salvage, subrogation and other recoveries. However, if a verdict or judgment is reduced by any process other than by the trial court, resulting in an ultimate saving to the Reinsurer, or a judgment is reversed outright, the expenses incurred in securing such reduction or reversal shall be shared by the Company and the Reinsurer in the proportion that each benefits from such reduction or reversal, and the expenses incurred up to the time of the original verdict or judgment shall be shared in proportion to each party's interest in such original verdict or judgment. The Reinsurer's liability for such loss adjustment expense shall be in addition to its liability for ultimate net loss. - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- Page 8 - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- ARTICLE VIII - SUBROGATION The Reinsurer shall be credited with recoveries from subrogation (i.e., reimbursement obtained or recovery made by the Company, less the actual cost, excluding salaries of officials and employees of the Company and sums paid to attorneys as retainer, of obtaining such reimbursement or making such recovery) on account of claims and settlements involving reinsurance hereunder. Recoveries therefrom shall always be used to reimburse the excess carriers in the reverse order of their priority according to their participation before being used in any way to reimburse the Company for its primary loss. The Company hereby agrees to enforce its rights to subrogation relating to any loss, a part of which loss was sustained by the Reinsurer, and to prosecute all claims arising out of such rights. ARTICLE IX - REINSURANCE PREMIUM A. COVERAGE A As premium for the reinsurance provided hereunder during each underwriting year, the Company shall pay the Reinsurer a provisional and deposit premium of $2,800,000 for the underwriting year in four equal installments of $700,000 on March 31, June 30, September 30 and December 31 of each underwriting year. B. COVERAGE B 1. As premium for the reinsurance provided hereunder during each underwriting year, the Company shall pay the Reinsurer the percentage of its excess limits earned premium set forth in Schedule A, subject to the minimum premiums, net of ceding commission, for health care facilities set forth below: a. As respects hospitals with at least 100 occupied beds, $2,000 per $1,000,000 of policy limit; b. As respects hospitals with less than 100 occupied beds, $1,500 per $1,000,000 of policy limit; c. As respects non-hospital health care exposures, $1,500 per $1,000,000 of policy limit; d. As respects nursing homes or long-term care facilities, $1,000 per $1,000,000 of policy limit. 2. The Company shall pay the Reinsurer a provisional and deposit premium of $600,000 for the underwriting year in four equal installments of $150,000 on March 31, June 30, September 30 and December 31 of each underwriting year. - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- Page 9 - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- 3. As soon as possible after the end of each underwriting year, the Company shall report its excess limits earned premium for the underwriting year. Any additional premium due the Reinsurer, at the rate shown in subparagraph 1 of paragraph B, shall be paid by the Company with its report, and any return premium due the Company shall be remitted promptly. C. COVERAGES C AND D 1. As premium for the reinsurance provided hereunder during each underwriting year, the Company shall pay the Reinsurer 0.7% of its net earned premium applicable to all subject business for the underwriting year. 2. The Company shall pay the Reinsurer a deposit premium of $294,000 in four equal installments of $73,500 on March 31, June 30, September 30 and December 31 of each underwriting year. 3. As soon as possible after the end of each underwriting year, the Company shall provide a report to the Reinsurer setting forth the premium due hereunder for the underwriting year, computed in accordance with subparagraph 1 of paragraph C, and any additional premium due the Reinsurer or return premium due the Company shall be remitted promptly. 4. "Net earned premium" as used in this paragraph C is defined as all gross earned premium of the Company for the classes of business reinsured hereunder, less the earned portion of premiums ceded by the Company for facultative reinsurance which inures to the benefit of these Coverages C and D. Net earned premium shall include such premium for extended reporting periods, which shall be considered fully earned by the Company on the last day of the policy period. ARTICLE X - COMMISSION - COVERAGE B A. As respects Coverage B business only, the Reinsurer shall allow the Company a 25% commission on all premiums ceded to the Reinsurer hereunder. The Company shall allow the Reinsurer return commission on return premiums at the same rate. B. It is expressly agreed that the ceding commission allowed the Company includes