-----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, Lba8dmvcojlD3T3ziWpZUlVXfulASWSSbOXEWKg185t2y+pfc10+AaKrTMfbqDjj k+K2JdB933pMmAIx480LuA== 0000950144-99-003680.txt : 19990402 0000950144-99-003680.hdr.sgml : 19990402 ACCESSION NUMBER: 0000950144-99-003680 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990331 FILER: COMPANY DATA: COMPANY CONFORMED NAME: MEDICAL ASSURANCE INC CENTRAL INDEX KEY: 0000944492 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 630720042 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-12129 FILM NUMBER: 99580596 BUSINESS ADDRESS: STREET 1: P O BOX 590009 CITY: BIRMINGHAM STATE: AL ZIP: 35259 BUSINESS PHONE: 2058774400 MAIL ADDRESS: STREET 1: P O BOX 590009 CITY: BIRMINGHAM STATE: AL ZIP: 35259 10-K 1 MEDICAL ASSURANCE INC 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K (Mark One) X Annual report pursuant to section 13 or 15(d) of the Securities - --- Exchange Act of 1934 for the fiscal year ended December 31 1998, or Transition report pursuant to section 13 or 15(d) of the Securities - --- Exchange Act of 1934 for the transition period from to ------- -------. Commission file number: 001-12129 Medical Assurance, Inc. ------------------------------------------------------ (Exact name of registrant as specified in its charter) Delaware 63-1137505 ---------------------- ------------------- (State of incorporation (I.R.S. Employer or organization) Identification No.) 100 Brookwood Place, Birmingham, AL 35209 - ------------------------------------------------------- (Address of principal executive offices) (Zip Code) Securities registered pursuant to Section 12(b) of the Act: Common Stock, par value $1.00 per share Securities registered pursuant to Section 12(g) of the Act: None. 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 period 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 is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of voting stock held by non-affiliates of the registrant at March 19, 1999 was $566,643,017. As of March 19, 1999, the registrant had outstanding approximately 23,213,156 shares of its common stock. Exhibit Index at page 56 Page 1 of 63 Pages 2 Documents incorporated by reference in this Form 10-K: (i) The Registration Statement on Form S-1 with respect to the common stock of Mutual Assurance, Inc. (Commission File No. 33-35223) is incorporated by reference into Part IV of this report. (ii) The MAIC Holdings, Inc. Annual Report on Form 10-K for the fiscal year ended December 31, 1995 (Commission File No. 0-19439) is incorporated by reference into Part IV of this report. (iii) Registration Statement on Form S-4 with respect to the common stock of MAIC Holdings, Inc. (Commission File No. 33-91508) originally filed April 20, 1995 is incorporated by reference into Parts I and IV of this report. (iv) The Mutual Assurance, Inc. Current Report on Form 8-K for event occurring August 28, 1995 (Commission File No. 0-19439) is incorporated by reference into Part IV of this Report. (v) The MAIC Holdings, Inc. Annual Report on Form 10-K for the fiscal year ended December 31, 1996 (Commission File No. 001-12129) is incorporated by reference into Part IV of this report. (vi) The MAIC Holdings, Inc. Proxy Statement for the 1996 Annual Meeting (Commission File No. 0-19439) is incorporated herein by reference into Part IV of this report. (vii) The Registration Statement on Form S-4 with respect to the Common Stock of MAIC Holdings, Inc. (Commission File No. 333-13465) is incorporated by reference into Part IV of this report. (viii) The Medical Assurance, Inc. Annual Report on Form 10-K for the fiscal year ended December 31, 1997 (Commission File No. 001-12129) is incorporated herein by reference into Part IV of this report. (ix) The definitive proxy statement for the 1999 Annual Meeting of the Stockholders of Medical Assurance, Inc. is incorporated by reference into Part III of this Report. 2 3 PART 1 ITEM 1. BUSINESS OF THE COMPANY Medical Assurance, Inc. ("MAI"), formerly known as MAIC Holdings, Inc., was incorporated in the state of Delaware on February 8, 1995 by its sole incorporator, Mutual Assurance, Inc., an Alabama stock insurer ("Mutual Assurance"), to serve as a holding company for Mutual Assurance and its subsidiaries. MAI is the holder of one-hundred percent (100%) of the capital stock of Mutual Assurance, Medical Assurance of West Virginia, Inc., a West Virginia stock insurer ("MA-West Virginia"), Medical Assurance of Indiana, Inc. (formerly Physicians Insurance Company of Indiana, Inc.), an Indiana stock insurer ("MA-Indiana"), and Missouri Medical Insurance Company, a Missouri stock insurer ("MOMEDICO"). MAI, through its insurance subsidiaries, is nationally recognized for providing malpractice protection to physicians, hospitals, dentists and managed care and health care organizations through programs which coordinate traditional insurance with effective clinical risk management. MAI and its subsidiaries comprise insurance company holding systems under the laws of Alabama, West Virginia, Indiana and Missouri. MAI and its subsidiaries are sometimes collectively referred to as the Company. In 1995, the Board of Directors and Shareholders of Mutual Assurance approved a Plan of Exchange (the "Plan of Exchange") in accordance with the Alabama Insurance Code in order to form a holding company for Mutual Assurance and its subsidiaries. The Plan of Exchange provided for the mandatory exchange of one share of MAI common stock for each share of issued and outstanding Mutual Assurance common stock. The Plan of Exchange was effected on August 31, 1995. At the effective time of the Plan of Exchange, MAI had no stockholders. As a result of the Plan of Exchange, Mutual Assurance became a wholly-owned subsidiary of MAI and the shareholders of Mutual Assurance became the sole stockholders of MAI without any material change in their proportionate ownership of Mutual Assurance and its subsidiaries. Additionally, in accordance with the Plan of Exchange, Mutual Assurance distributed as a dividend to MAI all of its capital stock in MA-West Virginia and MA-Indiana. For accounting purposes, the historical financial statements of Mutual Assurance and its subsidiaries were restated as the consolidated financial statements of MAI and its subsidiaries in a manner similar to that of a pooling combination. Prior to the Plan of Exchange, MAI had no assets, liabilities, revenues or net income. Business Expansion The Company has been the predominant carrier of professional liability insurance for Alabama physicians since it began business in 1977. The Company is actively writing medical liability insurance for health care providers in states principally located in the south and mid-west and is capable of responding outside the region when an opportunity for business arises. In 1998, approximately 68% of the written premiums of the Company were derived from business in states other than Alabama. The Company has expanded its business by increasing the number of states in which it directly writes insurance and by acquiring or combining with other professional liability insurers. The Company intends to offer medical malpractice liability insurance on a national basis and has applied for authority to write directly property and casualty insurance in almost all of the states. The Company is currently qualified to reinsure professional medical liability in substantially all states. See "Marketing" and "Regulation" within this caption. 3 4 Effective January 1, 1994, the Company purchased 100% of the common stock of MA-West Virginia (formerly known as West Virginia Hospital Insurance Company). Effective January 1, 1995, the Company purchased approximately 52% of the outstanding capital stock of MA-Indiana from the Indiana State Medical Association and during the remainder of 1995, acquired substantially all of the remaining shares of the capital stock of MA-Indiana. Effective July 16, 1995, Mutual Assurance acquired the recurring professional liability insurance business for health care providers of Physicians Insurance Company of Ohio, an Ohio stock insurer, and its subsidiaries (collectively referred to hereafter as "PIC-Ohio"). On December 20, 1996, the Company acquired MOMED Holding Co. ("MOMED"). MOMED operates as an insurance holding company, and through its wholly-owned subsidiary, MOMEDICO, is engaged in the business of providing medical professional liability insurance to physicians principally in the State of Missouri. On January 1, 1999 Mutual Assurance completed it's purchase of the ongoing book of medical professional liability insurance business of Medical Defense Associates (MDA) and Medical Defense Insurance Company (MDIC) of Springfield, Missouri. Under terms of the agreement Mutual Assurance will manage all existing policies and prior liabilities of MDA and MDIC. INSURANCE PRODUCTS The Company offers professional liability insurance and reinsurance for providers of health care services. Professional liability insurance provides insurance against the legal liability of an insured (and against loss, damage or expense incidental to a claim of such liability) arising out of the death, injury or disablement of a person as the result of negligence or other misconduct in rendering professional service. While professional liability insurance for physicians and their related practice entities is the principal product offered by the Company, the Company has undertaken to develop other insurance products necessitated by changes in the health care industry. The Company has developed and markets through its insurance subsidiaries liability insurance products for hospitals and other health care facilities, dentists, managed care organizations, physician practice management companies and integrated delivery systems to include not only direct and vicarious professional liability insurance, but general liability insurance, errors and omissions coverages, directors and officers liability insurance, employment practices liability insurance and other related coverages. The Company also offers professional office package and workers compensation insurance products for physicians and dentists and workers compensation insurance for health care facilities. The Company presently intends to continue its efforts to develop insurance products designed to meet the needs of customers in the health care market. The consolidation in the health care industry has resulted in intense competition in the professional liability market focusing on the largest accounts. As a result, the Company has developed additional insurance products such as workers' compensation and accident and health insurance to offer through certain integrated delivery systems where the Company can strengthen its professional liability relationship with the health care providers comprising that integrated delivery system. As such products are developed the Company has offered them through various programs to entities and individuals other than health care providers. MARKETING The Company markets its professional liability insurance products directly and through independent agents. In connection with its direct marketing efforts, the Company has provided and continues to provide various services and communications to its insured physicians, dentists and hospitals 4 5 to promote its professional liability insurance products. These services and communications include provision of risk management consultation, loss prevention seminars and other educational programs for physicians, dentists, nurses and hospital administrators; legislative oversight and active support or opposition of proposed legislation relating to liability issues affecting the health care industry; the preparation and dissemination of newsletters and other printed material with information of interest to the health care industry; and attendance at meetings of the state and local medical societies and related organizations. In 1995, the Company became an accredited provider of continuing medical education that has enabled it to sponsor numerous risk management education seminars which has helped the Company gain exposure among potential insureds. The purpose of these communications and services is to convey that the Company understands the insurance needs of the health care industry, and to promote a commonality of interest between the Company, its insureds, and the medical community generally. The Company has entered into endorsement and marketing agreements with organized medical societies and associations in the states in which it offers professional liability insurance, including the Medical Association of the State of Alabama, the Alabama Dental Association, the West Virginia Hospital Association, the Medical Association of the State of West Virginia, the Indiana State Medical Association, the Indiana Dental Association, and the Missouri State Medical Association. Each of the above referenced endorsement and marketing agreements generally provides the Company access to the meetings of the respective state medical associations in order to make presentations and access to their respective publications for advertisements. In addition, each of the respective state medical associations agreed to assist the Company in marketing its products and developing loss prevention programs, in monitoring proposed legislation and administrative regulations in the respective states, and in providing information on health care matters relating primarily to professional liability. The Company generally pays annual compensation to each of the associations for the endorsement and services provided under each respective contract. The Company relies on direct marketing of its professional liability insurance products to Alabama physicians and hospitals and to the majority of its insureds in Missouri. As a result, the Company is not required to pay commissions to insurance agents on the sale of a substantial portion of its insurance products. The Company has increasingly relied on the use of agents and brokers in its efforts to increase revenues through expansion of its business outside of Alabama and Missouri and through the sale of insurance products other than its historical core business of providing medical malpractice liability insurance to physicians and surgeons. Since 1995, the Company has engaged a related party to manage the distribution of a certain subset of its insurance and reinsurance products throughout the United States, including without limitation, medical malpractice reinsurance, excess medical malpractice insurance, managed care liability insurance, accident and health insurance and reinsurance, and workers' compensation insurance and reinsurance. UNDERWRITING AND CLAIMS The Company establishes and implements underwriting procedures for all forms of insurance coverage. The Company is responsible for claims investigation, case management, defense planning, and coordination and control of attorneys in the defense of claims of its insureds. The Company has several underwriting and claims committees whose members principally consist of local physicians, dentists and representatives of hospitals and health care entities who advise and participate in the administration of underwriting and claims management with respect to the professional liability insurance written in many states. The current policy of the Company is and has been to oppose settlement of and to defend 5 6 aggressively all claims that appear to have no merit. The Company believes that it has developed relationships with attorneys in Alabama, Ohio, and West Virginia who have significant experience in the defense of medical professional liability claims and who are able to defend aggressively claims against its insureds. The Company intends to develop similar relationships with defense counsel in other states in which it does business. Business expansion through acquisitions of, or combinations with, insurers who have a significant presence in a state has enhanced the ability of the Company to engage local defense counsel who will respond to its defense strategy. The Company's claims management philosophy contributes to increased loss adjustment expenses compared to those of other property and casualty lines or others specializing in medical professional liability insurance, but the Company believes it results in greater policyholder loyalty and contributes to the Company's superior combined ratio, which is currently below the industry average. LOSS RESERVES Loss reserves are the liabilities established by the Company to provide funds for payment of policyholders' claims in the future. A medical professional liability insurance company must accumulate substantial loss reserves because it has promised to pay substantial amounts in the future for claims that have occurred in prior contract periods. These loss reserves are established as balance sheet liabilities representing estimates of future amounts needed to pay claims and related expenses with respect to insured events which have occurred, including events that have not yet been reported to the carrier. Loss and loss adjustment expense reserves associated with medical professional liability coverage tend to be relatively higher than those associated with other types of property and casualty insurance for two primary reasons. First, the yearly increases in the overall costs of medical professional liability insurance coverage have historically been among the highest of the property and casualty insurance lines. These increased costs can be attributed principally to increases in both the frequency and severity of medical professional liability claims. Second, the delays between the collection of premiums and the payment of losses is longer for medical professional liability insurance than other property and casualty lines. This delay, which is commonly referred to as the "long tail," is the result of the length of time that elapses between the incident giving rise to an insured claim and its reporting to the insurer, and the length of time that elapses between the reporting of the claim to the insurer and the ultimate resolution of the claim. Frequently, injuries are not discovered until years after an incident, or the claimant may simply elect initially not to