United States
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the quarterly period ended September 30, 2002
or
[_] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transaction period from ____________to
___________.
Commission file number 1-11983
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FPIC Insurance Group, Inc.
--------------------------
(Exact name of registrant as specified in its charter)
Florida 59-3359111
- -------------------------------------- ------------------------------------
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
225 Water Street, Suite 1400, Jacksonville, Florida 32202
--------------------------------------------------------- -----------------
(Address of principal executive offices) (Zip Code)
(904) 354-2482
----------------------------------------------------
(Registrant's telephone number, including area code)
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 whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes [X] No [ ]
As of November 6, 2002, there were 9,390,795 shares of the registrant's common
stock outstanding.
FPIC Insurance Group, Inc.
Index to Quarterly Report on Form 10-Q
Part I Financial Information Page
- --------------------------------------------------------------------------------
Item 1. Condensed Consolidated Financial Statements of FPIC Insurance Group,
Inc. and Subsidiaries
Condensed Consolidated Statements of Financial Position........... 3
Condensed Consolidated Statements of Income (Loss) and
Comprehensive Income (Loss).................................. 4
Condensed Consolidated Statements of Changes in Shareholders'
Equity....................................................... 5
Condensed Consolidated Statements of Cash Flows................... 6
Notes to the Condensed Consolidated Financial Statements.......... 7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.............................................17
Item 3. Quantitative and Qualitative Disclosures About Market Risk........32
Item 4. Disclosure Controls and Procedures................................32
Part II Other Information Page
- --------------------------------------------------------------------------------
Item 1. Legal Proceedings.................................................33
Item 2. Changes in Securities and Use of Proceeds.........................33
Item 3. Defaults Upon Senior Securities...................................33
Item 4. Submission of Matters to a Vote of Security Holders...............33
Item 5. Other Information.................................................33
Item 6. Exhibits and Reports on Form 8-K..................................33
Signatures ..................................................................34
Certification of John R. Byers pursuant to 19 U.S.C. Section 1350 as adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002...............35
Certification of Kim D. Thorpe pursuant to 19 U.S.C. Section 1350 as adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002...............36
FPIC Insurance Group, Inc. and Subsidiaries
Condensed Consolidated Statements of Financial Position
As of September 30, 2002 and December 31, 2001
(In Thousands, Except Common Share Data)
(unaudited)
Sept 30, Dec 31,
2002 2001
-------------- ------------
Assets
Cash and cash equivalents $ 76,418 75,220
Bonds and U.S. Government securities, available for sale 407,417 348,949
Equity securities, available for sale 5 8
Other invested assets, at equity 2,391 2,572
Other invested assets, at cost 10,650 10,962
Real estate 4,379 4,255
-------------- ------------
Total cash and investments 501,260 441,966
Premiums receivable, net 107,092 73,362
Accrued investment income 6,740 4,605
Reinsurance recoverable on paid losses 6,139 7,305
Due from reinsurers on unpaid losses and advance premiums 143,308 80,410
Ceded unearned premiums 95,098 40,794
Property and equipment, net 4,420 4,727
Deferred policy acquisition costs 4,756 9,001
Deferred income taxes 37,004 19,944
Prepaid expenses 932 1,664
Goodwill 18,870 67,232
Intangible assets 1,105 1,317
Federal income tax receivable 829 5,273
Other assets 18,772 13,222
-------------- ------------
Total assets $ 946,325 770,822
============== ============
Liabilities and Shareholders' Equity
Loss and loss adjustment expenses $ 403,130 318,483
Unearned premiums 190,687 146,761
Reinsurance payable 77,584 26,689
Paid in advance and unprocessed premiums 4,992 9,942
Revolving credit facility 37,000 37,000
Term loan 11,667 16,042
Deferred credit 9,064 10,007
Deferred ceding commission 5,632 --
Accrued expenses and other liabilities 48,788 31,324
-------------- ------------
Total liabilities 788,544 596,248
-------------- ------------
Commitments and contingencies (note 10)
Common stock, $.10 par value, 50,000,000 shares authorized;
9,390,795 and 9,337,755 shares issued and outstanding at
September 30, 2002 and December 31, 2001, respectively 939 934
Additional paid-in capital 38,270 37,837
Accumulated other comprehensive income (loss) 2,432 (26)
Retained earnings 116,140 135,829
-------------- ------------
Total shareholders' equity 157,781 174,574
-------------- ------------
Total liabilities and shareholders' equity $ 946,325 770,822
============== ============
See accompanying notes to the condensed consolidated financial statements.
3
FPIC Insurance Group, Inc. and Subsidiaries
Condensed Consolidated Statements of Income (Loss) and
Comprehensive Income (Loss)
(In Thousands, Except Common Share Data)
(unaudited)
------------------------------------------------------------------
Three months ended Sept 30, Nine months ended Sept 30,
2002 2001 2002 2001
---------------------------------- ----------------- ------------
Revenues
Net premiums earned $ 30,435 29,686 117,337 96,005
Claims administration and management fees 9,640 9,690 25,561 24,584
Net investment income 5,241 5,817 15,942 18,473
Commission income 2,391 2,230 4,427 3,794
Net realized investment gains 1,969 673 2,113 293
Finance charges and other income 284 207 770 879
---------------------------------- ----------------- ------------
Total revenues $ 49,960 48,303 166,150 144,028
---------------------------------- ----------------- ------------
Expenses
Net losses and loss adjustment expenses $ 30,549 27,301 105,733 90,042
Other underwriting expenses 2,286 6,825 15,772 16,833
Claims administration and management expenses 7,927 8,559 23,184 23,770
Interest expense 1,387 983 3,857 3,321
Other expenses 226 992 403 2,913
---------------------------------- ----------------- ------------
Total expenses $ 42,375 44,660 148,949 136,879
---------------------------------- ----------------- ------------
Income from operations before taxes and cumulative
effect of accounting change $ 7,585 3,643 17,201 7,149
Less: Income taxes 3,170 544 7,312 894
---------------------------------- ----------------- ------------
Income before cumulative effect of accounting
change $ 4,415 3,099 9,889 6,255
Less: Cumulative effect of accounting change
(net of an $18,784 income tax benefit) (note 3) -- -- 29,578 --
---------------------------------- ----------------- ------------
Net income (loss) $ 4,415 3,099 (19,689) 6,255
================================== ================= ============
Basic earnings (loss) per common share $ 0.47 0.33 (2.10) 0.67
================================== ================= ============
Diluted earnings (loss) per common share $ 0.47 0.33 (2.08) 0.66
================================== ================= ============
Basic weighted average common shares outstanding 9,391 9,405 9,385 9,400
================================== ================= ============
Diluted weighted average common shares outstanding 9,404 9,521 9,476 9,473
================================== ================= ============
Comprehensive Income (Loss)
Net income (loss) $ 4,415 3,099 (19,689) 6,255
---------------------------------- ----------------- ------------
Other comprehensive income:
Cumulative effect of accounting change -- -- -- 124
Unrealized holding gains on debt and
equity securities 3,274 5,934 4,335 9,182
Unrealized holding losses on derivative
financial instruments (656) (2,094) (720) (3,393)
Income tax expense related to unrealized
gains and losses (982) (1,674) (1,357) (2,329)
---------------------------------- ----------------- ------------
Other comprehensive income $ 1,636 2,166 2,258 3,584
---------------------------------- ----------------- ------------
Comprehensive income (loss) $ 6,051 5,265 (17,431) 9,839
================================== ================= ============
See accompanying notes to the condensed consolidated financial statements.
4
FPIC Insurance Group, Inc. and Subsidiaries
Condensed Consolidated Statements of Shareholders' Equity
For the Nine Months Ended September 30, 2002
and the Year Ended December 31, 2001
(In Thousands)
Accumulated
Additional Other
Common Paid-in Unearned Comprehensive Retained
Stock Capital Compensation Income (Loss) Earnings Total
-------- ----------- ------------- -------------- ---------- ----------
Balances at December 31, 2000 $ 938 37,827 (105) 968 132,899 172,527
-------- ----------- ------------- -------------- ---------- ----------
Net income -- -- -- -- 2,930 2,930
Cumulative effect of accounting
change -- -- -- 124 -- 124
Compensation earned on options -- -- 105 -- -- 105
Unrealized gain on debt and
equity securities, net -- -- -- 778 -- 778
Unrealized loss on derivative
financial instruments, net -- -- -- (1,896) -- (1,896)
Repurchase of shares, net (4) 10 -- -- -- 6
-------- ----------- ------------- -------------- ---------- ----------
Balances at December 31, 2001 $ 934 37,837 -- (26) 135,829 174,574
-------- ----------- ------------- -------------- ---------- ----------
Net loss -- -- -- -- (19,689) (19,689)
Unrealized gain on debt and
equity securities, net -- -- -- 2,700 -- 2,700
Unrealized loss on derivative
financial instruments, net -- -- -- (442) -- (442)
Amortization of unrealized loss on
derivative financial instruments -- -- -- 200 -- 200
Issuance of shares 5 433 -- -- -- 438
-------- ----------- ------------- -------------- ---------- ----------
Balances at September 30, 2002
(unaudited) $ 939 38,270 -- 2,432 116,140 157,781
======== =========== ============= ============== ========== ==========
See accompanying notes to the condensed consolidated financial statements.