provision for all dividends, commissions, taxes, assessments, and all other expenses of whatever nature, except loss adjustment expense. ARTICLE XI - PREMIUM ADJUSTMENT - COVERAGE A A. As respects Coverage A business only, the provisional and deposit premium paid by the Company shall be adjusted periodically in accordance with the provisions set forth herein. - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- Page 10 - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- The first adjustment period shall be from the effective date of this Contract through December 31, 2000, and each subsequent 36-month period shall be a separate adjustment period. However, if this Contract is terminated, the final adjustment period shall be from the beginning of the then current adjustment period through the date of termination. B. The adjusted premium for each adjustment period shall be equal to the Reinsurer's losses incurred for the adjustment period, plus 1.27% of the Company's net earned premium for the same adjustment period, but the adjusted premium shall not exceed an amount equal to 9.21% of the Company's net earned premium for the adjustment period, nor be less than 1.27% of the Company's net earned premium for the adjustment period. C. Within 45 days after 24 months following the beginning of each underwriting year within each adjustment period, the Company shall calculate and report the adjusted premium for the period from the beginning of the then current adjustment period through the underwriting year under consideration, based on the Reinsurer's losses incurred and the Company's net earned premium for the adjustment period as of the date of the calculation. If the adjusted premium exceeds the reinsurance premiums previously paid for the same period, the Company shall remit the difference to the Reinsurer with its report. If the adjusted premium is less than reinsurance premiums previously paid for the adjustment period, the Reinsurer shall remit the difference to the Company as promptly as possible after receipt and verification of the Company's report. D. The Company shall calculate and report the adjusted premium for each adjustment period within 45 days after 12 months following the end of the adjustment period, and within 45 days after the end of each 12-month period thereafter until all losses under policies with effective or renewal dates during the adjustment period have been finally settled. If the adjusted premium exceeds the reinsurance premiums previously paid for the adjustment period, the Company shall remit the difference to the Reinsurer with its report. If the adjusted premium is less than reinsurance premiums previously paid for the adjustment period, the Reinsurer shall remit the difference to the Company as promptly as possible after receipt and verification of the Company's report. E. "Net Earned Premium" as used in this Article is defined as the gross earned premium of the Company for primary policy limits of $2,000,000 or less for the classes of business reinsured hereunder, including policies with effective or renewal dates during the adjustment period, as set forth in the Company's report entitled "Subject Premium by Limit," less the earned portion of premiums ceded by the Company for reinsurance which inures to the benefit of this Coverage A, if any. Net earned premium shall include such premium for extended reporting periods, which shall be considered fully earned by the Company on the last day of the policy period. F. "Losses incurred" as used herein shall mean losses and loss adjustment expense paid by the Reinsurer as of the effective date of calculation, plus the ceded reserves for losses and loss adjustment expense outstanding as of the same date, it being understood and agreed that all losses under policies with effective or renewal dates during an adjustment period shall be - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- Page 11 - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- charged to that adjustment period, regardless of the date said losses actually occur, unless this Contract is terminated on a "cutoff" basis, in which event the Reinsurer shall have no liability for losses occurring after the effective date of termination. ARTICLE XII - OFFSET The Company and the Reinsurer shall have the right to offset any balance or amounts due from one party to the other under the terms of this Contract or any other contract heretofore or hereafter entered into between the Company, whether acting as assuming reinsurer or ceding company. The party asserting the right of offset may exercise such right any time whether the balances due are on account of premiums or losses or otherwise. ARTICLE XIII - ACCESS TO RECORDS The Reinsurer or its designated representatives shall have access at any reasonable time to all records of the Company which pertain in any way to this reinsurance. ARTICLE XIV - NET RETAINED LINES A. This Contract applies only to that