pursue the recovery of damages. Once a claim is initiated, the complexity of medical professional liability claims also contributes to the long tail. There are two types of liability insurance policies, occurrence and claims-made. Under occurrence coverage, insurance is provided against claims of liability arising from incidents which "occur" during the policy period, regardless of when claims arising out of such incidents may be reported. Claims-made coverage provides protection against only those claims which arise out of incidents occurring and of which notice to the insurer is given while coverage is effective. Claims-made policies enable the insurer to estimate its loss reserves with more certainty as reserves for losses are accrued in the year that a claim is reported instead of in the year of occurrence as is the case with occurrence policies. As a result, there is less dependence on the actuarial determination of claims incurred but not reported in establishing the amount of loss reserves with respect to claims-made coverage. At December 31, 1998, the Company's reserves were comprised of approximately 27% occurrence reserves and approximately 73% claims-made reserves. The determination of loss reserves is essentially a projection of ultimate losses through an actuarial analysis of the claims history of the Company and other professional liability insurers, subject to adjustments deemed appropriate to management due to changing circumstances. Included in their claims history are losses and loss adjustment expenses paid by the Company in prior periods and case reserves 6 7 for anticipated losses and loss adjustment expenses developed by their respective claims departments as claims are reported and investigated. Actuaries rely primarily on such historical loss experience in determining reserve levels on the assumption that historical loss experience provides a good indication of future loss experience despite the uncertainties in loss cost trends and the delays in reporting and settling claims. As additional information becomes available, the estimates reflected in earlier loss reserves may be revised. Any increase in the amount of reserves, including reserves for insured events of prior years, could have an adverse effect on consolidated results of the Company for the period in which the adjustments are made. The uncertainties inherent in estimating ultimate losses on the basis of past experience have grown significantly in recent years principally as a result of judicial expansion of liability standards and expansive interpretations of insurance contracts. These uncertainties may be further affected by, among other factors, changes in the rate of inflation and changes in the propensities of individuals to file claims, and changes in the laws of the states in which the Company does business. Despite these uncertainties, management believes that the methods used by the Company to establish reserves are reasonable and appropriate. These methods include a detailed review of reserves for losses and loss adjustment expenses of each insurance subsidiary being performed by the Company's independent actuaries for each fiscal year. The independent actuaries prepare a report that includes a recommendation as to the respective levels of reserves. Management considers this recommendation as well as other factors, such as known, anticipated or estimated changes in frequency and severity of claims and loss retention levels and premium rates, in establishing the amount of its reserves for losses and loss adjustment expenses. In connection with the audit of the Company's consolidated financial statements at the end of each fiscal year, the Company's independent auditors (whose unqualified report is included in Part II of this report) also perform an analysis on the consolidated loss reserves to determine if there is sufficient historical claims experience upon which to rely in projecting loss reserves and to determine if the amount of loss reserves is adequate based on such analysis. In addition, the statutory filings of each insurance company with the insurance regulators must now be accompanied by an independent actuary's certification as to their respective reserves in accordance with the requirements of the National Association of Insurance Commissioners. In establishing the amount of reserves for losses and loss adjustment expenses for interim periods in the following year, management estimates a loss ratio giving consideration to the recommendation in the report of the independent actuaries and other factors described above. The estimated loss ratio and existing reserves are subject to further adjustment during the year, as deemed appropriate by management, to give consideration to unusual material events. Management consults with its independent actuaries during the year for advice concerning the adequacy of reserves and loss ratios. CLAIMS RECONCILIATION The following table sets forth an analysis of consolidated property and casualty loss reserve liabilities and loss adjustment expense ("LAE") for the Company and provides a reconciliation of beginning and ending consolidated liability balances for the years ended December 31, 1998, 1997 and 1996. As of December 31, 1998, MAI's insurance subsidiaries had consolidated reserves for losses and LAE on a generally accepted accounting principles basis that exceeded those on a statutory basis by approximately $18 million, which is principally due to the portion of GAAP reserves that are reflected for statutory accounting purposes as unearned premiums. These unearned premiums are applicable to extended reporting endorsements issued without a premium charge upon death, disability, or retirement. 7 8
YEAR ENDED DECEMBER 31, ----------------------------------------- 1998 1997 1996 ----------------------------------------- (DOLLARS IN 000'S) Reserve liability, net of reinsurance recoverables, at beginning of year $ 464,122 $ 440,040 $ 352,521 Provisions for losses and LAE occurring in the current year, net of reinsurance Insurance subsidiaries 141,201 124,352 100,186 Acquired subsidiary - - Decrease in estimated losses and LAE for claims occurring in prior years, net of reinsurance (47,308) (46,679) (27,427) --------- --------- --------- Total incurred during current year, net of reinsurance 93,893 77,673 72,759 Losses and LAE payments for claims, net of reinsurance, occurring during: The current year Insurance subsidiaries (9,891) (5,201) (3,468) Acquired subsidiary - - Prior years (67,383) (48,390) (27,415) --------- --------- --------- Total paid, net of reinsurance (77,274) (53,591) (30,883) --------- --------- --------- Reserve liability, net of reinsurance recoverables, of acquired subsidiaries 0 0 45,643 --------- --------- --------- Reserve liability, net of reinsurance recoverables, at end of year $ 480,741 $ 464,122 $ 440,040 ========= ========= ========= Gross liability at end of year $ 660,631 $ 614,720 $ 548,732 Reinsurance recoverable 179,890 150,598 108,692 --------- --------- --------- Net liability at end of year $ 480,741 $ 464,122 $ 440,040 ========= ========= ========= Gross re-estimated liability $ 568,287 $ 445,223 Re-estimated recoverable 151,473 97,965 --------- --------- Net re-estimated liability $ 416,814 $ 347,258 ========= =========
Note: The above amounts exclude life reserves. 8 9 LOSS RESERVE DEVELOPMENT TABLE The following table includes information regarding the development of property and casualty reserves for liability for unpaid losses and LAE of the Company for the years ended December 31, 1988 through 1998: (i) the line entitled "Balance Sheet Reserves, Net of Reinsurance Recoverables" reflects the amount recorded as the reserve for liability for unpaid losses and LAE in the consolidated balance sheet at the end of each year (the "Balance Sheet Reserves"); (ii) the section entitled "Cumulative Paid, Net of Reinsurance Recoverables, As Of" reflects the cumulative amounts paid as of the end of each succeeding year with respect to the previously recorded Balance Sheet Reserves; (iii) the section entitled "Reestimated Net Liability As Of" reflects the reestimated amount of the liability previously recorded as "Balance Sheet Reserves" that includes the cumulative amounts paid and an estimate of additional liability based upon claims experience as of the end of each succeeding year (the "Net Reestimated Liability"); (iv) the line entitled "Redundancy (Deficiency)" reflects the difference between the previously recorded Balance Sheet Reserve for each applicable year and the Net Reestimated Liability relating thereto as of the end of the most recent fiscal year; and (v) the line entitled "% Redundancy (Deficiency)" reflects the ratio that the Redundancy (Deficiency) bears to the Balance Sheet Reserve in each year during such period. The table also includes a section that is intended to compare the Net Reestimated Liability for losses and LAE with the Balance Sheet Reserves as increased to include the reserve for liability for unpaid losses and LAE assumed when the Company commuted substantially all of its quota share reinsurance agreements for losses applicable to all periods prior to August 1, 1989 (the "Commutation"). Pursuant to the Commutation, the Company assumed in 1989 and 1990 liability for unpaid losses and LAE in the amount of approximately $21 million and $2 million, respectively, previously ceded to reinsurers. Reserves for such reassumed liability had not been included in the Company's balance sheet prior to 1989 because it had been ceded to reinsurers. The reserves for such previously ceded liability were first included in the Company's balance sheet reserves at the end of the years in which they were reassumed, namely 1989 and 1990. On the other hand, the "Reestimated Liability" for the last succeeding year in the table has included the cumulative unpaid losses and LAE expenses in the reestimated liability attributable to years prior to 1989. Accordingly, Reestimated Liability in the above-referenced years compares cumulative liability for previously ceded unpaid losses and loss adjustment expenses with Balance Sheet Reserves that do not include reserves for such liability. The restated portion of the table includes (i) a line entitled "Reserves Assumed in 1989 and 1990 Commutation Cumulative" to reflect the reserves for liability for unpaid losses and LAE assumed by Mutual Assurance in the Commutation; (ii) a line entitled "Balance Sheet Reserves, Net of Reinsurance Recoverables, After Giving Effect to 1989 and 1990 Commutation" to reflect the sum of the Balance Sheet Reserves and the cumulative reserve for liability for unpaid losses and LAE assumed in the Commutation (the "Adjusted Balance Sheet Reserves"); (iii) a line entitled "Redundancy (Deficiency) in Balance Sheet Reserves, Net of Reinsurance Recoverables, After Giving Effect to 1989 and 1990 Commutation" to reflect the difference between the Adjusted Balance Sheet Reserves and the Net Reestimated Liability for each year prior to 1989; and (iv) a line entitled "% Redundancy (Deficiency) After Giving Effect to 1989 and 1990 Commutation" to reflect the ratio that such difference bears to the Adjusted Balance Sheet Reserves. Information presented in the following table is cumulative and, accordingly, each amount includes the effects of all changes in amounts for prior years. The information relating to subsidiaries other than Mutual Assurance is limited to the property and casualty reserves from their respective dates of acquisition. The GAAP basis claims reserves have not been discounted. The Company believes that the table reflects its conservative approach to the reservation of losses and LAE, particularly when compared with the amount of paid losses and LAE as set forth in the table. 9 10
Year Ended December 31, 1988 1989 1990 1991 1992 - ------------------------------------------------------------------------------------------------------- (Dollars in 000's) Balance Sheet Reserves, net of Reinsurance Recoverables 119,396 169,732 202,937 228,119 252,739 Cumulative Paid, net of Reinsurance Recoverables, As Of: End Of Year 0 0 0 0 0 One Year Later 13,697 15,986 17,340 19,560 19,752 Two Years Later 27,516 30,361 34,374 35,461 36,185 Three Years Later 39,210 45,266 44,498 46,417 52,550 Four Years Later 50,250 52,702 52,076 58,124 58,526 Five Years Later 54,118 59,235 61,196 62,573 63,325 Six Years Later 59,168 65,976 63,682 65,090 68,021 Seven Years Later 64,206 66,033 65,877 68,719 Eight Years Later 63,953 67,625 69,014 Nine Years Later 65,436 70,563 Ten Years Later 66,832 Re Estimated Net Liability As Of: End Of Year 119,396 169,732 202,937 228,119 252,739 One Year Later 133,910 170,626 195,747 217,558 241,655 Two Years Later 137,080 161,414 185,535 205,277 221,236 Three Years Later 128,526 156,413 173,996 185,349 190,744 Four Years Later 126,641 144,929 157,884 159,301 167,062 Five Years Later 115,556 133,054 135,828 139,570 136,996 Six Years Later 108,017 113,737 119,336 114,407 108,862 Seven Years Later 93,649 101,621 93,875 98,177 Eight Years Later 85,378 83,554 83,266 Nine Years Later 73,655 80,392 Ten Years Later 72,724 Redundancy(Deficiency) 46,672 89,340 119,671 129,942 143,877 % Redundancy(Deficiency) 39.09% 52.64% 58.97% 56.96% 56.93% Reserves Assumed in 1989 & 1990 Commutation - Cumulative 19,075 1,969 Balance Sheet Reserves, net of Reinsurance Recoverables, after giving effect to 1989 & 1990 Commutation 138,471 171,701 202,937 228,119 252,739 Redundancy(Deficiency) in Balance Sheet Reserves, net of Reinsurance Recoverables, after giving effect to 1989 & 1990 Commutation 65,747 91,309 119,671 129,942 143,877 % Redundancy(Deficiency) after giving effect to 1989 & 1990 Commutation 47.48% 53.18% 58.97% 56.96% 56.93% 1993 1994 1995 1996 1997 1998 -------------------------------------------------------- Balance Sheet Reserves, net of Reinsurance Recoverables 272,392 295,541 352,521 440,040 464,122 480,741 Cumulative Paid, net of Reinsurance Recoverables, As Of: End Of Year 0 0 0 0 0 0 One Year Later 21,296 24,102 27,532 48,390 67,383 Two Years Later 40,988 42,115 58,769 98,864 Three Years Later 53,186 58,793 80,061 Four Years Later 61,153 65,520 Five Years Later 66,419 Six Years Later Seven Years Later Eight Years Later Nine Years Later Ten Years Later Re Estimated Net Liability As Of: End Of Year 272,392 295,541 352,521 440,040 464,122 480,741 One Year Later 251,445 268,154 325,212 393,363 416,814 Two Years Later 220,385 239,243 280,518 347,258 Three Years Later 194,213 200,311 237,280 Four Years Later 159,096 157,836 Five Years Later 126,379 Six Years Later Seven Years Later Eight Years Later Nine Years Later Ten Years Later Redundancy(Deficiency) 146,013 137,705 115,241 92,782 47,308 % Redundancy(Deficiency) 53.60% 46.59% 32.69% 21.08% 10.19% Reserves Assumed in 1989 & 1990 Commutation - Cumulative Balance Sheet Reserves, net of Reinsurance Recoverables, after giving effect to 1989 & 1990 Commutation 272,392 295,541 352,521 440,040 464,122 Redundancy(Deficiency) in Balance Sheet Reserves, net of Reinsurance Recoverables, after giving effect to 1989 & 1990 Commutation 146,013 137,705 115,241 92,782 47,308 % Redundancy(Deficiency) after giving effect to 1989 & 1990 Commutation 53.60% 46.59% 32.69% 21.08% 10.19%
Note: There may be a difference of 1 (,000) in the redundancies due to rounding 10 11 REINSURANCE In managing its underwriting risks and liquidity position, the Company transfers portions of its insurance risks to reinsurers. This cession of risks involves the payment of premiums to those reinsurers for their assumption of these risks. Reinsurance protects the Company against losses of a catastrophic nature and stabilizes underwriting results in those years in which such losses occur. The cession of reinsurance does not discharge the Company from liability to the policyholders, but it does permit recourse by it against the reinsurer for losses paid within the scope of the reinsurance contract. Risks are reinsured under treaties pursuant to which the reinsurer agrees to assume all or a portion of all risks insured by the Company above its individual risk retention and up to the maximum individual limit offered (currently $26 million). Generally, the Company's risk retention level is dependent upon numerous factors including volume of business in a particular region, service infrastructure within a region, level of experience within a region, and the Company's analysis of the potential underwriting results within each region. As a consequence, the Company's retention has varied between $200,000 and $2 million since 1989. Its retention prior to that time is $4 million as a result of profitable commutation of prior reinsurance treaties. Currently, the Company retains $2 million in Alabama, $1 million in Missouri and West Virginia, and $250,000 elsewhere. The Company reinsures the risks above the maximum limits of its reinsurance treaties on a facultative basis - the reinsurer agrees to insure a particular risk up to a designated limit. Reinsurance is placed under reinsurance treaties and agreements with a number of individual companies to avoid concentrations of credit risk. For policy periods beginning on or after August 1, 1989, the Company has not placed more than 25% of the total amount of risks ceded to reinsurers with any one reinsurer. The Company relies on reinsurance brokers to assist in the analysis of the credit quality of its reinsurers. Although reinsurer insolvencies have resulted in financial difficulties for some insurance companies, the Company's reinsurance recoverable at December 31, 1998 did not include any amounts due from any financially troubled reinsurer. INVESTMENTS Investment management services are provided to the Company by independent third party investment managers. Such services include reviewing and recommending investment policies and implementing and executing investment strategies and are currently provided for a fee based upon the market value of the investment portfolio managed by the Company. The general investment policies of the Company are intended to accommodate its need for liquidity and current income. The primary objective is to achieve a high level of after-tax income, while minimizing risk. Accordingly, investment assets of the Company substantially