5
FPIC Insurance Group, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(In Thousands)
(unaudited)
-------------------------------------
Nine months ended Sept 30,
2002 2001
----------------- ------------------
Cash flows from operating activities:
Net (loss) income $ (19,689) 6,255
Adjustments to reconcile net (loss) income to cash provided by
operating activities:
Cumulative effect of accounting change 29,578 --
Depreciation, amortization and accretion 8,720 11,930
Realized gain on investments (2,113) (293)
Realized loss on sale of property and equipment 12 8
Noncash compensation -- 95
Net loss from equity investments 180 516
Deferred income tax benefit 367 110
Changes in assets and liabilities:
Premiums receivable, net (33,730) (24,223)
Accrued investment income, net (2,135) 190
Reinsurance recoverable on paid losses 1,166 1,567
Due from reinsurers on unpaid losses and advance premiums (62,898) (13,203)
Ceded unearned premiums (54,304) (24,967)
Deferred policy acquisition costs (4,596) (9,798)
Prepaid expenses 732 (146)
Federal income tax receivable 4,444 2,738
Other assets (1,225) 1,909
Loss and loss adjustment expenses 84,647 17,680
Unearned premiums 43,926 37,371
Reinsurance payable 50,895 13,444
Paid in advance and unprocessed premiums (4,950) (2,915)
Deferred ceding commission 8,446 --
Accrued expenses and other liabilities 4,572 5,267
----------------- ------------------
Net cash provided by operating activities $ 52,045 23,535
----------------- ------------------
Cash flows from investing activities:
Proceeds from sale or maturity of bonds and U.S. Government securities 180,457 119,865
Purchase of bonds and U.S. Government securities (226,069) (62,986)
Proceeds from the sale of equity securities -- 565
Purchase of equity securities -- (53)
Proceeds from sale of other invested assets 366 51
Purchase of other invested assets (54) --
Purchase of real estate investments (336) (112)
Purchase of property and equipment (1,274) (1,020)
Proceeds from the sale of property and equipment -- 4
----------------- ------------------
Net cash (used in) provided by investing activities $ (46,910) 56,314
----------------- ------------------
Cash flows from financing activities:
Receipt of revolving credit facility and term loan -- 54,500
Payment on revolving credit facility and term loan (4,375) (67,219)
Repurchase of common stock -- (233)
Issuance of common stock 438 215
----------------- ------------------
Net cash used in financing activities $ (3,937) (12,737)
----------------- ------------------
Net increase in cash and cash equivalents 1,198 67,112
Cash and cash equivalents at beginning of period 75,220 18,967
----------------- ------------------
Cash and cash equivalents at end of period $ 76,418 86,079
================= ==================
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest $ 3,447 4,567
================= ==================
Federal income taxes $ 3,250 540
================= ==================
Supplemental disclosure of noncash investing activities:
Due to broker on unsettled investment trades, net $ 7,848 --
================= ==================
See accompanying notes to the condensed consolidated financial statements.
6
FPIC Insurance Group, Inc. and Subsidiaries
Notes to the Condensed Consolidated Financial Statements - Unaudited
(In Thousands, Except Common Share Data)
1. Organization and Basis of Presentation
The accompanying condensed, consolidated financial statements represent the
consolidation of FPIC Insurance Group, Inc. and all majority owned and
controlled subsidiaries (the "Company"). All significant transactions
between the parent and consolidated subsidiaries have been eliminated.
Reference is made to the Company's most recently filed Form 10-K, which
includes information necessary for understanding the Company's businesses
and financial statement presentations. In particular, the Company's
significant accounting policies are presented in Note 2 to the consolidated
financial statements included in that report.
The condensed, consolidated quarterly financial statements are unaudited.
These statements include all adjustments, consisting only of normal
recurring accruals, that are, in the opinion of management, necessary for
the fair presentation of results for interim periods. Certain prior period
data have been reclassified to conform to the current period presentation.
The results reported in these condensed, consolidated quarterly financial
statements should not be regarded as necessarily indicative of results that
may be expected for the entire year. For example, the timing and magnitude
of claim losses incurred by the Company's insurance subsidiaries due to the
estimation process inherent in determining the liability for loss and loss
adjustment expenses ("LAE") can be relatively more significant to results
of interim periods than to results for a full year. In addition, variations
in the amount and timing of realized investment gains and losses could
cause significant variations in periodic net earnings as can the mix of
taxable and non-taxable investment income.
Effective January 1, 2002, the Company adopted Financial Accounting
Standard No. ("FAS") 142, "Goodwill and Other Intangible Assets." FAS 142
addresses financial accounting and reporting for acquired goodwill and
other intangible assets and supersedes Accounting Principles Board Opinion
No. 17, "Intangible Assets." The standard provides that goodwill and other
intangible assets with indefinite lives are no longer to be amortized.
These assets are to be reviewed for impairment annually, or more frequently
if impairment indicators are present. Separable intangible assets that have
finite lives will continue to be amortized over their useful lives. During
the quarter ended March 31, 2002, the Company completed the transitional
impairment analysis, which resulted in an impairment charge of $29.6
million, net of an $18.8 million income tax benefit. See Note 3 for
additional discussion of the impact of FAS 142 on the Company's financial
position and results of operations.
2. Investments
Data with respect to bonds, U.S. Government and equity securities,
available for sale, are shown below.
Amortized cost
of investments
Proceeds in bonds, US
from sales Gross Gross Government
and realized realized and equity
Nine Months Ended maturities gains losses securities
--------------------------- ------------- ------------- ------------ ------------------
September 30, 2002 $ 180,457 5,662 3,549 As of September 30, 2002 $ 400,260
September 30, 2001 $ 120,430 2,029 1,680 As of December 31, 2001 $ 346,131
Realized investment gains and losses are recorded when investments are
sold, other-than-temporarily impaired or in certain situations, as required
by generally accepted accounting principles ("GAAP"), when investments are
marked-to-market with the corresponding gain or loss included in earnings.
7
FPIC Insurance Group, Inc. and Subsidiaries
Notes to the Condensed Consolidated Financial Statements - Unaudited
(In Thousands, Except Common Share Data)
3. Goodwill
The Company adopted FAS 142 effective January 1, 2002. In connection with
the adoption of FAS 142, the Company discontinued the amortization of
goodwill. The changes in the carrying amount of goodwill for the nine
months ended September 30, 2002, are as follows:
Reciprocal Third Party
Insurance Management Administration Total
-------------- ---------------- -------------------- -----------
Balance as of December 31, 2001 $ 10,833 49,140 7,259 67,232
Impairment charge -- (41,103) (7,259) (48,362)
-------------- ---------------- -------------------- -----------
Balance as of September 30, 2002 $ 10,833 8,037 -- 18,870
============== ================ ==================== ===========
In connection with its adoption of FAS 142, the Company engaged independent
valuation consultants to perform transitional impairment tests at each of
its operating segments: insurance, reciprocal management and third party
administration ("TPA"). These operating segments meet the reporting unit
requirements as defined by FAS 142.
The fair values for each of the reporting units were calculated using one
or more of the following approaches: (i) market multiple approach; (ii)
discounted cash flow ("DCF") approach; or (iii) asset approach.
o Under the market multiple approach, the values of the reporting units
were based on the market prices and performance fundamentals of similar
public companies.
o Under the DCF approach, the values of the reporting units were based on
the present value of the projected future cash flows to be generated.
o Under the asset approach, the value of a reporting unit is the
difference in the fair value of total assets and the fair value of
total liabilities. The fair value of each asset and liability may in
turn be estimated using an income approach, market approach or cost
approach.
Based on the results of the impairment tests, goodwill was not deemed to be
impaired at the insurance segment, since the fair value of the reporting
unit exceeded its carrying value. Therefore, the second step of the
goodwill impairment test was not performed. However, the carrying values of
the reciprocal management and TPA segments exceeded their respective fair
values, indicating a potential impairment of goodwill. Under step 2 of the
test, the implied fair values of the reciprocal management and TPA goodwill
were compared to their carrying values to measure the amount of impairment
loss. As a result, a non-cash transitional impairment charge of $29.6
million (net of an income tax benefit of $18.8 million) was recognized and
recorded as a cumulative effect of accounting change in the accompanying
September 30, 2002 consolidated statements of income.
In management's opinion, the transitional impairment charge at the
reciprocal management segment primarily reflects certain intangibles and
synergies, which are opportunistic in nature, carry a relatively higher
degree of uncertainty, and therefore were treated conservatively in the
valuation required by FAS 142. The transitional impairment charge at the
TPA segment primarily reflects changes in market conditions and an increase
in competition in recent years in the markets served by the Company's TPA
segment.