portion of any policy which the Company retains net for its own account, and in calculating the amount of any loss hereunder and also in computing the amount or amounts in excess of which this Contract attaches, only loss or losses in respect of that portion of any policy which the Company retains net for its own account shall be included. B. The amount of the Reinsurer's liability hereunder in respect of any loss or losses shall not be increased by reason of the inability of the Company to collect from any other reinsurer(s), whether specific or general, any amounts which may have become due from such reinsurer(s), whether such inability arises from the insolvency of such other reinsurer(s) or otherwise. ARTICLE XV - ERRORS AND OMISSIONS Inadvertent delays, errors or omissions made in connection with this Contract or any transaction hereunder shall not relieve either party from any liability which would have attached had such delay, error or omission not occurred, provided always that such error or omission is rectified as soon as possible after discovery. - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- Page 12 - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- ARTICLE XVI - CURRENCY A. Whenever the word "Dollars" or the "$" sign appears in this Contract, they shall be construed to mean United States Dollars and all transactions under this Contract shall be in United States Dollars. B. Amounts paid or received by the Company in any other currency shall be converted to United States Dollars at the rate of exchange at the date such transaction is entered on the books of the Company. ARTICLE XVII - TAXES In consideration of the terms under which this Contract is issued, the Company will not claim a deduction in respect of the premium hereon when making tax returns, other than income or profits tax returns, to any state or territory of the United States of America or the District of Columbia. ARTICLE XVIII - FEDERAL EXCISE TAX (Applicable to those reinsurers, excepting Underwriters at Lloyd's London and other reinsurers exempt from Federal Excise Tax, who are domiciled outside the United States of America.) A. The Reinsurer has agreed to allow for the purpose of paying the Federal Excise Tax the applicable percentage of the premium payable hereon as imposed under Section 4371 of the Internal Revenue Code to the extent such premium is subject to the Federal Excise Tax. B. In the event of any return of premium becoming due hereunder the Reinsurer will deduct the applicable percentage from the return premium payable hereon and the Company or its agent should take steps to recover the tax from the United States Government. ARTICLE XIX - INSOLVENCY A. In the event of the insolvency of the Company, this reinsurance shall be payable directly to the Company or to its liquidator, receiver, conservator or statutory successor immediately upon demand, with reasonable provision for verification, on the basis of the liability of the Company without diminution because of the insolvency of the Company or because the liquidator, receiver, conservator or statutory successor of the Company has failed to pay all or a portion of any claim. It is agreed, however, that the liquidator, receiver, conservator or statutory successor of the Company shall give written notice to the Reinsurer of the pendency of a claim against the Company indicating the policy or bond reinsured which claim would involve a possible liability on the part of the Reinsurer within a reasonable time after such claim is filed in the conservation or liquidation proceeding or in the receivership, - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- Page 13 - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- and that during the pendency of such claim, the Reinsurer may investigate such claim and interpose, at its own expense, in the proceeding where such claim is to be adjudicated, any defense or defenses that it may deem available to the Company or its liquidator, receiver, conservator or statutory successor. The expense thus incurred by the Reinsurer shall be chargeable, subject to the approval of the Court, against the Company as part of the expense of conservation or liquidation to the extent of a pro rata share of the benefit which may accrue to the Company solely as a result of the defense undertaken by the Reinsurer. B. Where two or more reinsurers are involved in the same claim and a majority in interest elect to interpose defense to such claim, the expense shall be apportioned in accordance with the terms of this Contract as though such expense had been incurred by the Company. C. It is further understood and agreed that, in the event of the insolvency of the Company, the reinsurance under this Contract shall be payable directly by the Reinsurer to the Company or to its liquidator, receiver or statutory successor, except as provided by Section 4118(a) of the New York Insurance Law or except (1) where this Contract