consist of fixed maturity securities, all of which are investment grade as defined by national rating agencies. See Note 2 of the Notes to the Consolidated Financial Statements for a description of the investments of the Company at December 31, 1998. COMPETITION Traditionally, the physicians and surgeons professional liability market, the hospital professional liability market and the dental professional liability market in the State of Alabama have been highly competitive. The Company acquired a substantial share of the Alabama physicians and surgeons professional liability insurance market in 1977 when the primary Alabama medical professional liability carrier withdrew from Alabama. Competitors, some of which have greater financial resources than the Company, have entered or reentered the Alabama market and many insurance companies currently offer 11 12 professional liability insurance in Alabama. Other companies engaged in similar lines of business in other states may enter the Alabama market in the future. However, the Company has maintained a dominant market share in Alabama through aggressive defense policies, competitive pricing and a substantial direct marketing effort. The Company plans to continue to expand the business of the Company into other states through increased use of independent agents to market its products and writing new business with multi-state health care providers having a prior relationship with the Company. The Company also intends to expand its business through business combinations with medical professional liability insurers having name recognition and significant support in the medical community in the states in which they do business. The Company believes that it will be competitive with companies who have been offering medical professional liability insurance in those states in which the Company writes insurance. In its marketing efforts in other states, the Company must compete with insurance companies that have pre-existing relationships with prospective customers and name recognition in those states, and that in many cases have greater resources than the Company. Marketing efforts in states other than Alabama will take substantial time and resources in order for prospective customers to become familiar with the Company and its insurance products. The Company believes that the principal competitive factors in the professional liability insurance business are service, name recognition, and price, and that it competes effectively in all these areas. The Company enjoys significant name recognition in the State of Alabama by virtue of having been organized by, and operated for the principal benefit of, Alabama physicians. The Company has attempted to use its heritage as a policyholder-founded company dedicated to the medical professional liability insurance industry in general as a means to compete in other states both directly and indirectly through its affiliates. The services offered by the Company to its insureds as well as the medical community in general are intended to promote name recognition and to maintain and improve loyalty among the insureds. REGULATION The insurance industry is highly regulated, primarily by departments or agencies of the state governments. The Insurance Codes of the various states in which the Company does business delegate regulatory, supervisory and administrative powers to the State Commissioners or Departments of Insurance. Such regulation, supervision and administration involve, among other things, the licensing of insurers, financing of insurers, periodic examinations of the affairs and financial condition of insurers, and review of annual and other mandatory reports on the financial condition of insurers. Insurance companies are required to be licensed by the states in which they do business. The Company is currently licensed to do business as a property and casualty insurer in 41 states and the District of Columbia and has or will apply for authority to do business in almost all states. In addition to being licensed as a property and casualty insurer, the Company must submit for prior approval all property and casualty policies, endorsements, underwriting manuals, and rates to the Commissioners of Insurance in order to do business in states in which it is licensed. Currently, the Company is able to write professional liability insurance in 27 states. Approval of policy forms and rates may take a substantial period of time after the license has been issued in a particular state. Further, the possibility exists that the Company may be unable to do business in a state in which it is licensed if desired policies, endorsements, forms, manuals, or rates are not approved by the Commissioner of Insurance in that state. The Company is an insurance holding company system regulated under the Alabama Insurance Holding Company System Regulatory Act, the West Virginia Holding Company System Act, the Indiana Holding Company System Regulatory Act and the Missouri Holding Company System Regulatory Act 12 13 (collectively the "Holding Company Acts"). The Holding Company Acts generally prohibit anyone from acquiring control of an insurance company without the approval of the Commissioner in the state of domicile of such insurance company. Under the Holding Company Acts, control is presumed to exist if any person or persons acting in concert, directly or indirectly, owns, controls, holds with the power to vote or holds proxies representing a certain percentage of the voting securities of another person (5% in Alabama, 10% in West Virginia, Indiana and Missouri). MAI's insurance subsidiaries must comply with mandatory capital and solvency standards in the states in which they are authorized to do business. In addition, the state insurance codes generally limit the source of dividends payable by a stock insurer to that part of its available surplus funds which is derived from realized net profits on its business. The Holding Company Acts require that a domestic insurer give prior notice to the state Commissioner before the payment of any extraordinary dividend. The Holding Company Acts would permit MAI's insurance subsidiaries to dividend to MAI as much as approximately $37.6 million in 1999 without such notice to the Commissioners. In turn, Delaware corporate law limits MAI from paying dividends in excess of its surplus. EMPLOYEES At December 31, 1998, MAI and its subsidiaries employed 271 persons. None of the employees of MAI or its subsidiaries is represented by a labor union. MAI considers its employee relations to be good. ITEM 2. PROPERTIES Mutual Assurance is the fee owner of one office building located in the metropolitan area of Birmingham, Alabama. Mutual Assurance purchased its current home office building in March 1989 and during 1993 sold the office building which it formerly occupied. MAI and its subsidiaries are occupying approximately 55,226 square feet of office space in its current home office building. The remaining 101,427 square feet of office space in this building are leased to unaffiliated persons or are available to be leased. The office building owned by Mutual Assurance is currently unencumbered. MOMED is the fee owner of one office building located in the metropolitan area of St. Louis, Missouri. MOMED and its subsidiaries are occupying 7,709 square feet as their home offices and the remaining 6,501 square feet of office space in this building are leased to unaffiliated persons or is available to be leased. MOMED also owns an apartment building that is held as an investment in real estate. The home office building currently secures a bank loan in the approximate amount of $397,000 and the investment property secures a bank loan in the approximate amount of $147,000. MAI's other insurance subsidiaries maintain additional office space under leases with unaffiliated persons which are not considered material. ITEM 3. LEGAL PROCEEDINGS MAI's insurance subsidiaries are involved in various legal actions, a substantial number of which arise primarily from claims made under insurance policies. While the outcome of all legal actions is not presently determinable, management and its legal counsel are of the opinion that these actions will not have a material adverse effect on the financial position or results of operations of MAI and its subsidiaries. 13 14 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. EXECUTIVE OFFICERS OF MAI The executive officers of MAI serve at the pleasure of the Board of Directors. Set forth below are the current executive officers of MAI and a brief description of their principal occupation and employment during the last five years. A. DERRILL CROWE, M.D. - Age 62- Dr. Crowe has been Chairman of the Board and President of MAI since its formation on February 8, 1995. Dr. Crowe has been President, Chief Executive Officer and a director of Mutual Assurance since its organization in 1976. Dr. Crowe serves as a director of each of MAI's insurance subsidiaries and participates on their respective claims and underwriting committees. Dr. Crowe currently serves on the Board of Directors of Citation Corp. PAUL R. BUTRUS - Age 58 - Mr. Butrus has served as a director and Executive Vice President of MAI since its formation on February 8, 1995. Mr. Butrus has been employed by Mutual Assurance and its subsidiaries since 1977, and has served as a director of Mutual Assurance since February 1992. Mr. Butrus serves as a director of each of MAI's insurance subsidiaries and participates on their respective claims and underwriting committees. Mr. Butrus also serves on the Board of Directors of Prime Medical Services, Inc. PAUL D. EVEREST, M.D. - Age 78 - Dr. Everest has served as a director of MAI since its formation on February 8, 1995. He has served as a director of Mutual Assurance since 1982. Dr. Everest practices medicine in Montgomery, Alabama, specializing in orthopedic surgery. JAMES J. MORELLO - Age 50 - Mr. Morello has been the Treasurer of MAI since its formation on February 8, 1995. Mr. Morello has been employed as Treasurer and Chief Financial Officer of Mutual Assurance since 1984. Mr. Morello is a certified public accountant. ROBERT D. FRANCIS - Age 36 - Mr. Francis has been the Secretary and Chief Underwriting Officer of MAI since its formation on February 8, 1995. Mr. Francis has served as Secretary and Senior Vice President of Mutual Assurance and was initially employed by Mutual Assurance in 1984. Mr. Francis is currently responsible for Underwriting and Production of Mutual Assurance and for supervising and coordinating underwriting and sales activities of MAI's other insurance subsidiaries. MARTIN ENNIS - Age 50 - Mr. Ennis has served as Chief Claims Officer of MAI since its formation on February 8, 1995. He is also Senior Vice President of Mutual Assurance, and has been employed by Mutual Assurance for over sixteen years, principally in claims administration and hospital services. Mr. Ennis is currently in charge of the claims department of Mutual Assurance and is responsible for supervising and coordinating claims administration and hospital services performed by other insurance subsidiaries of MAI. 14 15 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. At March 19, 1999, MAI had 2,098 stockholders of record and 23,213,156 shares of common stock outstanding. MAI's common stock currently trades on The New York Stock Exchange under the symbol "MAI". The quotations below reflect trading on The New York Stock Exchange:
Quarter 1998 1997 ------- ---- ---- High Low High Low ---- --- ---- --- First $27.27 $22.72 $17.94 $15.38 Second 27.27 24.26 20.63 16.19 Third 26.19 21.87 30.00 19.82 Fourth 33.06 23.29 30.00 26.13
On August 20, 1997, the Board of Directors of MAI declared a two-for-one stock split. The quarterly price range for MAI common stock shown above has been adjusted to reflect the stock split as if it had occurred on January 1, 1997. Information regarding restrictions on the ability of MAI and its insurance subsidiaries to pay dividends is incorporated by reference from the last paragraph under the caption "REGULATION" in Part I on page 12 of this Form 10-K. On December 3, 1998, the Board of Directors of MAI declared stock dividends of ten percent. The Company declared stock dividends of six percent in 1996 and 1995 and stock dividends of five percent in 1997, 1994, 1993, and 1992. Stock dividends should not be considered regular dividends as each dividend has been specially considered by the Board of Directors. The Company has not paid any cash dividends on its common stock. The Company currently intends to continue its policy of not paying a regular dividend. 15 16 ITEM 6. SELECTED FINANCIAL DATA
SELECTED FINANCIAL DATA 1998 1997 1996 1995 1994 - --------------------------------------------------------------------------------------------------------------- (in thousands, except share and per share amounts) Direct and assumed premiums written $ 192,479 $ 188,195 $ 137,840 $ 108,442 $ 74,275 Earned premiums 195,515 158,061 134,162 94,517 73,282 Reinsurance expense (54,199) (39,094) (29,644) (18,564) (11,856) Net premiums earned 141,316 118,967 104,518 75,953 61,426 Net investment income 39,402 38,474 32,114 29,582 23,072 Other income 12,885 3,301 2,642 4,738 1,109 Total revenues 193,603 160,742 139,274 110,273 85,607 Net losses and loss adjustment expenses 93,893 77,674 72,759 53,642 43,887 Net income (A) 47,400 37,458 31,149 29,663 24,767 Net income per share of common stock (Basic and Diluted) (B) $ 2.01 $ 1.58 $ 1.36 $ 1.29 $ 1.08 Weighted average number of shares outstanding (B) 23,552,721 23,657,736 22,947,544 22,919,488 23,016,735 BALANCE SHEET DATA: (C) (as of December 31) Total investments $ 791,579 $ 720,202 $ 666,759 $ 543,998 $ 437,865 Total assets 1,132,239 1,063,173 905,308 720,478 565,744 Reserve for losses and loss adjustment expenses 660,640 614,729 548,742 432,945 356,000 Total liabilities 808,059 775,985 660,743 512,465 404,194 Total capital 324,180 287,188 244,565 206,030 159,648 Total capital per share of common stock outstanding (B) $ 13.91 $ 12.14 $ 10.31 $ 8.99 $ 6.97 Common stock outstanding at end of year (B) 23,312,950 23,647,187 23,731,334 22,920,475 22,919,437
(A) Net income for 1998 was reduced by $1.1 million which represents the cumulative effect (net of tax) of an accounting change for guaranty fund assessments due to the adoption of the American Institute of Certified Public Accountants' Statement of Position 97-3. The cumulative effect reduced net income per share of common stock (Basic and Diluted) by $0.05 per share. (B) The Board of Directors declared special stock dividends in December 1998 (10%), 1997 (5%), 1996 (6%), 1995 (6%), 1994 (5%) and 1993 (5%); and in August 1997 the Board declared a two-for-one stock split. All Net income per share and Total capital per share data on this page has been restated as if the dividends and the stock split had been declared on January 1, 1994. Additionally, treasury stock is excluded from the date of acquisition for purposes of determining the weighted average number of shares outstanding used in the computation of net income per share of common stock. (C) As a result of the December 20, 1996 acquisition of MOMED, amounts attributable to MOMED are included in the above balance sheet data but are considered immaterial for inclusion in the Company's 1996 operations. Reference Note 10 of the Notes to Consolidated Financial Statements of Medical Assurance, Inc., and subsidiaries. 16 17 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE FINANCIAL CONDITION AND RESULTS OF OPERATION. For purposes of this management discussion and analysis, the term "Company" refers to Medical Assurance, Inc. (a Delaware Corporation) and its consolidated subsidiaries. The consolidated subsidiaries consist principally of operating insurance companies. LIQUIDITY AND CAPITAL RESOURCES The payment of losses, loss adjustment expenses, and operating expenses in the ordinary course of business is currently the Company's principal need for liquid funds. Cash used to pay these items has been provided by operating activities. Cash provided from these activities was sufficient during 1998 to meet the Company's operating needs, and the Company believes those sources will be sufficient to meet its cash needs for operating purposes for at least the next twelve months. Prolonged and increasing levels of inflation could cause increases in the dollar amount of losses and loss adjustment expenses and may therefore adversely affect future reserve development. To minimize such risk, the Company (a) maintains what management considers to be strong and adequate reinsurance; (b) conducts regular actuarial reviews to ensure, among other things, that reserves do not become deficient; and (c) maintains adequate asset liquidity. The Company did not borrow any funds during the years ended December 31, 1998 and 1997, and currently has no requirements indicating a need to borrow significant funds in the next twelve months. However, the need for additional capital may arise in order to achieve the Company's ultimate goals of expansion, as discussed in the following paragraphs. The Company continues to have available through a lending institution a line of credit in the amount of $40 million that could be used for these additional capital requirements. The Company is not charged a fee nor is it required to maintain compensating balances in connection with this line of credit. Additionally, in an effort to protect the Company's investment portfolio against the possibility of higher interest rates in the future, the Company reduced the average maturity of a portion of that portfolio during the third and fourth quarters of 1998. This reduction was the principal reason for the higher gross realized gains discussed in Note 2 of the accompanying Notes to Consolidated Financial Statements. The Company's Board of Directors has authorized the purchase of its common stock in the open market; the Company purchased 364,870 (after giving effect to the 1998 stock dividend) shares of its stock in 1998. At December 31, 1998, approximately $7.9 million remained available for purposes of purchasing its own common stock. On March 8, 1999 the Company announced that it had authorized an additional $10.0 million for the purchase of its stock. MARKET RISK The Company is exposed to various market risks, principally interest rates on its investment portfolio. Market risk represents the risk of changes in value of a financial instrument caused by fluctuations in interest rates. The Company handles market risks in accordance with its established policies, whose goal is to implement a strategic asset allocation that maximizes the long-term rate of return at a minimum level of risk given a set of asset classes and 17 18 restrictions. Market risk control relates principally to ratings of issuers and length to maturity. The Company does not enter into derivative transactions. The fair value of the Company's cash and short-term investment portfolio at December 31, 1998 approximated carrying value due to its short-term duration. Most of the investments in the long-term portfolio are at fixed rates, and have a fair value at December 31, 1998 of $657.4 million. Although not expected, a one percentage point change in the interest rate would change the fair value of that portfolio by approximately $24 million. The Company believes it is in a position to keep these investments until final maturity. Marketable equity securities at December 31, 1998 are recorded at a fair value of $44.1 million, including net unrealized gains of $2.9 million. The securities have exposure to price risk. BUSINESS EXPANSION The Company, through Mutual Assurance, has been developing a marketing strategy to address the insurance needs of hospitals and vertically-integrated health care providers. The Company expects organizations such as these to represent increasing market opportunities for professional liability and related insurance products because of the trend toward the consolidation of health care providers. In certain instances, Mutual Assurance's surplus is a competitive factor in this "large account" market because its principal competitors are larger than those with whom Mutual Assurance has historically had to compete. In addition to its expansion into this growing market for "large accounts," the Company also intends to expand through the acquisition of, or combination with, medical professional liability insurers that have a significant presence in states other than Alabama. The purchase of MOMED Holding Company (MOMED) was effective December 20, 1996. MOMED operations for the period December 20, 1996 through December 31, 1996 were considered immaterial for inclusion in the Company's consolidated statement of income. Selected consolidated financial data for MOMED and its subsidiaries, including its primary subsidiary, Missouri Medical Insurance Company, for the year ending December 31, 1996 is as follows (dollars in thousands):