8
FPIC Insurance Group, Inc. and Subsidiaries
Notes to the Condensed Consolidated Financial Statements - Unaudited
(In Thousands, Except Common Share Data)
The following table provides comparative disclosures of net income
excluding the cumulative effect of accounting change and goodwill
amortization, net of taxes, for the periods presented.
Three Months Ended Nine Months Ended
------------------------- --------------------------
Sept 30, Sept 30, Sept 30, Sept 30,
2002 2001 2002 2001
----------- ----------- ------------ ------------
Net income (loss):
Net income (loss), as reported $ 4,415 3,099 (19,689) 6,255
Cumulative effect of accounting change -- -- 29,578 --
----------- ----------- ------------ ------------
Net income, adjusted 4,415 3,099 9,889 6,255
Goodwill amortization, net of tax -- 539 -- 1,618
----------- ----------- ------------ ------------
Net income, comparative $ 4,415 3,638 9,889 7,873
=========== =========== ============ ============
Basic earnings (loss) per common share:
Net income (loss), as reported $ 0.47 0.33 (2.10) 0.67
Cumulative effect of accounting change -- -- 3.15 --
----------- ----------- ------------ ------------
Net income, adjusted 0.47 0.33 1.05 0.67
Goodwill amortization, net of tax -- 0.06 -- 0.17
----------- ----------- ------------ ------------
Net income, comparative $ 0.47 0.39 1.05 0.84
=========== =========== ============ ============
Diluted earnings (loss) per common share:
Net income (loss), as reported $ 0.47 0.33 (2.08) 0.66
Cumulative effect of accounting change -- -- 3.12 --
----------- ----------- ------------ ------------
Net income, adjusted 0.47 0.33 1.04 0.66
Goodwill amortization, net of tax -- 0.06 -- 0.17
----------- ----------- ------------ ------------
Net income, comparative $ 0.47 0.39 1.04 0.83
=========== =========== ============ ============
4. Intangible Assets
The following table provides a detail of the Company's intangible assets
and estimated amortization expense for the periods presented.
As of September 30, 2002 As of December 31, 2001
------------------------------ ------------------------------
Gross Accumulated Gross Accumulated
Balance Amortization Balance Amortization
-------------- ------------------------------------------------
Trade secrets $ 1,500 637 1,500 525
Non-compete agreements 500 304 500 250
Other 305 259 305 213
-------------- --------------- ------------------------------
Total $ 2,305 1,200 2,305 988
============== =============== ==============================
Three Months Ended Nine Months Ended
------------------------------ ------------------------------
Sept 30, Sept 30, Sept 30, Sept 30,
2002 2001 2002 2001
-------------- --------------- ------------------------------
Aggregate amortization expense $ 70 70 212 212
============== =============== ==============================
For the year ended December 31, 2002 2003 2004 2005 2006
-------------- --------------- ------------------------------ ---------------
Estimated amortization expense $ 282 252 221 186 150
5. Reinsurance
Effective July 1, 2002, the Company's largest insurance subsidiary, First
Professionals Insurance Company, Inc. ("First Professionals"), entered into
a finite reinsurance agreement with two insurance companies of the Hannover
Re group ("Hannover Re"). The agreement, which calls for First
Professionals to cede quota share portions of its 2002 and 2003 written
premiums, contains adjustable features, including a loss corridor, sliding
scale ceding commissions, and a cap on the amount of
9
FPIC Insurance Group, Inc. and Subsidiaries
Notes to the Condensed Consolidated Financial Statements - Unaudited
(In Thousands, Except Common Share Data)
losses that may be ceded to the reinsurer. The effect of these features is
to limit the reinsurers' aggregate exposure to loss and thereby reduce the
ultimate cost to First Professionals as the ceding company. These features
also have the effect of reducing the amount of protection relative to the
quota share amount of premiums ceded by First Professionals. While First
Professionals does not receive pro-rata protection relative to the amount
of premiums ceded, the amount of such protection is significant, as
determined in accordance with guidance under both statutory accounting
practices and GAAP. In addition to ceding a significant portion of its
risks to Hannover Re, the agreement also allows First Professionals to
reduce its financial leverage and to realize immediate reimbursement for
related up-front acquisition costs, thus adding to its financial capacity.
The following table illustrates the pro forma effects of the agreement on
selected consolidated financial information of the Company's insurance
subsidiaries.
Proforma Amounts
Excluding the Effects
of the Reinsurance
Agreement
--------------------------
Nine Months Ended Nine Months Ended
09/30/2002 09/30/2002
------------------------- --------------------------
Net Premiums Written $ 106,912 $ 174,479
Net Premiums Earned $ 117,337 $ 139,847
Loss and LAE Incurred $ 105,733 $ 123,966
Income from Operations Before Tax $ 10,598 $ 9,356
Statutory Surplus $ 119,048 $ 113,719
Ratio of Net Premiums Written to Statutory Surplus 0.9:1 1.5:1
First Professionals has the option to commute the agreement should the
business perform such that the underlying protection proves to be
unnecessary, in which case the reinsurance would cease, the underlying
reinsurance assets and liabilities would unwind, and any net funds under
the agreement, less a 4.2% risk charge to the reinsurers, would be retained
by First Professionals. The decision of whether to commute the agreement
and the timing of any such commutation will depend on the performance of
the underlying business, the need for the agreement based on the Company's
capital position and other relevant considerations.
6. Revolving Credit Facility and Term Loan
On August 31, 2001, the Company entered into a Revolving Credit and Term
Loan Agreement (the "credit facility") with five financial institutions.
The initial aggregate principal amount of the credit facility was $55.0
million, including (i) a $37.5 million revolving credit facility, which
matures on August 31, 2004, and (ii) a $17.5 million term loan facility,
repayable in twelve equal quarterly installments of approximately $1.5
million each, which commenced December 31, 2001.
Amounts outstanding under the credit facility bear interest at a variable
rate, primarily based upon LIBOR plus a margin of 2.50 percentage points,
which may be reduced to a minimum of 2.00 percentage points as the Company
reduces its outstanding indebtedness. As of September 30, 2002 and December
31, 2001, the interest rates on the credit facility were 4.30% and 4.16%,
respectively. In connection with the Company's credit facility, the Company
also entered into two interest rate swap agreements (the "swap
agreements"). See Note 7 for additional discussion of the Company's swap
agreements.
The Company is not required to maintain compensating balances in connection
with the credit facility, but is charged a fee on the unused portion, which
ranges from 30 to 40 basis points. Under the terms of the credit facility,
the Company is required to meet certain financial covenants. Significant
covenants are as follows: a) total debt to cash flow available for debt
service may not exceed 3.50:1; b) combined net premiums written to combined
statutory capital and surplus may not
10
FPIC Insurance Group, Inc. and Subsidiaries
Notes to the Condensed Consolidated Financial Statements - Unaudited
(In Thousands, Except Common Share Data)
exceed 2.00:1; c) the fixed charge coverage ratio may not be less than
2.00:1 at the end of each quarter through December 31, 2002, and thereafter
the fixed charge coverage ratio may not be less than 2.25:1; and d) funded
debt to total capital plus funded debt may not exceed 0.27:1. The credit
facility also contains minimum equity and risk-based capital requirements
and requires the Company's insurance subsidiaries to maintain at least an
A- (Excellent) group rating from A.M. Best Company ("Best").
On October 23, 2002, Best announced its decision to change the Company's
group rating from A- (Excellent) with a negative outlook to B++ (Very Good)
with a stable outlook. As a result of the rating change, the Company is in
non-compliance with the credit facility. As a result of such
non-compliance, the Company requested and received from its lenders an
agreement of forbearance dated October 24, 2002 (the "Forbearance"), under
which the lenders have agreed not to take any action with regard to this
covenant violation for a 30-day period, until November 23, 2002, to allow
adequate time for the Company and its lenders to agree on and finalize
appropriate revisions to the credit facility.
As of the date of this filing, the Company and its lenders have not
completed negotiations on revisions to the credit facility to cure the
potential event of default. In the event the Company and its lenders are
unable to complete revisions to the credit facility within the 30-day
forbearance period, which ends on or before November 23, 2002 (and assuming
the Company is unable to secure additional forbearance), the lenders would
be entitled under the terms of the credit facility to declare an event of
default and demand immediate repayment of the outstanding loans under the
credit facility.
In the event repayment of its loans is accelerated, the Company would not
have sufficient liquidity solely from immediate available operating funds
and would be required to secure replacement financing, raise additional
capital, restructure its operations and sell assets, or a combination of
these, in order to raise the funds necessary to repay its loans. Any such
circumstances would likely have a material detrimental impact on the
Company's results of operations and financial condition. While there can be
no absolute assurance of the successful completion of such revisions, based
upon the status of the negotiations between the parties to date, the
Company believes that suitable revisions will be completed within the 30-
day forbearance period, on or before November 23, 2002, and that
declaration by the lenders of an event of default is unlikely. The Company
does expect certain changes to the terms of its loan agreement. Upon
completion of its negotiations, management will publish the new terms.