specifically provides another payee of such reinsurance in the event of the insolvency of the Company or (2) where the Reinsurer with the consent of the direct insured or insureds has assumed such policy obligations of the Company as direct obligations of the Reinsurer to the payees under such policies and in substitution for the obligations of the Company to such payees. ARTICLE XX - ARBITRATION (BRMA 6M) A. As a condition precedent to any right of action hereunder, any dispute arising out of the interpretation, performance or breach of this Contract, including the formation or validity thereof, shall be submitted for decision to a panel of three arbitrators. Notice requesting arbitration will be in writing and sent certified or registered mail, return receipt requested. B. One arbitrator shall be chosen by each party and the two arbitrators shall, before instituting the hearing, choose an impartial third arbitrator who shall preside at the hearing. If either party fails to appoint its arbitrator within 30 days after being requested to do so by the other party, the latter, after 30 days notice by certified or registered mail of its intention to do so, may appoint the second arbitrator. C. If the two arbitrators are unable to agree upon the third arbitrator within 30 days of their appointment, the third arbitrator shall be selected from a list of six individuals (three named by each arbitrator) by a judge of the federal district court having jurisdiction over the geographical area in which the arbitration is to take place, or if the federal court declines to act, the state court having general jurisdiction in such area. D. All arbitrators shall be disinterested active or former executive officers of insurance or reinsurance companies or Underwriters at Lloyd's, London. - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- Page 14 - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- E. Within 30 days after notice of appointment of all arbitrators, the panel shall meet and determine timely periods for briefs, discovery procedures and schedules for hearings. F. The panel shall be relieved of all judicial formality and shall not be bound by the strict rules of procedure and evidence. Unless the panel agrees otherwise, arbitration shall take place in Minneapolis, Minnesota, but the venue may be changed when deemed by the panel to be in the best interest of the arbitration proceeding. Insofar as the arbitration panel looks to substantive law, it shall consider the law of the State of Minnesota. The decision of any two arbitrators when rendered in writing shall be final and binding. The panel is empowered to grant interim relief as it may deem appropriate. G. The panel shall make its decision considering the custom and practice of the applicable insurance and reinsurance business as promptly as possible following the termination of the hearings. Judgment upon the award may be entered in any court having jurisdiction thereof. H. Each party shall bear the expense of its own arbitrator and shall jointly and equally bear with the other party the cost of the third arbitrator. The remaining costs of the arbitration shall be allocated by the panel. The panel may, at its discretion, award such further costs and expenses as it considers appropriate, including but not limited to attorneys fees, to the extent permitted by law. ARTICLE XXI - SERVICE OF SUIT (Applicable if the Reinsurer is not domiciled in the United States of America, and/or is not authorized in any State, Territory or District of the United States where authorization is required by insurance regulatory authorities) A. It is agreed that in the event the Reinsurer fails to pay any amount claimed to be due hereunder, the Reinsurer, at the request of the Company, will submit to the jurisdiction of a court of competent jurisdiction within the United States. Nothing in this Article constitutes or should be understood to constitute a waiver of the Reinsurer's rights to commence an action in any court of competent jurisdiction in the United States, to remove an action to a United States District Court, or to seek a transfer of a case to another court as permitted by the laws of the United States or of any state in the United States. B. Further, pursuant to any statute of any state, territory or district of the United States which makes provision therefor, the Reinsurer hereby designates the party named in its Interests and Liabilities Agreement, or if no party is named therein, the Superintendent, Commissioner or Director of Insurance or other officer specified for that purpose in the statute, or his successor or successors in office, as its true and lawful attorney upon whom may be served any lawful process in any action, suit or proceeding instituted by or on behalf of the Company or any beneficiary hereunder arising out of this Contract. - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- Page 15 - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- TABLE OF CONTENTS