1996 ---- Premiums written $ 11,098 Net premiums earned 11,208 Net investment income 4,336 Net losses and loss adjustment expenses 6,720 Net income 4,333
The above summary operations information does not necessarily reflect the results of operations as they actually would have been if the acquisition had occurred at the beginning of the periods presented or of results which may occur in the future. In September 1998, the Company entered into an agreement with Medical Defense Holding Company (MDHC) of Springfield, Missouri to purchase the ongoing book of medical professional liability insurance business of MDHC's subsidiaries, Medical Defense Associates 18 19 (MDA) and Medical Defense Insurance Company (MDIC). The transaction was effective January 1, 1999. The Company has assumed day-to-day management of existing policies and prior liabilities of MDA and MDIC and provides aggregate excess of loss reinsurance to protect MDA and MDIC from adverse loss development in excess of an agreed upon threshold. IMPACT OF YEAR 2000 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 miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions, send invoices, or engage in similar normal business activities. The Company's comprehensive Year 2000 initiatives are designed to ensure that there is no adverse effect on the Company's core business operations and that transactions with customers, suppliers, and financial institutions are fully supported. The Company is well underway with these efforts, which are scheduled to be completed in mid-year 1999. New application systems, including hardware, that the Company has acquired and implemented or that are currently being implemented function properly with respect to dates in the year 2000 and thereafter. The Company presently believes that with planned modifications to existing software and conversions to new software, the Year 2000 issue will not pose significant operational problems for its computer systems. Because Year 2000 compliance is incidental to implementing the new software systems, costs specifically related to Year 2000 compliance are minimal. The Company is reliant on various third party business partners. The Company's own readiness for the year 2000 will be impacted by the readiness of these third parties. The Company has identified the third party relationships that it believes to be significant and has obtained information from the parties regarding their efforts and expectations related to Year 2000 compliance. To date, the Company is not aware of any third party issue that would materially impact the Company's results of operations, liquidity or capital resources. The Company has also evaluated the risk of claims against its policyholders for medical incidents resulting in bodily injury to patients as a consequence of Year 2000 computer or medical device failure. The Company has required that hospitals and other large health care facilities complete questionnaires as to their Year 2000 preparedness in underwriting their professional liability insurance policies. If the questionnaire of a health care facility is not returned or provides inadequate or unsatisfactory information regarding this issue, the policy issued to such facility will exclude coverage for medical incidents caused by Year 2000 problems. The Company has not surveyed insureds who are physicians and surgeons as to their Year 2000 compliance and intends to offer coverage for claims from such medical incidents because the Company does not believe that physicians and surgeons will have significantly greater risk of liability if they are not Year 2000 compliant. While the Company believes its planning efforts are adequate to address its Year 2000 concerns, there can be no guarantee that full compliance will be achieved or that the systems of other companies on which the Company's systems and operations rely will be converted on a 19 20 timely basis and therefore will not have a material effect on the Company. The Company's expectations about the completion of its Year 2000 efforts, the related costs, and its assessment of the anticipated business, operational and financial risks to the Company are subject to a number of uncertainties and assumptions regarding future events including, among others, representations of third parties and the continued availability of trained personnel. This disclosure as well as the information previously filed by the Company regarding its Year 2000 readiness during the period January 1, 1996 to October 19, 1998 are designated as a Year 2000 readiness disclosure related to the Year 2000 Information and Readiness Disclosure Act. RESULTS OF OPERATIONS - YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997 Premiums The following table presents information related to consolidated written and earned premiums and reinsurance expense (dollars in thousands):
Increase 1998 1997 (Decrease) ----------------------------------------- Direct and assumed premiums written $ 192,479 $ 188,195 $ 4,284 ======================================== Direct and assumed premiums earned $ 195,515 $ 158,061 $ 37,454 Premiums ceded (54,199) (39,094) (15,105) ---------------------------------------- Net premiums earned $ 141,316 $ 118,967 $ 22,349 ========================================
The increase in direct and assumed premiums written for the year ended December 31, 1998 compared to the year ended December 31, 1997 is due principally to an increase of $8.4 million of medical malpractice and accident and health premiums, offset by a decrease of $4.0 million of workers compensation premiums. Other variations in the normal course of business for the Company comprise the remainder of the variance. Direct and assumed premiums earned for the year ended December 31, 1998 increased $37.4 million as compared to the year ended December 31, 1997, primarily attributable to premiums earned from physician malpractice coverage and other new business written in late 1997 in states other than Alabama. The Company cedes reinsurance to provide for greater diversification of business, allow management to control exposure to potential losses arising from large risks, and provide additional capacity for growth. Premiums ceded are estimated based on the terms of the respective reinsurance agreements. The estimated expense is continually reviewed and any adjustments which become necessary are included in current operations. Amounts recoverable from reinsurers are estimated in a manner consistent with the loss liability associated with the reinsured policies. The $15.1 million increase in premiums ceded for the year ended December 31, 1998 as compared to the year ended December 31, 1997 is principally due to additional direct and assumed premiums in states other than Alabama, offset by increased reinsurance retentions, and consequently lower ceded premiums, for Alabama and West Virginia. The Company continually reviews the levels of coverage ceded and the related costs. 20 21 Investment Income The Company had consolidated net investment income of $39.4 million for the year ended December 31, 1998 as compared to $38.5 million for the year ended December 31, 1997 reflecting an increase of approximately $900,000. The increased income is primarily due to an increase in the amount of invested assets offset somewhat by a decrease in the yield. Invested assets increased to $761.1 million at December 31, 1998 from $681.1 million at December 31, 1997. The yield on invested assets decreased to 5.6% for 1998 from 5.9% for 1997. The average composition of invested assets changed little to 1998 from 1997, with non-taxable investments comprising an average of 54% for 1998 and 58% for 1997. For purposes of the above discussion, invested assets are comprised of fixed maturities and equity securities at amortized cost and short-term investments. The earnings on such invested assets constitute the related net investment income. The Company calculates the yield on invested assets by dividing the related investment income by the monthly average of invested assets. The principal investment objective of the Company is to achieve a high level of after-tax income while minimizing risk. Although fixed maturity securities are purchased with the initial intent to hold such securities until their maturity, disposals of securities prior to their respective maturities may occur if management believes such disposals are consistent with the Company's overall investment objectives, including maximizing after-tax yields. Other Income Other income increased to $12.9 million for the year ended December 31, 1998 compared to $3.3 million for the year ended December 31, 1997. The increase is principally attributable to a $9.5 million increase in capital gains realized upon the sale of securities during 1998 as compared to 1997. Losses The reserve for losses and loss adjustment expenses represents management's best estimates of the ultimate cost of all losses incurred but unpaid. The reserves were evaluated by independent consulting actuaries and reflect consideration of prior loss experience and changes in the frequency and severity of claims. Actual incurred losses may vary from estimated amounts due to the inherent difficulty in estimating development of long-tailed lines of business. The estimated liability is continually reviewed and any adjustments that become necessary are included in current operations. However, the Company's management believes its actual incurred losses and loss adjustment expenses will not vary significantly from reported estimated amounts. Consolidated losses and loss adjustment expenses (losses) and the related loss ratios are summarized in the following table (dollars in thousands). The ratio for losses below is based on premiums earned; the ratio for net losses is based on net premiums earned. 21 22
1998 1997 -------------------------------------------------------- Loss Loss Losses Ratio Losses Ratio -------------------------------------------------------- Losses $ 152,270 78% $ 118,025 75% === === Reinsurance recoveries (58,377) (40,351) ------------- ------------ Net losses $ 93,893 66% $ 77,674 65% ============= === ============ ===
The increase in the 1998 gross loss ratios reflects continued geographic expansion and additional coverages offered. When expanding into areas where the Company has no significant prior loss experience, the Company follows loss estimation processes which result in higher gross loss ratios. Additionally, the Company reinsures a higher proportion of these risks, thereby lowering the net loss ratio. Thus, the 1998 net loss ratio of 66% did not vary significantly from the 1997 net loss ratio of 65%. Loss ratios in both years reflect improvement of loss development in prior years coverage. However, the improvement of loss development for prior years could have a smaller impact on the loss ratios of future years. See Note 6 to the Consolidated Financial Statements for additional information concerning losses. Underwriting, Acquisition and Insurance Expenses Underwriting, acquisition and insurance expenses are summarized in the following table (in thousands):
Increase 1998 1997 (Decrease) ---------------------------------------- Underwriting, acquisition and insurance expenses before reduction by ceding commissions earned $ 44,624 $ 38,853 $ 5,771 Ceding commissions earned (11,116) (4,950) (6,166) ---------------------------------------- $ 33,508 $ 33,903 $ (395) ========================================
The increase in underwriting, acquisition and insurance expenses is due to amortization of increased policy acquisition costs associated with new business and increased costs from state guaranty fund assessments, offset by additional ceding commissions earned. Ceding commissions earned increased primarily because during 1998 a greater portion of the Company's reinsurance treaties provided for a ceding commission than was the case during 1997. See Note 5 to the Consolidated Financial Statements. 22 23 Income Taxes The Company's effective tax rate for the years ended December 31, 1998 and 1997 was 26% and 24%, respectively. The effective tax rates were lower than the statutory rate of 35% primarily because of the effect of tax exempt investment income. The increase is principally due to the tax exempt income representing a lesser percentage of operating income in 1998. There are no loss carryforwards included in the deferred tax asset. RESULTS OF OPERATIONS - YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996 Premiums The following table presents information related to consolidated written and earned premiums and reinsurance expense (dollars in thousands):
Increase 1997 1996 (Decrease) ---------------------------------------------- Direct and assumed premiums written $ 188,195 $ 137,840 $ 50,355 ============================================== Direct and assumed premiums earned $ 158,061 $ 134,162 $ 23,899 Premiums ceded (39,094) (29,644) (9,450) ---------------------------------------------- Net premiums earned $ 118,967 $ 104,518 $ 14,449 ==============================================
Of the $50.4 million increase in written premiums, $23.3 million is attributable to increased medical malpractice premiums, of which $11.0 million relates to the inclusion of MOMED in 1997. The remaining increase is attributable to other related lines of business, which principally includes an increase of $18.9 million in accident and health premiums, and an $8.4 million increase in workers compensation premiums. The $9.5 million increase in premiums ceded for the year ended December 31, 1997 as compared to the year ended December 31, 1996 is principally due to additional written and assumed premiums, and as respects this new business, increased cessions of risks to reinsurers. Investment Income The Company had consolidated net investment income of $38.5 million for the year ended December 31, 1997 as compared to $32.1 million for the year ended December 31, 1996, reflecting an increase of $6.4 million. The increased income is primarily due to (a) an increase in the amount of invested assets, and (b) 1997 investment income attributable to MOMED of $4.3 million. Invested assets increased to $681.1 million at December 31, 1997 from $639.9 million at December 31, 1996 which includes $74.5 million and $72.7 million at 1997 and 1996, respectively, attributable to MOMED. The yield on invested assets decreased to 5.9% for 1997 from 6.1% for 1996. The average composition of invested assets changed little from 1996 to 1997, with non-taxable investments comprising an average of 58% for 1997 and 56% for 1996. Equity securities increased to $44.9 million at December 31, 1997 from $33.1 million at December 31, 1996. The equity securities for 1997 consisted of $23.2 million of fixed rate 23 24 preferred stocks and $21.7 million of common stocks compared to $22.3 million of fixed rate preferred stocks and $10.8 million of common stocks for 1996. Disposition of investments prior to maturity may result in a net gain or loss which would be classified as "Other Income." Other Income Other income increased by approximately $600,000 for the year ended December 31, 1997 compared to the year ended December 31, 1996. The increase is principally attributable to greater capital gains realized upon the sale of securities during 1997. Losses Consolidated loss and loss adjustment expenses (losses) and the related loss ratios are summarized in the following table (dollars in thousands). The ratio for losses below is based on premiums earned; the ratio for net losses is based on net premiums earned.