In accordance with the terms of the Forbearance, the Company has pledged
cash collateral of $2 million to the lenders and has agreed to set aside an
additional $1 million in cash collateral to be pledged to the lenders no
later than January 31, 2003. In addition, the Company has paid forbearance
fees to the lenders in the aggregate amount of $0.2 million.
7. Derivative Financial Instruments
The Company uses its swap agreements to minimize fluctuations in cash flows
caused by interest rate volatility and to effectively convert all of its
floating-rate debt to fixed-rate debt. Such agreements involve the exchange
of fixed and floating interest rate payments over the life of the agreement
without the exchange of the underlying principal amounts. Accordingly, the
impact of fluctuations in interest rates on these swap agreements is offset
by the opposite impact on the related debt. Amounts paid or received under
the swap agreements are recognized as increases or reductions in interest
expense in the periods in which they accrue. The swap agreements are only
entered into with creditworthy counterparties.
11
FPIC Insurance Group, Inc. and Subsidiaries
Notes to the Condensed Consolidated Financial Statements - Unaudited
(In Thousands, Except Common Share Data)
The swap agreements in effect as of September 30, 2002 are as follows:
Notional Amount Maturities Receive Rate (1) Pay Rate
---------------------------------------------------------------
$ 37,000 08/31/2004 1.80% 6.45%
$ 11,667 08/31/2004 1.80% 5.97%
(1) Based on three-month LIBOR
8. Segment Information
The business segments presented in this document have been determined in
accordance with the provisions of FAS 131, "Disclosures about Segments of
an Enterprise and Related Information." The Company has three main
operating segments as follows: insurance, reciprocal management and TPA.
Holding company operations are included within the insurance segment due to
the segment's size and prominence and the substantial attention devoted to
the segment.
Through its four insurance subsidiaries, the Company specializes in
professional liability insurance products and services for physicians,
dentists, other healthcare providers and attorneys. The Company provides
reciprocal management services, brokerage and administration services for
reinsurance programs and brokerage services for the placement of annuities
in structured settlements through its reciprocal management subsidiaries.
In addition, the Company provides TPA services through its subsidiary that
markets and administers self-insured plans for both large and small
employers, including group accident and health insurance, workers'
compensation and general liability and property insurance. The Company
evaluates a segment's performance based on net income and accounts for
intersegment sales and transfers as if the sales or transfers were to a
third party. All segments are managed separately as each segment's business
is different and distinct. Consolidating information by each segment is
summarized in the tables below.
As of As of
Identifiable Assets: Sept 30, 2002 Dec 31, 2001
-------------- ----------------
Insurance $ 910,288 706,290
Reciprocal management 35,769 61,468
Third party administration 6,712 14,788
Intersegment eliminations (6,444) (11,724)
-------------- ----------------
Total assets $ 946,325 770,822
============== ================
Three Months Ended Nine Months Ended
--------------------------------- -------------------------------
Sept 30, 2002 Sept 30, 2001 Sept 30, 2002 Sept 30, 2001
-------------- ---------------- ---------------------------------
Total Revenues:
Insurance $ 38,546 36,429 137,946 115,484
Reciprocal management 9,432 8,475 21,852 19,938
Third party administration 4,157 4,440 11,208 12,220
Intersegment eliminations (2,175) (1,041) (4,856) (3,614)
-------------- ---------------- -------------- --------------
Total revenues $ 49,960 48,303 166,150 144,028
============== ================ ============== ==============
Net Income (Loss):
Insurance $ 1,373 1,093 5,180 2,878
Reciprocal management 2,635 1,602 (19,920) 3,031
Third party administration 407 404 (4,949) 346
-------------- ---------------- -------------- --------------
Net income (loss) $ 4,415 3,099 (19,689) 6,255
============== ================ ============== ==============
12
FPIC Insurance Group, Inc. and Subsidiaries
Notes to the Condensed Consolidated Financial Statements - Unaudited
(In Thousands, Except Common Share Data)
9. Reconciliation of Basic and Diluted Earnings Per Common Share
Data with respect to the Company's basic and diluted earnings per common
share are shown below.
Three Months Ended Nine Months Ended
------------------------- ----------------------------
Sept 30, Sept 30, Sept 30, Sept 30,
2002 2001 2002 2001
------------------------- -------------- -------------
Net income (loss):
Income before cumulative effect of accounting change $ 4,415 3,099 9,889 6,255
Cumulative effect of accounting change -- -- (29,578) --
------------------------- -------------- -------------
Net income (loss) $ 4,415 3,099 (19,689) 6,255
========================= ============== =============
Basic earnings (loss) per common share:
Income before cumulative effect of accounting change $ 0.47 0.33 1.05 0.67
Cumulative effect of accounting change -- -- (3.15) --
------------------------- -------------- -------------
Net income (loss) $ 0.47 0.33 (2.10) 0.67
========================= ============== =============
Diluted earnings (loss) per common share:
Income before cumulative effect of accounting change $ 0.47 0.33 1.04 0.66
Cumulative effect of accounting change -- -- (3.12) --
------------------------- -------------- -------------
Net income (loss) $ 0.47 0.33 (2.08) 0.66
========================= ============== =============
Basic weighted average shares outstanding 9,391 9,405 9,385 9,400
Common stock equivalents 13 116 91 73
------------------------- -------------- -------------
Diluted weighted average shares outstanding 9,404 9,521 9,476 9,473
========================= ============== =============
10. Commitments and Contingencies
The Company's insurance subsidiaries from time to time become subject to
claims for extra-contractual obligations or risks in excess of policy
limits in connection with their insurance claims. These claims are
sometimes referred to as "bad faith" actions as it is alleged that the
insurance company acted in bad faith in the administration of a claim
against an insured. Bad faith actions are infrequent and generally occur in
instances where a jury verdict exceeds the insured's policy limits. Under
such circumstances, it is routinely alleged that the insurance company
failed to negotiate a settlement of a claim in good faith within the
insured's policy limit. The Company has evaluated such exposures as of
September 30, 2002, and believes its position and defenses are meritorious.
However, there can be no absolute assurance as to the outcome of such
exposures. The Company currently maintains insurance for such occurrences,
which serves to limit exposure to such claims. However, in one such case,
arising in 1993, no such coverage is available and an estimate of possible
loss currently cannot be made. In addition, multiple claims for extra
contractual obligations in a single year could result in potential
exposures materially in excess of insurance coverage or in increased costs
of insurance coverage.
The Company may also become involved in legal actions not involving claims
under its insurance policies from time to time. The Company has evaluated
such exposures as of September 30, 2002, and in all cases, believes its
position and defenses are meritorious. However, there can be no absolute
assurance as to the outcome of such exposures.
The Company is nearing completion of the examination of its 1998 and 1999
federal income tax returns by the Internal Revenue Service and in
connection therewith, established a $1.0 million reserve in the second
quarter of 2002 for potential tax contingencies. Management believes that
its positions are meritorious on these and other potential issues raised in
the examination and that the
13
FPIC Insurance Group, Inc. and Subsidiaries
Notes to the Condensed Consolidated Financial Statements - Unaudited
(In Thousands, Except Common Share Data)
accrual made is appropriate; however, there can be no assurance that the
Company will ultimately prevail on such matters.
11. Related Party Transactions
On July 1, 1998, First Professionals began assuming reinsurance from
Physicians' Reciprocal Insurers ("PRI"), a writer of medical professional
liability ("MPL") insurance in the state of New York. PRI is managed by
it's attorney-in-fact, Administrators For The Professions, ("AFP"), which
effective January 1, 1999 was acquired by and became a wholly owned
subsidiary of the Company. Under one contract, which reinsures PRI for
policies with limits of $1.0 million in excess of $1.0 million, First
Professionals assumes losses only and pays PRI a ceding commission on the
premium assumed. This contract has been renewed annually. Effective April
1, 2002, the contract was changed to reinsure PRI for policies with limits
of $1.0 million in excess of $1.3 million. Under another contract, which
First Professionals and PRI ceased to renew for periods subsequent to
December 31, 2000, First Professionals reinsured PRI for losses of $0.25
million in excess of $0.5 million on each claim. During the first nine
months of 2002 and 2001, the Company assumed written premiums of
approximately $9.6 million and $10.6 million, respectively, under these
contracts. The Company earned approximately $7.1 million and $13.5 million,
during the first nine months of 2002 and 2001, respectively, under these
contracts. The Company incurred commissions payable to PRI of approximately
$1.8 million and $1.6 million during the first nine months of 2002 and
2001, respectively, under these contracts. The Company has incurred losses
and LAE related to these contracts of approximately $2.6 million and $7.1
million for the first nine months of 2002 and 2001, respectively. Premiums
on these contracts are paid by PRI on a quarterly basis. As of September
30, 2002 and December 31, 2001, the amount due from PRI under these
contracts was approximately $5.8 million and $2.4 million, respectively.