ARTICLE PAGE I Classes of Business Reinsured 1 II Commencement and Termination 2 III Territory 3 IV Exclusions 3 V Retention and Limit 4 VI Definitions 5 VII Claims and Loss Adjustment Expense 8 VIII Subrogation 9 IX Reinsurance Premium 9 X Commission - Coverage B 10 XI Premium Adjustment - Coverage A 11 XII Offset 12 XIII Access to Records 12 XIV Net Retained Lines 12 XV Errors and Omissions 12 XVI Currency 13 XVII Taxes 13 XVIII Federal Excise Tax 13 XIX Insolvency 13 XX Arbitration (BRMA 6M) 14 XXI Service of Suit 15 Schedule A
- ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- SCHEDULE A MEDICAL PROFESSIONAL LIABILITY EXCESS OF LOSS REINSURANCE CONTRACT EFFECTIVE: JANUARY 1, 1998 issued to Midwest Medical Insurance Company Minneapolis, Minnesota
COVERAGE PERCENTAGE OF BY LAYER PRECEDING $1,000,000 PREMIUM $1,000,000 excess of 50.0% $2,000,000 $1,000,000 excess of 55.0% $3,000,000 $1,000,000 excess of 60.0% $4,000,000 $1,000,000 excess of 65.0% $5,000,000 $1,000,000 excess of 70.0% $6,000,000 $1,000,000 excess of 70.0% $7,000,000 $1,000,000 excess of 70.0% $8,000,000 $1,000,000 excess of 70.0% $9,000,000 $1,000,000 excess of 70.0% $10,000,000 $1,000,000 excess of 70.0% $11,000,000
- ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- GENERAL LIABILITY POLLUTION EXCLUSION APPENDIX In accordance with the provisions of Article IV - Exclusions, this exclusion applies: 1. To bodily injury or property damage arising out of the actual, alleged or threatened discharge, dispersal, release or escape of pollutants: a. at or from premises owned, rented or occupied by a named insured; b. at or from any site or location used by or for a named insured or others for the handling, storage, disposal, processing or treatment of waste; c. which are at any time transported, handled, stored, treated, disposed of, or processed as waste by or for a named insured or any person or organization for whom a named insured may be legally responsible; or d. at or from any site or location on which a named insured or any contractors or subcontractors working directly or indirectly on behalf of a named insured are performing operations; i. if the pollutants are brought on or to the site or location in connection with such operations; or ii. if the operations are to test for, monitor, clean up, remove, contain, treat, detoxify, or neutralize the pollutants. 2. To any loss, cost or expense arising out of any governmental direction or request that a named insured test for, monitor, clean up, remove, contain, treat, detoxify or neutralize pollutants. Pollutants means any solid, liquid, gaseous or thermal irritant or contaminant, including smoke, vapor, soot, fumes, acids, alkalis, chemicals and waste. Waste includes materials to be recycled, reconditioned or reclaimed. Subparagraphs (a) and (d)(i) of paragraph (1) do not apply to bodily injury or property damage caused by heat, smoke or fumes from a hostile fire. As used in this exclusion, a hostile fire means one which becomes uncontrollable or breaks out from where it was intended to be. - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- MEDICAL PROFESSIONAL LIABILITY EXCESS OF LOSS REINSURANCE CONTRACT EFFECTIVE: JANUARY 1, 1998 issued to Midwest Medical Insurance Company Minneapolis, Minnesota - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- EX-10.G 3 EXHIBIT 10G. EXHIBIT 10G. 1998 OFFICERS SHORT-TERM INCENTIVE PLAN MIDWEST MEDICAL INSURANCE COMPANY 1998 SHORT TERM INCENTIVE PLACE DESIGN 1. PLAN PARTICIPANTS - President - Senior Vice President - Vice President 2. PERFORMANCE MEASURES AND WEIGHTINGS - Combined Ratio 50% - Retention 20% - Growth 20% - Budget 10% 3. PLAN TRIGGER - The Threshold for Combined Ratio must be attained for the plan to activate and awards to be made under any performance measure. 4. PARTICIPATION LEVELS - Tier I - President - Tier II - Senior Vice President - Tier III - Vice President 5. GOAL/TARGET AWARDS (% OF BASE SALARY) - Tier I 35% - Tier II 30% - Tier III 25% 6. AWARD CALCULATIONS - Each performance measure is set up with a series of "cliffs". - Performance between "cliffs" would result in an award based on the lower "cliff". - Performance below Threshold will result in no award being made. - Performance beyond Maximum will not increase the award. AWARD SUMMARY *
Threshold Goal Maximum --------- ---- ------- Tier I 15.75% 35.00% 50.75% Tier II 13.50% 30.00% 43.50% Tier III 11.25% 25.00% 36.25%