1997 1996 ----------------------------------------------- Loss Loss Losses Ratio Losses Ratio ----------------------------------------------- Losses $ 118,025 75% $ 104,025 78% === === Reinsurance recoveries (40,351) (31,266) --------- --------- Net losses $ 77,674 65% $ 72,759 70% ========= === ========= ===
The above loss ratios reflect improvement of loss development in prior years' coverage. The increase in reinsurance recoveries primarily results from the increase in losses and loss adjustment expenses and the increased cessions to reinsurers. Underwriting, Acquisition and Insurance Expenses Consolidated expenses increased by $8.2 million (32%) for the year ended December 31, 1997 compared to the year ended December 31, 1996, of which $2.4 million is attributable to the inclusion of MOMED in 1997. The additional increase results primarily from policy acquisition costs associated with new business, along with the other costs associated with the Company's business strategy. Income Taxes The Company's effective tax rate for the years ended December 31, 1997 and 1996 was 24%. The effective tax rates were lower than the statutory rate of 35% principally because of the effect of tax exempt investment income. There are no loss carryforwards included in the deferred tax asset. 24 25 FORWARD LOOKING STATEMENTS This discussion contains historical information, as well as forward-looking statements that are based upon Medical Assurance's estimates and anticipation of future events that are subject to certain risks and uncertainties that could cause actual results to vary materially from the expected results described in the forward-looking statements. The Company's expectations regarding losses, the retention of current business, expansion of product lines, development of business in new geographical areas, Year 2000 compliance, and market risks depend on a variety of factors, including economic, competitive and market conditions which may be beyond the Company's control and are thus difficult or impossible to predict. In view of the many uncertainties inherent in the forward-looking statements made in this document, the inclusion of such information should not be taken as representation by the Company or any other person that Medical Assurance's objectives or plans will be realized. 25 26 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Refer to Disclosure under the caption "Market Risk" in Item 7. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. The Consolidated Financial Statements and Financial Statement Schedules of MAI and subsidiaries listed in Item 14(a) have been included herein beginning on page 30. The Supplementary Financial Information required by Item 302 of Regulation S-K is included in Note 12 of the Notes to Consolidated Financial Statements of MAI and its subsidiaries. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. Not Applicable. 26 27 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. The information required by this Item regarding executive officers is included in Part I of this Form 10-K (Page 14) in accordance with Instruction 3 of the Instructions to Paragraph (b) of Item 401 of Regulation S-K. The information required by this Item regarding directors is incorporated by reference pursuant to General Instruction G(3) of Form 10-K from MAI's definitive proxy statement for the 1999 Annual Meeting of its Stockholders to be filed with the Securities and Exchange Commission pursuant to Regulation 14A on or before April 30, 1999. ITEM 11. EXECUTIVE COMPENSATION. The information required by this Item is incorporated by reference pursuant to General Instruction G(3) of Form 10-K from MAI's definitive proxy statement for the 1999 Annual Meeting of its Stockholders to be filed with the Securities and Exchange Commission pursuant to Regulation 14A on or before April 30, 1999. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. PRINCIPAL STOCKHOLDERS. The information required by this Item is incorporated by reference pursuant to General Instruction G(3) of Form 10-K from MAI's definitive proxy statement for the 1999 Annual Meeting of its Stockholders to be filed with the Securities and Exchange Commission pursuant to Regulation 14A on or before April 30, 1999. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The information required by this Item is incorporated by reference pursuant to General Instruction G(3) of Form 10-K from MAI's definitive proxy statement for the 1999 Annual Meeting of its Stockholders to be filed with the Securities and Exchange Commission pursuant to Regulation 14A on or before April 30, 1999. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (a) FINANCIAL STATEMENTS. The following consolidated financial statements of Medical Assurance, Inc. and subsidiaries are included herein in accordance with Item 8 of Part II of this report. Report of Ernst & Young LLP. Consolidated balance sheets - December 31, 1998 and 1997 Consolidated statements of changes in capital - years ended December 31, 1998, 1997 and 1996 27 28 Consolidated statements of income - years ended December 31, 1998, 1997 and 1996 Consolidated statements of cash flows - years ended December 31, 1998, 1997 and 1996 Notes to consolidated financial statements. FINANCIAL STATEMENT SCHEDULES. The following consolidated financial statement schedules of MAI and subsidiaries are included herein in accordance with Item 14(d): Schedule I - Summary of Investments - Other than Investments in Related Parties. Schedule II - Condensed Financial Information of MAI. Schedule III - Supplementary Insurance Information. Schedule IV - Reinsurance. Schedule VI - Supplementary Property and Casualty Information. 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. (b) MAI did not file any Reports on Form 8-K during the quarter ended December 31, 1998. (c) The exhibits required to be filed by Item 14(c) are listed herein in the Exhibit Index. (d) Financial Data Schedule as required by EDGAR (for SEC Use Only). 28 29 SIGNATURES Pursuant to the requirements of Section 13 of 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, on this the 26th day of March, 1999. MEDICAL ASSURANCE, INC. By: /s/ A. Derrill Crowe, M.D. -------------------------- A. Derrill Crowe, M.D. President 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.
Name Title Date - ---- ----- ---- /s/ A. Derrill Crowe President (principal March 26, 1999 - --------------------------------- executive officer) A. Derrill Crowe, M.D. and Director /s/ James J. Morello Treasurer (principal March 26, 1999 - --------------------------------- financial officer and James J. Morello principal accounting officer) /s/ Paul R. Butrus Director March 26, 1999 - --------------------------------- Paul R. Butrus /s/ Richard V. Bradley, M.D. Director March 26, 1999 - --------------------------------- Richard V. Bradley /s/ Norton E. Cowart Director March 26, 1999 - --------------------------------- Norton E. Cowart /s/ Paul D. Everest Director March 26, 1999 - --------------------------------- Paul D. Everest, M.D. /s/ Robert E. Flowers, M.D. Director March 26, 1999 - --------------------------------- Robert E. Flowers, M.D. /s/ Leon C. Hamrick Director March 26, 1999 - --------------------------------- Leon C. Hamrick, M.D. /s/ John P. North, Jr. Director March 26, 1999 - --------------------------------- John P. North, Jr.
29 30 Medical Assurance, Inc. and Subsidiaries Consolidated Financial Statements Years ended December 31, 1998, 1997 and 1996 CONTENTS Report of Independent Auditors..............................................31 Audited Consolidated Financial Statements Consolidated Balance Sheets.................................................32 Consolidated Statements of Changes in Capital...............................34 Consolidated Statements of Income...........................................35 Consolidated Statements of Cash Flows.......................................36 Notes to Consolidated Financial Statements..................................38 30 31 REPORT OF INDEPENDENT AUDITORS Board of Directors Medical Assurance, Inc. We have audited the accompanying consolidated balance sheets of Medical Assurance, Inc. and subsidiaries as of December 31, 1998 and 1997 and the related consolidated statements of income, changes in capital 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 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 consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Medical Assurance, Inc. 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 therein. Ernst & Young LLP Birmingham, Alabama February 8, 1999 31 32 Medical Assurance, Inc. and Subsidiaries Consolidated Balance Sheets
DECEMBER 31 1998 1997 -------------------------------------- (DOLLAR AMOUNTS IN THOUSANDS) ASSETS Investments: Fixed maturities available for sale, at fair value $ 657,404 $ 617,914 Equity securities available for sale, at fair value 44,124 44,880 Real estate, net 11,619 11,933 Short-term investments 78,432 45,475 ------------- ------------ Total investments 791,579 720,202 Cash and cash equivalents 9,022 12,248 Premiums receivable 59,949 92,051 Receivable from reinsurers 179,890 150,598 Prepaid reinsurance premiums 13,467 17,580 Deferred taxes 26,897 33,273 Other assets 51,435 37,221 ------------- ------------ $ 1,132,239 $ 1,063,173 ============= ============
32 33
DECEMBER 31 1998 1997 ------------------------------------- (DOLLAR AMOUNTS IN THOUSANDS) LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Policy liabilities and accruals: Reserve for losses and loss adjustment expenses $ 660,640 $ 614,729 Unearned premiums 76,229 79,700 Reinsurance premiums payable 42,596 53,752 -------------- -------------- Total policy liabilities 779,465 748,181 Income taxes payable 2,476 1,240 Other liabilities 26,118 26,564 -------------- -------------- Total liabilities 808,059 775,985 Commitments and contingencies - - Stockholders' equity: Common stock, par value $1 per share: 100,000,000 shares authorized; 23,899,983 and 21,721,562 shares issued, respectively 23,900 21,722 Additional paid-in capital 206,562 143,037 Accumulated other comprehensive income, net of deferred taxes of $6,611 and $7,947, respectively 12,277 14,704 Retained earnings 91,622 109,524 -------------- -------------- 334,361 288,987 Less treasury stock at cost, 587,033 and 222,201 shares, respectively (10,181) (1,799) -------------- -------------- Total stockholders' equity 324,180 287,188 -------------- -------------- $ 1,132,239 $ 1,063,173 ============== ==============
See accompanying notes. 33 34 Medical Assurance, Inc., and Subsidiaries Consolidated Statements of Changes in Capital (dollar amounts in thousands)
ACCUMULATED ADDITIONAL OTHER COMMON PAID-IN COMPREHENSIVE RETAINED STOCK CAPITAL INCOME EARNINGS ------------- ------------- --------------- ---------- Balance at December 31, 1995 $ 9,377 $ 92,013 $ 13,363 91,415 6% stock dividend* 584 18,919 - (19,537) Common stock issued for service awards 1 34 - - Common stock issued for compensation 1 20 - - Common stock issued for acquisition 376 12,232 - - Comprehensive income: Change in fair value of securities available for sale, net of deferred taxes - - (5,206) - Net income - - - 31,149 Total Comprehensive income ----------- ----------- ------------- --------- Balance at December 31, 1996 10,339 123,218 8,157 103,027 100% stock dividend 10,340 (10,340) - - 5% stock dividend* 1,032 29,862 - (30,961) Common stock issued for service awards 1 41 - - Common stock issued for compensation 9 247 - - Common stock issued for acquisition 1 9 - - Purchase of treasury stock - - - - Sale of treasury stock - - - - Comprehensive income: Change in fair value of securities available for sale, net of deferred taxes - - 6,547 - Net income - - - 37,458 Total Comprehensive income ----------- ----------- ------------- ---------- Balance at December 31, 1997 21,722 143,037 14,704 109,524 10% stock dividend* 2,170 63,079 - (65,302) Common stock issued for service awards 1 28 - - Common stock issued for compensation 7 195 - - Purchase of treasury stock - - - - Sale of treasury stock - 223 - - Comprehensive income: Change in fair value of securities available for sale, net of deferred taxes - - (2,427) - Net income - - - 47,400 Total Comprehensive income ------------- ------------- --------------- ----------- Balance at December 31, 1998 $ 23,900 $ 206,562 $ 12,277 91,622 ============= ============= =============== =========== TREASURY STOCK TOTAL ------------ ------------ Balance at December 31, 1995 (138) 206,030 6% stock dividend* - (34) Common stock issued for service awards - 35 Common stock issued for compensation - 21 Common stock issued for acquisition (38) 12,570 Comprehensive income: Change in fair value of securities available for sale, net of deferred taxes - Net income - Total Comprehensive income 25,943 ----------- ------------ Balance at December 31, 1996 (176) 244,565 100% stock dividend - - 5% stock dividend* - (67) Common stock issued for service awards - 42 Common stock issued for compensation - 256 Common stock issued for acquisition - 10 Purchase of treasury stock (1,708) (1,708) Sale of treasury stock 85 85 Comprehensive income: Change in fair value of securities available for sale, net of deferred taxes - Net income - Total Comprehensive income 44,005 ----------- ------------ Balance at December 31, 1997 (1,799) 287,188 10% stock dividend* - (53) Common stock issued for service awards - 29 Common stock issued for compensation - 202 Purchase of treasury stock (8,701) (8,701) Sale of treasury stock 319 542 Comprehensive income: Change in fair value of securities available for sale, net of deferred taxes - Net income - Total Comprehensive income 44,973 ----------- ------------ Balance at December 31, 1998 (10,181) $ 324,180 =========== ============
*Cash paid for fractional shares See accompanying notes. 34 35 Medical Assurance, Inc., and Subsidiaries Consolidated Statements of Income
YEAR ENDED DECEMBER 31 1998 1997 1996 ------------------------------------------------ (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) Direct and assumed premiums written $ 192,479 $ 188,195 $ 137,840 ============= ============== =========== Revenues: Premiums earned $ 195,515 $ 158,061 $ 134,162 Premiums ceded (54,199) (39,094) (29,644) ------------- --------------- ----------- Net premiums earned 141,316 118,967 104,518 Net investment income 39,402 38,474 32,114 Other income 12,885 3,301 2,642 ------------- --------------- ----------- Total revenues 193,603 160,742 139,274 Expenses: Losses and loss adjustment expenses 152,270 118,025 104,025 Reinsurance recoveries (58,377) (40,351) (31,266) ------------- --------------- ----------- Net losses and loss adjustment expenses 93,893 77,674 72,759 Underwriting, acquisition, and insurance expenses 33,508 33,903 25,729 ------------- --------------- ----------- Total expenses 127,401 111,577 98,488 ------------- --------------- ----------- Income before income taxes and cumulative effect of accounting change 66,202 49,165 40,786 Provision for income taxes: Current expense 9,967 12,373 11,330 Deferred expense (benefit) 7,712 (666) (1,693) ------------- --------------- ----------- 17,679 11,707 9,637 ------------- --------------- ----------- Income before cumulative effect of accounting change 48,523 37,458 31,149 Cumulative effect of accounting change, net of tax (1,123) - - ------------- -------------- ------------ Net income $ 47,400 $ 37,458 $ 31,149 ============= ============== ============ Basic and diluted earnings per share Income before cumulative effect of accounting change $ 2.06 $ 1.58 $ 1.36 Cumulative effect of accounting change, net of tax (0.05) - - ------------- -------------- ------------ Net income $ 2.01 $ 1.58 $ 1.36 ============= ============== ============ Weighted average number of common shares outstanding 23,553 23,658 22,948 ============= ============== ============