The excess of loss reinsurance treaty between First Professionals and PRI
related to losses of $0.25 million in excess of $0.5 million and the
reinsurance treaty in which First Professionals reinsures PRI for policies
with limits of $1.0 million in excess of $1.3 million both contain clauses
under which PRI has the option to commute each such agreement. During the
first quarter of 2002, the 2000 treaty relating to losses of $0.25 million
in excess of $0.5 million was commuted. The commutation eliminated all of
First Professionals' present and future liabilities under the treaty in
exchange for the return by First Professionals of all but the minimum
contract premium to PRI. As a result of this commutation, First
Professionals reported approximately $9.3 million of paid losses and LAE
with a corresponding reduction in reserves. There was no net income effect
from this commutation, due to the prior accrual of such charges.
Effective January 1, 2000, First Professionals entered into a 100% quota
share reinsurance agreement with PRI to assume PRI's death, disability and
retirement risks under its claims-made insurance policies in exchange for
cash and investments in the amount of $47.0 million. During 2000, a GAAP
valuation of the underlying liability was completed and a deferred credit
in the amount of $13.2 million was recognized in the statement of financial
position. The deferred credit, which is being amortized into income over 20
years, represents the difference between the GAAP valuation of the
liability and the initial premium received. The liability was calculated
using benefit assumptions and elements of pension actuarial models (i.e.
mortality, morbidity, retirement, interest and inflation rate assumptions).
In connection with the agreement, First Professionals recognized a 5%
ceding commission expense, which is being deferred and amortized as
premiums are earned under the agreement.
In accordance with a management agreement, AFP performs underwriting,
administrative and investment functions on PRI's behalf for which it
receives compensation. Compensation under the agreement as originally in
effect was equal to 13% of PRI's direct premiums written, with an
adjustment for expected return premiums, plus or minus 10% of PRI's
statutory net income or loss.
14
FPIC Insurance Group, Inc. and Subsidiaries
Notes to the Condensed Consolidated Financial Statements - Unaudited
(In Thousands, Except Common Share Data)
In addition, the management agreement provides that AFP is to be reimbursed
by PRI for certain expenses paid by AFP on PRI's behalf, namely salaries
and related payroll costs of personnel in AFP's claims, legal and risk
management departments. Such directly reimbursed expenses are not reported
in the accompanying condensed, consolidated financial statements.
During the third quarter, the agreement was amended by AFP and PRI to
remove the sharing by AFP of 10% of the net income or net loss of PRI,
effective January 1, 2002. With regard to profit sharing amounts already
earned and collected, AFP has agreed to hold the years 1999, 2000 and 2001
open for re-determination and possible adjustment for a period of five
years each (expiring 2004, 2005 and 2006, respectively.) Such adjustments
would be based primarily on development of and related adjustments, if any,
to loss and LAE reserves for those years. AFP has also agreed to pay 6%
annual interest on amounts already earned and collected under the original
agreement for the remaining open periods. AFP has earned and collected
profit sharing amounts under the original agreement totaling $3.6 million
for the three years ended December 31, 2001. In addition, AFP will be
reimbursed for 50% of the costs of the risk management department it
maintains for PRI insureds, for which it is not already reimbursed. The
management agreement and amendments were reviewed and approved by the New
York State Insurance Department.
The Company's revenues and results of operations are financially sensitive
to the revenues and results of operations of PRI. In addition PRI, as an
MPL insurer, is subject to many of the same types of risks as those of the
Company's insurance subsidiaries. Claims administration and management fees
earned by AFP based on 13% of PRI's direct written premiums were $16.3
million and $15.1 million for the nine months ended September 30, 2002 and
2001, respectively. The income received by AFP related to PRI's statutory
net income was $0 and $0.3 million for the nine months ended September 30,
2002 and 2001, respectively. Directly reimbursed expenses amounted to $10.3
million, and $8.2 million for the first nine months of 2002 and 2001,
respectively.
In addition, the Company has entered into guarantees on behalf of PRI
related to two of its former ceded reinsurance contracts with unaffiliated
carriers whereby such contracts have been commuted. Under the terms of
these commutations, PRI was required to obtain such guarantees as further
assurance to the reinsurer of their respective complete release from
liability.
Effective July 1, 2000, the Company entered into an agreement with PRI
whereby the Company, through its 70% owned subsidiary, Professional Medical
Administrators, LLC. ("PMA"), manages an MPL insurance program in
Pennsylvania established primarily for the benefit of PRI whereby business
is written on First Professionals' policy forms and ceded to PRI under a
90% quota share reinsurance agreement. The Company receives a ceding
commission equal to 27% of premiums written under the program, in return
for its services to PRI, which include underwriting, claims management and
other administrative aspects of this program. PMA also pays all commissions
and brokerage for the placement of business under the program. Effective
January 1, 2002, the terms of this agreement were amended to cede 100% of
the premiums written to PRI. The amendment has been filed and is pending
approval by the New York State Insurance Department. During the nine months
ended September 30, 2002 and 2001, premiums written and ceding commissions
under this program were as follows:
Nine Months Ended
Sept 30, 2002 Sept 30, 2001
--------------------------------
Direct Premiums written $ 10,565 11,185
Ceded premiums written $ (10,480) (10,004)
Ceding commissions $ 2,284 1,429
15
FPIC Insurance Group, Inc. and Subsidiaries
Notes to the Condensed Consolidated Financial Statements - Unaudited
(In Thousands, Except Common Share Data)
On July 1, 1998, First Professionals and Anesthesiologists Professional
Assurance Company ("APAC") entered into a quota share reinsurance agreement
whereby these two subsidiaries cede a 25% quota share portion of all
business written by them related to anesthesiologists and certain related
specialties to American Professional Assurance Ltd, of which the Company is
a 9.9% shareholder. These agreements were entered into in connection with
and at the time of the Company's acquisition of APAC. During the first nine
months of 2002 and 2001, the Company ceded premiums of approximately $7.1
million and $3.8 million, respectively, and received ceding commissions of
approximately $1.4 million and $0.8 million, respectively.
12. Subsequent Events
On October 23, 2002, Best announced its decision to change the Company's
group rating from A- (Excellent) with a negative outlook to B++ (Very Good)
with a stable outlook. Based on Best's published rating guidelines, a
rating of B++ (Very Good) is a "Secure" rating assigned to companies that
have, on balance, very good balance sheet strength, operating performance
and business profile, when compared to standards established by Best. As a
result of the rating change, the Company is in non-compliance with its
credit facility. As a result of such non-compliance, the Company requested
and received from its lenders a forbearance agreement dated October 24,
2002 under which the lenders have agreed not to take any action with regard
to this non-compliance for a 30-day period, until November 23, 2002, to
allow adequate time for the Company and its lenders to agree and finalize
appropriate revisions to the credit facility. Further discussion regarding
the status of such negotiations appears in Note 6.
13. New Accounting Pronouncements
In June 2002, the Financial Accounting Standards Board ("FASB") issued FAS
146, "Accounting for Costs Associated with Exit or Disposal Activities."
FAS 146 addresses financial accounting and reporting for costs associated
with exit or disposal activities and nullifies Emerging Issues Task Force
Issue No. 94-3, "Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain Costs
Incurred in a Restructuring)." FAS 146 is effective for exit or disposal
activities initiated on or after December 31, 2002. The Company believes
the adoption of FAS 146 will not have a significant impact on its
consolidated financial statements.
In October 2002, the FASB issued FAS 147, "Acquisitions of Certain
Financial Institutions - an amendment of FASB Statements No. 72 and 144 and
FASB Interpretation No. 9." FAS 147 requires acquisitions of financial
institutions, except for transactions between two or more mutual
enterprises, be accounted for in accordance with FAS 141, "Business
Combinations," and FAS 142, "Goodwill and Other Intangible Assets." FAS
147, effective October 1, 2002, amends FAS 144 to include in its scope
long-term customer-relationship intangible assets of financial institutions
such as depositor and borrower relationship intangible assets and credit
cardholder intangible assets. The Company believes the adoption of FAS 147
will not have a significant impact on its consolidated financial
statements.
16
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations For purposes of this management discussion and
analysis, the term "Company" refers to FPIC Insurance Group, Inc. and
subsidiaries. The following discussion and analysis of financial condition,
results of operations, liquidity and capital resources and other matters should
be read in conjunction with the accompanying condensed, consolidated financial
statements for the three months and nine months ended September 30, 2002 and
2001, included in Part I, Item 1, as well as the audited, consolidated financial
statements and notes included in the Company's Form 10-K for the year ended
December 31, 2001, which was filed with the Securities and Exchange Commission
on March 27, 2002.
Safe Harbor Disclosure
The Private Securities Litigation Reform Act of 1995 provides a "safe harbor"
for forward-looking statements. Any written or oral statements made by or on
behalf of the Company may include forward-looking statements, which reflect the
Company's current views with respect to future events and financial performance.