* Assumes all performance measures are Threshold, Goal, Maximum. "Budget" counted only on Goal and Maximum. 2 PLAN ADMINISTRATION 1. PURPOSE The primary purpose of the Midwest Medical Insurance Holding Company Short Term Incentive Plan is to provide a means whereby key executives may be rewarded according to their impact on, and contribution to, the operating success of the organization. 2. DEFINITIONS "Base Salary" is the Plan Participant's salary in effect as of the end of the Plan Year. "Threshold" is the minimum level of performance required to generate an award. Performance below Threshold will result in no award being granted. "Goal" is the level of performance that reflects 100% attainment of the performance measure, thus triggering a target (or 100%) award. "Maximum" is the level of performance resulting in the maximum award available under the Plan being granted. Performance beyond Maximum will not increase the award. "Combined Ratio" is defined as a ratio which signifies the impact of all aspects of the Company's operation, premiums, losses, expenses, etc. The Threshold for Combined Ratio must be attained for the Plan to activate and awards to be made under any performance measure. "Retention" refers to the number of policy renewals retained subsequent to January 1, 1999. "Growth" refers to the number of new policyholders from new accounts generated during fiscal 1998. "Budget" is the 1998 MMIHC Corporate Operating Expense Budget. "Committee" refers to the Compensation Committee of the Board of Directors. 3. PLAN ADMINISTRATOR The Plan Administrator will be the Chairman of the Committee. The actions of the Plan Administrator are subject to the approval of the Committee, as appropriate. 4. PLAN ADMINISTRATION The Plan Administrator will be responsible for all matters relative to the effective administration of the Plan, including its interpretation, and resolution of issues where the Plan is silent. The Plan Administrator's actions in all material matters will be subject to the Committee's review. 5. PLAN PARTICIPATION Participation in the Plan is at the discretion of the Plan Administrator. Participation in any one year does not guarantee participation in future years or participation at the same Tier (or award level). 3 6. AWARD LEVELS Award Levels under the Plan are specified under the Plan Design section. 7. EFFECTIVE DATE The effective date of the Plan is January 1, 1998. 8. PLAN YEAR The Plan Year is the Company's fiscal year. 9. TERMINATION OF EMPLOYMENT A Participant who terminates their employment or whose employment is terminated by the Company forfeits all rights under the Plan. 10. DEATH, DISABILITY, RETIREMENT In the event of death, permanent disability, or retirement, a prorated award will be made based on the active time in the Plan and the level of performance attained. The Plan Administrator may use discretion in determining awards under these circumstances. 11. EMPLOYMENT The Plan is not an employment contract, nor is there any intent to confer a right to employment to a Plan Participant. The Plan does not, in any way, restrict the Company's right to terminate a Participant's employment. 12. AMENDMENT OF THE PLAN The Plan Administrator is free to amend the Plan at any time, subject to the approval of the Committee, concerning material matters. If the amendment materially impacts the interests of the Participant, they will be notified as soon as possible. 13. TERMINATION OF THE PLAN The Plan Administrator, with the approval of the Committee, is free to terminate the Plan at any time. Under these circumstances, a prorated award will be made. The basis for the level of performance attained at the time of termination. 14. RIGHTS OF THE PARTICIPANT Plan Participants have no rights under the Plan that may be pledged, borrowed against, or sold. 4 MMIC COMBINED RATIO Goal based upon actual amounts in the 1998 Business Plan approved by Board November 12, 1997. The goal combined ratio excludes retrospective premium credits and any premium adjustments from the IA or NE merger from the calculation. (see attached)
Performance Award Goal Level Level ---- ----------- ----- Maximum 97.9 85% 150% 106.6 92.5 125 Goal/Target 115.2 100. 100 123.8 107.5 75 Threshold 132.5 115. 50
(Plan trigger - This threshold combined ratio must be attained to receive any award under the entire plan)
COMBINED RATIO TARGET AWARD --------------------------- Tier I 17.50% of salary II 15.00 of salary III 12.50 of salary
5 MMIC COMBINED RATIO EXPLANATION (in thousands of $)
1998 Combined 1998 Combined Budget Ratio Modified Ratio ------ -------- -------- -------- Direct Premium Earned 45,000 45,000 Retro & IA Merger Refund (3,900) --- Reinsurance Ceded - Current Year (6,500) (6,500) Reinsurance Ceded - Prior Year 600 600 ------ ----- Net Earned Premium 35,200 39,100 ------ ------ Loss & ALAE Incurred 32,980 32,980 ULAE Incurred 5,669 5,669 Underwriting Expense Incurred 6,399 6,399 ----- ----- Total Expenses 45,048 128.0 45,048 115.2 ------ ------ --- (5,948) Retro & IA Merger Refund --- (3,900) ------- Net Underwriting (loss) (9,848) (9,848) ------ ------ ------ ------
Finance Charges ($756) included with Direct Premium. 6 RETENTION Percentage of December 31, 1998 Physician Policies in force which are available for renewal and are retained at the January 1, 1999 renewal. January 1, 1999 retirements and those not offered a renewal policy for Underwriting reasons are not available for renewal.