See accompanying notes. 35 36 Medical Assurance, Inc., and Subsidiaries Consolidated Statements of Cash Flows
YEAR ENDED DECEMBER 31 1998 1997 1996 ------------------------------------------------------------- (DOLLAR AMOUNTS IN THOUSANDS) OPERATING ACTIVITIES Net income $ 47,400 $ 37,458 $ 31,149 Adjustments to reconcile net income to net cash provided (used) by operating activities: Depreciation 1,631 1,328 1,236 Amortization 1,587 1,683 (2,197) Net realized gain on sale of investments (11,281) (1,739) (1,532) Deferred income taxes (benefit) 7,712 (666) (1,693) Policy acquisition costs deferred, net of related amortization (5,693) (2,714) 1,186 Other 407 278 (68) Changes in assets and liabilities, net of effects of business combinations: Premiums receivable 32,102 (58,155) (13,152) Income taxes receivable/payable 1,236 (1,612) 952 Receivable from reinsurers (29,292) (41,906) (16,765) Prepaid reinsurance premiums 4,113 (3,428) (356) Other assets (9,803) (4,137) (1,212) Reserve for losses and loss adjustment expenses 45,911 65,987 58,695 Unearned premiums (3,471) 24,780 5,045 Reinsurance premiums payable (11,156) 21,963 4,377 Other liabilities (446) 4,124 9,171 ------------------- ------------ -------------- Net cash provided by operating activities 70,957 43,244 74,836 INVESTING ACTIVITIES Purchases of fixed maturities available for sale (343,566) (211,806) (155,606) Purchases of equity securities available for sale (14,399) (15,691) (23,159) Proceeds from sale or maturities of fixed maturities available for sale 308,793 166,587 133,145 Proceeds from sale of equity securities available for sale 16,905 6,890 2,084 Purchases of real estate (205) (253) 0 Net decrease (increase) in short-term investments (32,957) 10,928 (16,675) Purchase of subsidiaries - - (7,263) Distribution from subsidiaries - - 3,628 Other - 6 (1,161) ------------------- ------------ -------------- Net cash used by investing activities (65,429) (43,339) (65,007)
36 37
YEAR ENDED DECEMBER 31 1998 1997 1996 ------------------------------------------------------------------ FINANCING ACTIVITIES Dividends paid $ (53) $ (67) $ (34) Purchase of treasury stock, net (8,701) (1,623) - ---------------- ----------------- ----------------- Net cash used by financing activities (8,754) (1,690) (34) ---------------- ----------------- ----------------- Increase (decrease) in cash and and cash equivalents (3,226) (1,785) 9,795 Cash and cash equivalents at beginning of year 12,248 14,033 4,238 ---------------- ------------------ ----------------- Cash and cash equivalents at end of year $ 9,022 $ 12,248 $ 14,033 ================ ================== ================= SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Cash paid during the year for income taxes $ 8,072 $ 12,175 $ 11,075 ================ ================== =================
See accompanying notes. 37 38 Medical Assurance, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 1. ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION The accompanying consolidated financial statements include the accounts of Medical Assurance, Inc. (a Delaware corporation) and its subsidiaries. All significant intercompany accounts and transactions between consolidated companies have been eliminated. BASIS OF PRESENTATION The preparation of financial statements in accordance with generally accepted accounting principles (GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The significant accounting policies followed by the Company that materially affect financial reporting are summarized in these notes to the financial statements. SEGMENT INFORMATION The Company operates in the United States of America and in only one reportable industry segment, which is providing professional and general liability insurance for physicians and surgeons, dentists, hospitals, and others engaged in the delivery of health care. INVESTMENTS The Company invests only in investment grade securities with the intent at the time of purchase that such securities will be held until maturity. However, recognizing the need for the ability to respond to changes in tax position and in market conditions, management has designated the debt and equity securities included in its investment portfolio as available-for-sale. Securities classified as available-for-sale are carried at market value, and unrealized gains and losses on such available-for-sale securities are excluded from earnings and reported, net of tax effect, in stockholders' equity as "Accumulated other comprehensive income" until realized. Real estate is reported at cost, less allowances for depreciation. Short-term investments, primarily composed of investments in United States (U.S.) Treasury obligations, are reported at cost, which approximates fair value. Investment income includes amortization of premium and accretion of discount related to debt securities acquired at other than par value. Debt securities with maturities beyond one year when purchased are classified as fixed maturities. Realized gains and losses on sales of investments, and declines in value judged to be other-than-temporary, are recognized on the specific identification basis. 38 39 Medical Assurance, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) Fair values for fixed maturity and equity securities are based on quoted market prices, where available. For fixed maturity and equity securities not actively traded, fair values are estimated using values obtained from independent pricing services. The carrying amounts reported in the balance sheet for cash and cash equivalents and short-term investments approximate their fair values. REAL ESTATE Property and leasehold improvements are classified as investment real estate. All balances are stated on the basis of cost. Depreciation is computed over their estimated useful lives using the straight-line method. Accumulated depreciation was approximately $4.6 million and $3.9 million at December 31, 1998 and 1997, respectively. Rental income and expenses are included in net investment income. CASH AND CASH EQUIVALENTS For purposes of the consolidated statements of cash flows, the Company considers all demand deposits and overnight investments to be cash equivalents. REINSURANCE Certain premiums are assumed from and ceded to other insurance companies under various reinsurance agreements. The Company cedes reinsurance to provide for greater diversification of business, allow management to control exposure to potential losses arising from large risks, and provide additional capacity for growth. A significant portion of the reinsurance is effected under reinsurance contracts known as treaties and, in some instances, by negotiation on individual risks. Reinsurance expense is estimated based on the terms of the respective reinsurance agreements. The estimated expense is continually reviewed and any adjustments which become necessary are included in current operations. Amounts recoverable from reinsurers are estimated in a manner consistent with the loss liability associated with the reinsured policies. DEFERRED POLICY ACQUISITION COSTS Costs that vary with and are directly related to the production of new and renewal premiums (primarily premium taxes, commissions and underwriting salaries) are deferred to the extent they are recoverable against unearned premiums and are amortized as related premiums are earned. 39 40 Medical Assurance, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSES The reserve for losses and loss adjustment expenses represents management's best estimates of the ultimate cost of all losses incurred but unpaid. The estimated liability is continually reviewed, and any adjustments which become necessary are included in current operations. CAPITAL RESOURCES As of December 31, 1998, the Company did not have any material commitments for capital expenditures. The Company continues to have available through a lending institution a line of credit in the amount of $40 million that could be used for additional capital requirements. RECOGNITION OF REVENUES Insurance premiums are recognized as revenues pro rata over the terms of the policies. PENSION PLANS The Company has a defined contribution pension plan for employees who are at least 21 years of age and have one or more years of service. The Company funds the plan by contributing an amount equal to 10% of each participant's eligible wages. Consolidated pension plan expense for the years ended December 31, 1998, 1997 and 1996 was approximately $967,000, $809,000 and $834,000, respectively. EMPLOYEE STOCK PURCHASE PLAN The Company has a stock purchase plan for full-time employees who have completed minimum service requirements. The plan allows each eligible employee to purchase shares of the Company's common stock in the public market and the Company will loan to each participant $0.35 for each $0.65 deposited in the plan. The stock purchased with the loaned proceeds vests with the employee at the end of four years. These loans are amortized to expense over the four-year vesting period. STOCK OPTIONS In 1997, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation" that calls for companies to measure employee stock compensation expense based on the fair value method of accounting. However, as allowed by the statement, the Company elected the continued use of Accounting Principles Board Opinion No. 25 "Accounting for Stock Issued to Employees" with pro forma disclosure of net income and earnings per share determined as if the fair value method had been applied in measuring compensation cost. 40 41 Medical Assurance, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) INCOME TAXES The Company files a consolidated federal income tax return. Deferred income taxes are provided for temporary differences between financial and income tax reporting relating primarily to unrealized gains on securities, discounting of losses and loss adjustment expenses for income tax reporting, and the limitation of the unearned premiums deduction for income tax reporting. EARNINGS PER SHARE Earnings per share data has been stated giving retroactive effect for the 10%, 5%, and 6% stock dividends declared in December of 1998, 1997 and 1996, respectively, as well as the two-for-one stock split declared in August 1997. Weighted average shares outstanding for the years ending December 31, 1998, 1997 and 1996 were 23,552,721, 23,657,736, and 22,947,544, respectively. ACCOUNTING CHANGES Pursuant to the American Institute of Certified Public Accountants' Statement of Position (SOP) 97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments," the Company changed its accounting policy effective January 1, 1998 regarding guaranty fund assessments. Previously, the Company recognized guaranty assessments in the period that notification regarding the assessment was received. Guaranty assessments are now recognized when an assessment is imposed or it is probable that an assessment will be imposed and there is an obligation to pay the assessment, the amount of which can be reasonably estimated. The cumulative effect on prior years has been included in net income for the first quarter of 1998 in accordance with SOP 97-3. The adoption of the SOP decreased underwriting, acquisition and insurance expenses for 1998 by $1.7 million. In 1998, the Company adopted SFAS 130, "Reporting Comprehensive Income," which establishes standards for the reporting and display of comprehensive income and its components in a full set of general purpose financial statements. The statement requires that enterprises classify items of other comprehensive income separately from retained earnings and additional paid-in capital in the equity section of the balance sheet. Items of other comprehensive income are displayed in the Consolidated Statements of Changes in Capital, and amounts for 1997 and 1996 have been reclassified for comparative purposes. 41 42 Medical Assurance, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 2. INVESTMENTS The amortized cost and estimated fair value of fixed maturities and equity securities (in thousands) are as follows:
December 31, 1998 Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value ------------------------------------------------------------------------- U.S. Treasury securities $ 30,877 $ 1,230 $ (171) $ 31,936 State and municipal bonds 405,529 13,452 (2,054) 416,927 Corporate bonds 119,713 4,305 (958) 123,060 Mortgage-backed securities 79,628 1,368 (1,185) 79,811 Certificates of deposit 5,670 - - 5,670 ------------------------------------------------------------------------- 641,417 20,355 (4,368) 657,404 Equity securities 41,223 4,727 (1,826) 44,124 ------------------------------------------------------------------------- $ 682,640 $ 25,082 $ (6,194) $701,528 ========================================================================= December 31, 1997 Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value ------------------------------------------------------------------------- U.S. Treasury securities $ 30,469 $ 800 $ (1) $ 31,268 State and municipal bonds 350,746 15,017 (1) 365,762 Corporate bonds 132,162 3,042 (74) 135,130 Mortgage-backed securities 79,269 998 (183) 80,084 Certificates of deposit 5,670 - - 5,670 ------------------------------------------------------------------------- 598,316 19,857 (259) 617,914 Equity securities 41,827 3,745 (692) 44,880 ------------------------------------------------------------------------- $ 640,143 $ 23,602 $ (951) $662,794 =========================================================================
The amortized cost and estimated fair value of fixed maturities (in thousands) at December 31, 1998, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. The Company uses the call date as the contractual maturity for prerefunded state and municipal bonds which are 100% backed by U.S. Treasury obligations. 42 43 Medical Assurance, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued)
Amortized Estimated Cost Fair Value ------------------------------------- Due in one year or less $ 39,799 $ 40,274 Due after one year through five years 319,933 328,269 Due after five years through ten years 127,188 132,304 Due after ten years 74,869 76,746 Mortgage-backed securities 79,628 79,811 ------------------------------------- $ 641,417 $ 657,404 =====================================
Excluding investments in bonds and notes of the U.S. Government, U.S. Government agency, or prerefunded state and municipal bonds which are 100% backed by U.S. Treasury obligations, no investment in any person or its affiliates exceeded 10% of stockholders' equity at December 31, 1998. Amounts of investment income by investment category (in thousands) are as follows:
Year ended December 31 1998 1997 1996 ------------------------------------------------- Fixed maturities $ 34,926 $ 35,570 $ 29,689 Equities 1,877 1,701 748 Real estate 1,416 1,388 1,330 Short-term investments 2,955 2,122 1,581 Other 1,021 64 836 ------------------------------------------------- 42,195 40,845 34,184 Investment expenses (2,793) (2,371) (2,070) ------------------------------------------------- Net investment income $ 39,402 $ 38,474 $ 32,114 =================================================
Gross gains and losses from sales of available-for-sale securities (in thousands) are included in other income as follows:
Year ended December 31 1998 1997 1996 -------------------------------------------------- Gross gains $ 11,827 $ 2,283 $ 2,082 Gross losses (546) (544) (550) -------------------------------------------------- Net Gains $ 11,281 $ 1,739 $ 1,532 ==================================================
These amounts, net of related tax expense of $3.9 million, $0.6 million, and $0.5 million, respectively, were reclassified from "Accumulated other comprehensive income" included in stockholders' equity to "Other income" in the Consolidated Statements of Income. Proceeds from sales of investments in available-for-sale securities were $272.5 million, $128.5 million and $83.4 million during 1998, 1997 and 1996, respectively. 43 44 Medical Assurance, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 3. REINSURANCE The effect of reinsurance on premiums written and earned (in thousands) in 1998 was as follows:
Premiums Written Earned -------------------------------------- Direct $ 179,668 $ 185,994 Assumed 12,811 9,521 Ceded (50,692) (54,199) -------------------------------------- Net premiums $ 141,787 $ 141,316 ======================================
Reinsurance contracts do not relieve the Company from its obligations to policyholders. A contingent liability exists with respect to reinsurance ceded to the extent that any reinsurer does not meet the obligations assumed under the reinsurance agreements. The Company continually monitors its reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. At December 31, 1998, all reinsurance recoverables are considered collectible; the amounts as shown in the accompanying consolidated balance sheets approximate the fair value of the amounts recoverable from reinsurers. As required by the various state insurance laws, reinsurance recoverables totaling approximately $10 million are collateralized by letters of credit or funds withheld. 4. INCOME TAXES Deferred income taxes reflect the net tax effects of temporary differences between the amount of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax liabilities and assets (in thousands) are as follows:
December 31 1998 1997 ----------------------------- Deferred tax liabilities: Adjustment to net unrealized gains on investments $ 6,611 $ 7,947 Deferred acquisition costs 4,557 2,556 Other 2,457 726 -------------------------------- Total deferred tax liabilities 13,625 11,229 Deferred tax assets: Unpaid loss discount 34,727 40,154 Unearned premium adjustment 5,795 4,348 -------------------------------- Total deferred tax assets 40,522 44,502 -------------------------------- Net deferred tax assets $ 26,897 $ 33,273 ================================
44 45 Medical Assurance, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) In the opinion of management, it is more likely than not that the Company will realize the benefit of the deferred tax assets, and therefore, no valuation allowance has been established. A reconciliation of "expected" income tax expense (35% of income before income taxes) to actual income tax expense in the accompanying financial statements (in thousands) follows:
Year ended December 31 1998 1997 1996 ----------------------------------------------- Computed "expected" tax expense $ 23,171 $ 17,208 $ 14,305 Tax-exempt municipal and state bond income (5,744) (5,153) (4,766) Other 252 (348) 98 ----------------------------------------------- Total $ 17,679 $ 11,707 $ 9,637 ===============================================
5. DEFERRED POLICY ACQUISITION COSTS Deferred policy acquisition costs include premium taxes, ceding commissions, brokerage fees and agents' commissions, and salaries, benefits and other expenses associated with underwriting. Unamortized deferred policy acquisition costs are included in other assets on the consolidated balance sheets and amounted to approximately $13.0 million and $7.3 million at December 31, 1998 and 1997, respectively. As is common practice within the industry, reinsurance ceding commissions are deducted from acquisition costs and amounted to $11.1 million, $4.9 million, and $0 for the years ended December 31, 1998, 1997 and 1996, respectively. Amortization of deferred policy acquisition costs amounted to approximately $13.7 million, $15.4 million, and $11.1 million for the years ended December 31, 1998, 1997 and 1996, respectively. Underwriting and insurance costs that are not directly related to the production of new and renewal premiums are charged to expense as incurred. These costs were $19.8 million, $18.5 million and $14.7 million for the years ended December 31, 1998, 1997 and 1996, respectively. 45 46 Medical Assurance, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 6. RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSES Activity in the reserve for losses and loss adjustment expenses (reserves) is summarized as follows (in thousands):
Year ended December 31 1998 1997 1996 ------------------------------------------------------- Balance at January 1 $ 614,729 $ 548,742 $ 432,945 Less reinsurance recoverables 150,598 108,692 80,468 ----------------------------------------------------- Net balance at January 1 464,131 440,050 352,477 Incurred related to: Current year 141,201 124,353 100,186 Prior years (47,308) (46,679) (27,427) ----------------------------------------------------- Total Incurred 93,893 77,674 72,759 Paid related to: Current year (9,891) (5,203) (3,468) Prior years (67,383) (48,390) (27,361) ----------------------------------------------------- Total paid (77,274) (53,593) (30,829) Reserves of entity acquired - - 45,643 ----------------------------------------------------- Net balance at December 31 480,750 464,131 440,050 Plus reinsurance recoverables 179,890 150,598 108,692 ----------------------------------------------------- Balance at December 31 $ 660,640 $ 614,729 $ 548,742 =====================================================
The reserves were evaluated by independent consulting actuaries and reflect consideration of prior loss experience and changes in the frequency and severity of claims. Actual incurred losses may vary from estimated amounts due to the inherent difficulty in estimating development of long-tailed lines of business. In recent years, the Company has experienced favorable development of prior year losses relative to the original estimates; there are no assurances that such favorable development will continue. The Company's management believes the unearned premiums under contracts, together with the related anticipated investment income to be earned, is adequate to discharge the related contract liabilities. 7. COMMITMENTS AND CONTINGENCIES The Company is involved in various legal actions arising primarily from claims made under insurance policies. The legal actions arising from claims made under insurance policies have been considered by the Company in establishing its reserves. While the outcome of all legal actions is not presently determinable, the Company's management and its legal counsel are of the opinion that the settlement of these actions will not have a material adverse effect on the Company's financial position or results of operations. 46 47 Medical Assurance, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 8. STOCKHOLDERS' EQUITY At December 31, 1998, Medical Assurance, Inc. had 100 million shares of authorized common stock and 50 million shares of authorized preferred stock. The Board of Directors has the authority to determine the provisions for the issuance of shares of the preferred stock, including the number of shares to be issued and the designations, powers, preferences and rights, and the qualifications, limitations or restrictions of such shares. At December 31, 1998, the Board of Directors had not authorized the issuance of any preferred stock nor determined any provisions for the preferred stock. The Board of Directors declared stock dividends of 10%, 5% and 6% in December 1998, 1997 and 1996, respectively. In addition, the Board of Directors declared a two-for-one stock split in the form of a 100% stock dividend on August 20, 1997. Cash was paid to shareholders for fractional shares. Earnings per share data for 1998, 1997 and 1996 have been stated as if all of the above dividends had been declared on January 1, 1996. The Board of Directors of Medical Assurance, Inc. has reserved 1.5 million shares of common stock for issuance in accordance with the Mutual Assurance Stock Award Plan assumed by Medical Assurance, Inc. Under the terms of the plan, shares of Medical Assurance, Inc. stock are available to be awarded to key employees of Medical Assurance, Inc. and its subsidiaries. As of December 31, 1998 and 1997, there were 21,600 and 13,489 shares, respectively, (after giving effect to subsequent stock dividends and stock split) issued under the plan. "Accumulated other comprehensive income" shown in the Consolidated Statements of Changes in Capital is solely comprised of net unrealized gains on securities available for sale. 9. STOCK OPTIONS Under the Company's Incentive Compensation Stock Plan, 76,777 options and 230,485 options were granted in 1998 and 1997, respectively, at $27.33 per share and $25.92 per share, respectively. All options were granted at a price equal to the market price of the stock on the date of the grant. Stock options expire in ten years and were fully vested as of the grant date but are not exercisable for six months. The number of options granted and the exercise price have been adjusted for the stock dividends declared in 1998 and 1997. There were no options granted prior to 1997 and no options have been exercised to date. Had the fair value method of accounting discussed in SFAS 123 been applied, net income would have been reduced by $0.6 million or $0.02 basic earnings per share in 1998 and $1.7 million or $0.07 basic earnings per share in 1997. The average fair value of options granted during 1998 and 1997 was $11.43 and $12.80, respectively. The fair value was estimated using the Black-Scholes option pricing model based on the weighted average assumptions for 1998 (1997) of: risk-free interest rate of 4.75% (5.92%), volatility of 0.250 (0.244), and, for both years, expected life of 8 years and a dividend yield of 0%. 47 48 Medical Assurance, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 10. BUSINESS EXPANSION During 1996 the Company completed the acquisition of MOMED Holding Company (MOMED), parent of Missouri Medical Insurance Company. The acquisition was not material to the assets, stockholders' equity or operations of the Company. This purchase was effective December 20, 1996; however, MOMED operations for the period December 20, 1996 through December 31, 1996 were considered immaterial for inclusion in the Company's 1996 consolidated statement of income. MOMED operations are included in the Company's 1998 and 1997 consolidated statement of income. Revenues for MOMED for the year ended December 31, 1996 were approximately $15.8 million. Net income for MOMED for the year ended December 31, 1996 was approximately $4.3 million. 11. STATUTORY ACCOUNTING AND DIVIDEND RESTRICTIONS The Company's insurance subsidiaries are required to file statutory financial statements with state insurance regulatory authorities. GAAP differs from statutory accounting practices prescribed or permitted by regulatory authorities. Differences between financial statement net income and statutory net income are principally due to: (a) policy acquisition costs which are deferred under GAAP but expensed for statutory purposes; (b) subsidiaries which are consolidated for GAAP but are accounted for using the equity method for statutory purposes with the annual change in the equity charged or credited directly to capital rather than entering into the determination of net income; and (c) deferred income taxes which are recorded under GAAP but not for statutory purposes. At December 31, 1998 and 1997, statutory capital for each company was sufficient to satisfy regulatory requirements. Amounts of statutory capital and surplus for the Company's insurance subsidiaries were $245.0 million and $212.0 million at December 31, 1998 and 1997, respectively. The combined amounts of statutory net income for the years ended December 31, 1998, 1997 and 1996 for the Company's insurance subsidiaries were $36.2 million, $28.2 million, and $31.4 million, respectively. Consolidated retained earnings are comprised primarily of subsidiaries' retained earnings. Each insurance company is restricted under the applicable State Insurance Code as to the amount of dividends it may pay without regulatory consent. In 1999, the insurance subsidiaries can pay dividends in the aggregate up to approximately $37.6 million without regulatory consent. 48 49 Medical Assurance, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 12. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED) The following is a summary of unaudited quarterly results of operations (in thousands, except per share amounts) for 1998 and 1997:
1998 1st 2nd 3rd 4th ------------------------------------------------------- Net premiums earned $ 31,764 $ 34,579 $ 37,676 $ 37,297 Net investment income 9,688 9,732 10,157 9,825 Other income 887 1,900 4,899 5,199 Income before cumulative effect of accounting change 9,859 11,397 13,536 13,731 Net income 8,736 11,397 13,536 13,731 Basic and diluted earnings per share: Income before cumulative effect of accounting change 0.42 0.48 0.57 0.59 Net Income 0.37 0.48 0.57 0.59 1997 1st 2nd 3rd 4th ------------------------------------------------------- Net premiums earned $ 28,402 $ 29,138 $ 30,774 $ 30,653 Net investment income 9,458 9,426 9,523 10,067 Other income 611 128 1,283 1,279 Net income 8,414 8,781 9,894 10,370 Basic and diluted earnings per share 0.35 0.37 0.42 0.44
Quarterly earnings per share data for 1998 and 1997 have been restated giving retroactive effect as if the 1998 and 1997 dividends and the 1997 stock split had been declared on January 1, 1997. The sum of the above amounts may vary from the annual amounts because of rounding. The amounts shown above for the first three quarters of 1998 differ from the interim amounts previously reported due to the effect (which was immaterial) of adopting SOP 97-3 as discussed in Note 1. 49 50 MEDICAL ASSURANCE, INC. AND SUBSIDIARIES SCHEDULE I - SUMMARY OF INVESTMENTS - OTHER THAN INVESTMENTS IN RELATED PARTIES December 31, 1998 (dollars in thousands)