These forward-looking statements are subject to certain uncertainties and other
factors that could cause actual results to differ materially from such
statements. These uncertainties and other factors include, but are not limited
to:
(i) Uncertainties relating to government and regulatory policies (such as
subjecting the Company to insurance regulation or taxation in
additional jurisdictions or amending, revoking or enacting any laws,
regulations or treaties affecting the Company's current operations);
(ii) The occurrence of insured or reinsured events with a frequency or
severity exceeding the Company's estimates;
(iii) Legal developments, including claims for extra-contractual obligations
or in excess of policy limits in connection with the administration of
insurance claims;
(iv) Developments in global financial markets that could affect the
Company's investment portfolio and financing plans;
(v) Developments in reinsurance markets that could affect the Company's
reinsurance program;
(vi) The impact of mergers and acquisitions, including the ability to
successfully integrate acquired businesses and achieve cost savings,
competing demands for the Company's capital and the risk of undisclosed
liabilities;
(vii) Risk factors associated with financing and refinancing, including the
willingness of credit institutions to provide financing and the
availability of credit;
(viii) The competitive environment in which the Company operates, including
reliance on agents to place insurance, physicians electing to practice
without insurance coverage, related trends and associated pricing
pressures and developments;
(ix) The actual amount of new and renewal business and market
acceptance of expansion plans;
(x) The impact of surplus constraints on growth;
(xi) Rates, including rates on excess policies, being subject to or mandated
by regulatory approval;
(xii) The loss of the services of any of the Company's executive officers;
(xiii) Changing rates of inflation and other economic conditions;
(xiv) The uncertainties of the loss reserving process;
(xv) The ability to collect reinsurance recoverables; and
(xvi) Changes in the Company's financial ratings resulting from one or more
of these uncertainties or other factors and the potential impact on
agents' ability to place insurance business on behalf of the Company.
The words "believe," "anticipate," "foresee," "estimate," "project," "plan,"
"expect," "intend," "hope," "should," "will," "will likely result" or "will
continue" and variations thereof or similar expressions identify forward-looking
statements. Readers are cautioned not to place undue reliance on these
forward-looking statements, which speak only as of their dates. The Company
undertakes no obligation to publicly update or revise any forward-looking
statements, whether as a result of new information, future events or otherwise.
17
Critical Accounting Policies
The Company's discussion and analysis of its financial condition and results of
operations are based upon the Company's consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States of America. The preparation of these financial statements
requires management to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenues, expenses, and related disclosures of
contingent assets and liabilities. On an on-going basis, management evaluates
its estimates, including those related to income taxes, loss and loss adjustment
expense ("LAE") reserves, contingencies and litigation. The Company bases its
estimates on historical experience and on various other assumptions that are
believed to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results may differ from
these estimates under different assumptions or conditions.
A discussion of the critical accounting policies believed by the Company to
affect its more significant judgments and estimates used in preparation of the
Company's consolidated financial statements is included in the Company's Form
10-K for the year ended December 31, 2001, which was filed with the Securities
and Exchange Commission on March 27, 2002. In some cases, the estimates included
in the Company's financial statements for interim periods are determined using
abbreviated methods, which are less comprehensive than those used in preparation
of its annual financial statements.
Revenue Recognition.
Management fees of the reciprocal management segment, determined as a percentage
of Physicians' Reciprocal Insurers ("PRI") premiums, are recognized as billed
and earned under the contract, which generally corresponds with the reported
premiums written of PRI. Such management fees are estimated, billed and earned
for quarterly reporting purposes based upon semi-annual estimates of the
reported premiums written of PRI rather than actual written premiums for a
quarter, which may vary significantly from quarter to quarter, in order that
such management fees are recognized ratably over the period in relation to the
services provided by the reciprocal management segment to PRI.
Loss and Loss Adjustment Expenses.
For the purposes of setting aside reserves on risks insured during the current
year, including interim periods, for which very little experience is present, a
forecasted loss ratio is determined that is applied to earned premiums during
the period. This forecasted loss ratio is judgmentally determined taking into
account the results of the most recent actuarial study performed, current
pricing and underwriting, and expected loss and LAE trends and other pertinent
considerations. In addition, management monitors and analyzes key loss and LAE
indicators and trends throughout the year, including but not limited to paid
losses, newly reported claims and incidents, closed claim activity, and other
metrics in order to assess the reasonableness of its loss reserve estimates and
the forecasted loss and LAE ratio being applied during the current period.
The following accounting policy has changed with the Company's adoption,
effective January 1, 2002, of Financial Accounting Standard No. ("FAS") 142,
"Goodwill and Other Intangible Assets."
Goodwill and Intangible Assets.
The Company has made acquisitions in the past that included a significant amount
of goodwill and other intangible assets. Under generally accepted accounting
principles ("GAAP") in effect through December 31, 2001, these assets were
amortized over their estimated useful lives, and were tested periodically to
determine if they were recoverable from operating earnings on an undiscounted
basis over their useful lives.
Effective January 1, 2002, the Company adopted FAS 142. In accordance with FAS
142, goodwill and indefinite lived intangible assets will no longer be amortized
but will be subject to an annual (or under certain circumstances more frequent)
impairment test based on its estimated fair value. Other intangible
18
assets that meet certain criteria will continue to be amortized over their
useful lives and will also be subject to an impairment test based on estimated
fair value. There are many assumptions and estimates underlying the
determination of an impairment loss. Another estimate using different, but still
reasonable, assumptions could produce a significantly different result.
Therefore, additional impairment losses could be recorded in the future.
The Company completed the transitional impairment analysis required by FAS 142
during the first quarter of 2002 and recorded an impairment charge of $29.6
million, net of an $18.8 million income tax benefit. See Notes 1 and 3 to the
condensed, consolidated financial statements, which appear in Part I, Item 1,
preceding, for a discussion of the new accounting policy for goodwill and
intangible assets. Had the new standard been in effect in 2001, net income and
diluted earnings per share for the nine months ended September 30, 2001 would
have increased $1.6 million and $0.17, respectively, as a result of the
elimination of goodwill amortization.
Results of Operations: Three Months and Nine Months Ended September 30, 2002
Compared to Three Months and Nine Months Ended September 30, 2001
Total revenues for the third quarter 2002 increased 3% to $50.0 million from
$48.3 million for the third quarter 2001. Total revenues for the nine months
ended September 30, 2002 increased 15% to $166.2 million from $144.0 million for
the nine months ended September 30, 2001. The increase in revenues is primarily
the result of price improvements on the Company's core medical professional
liability ("MPL") business and growth in the number of policyholders. Net
premiums earned on the Company's MPL business increased 5% to $30.0 million for
the three months ended September 30, 2002 from $28.7 million for the three
months ended September 30, 2001. For the nine months ended September 30, 2002,
net premiums earned on the Company's MPL business increased 33% to $115.5
million from $86.8 million for the nine months ended September 30, 2001. The
difference in the increase in net premiums earned for the three months ended
September 30, 2002 when compared to the nine months ended September 30, 2002 is
the result of First Professionals Insurance Company, Inc. ("First
Professionals") having entered into a finite quota share reinsurance agreement
with two insurance companies of the Hannover Re group ("Hannover Re"), effective
July 1, 2002, which resulted in an increase in ceded earned premiums of $22.5
million. Excluding the effects of the new reinsurance agreement, net premiums
earned were $52.9 million for the three months ended September 30, 2002. The
Company also had an increase in revenues earned by the Company's reciprocal
management segment primarily as a result of an increase in brokerage commissions
earned by FPIC Intermediaries, Inc. ("Intermediaries").
Total expenses for the third quarter 2002 decreased 5% to $42.4 million from
$44.7 million for the third quarter 2001. Total expenses for the nine months
ended September 30, 2002 increased 9% to $148.9 million from $136.9 million for
the nine months ended September 30, 2001. Net losses and LAE incurred for the
three months and nine months ended September 30, 2002 increased $3.2 million or
12% and $15.7 million or 17%, respectively, when compared with the three months
and nine months ended September 30, 2001. Net losses and LAE incurred on the
Company's MPL business increased 14% to $29.8 million for the three months ended
September 30, 2002 from $26.2 million for the three months ended September 30,
2001. Net losses and LAE incurred in the third quarter of 2002 were reduced by
an increase in ceded losses and LAE incurred under the Hannover Re reinsurance
agreement of $18.2 million for the three months ended September 30, 2002. For
the nine months ended September 30, 2002, net losses and LAE incurred on the
Company's MPL business increased 30% to $103.9 million from $80.0 million for
the nine months ended September 30, 2001. The increase in net losses and LAE
incurred for the three months and nine months ended September 30, 2002, reflects
growth in business, taking into consideration expected loss trends. The
increases in reported loss ratios for the third quarter of 2002 relative to
earlier quarters of 2002 reflect added conservatism in setting reserves aside on
current business. The increases in net losses and LAE were offset by declines
in other underwriting expenses and other expenses for the three months and nine
months ended September 30, 2002, primarily as a result of increased ceding
commissions related to the finite quota share agreement between First
Professionals and Hannover Re and the Company's
19
adoption of FAS 142. The adoption of FAS 142 eliminated amortization expense of
approximately $1.6 million after-tax for the nine months ended September 30,
2002.