Performance Award Goal Level Level ---- ----------- ----- Maximum 99.75% 105% 150% 97.38 102.5 125 Goal/Target 95.0 100. 100 92.63 97.5 75 Threshold 90.25 95. 50
RETENTION TARGET AWARD ---------------------- Tier I 7% of salary II 6 of salary III 5 of salary
7 GROWTH 1998 New Business premium written for all lines of business, physician, hospital, SIR, etc. Excludes new adds to existing accounts.
Performance Award Goal Level Level ---- ---------- ----- Maximum $3,170M 125% 150% 2,853M 112.5 125 Goal/Target 2,536M 100. 100 2,219M 87.5 75 Threshold 1,902M 75. 50
GROWTH TARGET AWARD ------------------- Tier I 7% of salary II 6 of salary III 5 of salary
8 BUDGET Attain 1998 MMIHC budget as approved in the 1998 Business Plan.
Performance Award Goal Level Level ---- ----------- ----- $10,522M 95-105% 100%
(Performance outside of this range results in no award) BUDGET TARGET AWARD ------------------- Tier I 3.5% of salary II 3.0 of salary III 2.5 of salary
9 EX-21 4 EXHIBIT 21 Midwest Medical Insurance Holding Company and Subsidiaries (Parent Company) Exhibit 21--Subsidiaries of the Registrant
PERCENT STATE OF ENTITY DESCRIPTION OWNED FEIN INCORPORATION - ---------------------------------------------------------------------------------------------------------------------------- Midwest Medical Insurance Holding Company Registrant n/a 41-1625287 Minnesota Midwest Medical Insurance Company Tier 1 Subsidiary 100% 41-1625288 Minnesota MMIHC Insurance Services, Inc. Tier 1 Subsidiary 100% 41-1819825 Minnesota Midwest Medical Solutions, Inc. Tier 1 Subsidiary 100% 41-1896304 Minnesota MedPower Information Resources, Inc. Tier 2 Subsidiary 100% 41-1895576 Minnesota
EX-24 5 EXHIBIT 24 Midwest Medical Insurance Holding Company and Subsidiaries EXHIBIT 24--POWERS OF ATTORNEY I, __________________________________, do hereby constitute and appoint David P. Bounk and Niles A. Cole, or either of them, my attorneys in fact for the purposes of signing in my name and on my behalf as a Director of Midwest Medical Insurance Holding Company, the filing of the annual 10K Form which provides additional information as required by the SEC. Dated: January_____, 1999 ____________________________________________ 1 Midwest Medical Insurance Holding Company and Subsidiaries EXHIBIT 24--POWERS OF ATTORNEY I, ________________________________, do hereby constitute and appoint David P. Bounk, my attorney in fact for the purposes of signing in my name and on my behalf as Director of Midwest Medical Insurance Holding Company, a registration statement on Form S-1 for the registration under the Securities Act of 1933, as amended, of Class A common stock of the Company, par value of $.01 per share, and any and all amendments to said registration statement, and to deliver on my behalf said registration statement and any and all amendments thereto, as each thereof is so signed, for filing with the Securities and Exchange Commission. Dated: April _____, 1999 ________________________________________________ 2 EX-27 6 EX27
7 1,000 YEAR DEC-31-1998 JAN-01-1998 DEC-31-1998 164,652 0 0 86,553 0 0 261,205 4,205 16,499 0 295,483 110,964 8,173 0 0 0 0 0 8,147 142,446 295,483 35,014 10,919 8,949 1,536 37,494 0 6,698 8,637 2,689 5,948 0 0 0 5,948 48.36 43.65 89,394 41,927 (4,433) 3,666 28,755 94,467 4,433
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