Cost or Amount at Which Amortized Fair Shown in the Type of Investment Cost Value Balance Sheet - ------------------------------------------------------------------------------------------------------------------------------------ Fixed Maturities: Bonds: U.S. Treasury Securities...................... $ 30,877 $ 31,936 $ 31,936 State and municipal bonds..................... 405,529 416,927 416,927 Corporate bonds............................... 119,713 123,060 123,060 Mortgage-backed securities.................... 79,628 79,811 79,811 Certificates of deposit....................... 5,670 5,670 5,670 ----------- ---------- ---------- Total fixed maturities...................... 641,417 $ 657,404 657,404 ----------- ========== ---------- Equity securities 41,223 $ 44,124 44,124 Real estate, net................................. 11,619 ========== 11,619 short-term investments........................... 78,432 78,432 ----------- ---------- Total investments........................... $ 772,691 $ 791,579 ========== ==========
50 51 MEDICAL ASSURANCE, INC. AND SUBSIDIARIES SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT December 31, 1998 and 1997 (dollars in thousands)
Condensed Balance Sheets December 31 1998 1997 ---------- -------- Assets Short-term investments $ 14,816 $ 2,593 Investment in subsidiaries - at equity 308,196 285,512 Receivable from subsidiaries 3,732 3,179 Cash 1,684 518 Other assets 60 342 ---------- --------- $ 328,488 $ 292,144 ========== ========= Liabilities and stockholders' equity Other liabilities $ 4,308 $ 4,956 Stockholders' equity Common stock 23,900 21,722 Other stockholders' equity, including unrealized gains or losses on securities of subsidiaries 300,280 265,466 ---------- --------- Total stockholders' equity $ 324,180 $ 287,188 ---------- --------- $ 328,488 $ 292,144 ========== =========
Condensed Statements of Income Year Ended Year Ended December 31, 1998 December 31, 1997 ----------------- ----------------- Revenues Investment income $ 327 $ 238 Other income 1,018 (1) ---------- --------- 1,345 237 Expenses Other expenses 1,739 2,030 ---------- --------- 1,739 2,030 ---------- --------- Loss before income tax benefit and equity in undistributed net income of subsidiaries (394) (1,793) Federal and state income tax benefit (54) (376) ---------- --------- Loss before equity in undistributed net income of subsidiaries (340) (1,417) Equity in undistributed net income of subsidiaries 47,740 38,875 ---------- --------- Net income $ 47,400 $ 37,458 ========== =========
51 52 MEDICAL ASSURANCE, INC. AND SUBSIDIARIES SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT December 31, 1998 and 1997 (dollars in thousands)
Condensed Statements of Cash Flows Year Ended December 31 1998 1997 -------- -------- Cash from Operating Activities $ (1,267) $ 17,433 Investing activities Cash received from subsidiaries 15,000 0 Net increase (decrease) in short-term investments, net (12,223) 2,548 Proceeds from sale of equity securities 1,685 0 Purchase of subsidiary Capital contribution to subsidiaries 0 (17,323) Other (295) (1,085) -------- -------- 4,167 (15,860) Financing activities Dividends paid (53) (67) Purchase of Treasury Stock (1,681) (1,623) -------- -------- (1,734) (1,690) Increase in cash $ 1,166 $ (117) ======== ========
Notes to Condensed Financial Statements 1. Basis of Presentation In the parent-only financial statements, the Company's investment in subsidiaries is stated at cost plus equity in undistributed earnings of subsidiaries since the date of acquisition. The Company's share of net income of its unconsolidated subsidiaries is included in consolidated income using the equity method. The parent-only financial statements should be read in conjunction with the Company's consolidated financial statements. 2. Related Party Transactions In 1998, the Company received dividends of $15 million from Mutual Assurance, Inc. 52 53 MEDICAL ASSURANCE, INC. AND SUBSIDIARIES SCHEDULE III - SUPPLEMENTARY INSURANCE INFORMATION Years Ended December 31, 1998, 1997, and 1996 (dollars in thousands)
1998 1997 1996 -------------------------------------- Deferred policy acquisition costs.......................... $ 13,020 $ 7,304 $ 4,590 Reserve for losses and loss adjustment expenses............ 660,640 614,729 548,742 Unearned premiums.......................................... 76,229 79,700 54,920 Net premiums earned........................................ 141,316 118,967 104,518 Premiums assumed from other companies...................... 12,811 12,628 11,681 Net investment income...................................... 39,402 38,474 32,114 Net losses and loss adjustment expenses.................... 93,893 77,674 72,759 Underwriting, acquisition and insurance expenses: Amortization of deferred policy acquisition costs..... 13,735 15,412 11,065 Other underwriting, acquisition and insurance expenses........................... 19,773 18,491 14,664 Net premiums written....................................... 141,787 140,200 105,961
53 54 MEDICAL ASSURANCE, INC. AND SUBSIDIARIES SCHEDULE IV - REINSURANCE Years Ended December 31, 1998, 1997, and 1996 (dollars in thousands)
1998 1997 1996 ------------------------------------------- PROPERTY & CASUALTY Earned premiums before reinsurance $ 161,954 $ 138,352 $ 118,211 Reinsurance expense (32,636) (32,432) (29,644) Assumed from other companies 6,240 11,401 15,951 --------- --------- --------- Net premiums earned $ 135,558 $ 117,321 $ 104,518 ========= ========= ========= Percentage of amount assumed to net 4.60% 9.72% 15.26% ========= ========= ========= ACCIDENT AND HEALTH Gross premiums earned $ 24,040 $ 8,308 $ 0 Ceded to other companies (21,563) (6,662) 0 Assumed from other companies 3,281 0 0 --------- --------- --------- Net premiums earned $ 5,758 $ 1,646 $ 0 ========= ========= ========= Percentage of amount assumed to net 56.98% 0.00% 0.00% ========= ========= ========= OTHER Gross premiums earned 0 0 0 Ceded to other companies 0 0 0 Assumed from other companies 0 0 0 --------- --------- --------- Net premiums earned $ 0 $ 0 $ 0 ========= ========= ========= Percentage of amount assumed to be net 0.00% 0.00% 0.00% ========= ========= ========= Total net premiums earned $ 141,316 $ 118,967 $ 104,518 ========= ========= =========
54 55 MEDICAL ASSURANCE, INC. AND SUBSIDIARIES SCHEDULE VI - SUPPLEMENTARY PROPERTY AND CASUALTY INSURANCE INFORMATION Years Ended December 31, 1998, 1997, and 1996 (dollars in thousands)
1998 1997 1996 -------------------------------------- Deferred policy acquisition costs....................... $ 13,020 $ 7,304 $ 4,590 Reserve for losses and loss adjustment expenses......... 660,640 614,729 548,732 Unearned premiums....................................... 76,229 79,700 54,920 Net premiums earned..................................... 141,316 118,967 104,518 Net investment income................................... 39,402 38,474 31,129 Losses and loss adjustment expenses incurred related to current year, net of reinsurance........ 141,201 124,353 100,186 Losses and loss adjustment expenses incurred related to prior year, net of reinsurance.......... (47,308) (46,679) (27,427) Amortization of deferred policy acquisition costs....... 13,735 15,412 11,065 Paid losses and loss adjustment expenses related to current year losses, net of reinsurance............ (9,891) (5,203) (3,468) Paid losses and loss adjustment expenses related to prior year losses, net of reinsurance.............. (67,383) (48,390) (27,415)
55 56 EXHIBIT INDEX
Exhibit Number Description Page - ------ ----------- ---- 3.1 Certificate of Incorporation of Medical Assurance, Inc. (3) 3.2 Certificate Amendment to Certificate of Incorporation of Medical Assurance, Inc. (9) 3.3 Bylaws of Medical Assurance, Inc. (3) 4 Specimen of Common Stock Certificate of Medical Assurance, Inc. (9) 10.1 Employment Agreement between A. Derrill Crowe, M.D. and Mutual Assurance, Inc., including amendments (1) 10.2 Employment Agreement between Bradley DeMonbrun, Ltd. and MOMED Holding Co., including amendments (7) 10.3 Medical Assurance, Inc. Incentive Compensation Plan (formerly known as the Mutual Assurance, Inc. 1995 Stock Award Plan) (3) 10.4 Amendment and Assumption Agreement by and between Mutual Assurance, Inc. and MAIC Holdings, Inc. dated April 8, 1996 (6) 10.5 MAIC Holdings, Inc. Director Deferred Compensation Plan (9) 10.6 MAIC Holdings, Inc. Executive Incentive Compensation Plan (9) 10.7 Agreement between the Medical Association of the State of Alabama and Mutual Assurance Society of Alabama dated July 1, 1977 (1) 10.8 Endorsement and Marketing Agreement by and between Mutual Assurance, Inc., West Virginia Health Services, Inc., a West Virginia corporation wholly-owned by West Virginia Hospital Association, a West Virginia non- profit corporation, and West Virginia Hospital Insurance Company, a West Virginia insurance company, dated January 1, 1994 (2)
56 57
Exhibit Number Description Page - ------ ----------- ---- 10.9 Endorsement and Marketing Agreement by and between Medical Assurance of West Virginia, Inc., a West Virginia insurance corporation and subsidiary of Mutual Assurance, Inc., and the West Virginia State Medical Association, a West Virginia non-profit corporation dated December 1, 1994 (2) 10.10 Endorsement, Marketing and Sponsorship Agreement effective as of January 1, 1995 between Physicians Insurance Company of Indiana and The Indiana State Medical Association (6) 10.11 Stock Purchase Agreement by and between Mutual Assurance, Inc. and Indiana State Medical Association, an Indiana non-profit corporation and Physicians Insurance Company of Indiana, an Indiana insurance company effective as of January 1, 1995 (2) 10.12 Escrow Agreement among Physicians Insurance Company of Ohio, Mutual Assurance, Inc., and SouthTrust Bank of Alabama, National Association effective as of July 16, 1995 (4) 10.13 Credit Agreement dated as of December 15, 1995, between Medical Assurance, Inc. and SouthTrust Bank of Alabama, National Association (5) 10.14 Agreement and Plan of Merger between MOMED Holding Co., MAIC Holdings, Inc., and MOMED Acquisition, Inc., dated June 11, 1996 (7) 10.15 Nomination Agreement between MOMED Holding Co. and Missouri State Medical Association dated July 21, 1994 (7) 10.16 Reciprocal Assistance Agreement between Missouri Medical Insurance Company, a Missouri corporation and the Missouri State Medical Association, a Missouri non-profit corporation, dated July 21, 1994 (7) 10.17 License Agreement between Missouri Medical Insurance Company, a Missouri corporation, and the Missouri State Medical Association, a Missouri non-profit corporation, dated July 21, 1994 (7)
57 58
Exhibit Number Description Page - ------ ----------- ---- 10.18 First Amended and Restated MOMED Holding Co. Self-Insured Directors and Officers Liability Trust Agreement between MOMED Holding Co., a Missouri corporation; its subsidiaries; and Boatmen's Trust Company, a trust company organized under the laws of Missouri, dated May 7, 1993 (7) 10.19 Nomination Agreement between MOMED Holding Co. and MAIC Holdings, Inc. dated December 10, 1996 (8) 21 Subsidiaries of Medical Assurance, Inc. (61) 23 Consent of Ernst & Young LLP (63) 27 Financial Data Schedule (for SEC use only).
58 59 (1) Filed as an exhibit to Mutual Assurance's Registration Statement on Form S-1 (Commission File No. 33-35223) and incorporated herein by the reference pursuant to Rule 12b-32 of the Securities and Exchange Commission. (2) Filed as an exhibit to Mutual Assurance's Form 10-K for the year ended December 31, 1994 (Commission File No. 0-19439) and incorporated herein by reference pursuant to Rule 12b-32 of the Securities and Exchange Commission. (3) Filed as an exhibit to MAIC Holdings' Registration Statement on Form S-4 (Commission File No. 33-91508) and incorporated herein by reference pursuant to Rule 12b-32 of the Securities and Exchange Commission. (4) Filed as an exhibit to Mutual Assurance's Form 8-K for event occurring August 28, 1995 (Commission File No. 0-19439) and incorporated herein by this reference pursuant to Rule 12b-32 of the Securities and Exchange Commission. (5) Filed as an exhibit to MAIC Holdings' Form 10-K for the year ended December 31, 1995 (Commission File No. 001-12129) and incorporated herein by reference pursuant to Rule 12b-32 of the Securities and Exchange Commission. (6) Filed as an exhibit to MAIC Holdings' Proxy Statement for the 1996 Annual Meeting (Commission File No. 0-19439) and incorporated herein by reference pursuant to Rule 12b-32 of the Securities and Exchange Commission. (7) Filed as an exhibit to MAIC Holdings' Registration Statement on Form S-4 (Commission File No. 333-13465) and incorporated herein by reference pursuant to Rule 12b-32 of the Securities and Exchange Commission. (8) Filed as an exhibit to MAIC Holdings' Form 10-K for the year ended December 31, 1997 (Commission File No. 001-12129) and incorporated herein by reference pursuant to Rule 12b-32 of the Securities and Exchange Commission. (9) Filed as an exhibit to the Medical Assurance, Inc. Form 10-K for the year ended December 31, 1997 (Commission File No. 001-12129) and incorporated herein by reference pursuant to Rule 12b-32 of the Securities and Exchange Commission. 59 EX-21 2 SUBSIDIARIES OF MEDICAL ASSURANCE INC 1 EXHIBIT 21 60 2 SUBSIDIARIES OF MEDICAL ASSURANCE, INC. Mutual Assurance, Inc. (Alabama) Mutual Assurance Agency of Ohio, Inc. (Ohio) MAI Corporation (Delaware) Mutual Assurance Agency, Inc. (Alabama) PROActive Insurance Corporation (Alabama) Educational Services Institute, Inc. (Alabama) Elow, Inc. (Alabama) Medical Assurance of West Virginia, Inc. (West Virginia) Medical Assurance of Indiana, Inc. (Indiana) MOMED Holding Co. (Missouri) Missouri Medical Insurance Company (Missouri) Professional Liability Associates, Inc. (Missouri) Momedico Professional Services, Inc. (Missouri) Specialty Underwriters Reinsurance Facility (Bermuda) Physicians Insurance Co. of Indiana Agency, Inc. (Indiana) The Woodfield Co. (Indiana) 61 EX-23 3 CONSENT OF ERNST & YOUNG LLP 1 EXHIBIT 23 62 2 Consent of Independent Auditors We consent to the incorporation by reference in the Registration Statement (Form S-8 No. 33-55276 and Form S-8 No. 333-08267) pertaining to the Open Market Stock Purchase Plan of Medical Assurance, Inc. of our report dated February 8, 1999, with respect to the consolidated financial statements and schedules of Medical Assurance, Inc. included in the Annual Report (Form 10-K) for the year ended December 31, 1998. Ernst & Young LLP Birmingham, Alabama March 26, 1999 63 EX-27 4 FINANCIAL DATA SCHEDULE
7 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE FINANCIAL STATEMENTS OF MEDICAL ASSURANCE FOR THE YEAR ENDED DECEMBER 31, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 YEAR DEC-31-1998 JAN-01-1998 DEC-31-1998 657,404 0 0 44,124 0 11,619 791,579 9,022 179,890 0 1,132,239 660,640 76,229 42,596 0 0 0 0 23,900 300,280 1,132,239 141,316 39,402 11,281 1,604 93,893 13,735 19,776 66,202 17,679 48,523 0 0 1,123 47,400 2.01 2.01 614,729 141,201 (47,308) (9,891) (67,383) 660,640 (47,308) Deferred policy acquisition costs, amortization of deferred policy acquisition costs and mortgage notes payable are not separately disclosed in the financial statements included in Form 10-K because items are immaterial for individual disclosure. Deferred policy acquisition costs are included as a component of other assets; amortization of deferred policy acquisition costs is included as a component of other underwriting expenses; mortgage notes payable are included as a component of other liabilities.
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