The Company reported net income of $4.4 million or $0.47 per diluted share for
the third quarter of 2002, an increase of $1.3 million or $0.14 per diluted
share, when compared with net income of $3.1 million or $0.33 per diluted share
for the third quarter of 2001. The Company incurred a net loss of $19.7 million
or $2.08 per diluted share for the nine months ended September 30, 2002 compared
with net income of $6.3 million or $0.66 per diluted share for the nine months
ended September 30, 2001. During the first quarter 2002, the adoption of FAS 142
resulted in a one-time, non-cash charge that reduced the carrying value of the
Company's goodwill by $48.4 million. The goodwill impairments resulting from the
adoption of FAS 142 were associated entirely with goodwill at the Company's
non-insurance segments. Income before cumulative effect of accounting change was
$9.9 million or $1.04 per diluted share for the nine months ended September 30,
2002, an increase of $3.6 million or $0.38 per diluted share when compared with
net income of $6.3 million or $0.66 per diluted share for the nine months ended
September 30, 2001.
Insurance Segment
The Company's insurance segment is made up of its four insurance subsidiaries,
First Professionals, Anesthesiologists Professional Assurance Company ("APAC")
and The Tenere Group, Inc. companies of Intermed Insurance Company ("Intermed")
and Interlex Insurance Company ("Interlex"). Holding company operations are
included within the insurance segment due to the segment's size and prominence
and the substantial attention devoted to the segment.
Effective October 3, 2002, the Company sold the renewal rights on Interlex's
legal professional liability insurance business to a subsidiary of Professionals
Direct, Inc. for $0.4 million. The sale of Interlex's renewal rights allows the
Company to focus on its core MPL business.
Unaudited data for the Company's insurance segment for the three months and nine
months ended September 30, 2002 and 2001 are summarized in the table below.
Dollar amounts are in thousands.
Three Months Ended Nine Months Ended
----------------------------------------- ------------------------------------------
Sept 30, Percentage Sept 30, Sept 30, Percentage Sept 30,
2002 Change 2001 2002 Change 2001
----------------------------------------- ------------------------------------------
Direct and assumed premiums written $ 90,856 24% $ 73,005 $ 270,540 54% $ 175,120
============= ============= ============== =============
Net premiums written $ (6,448) -115% $ 43,194 $ 106,912 -1% $ 108,410
============= ============= ============== =============
Net premiums earned $ 30,435 3% $ 29,686 $ 117,337 22% $ 96,005
Net investment income 5,185 -9% 5,683 15,782 -13% 18,047
Commission income 1 -96% 27 8 -83% 47
Net realized investment gains 1,969 193% 673 2,113 621% 293
Finance charges and other income 263 49% 177 700 29% 543
Intersegment revenues 693 279% 183 2,006 265% 549
------------- ------------- -------------- -------------
Total revenues 38,546 6% 36,429 137,946 19% 115,484
------------- ------------- -------------- -------------
Net losses and LAE 30,549 12% 27,301 105,733 17% 90,042
Other underwriting expense 2,286 -67% 6,825 15,772 -6% 16,833
Interest expense 1,227 25% 983 3,697 11% 3,321
Other expenses 226 -13% 260 368 -51% 752
Intersegment expenses 1,482 83% 809 2,800 -4% 2,915
------------- ------------- -------------- -------------
Total expenses 35,770 -1% 36,178 128,370 13% 113,863
------------- ------------- -------------- -------------
Income from operations before
taxes and cumulative effect of
accounting change 2,776 1006% 251 9,576 491% 1,621
Less: Income tax expense (benefit) 1,403 267% (842) 4,396 450% (1,257)
------------- ------------- -------------- -------------
Income before cumulative effect of
accounting change 1,373 26% 1,093 5,180 80% 2,878
------------- ------------- -------------- -------------
Less: Cumulative effect of
accounting change -- 0% -- -- 0% --
------------- ------------- -------------- -------------
Net income $ 1,373 26% $ 1,093 $ 5,180 80% $ 2,878
============= ============= ============== =============
20
Three Months Ended Nine Months Ended
----------------------------------------- ------------------------------------------
Selected Direct Professional Liability Sept 30, Percentage Sept 30, Sept 30, Percentage Sept 30,
Claim Information 2002 Change 2001 2002 Change 2001
- -------------------------------------------- ----------------------------------------- ------------------------------------------
Net paid losses and LAE on professional
liability claims only $ 22,745 -4% $ 23,737 $ 71,784 2% $ 70,120
============= ============= ============== =============
Average net paid loss per professional
liability claim closed with indemnity
payment $ 192 -6% $ 205 $ 192 6% $ 181
============= ============= ============== =============
Total professional liability claims and
incidents reported during the period 813 44% 564 2,456 63% 1,508
============= ============= ============== =============
Total professional liability claims
with indemnity payment 67 -9% 74 229 -8% 249
============= ============= ============== =============
Total professional liability claims and
incidents closed without indemnity
payment 366 10% 334 1,298 29% 1,006
============= ============= ============== =============
Sept 30, Percentage Sept 30,
2002 Change 2001
------------------------------------------
Professional liability policyholders (Excludes policyholders under fronting
arrangements of 5,104 and 3,767 as of September 30, 2002 and 2001, respectively) 17,447 33% ** 13,135
=============== =============
** Total retained professional liability policyholders have grown 25% since
December 31, 2001
Direct and assumed premiums written increased 24% to $90.9 million for the three
months ended September 30, 2002 from $73.0 million for the three months ended
September 30, 2001. Direct and assumed premiums written increased 54% to $270.5
million for the nine months ended September 30, 2002 from $175.1 million for the
nine months ended September 30, 2001. The increase in direct and assumed
premiums written primarily results from an increase in direct premiums written
on the Company's core MPL business related to rate increases realized by the
Company's insurance subsidiaries and growth in the number of policyholders.
First Professionals implemented rate increases in January and December 2001;
APAC implemented rate increases in July 2001 and 2002; and Intermed implemented
rate increases in November 2001 and July 2002. In addition, the Company
experienced growth in direct premiums written under fronting arrangements for
workers' compensation business of $15.6 million for the nine months ended
September 30, 2002 when compared to the nine months ended September 30, 2001.
The growth in direct premiums written was partially offset by a decline of $7.0
million in direct and assumed premiums written under group accident and health
("A&H") programs for the nine months ended September 30, 2002, which were
discontinued in 2001.
Net premiums written decreased 115% for the three months ended September 30,
2002 from $43.2 million for the three months ended September 30, 2001. Net
premiums written decreased 1% to $106.9 million for the nine months ended
September 30, 2002 from $108.4 million for the nine months ended September 30,
2001. The decline in net premiums written is related to the finite quota share
reinsurance agreement effective July 1, 2002 between the Company's largest
subsidiary, First Professionals, and Hannover Re. Under the terms of the
Hannover Re agreement, First Professionals ceded approximately $51.7 million of
its unearned premiums as of June 30, 2002, and $15.9 million of its direct
written premiums, net of other reinsurance, during the three months ended
September 30, 2002. The agreement, which calls for First Professionals to cede
quota share portions of its 2002 and 2003 written premiums, contains adjustable
features, including a loss corridor, sliding scale ceding commissions, and a cap
on the amount of losses that may be ceded to the reinsurer. The effect of these
features is to limit the reinsurers' aggregate exposure to loss and thereby
reduce the ultimate costs to First Professionals as the ceding company. These
features also have the effect of reducing the amount of protection relative to
the quota share amount of premiums ceded by First Professionals. While First
Professionals does not receive pro-rata protection relative to the amount of
premiums ceded, the amount of such protection is significant, as determined in
accordance with guidance under both statutory accounting practices and GAAP. In
addition to ceding a significant portion of its risks to Hannover Re, the
agreement also allows First Professionals to reduce its financial leverage and
to realize immediate reimbursement for its related up-front acquisition costs,
thus adding to its financial capacity. The consolidated statutory capital and
21
surplus of the Company's insurance subsidiaries was increased by approximately
$5.3 million as of September 30, 2002, as a result of the Hannover Re agreement,
and the consolidated statutory net premiums written to surplus ratio for the
nine months ended September 30, 2002, was lowered from 1.5:1 to 0.9:1 by virtue
of premiums ceded under the agreement in the third quarter. First Professionals
has the option to commute the agreement should the business perform such that
the underlying protection proves to be unnecessary, in which case the
reinsurance would cease, the underlying reinsurance assets and liabilities would
unwind, and any net funds under the agreement, less a 4.2% risk charge to
Hannover Re, would be retained by First Professionals. The decision of whether
to commute the agreement and the timing of any such commutation will depend on
the performance of the underlying business, the need for the agreement based on
the Company's capital position and other relevant considerations.
Net premiums earned increased 3% to $30.4 million for the three months ended
September 30, 2002 from $29.7 million for the three months ended September 30,
2001. Net premiums earned increased 22% to $117.3 million for the nine months
ended September 30, 2002 from $96.0 million for the nine months ended September
30, 2001. The increase in net premiums earned is due to rate increases
implemented by the Company's insurance subsidiaries and growth in the number of
policyholders. Net premiums earned on the Company's MPL business increased 5% to
$30.0 million for the three months ended September 30, 2002 from $28.7 million
for the three months ended September 30, 2001. For the nine months ended
September 30, 2002, net premiums earned on the Company's MPL business increased
33% to $115.5 million from $86.8 million for the nine months ended September 30,
2001. The difference in the increase in net premiums earned for the three months
ended September 30, 2002 when compared to the nine months ended September 30,
2002 is the result of the finite quota share reinsurance agreement between First
Professionals and Hannover Re effective July 1, 2002.
As a result of the hardening markets and significant price improvements, the
Company's insurance segment has already met and exceeded its growth targets for
the year 2002. The insurance subsidiaries have ceased accepting applications for
new business for the time being, but continue to renew existing core MPL
policyholders, including taking new policyholders who join existing policyholder
groups. The Company has also taken several steps to manage its recent growth,
including adding significant reinsurance coverage, re-allocating available
capital from other portions of the business to its core MPL insurance business
and by managing the growth of its core professional liability policyholder base
for calendar year 2002 to the low-20% range. Through September 30, 2002, total
retained professional liability policyholders have grown 25% to 17,447, since
December 31, 2002 and 33% since September 30, 2001; however, this growth trend
is expected to decline going forward based upon implementation of one or more of
the Company's growth management initiatives.
As the Company takes these steps, it is also considering ways to expand its
existing capacity. Ultimately, the Company will carefully consider any such
opportunities based upon its strategic goals and objectives, including
analysis of the highest and best use of its capital with a view towards building
value for its shareholders.
On August 2, 2002, Gerling Global Reinsurance Corporation of America
("Gerling"), one of the Company's current reinsurers, had its financial strength
rating lowered by A.M. Best Company ("Best") from A- (Excellent) to B+ (Very
Good). The rating action by Best follows an announcement by Gerling of its
intention to exit the U.S. non-life reinsurance market. Gerling has participated
in the Company's excess of loss reinsurance programs in 2000 at 15%, and in 2001
and 2002 at 20%. Gerling has also provided facultative reinsurance coverage for
non-standard risks. It is presently expected that Gerling will fully meet its
obligations to the Company. Management also anticipates that it will be able to
successfully replace Gerling's participation at the next reinsurance renewal
date, January 1, 2003. As of September 30, 2002, the aggregate amount of
reinsurance recoverables from Gerling was $9.9 million.
22
Net investment income declined 9% to $5.2 million for the three months ended
September 30, 2002 from $5.7 million for the three months ended September 30,
2001. Net investment income decreased 13% to $15.8 million for the nine months
ended September 30, 2002 from $18.0 million for the nine months ended September
30, 2001. The decline in net investment income is primarily due to lower
prevailing interest rates and reduced yields on fixed income investments,
beginning in the second half of 2001. The Company has also held more funds in
invested cash during 2002 as compared to 2001 in anticipation of possible
improvements in fixed income rates in the near term.
Net realized investment gains increased 193% to $2.0 million for the three
months ended September 30, 2002 from $0.7 million for the three months ended
September 30, 2001. Net realized investment gains increased 621% to $2.1 million
for the nine months ended September 30, 2002 from $0.3 million for the nine
months ended September 30, 2001. The Company engaged professional investment
managers during the third quarter of 2001 to manage and reposition the Company's
investment portfolio. The Company's investment strategy remains focused on high
quality, fixed income securities; however, management of the investment
portfolio may require that certain securities be liquidated to take advantage of
current market and economic conditions. The increase in net realized investment
gains is a reflection of this strategy.
Net losses and LAE incurred for the three months and nine months ended September
30, 2002 increased $3.2 million or 12% and $15.7 million or 17%, respectively
when compared with the three months and nine months ended September 30, 2001.
Net losses and LAE incurred on the Company's MPL business increased 14% to $29.8
million for the three months ended September 30, 2002 from $26.2 million for the
three months ended September 30, 2001. Net losses and LAE incurred in the third
quarter of 2002 were reduced by an increase in ceded losses and LAE incurred
under the Hannover Re reinsurance agreement of $18.2 million. For the nine
months ended September 30, 2002, net losses and LAE incurred on the Company's
MPL business increased 30% to $103.9 million from $80.0 million for the nine
months ended September 30, 2001. The Company's loss ratios for the three months
ended September 30, 2002 and 2001 were 100% and 92%, respectively. The Company's
loss ratios for the nine months ended September 30, 2002 and 2001 were 90% and
94%, respectively. The increase in net losses and LAE incurred for the three
months and nine months ended September 30, 2002 reflect growth in business,
taking into consideration expected loss trends. A loss ratio is defined as the
ratio of loss and LAE incurred to net premiums earned. The 4% decrease in the
reported loss ratio for the nine months ended September 30, 2002 is due to the
Company's exit from its former group A&H business (2%), loss expense reduction
and productivity (3%), changes in the mix of assumed reinsurance (1%), and
expected improvements in pricing (2%). These reductions were partially offset by
increases due to the effects of the new Hannover Re agreement (1%) and
additional conservatism in establishing reserves on 2002 business during the
third quarter (3%). The increases in reported loss ratios for the third quarter
of 2002 relative to earlier quarters of 2002 reflects added conservatism in
setting reserves aside on current business.
The liability for losses and LAE represents management's best estimate of the
ultimate cost of all losses incurred but unpaid and considers historical loss
experience, expected loss trends, the Company's loss retention levels and trends
in the frequency and severity of claims. The process of establishing reserves
for property and casualty claims is a complex process, requiring significant
reliance upon estimates. The Company's estimates are revised as additional
experience and other data become available and are reviewed periodically or as
other significant events occur that may affect reserves. Any such revisions
could result in future changes in the estimates of losses or reinsurance
recoverables and would be reflected in the Company's results of operations when
the change occurs.
The Company believes its liability for loss and LAE continues to be within a
reasonable range of adequacy. Based on analysis performed through the first nine
months of 2002, increases in newly reported claims and incidents have been
determined to be primarily attributable to growth and a modest increase in
frequency. These trends have been comprehended in the Company's pricing and
reserve estimates. Overall, paid losses and closed claims statistics for the
first nine months of 2002 and estimates
23
of ultimate severity remain stable. Given the inherent uncertainty in reserve
estimates, there can be no assurance that the ultimate amount of actual losses
will not exceed the related amounts currently estimated. Any such differences,
either positive or negative, could have a material effect on the Company's
results of operations and financial position.
Other underwriting expenses decreased 67% to $2.3 million for the three months
ended September 30, 2002 from $6.8 million for the three months ended September
30, 2001. Other underwriting expenses decreased 6% to $15.8 million for the nine
months ended September 30, 2002 from $16.8 million for the nine months ended
September 30, 2001. The decline in other underwriting expenses is primarily
attributable to ceding commissions recognized under the terms of the finite
quota share reinsurance agreement between First Professionals and Hannover Re in
the amount of $6.2 million. In addition, First Professionals, the Company's
largest insurance subsidiary, performed a study of its 2001 expenses incurred in
the administration of claims and based on the results of this study decreased
the amount of expenses allocated to LAE in 2002.
Other expenses decreased 13% to $0.2 million for the three months ended
September 30, 2002 from $0.3 million for the three months ended September 30,
2001. Other expenses decreased 51% to $0.4 million for the nine months ended
September 30, 2002 from $0.8 million for the nine months ended September 30,
2001. The decline in other expenses is due to the Company's adoption of FAS 142.
In accordance with FAS 142, the Company ceased the amortization of goodwill and
indefinite lived intangible assets during the first quarter 2002.
Income tax expense increased to $1.4 million for the three months ended
September 30, 2002 from an income tax benefit of $0.8 million for the three
months ended September 30, 2001. Income tax expense increased to $4.4 million
for the nine months ended September 30, 2002 from an income tax benefit of $1.3
million for the nine months ended September 30, 2001. In late 2001, the Company
engaged outside investment managers and began repositioning investments in
tax-exempt municipal securities to investments in taxable securities. The
increase in income tax expense is partially associated with the resulting
increase in the mix of investment income from taxable securities. In addition,
the Company is nearing completion of the examination of its 1998 and 1999
federal income tax returns by the Internal Revenue Service and in connection
therewith, established a $1.0 million reserve for potential tax contingencies
during the second quarter of 2002, which accounted for the remainder of the
increase in income tax expense. Management believes that its positions are
meritorious on these and other potential issues raised in the examination and
that the accrual made is appropriate; however, there can be no assurance that
the Company will ultimately prevail on such matters.
Reciprocal Management Segment
The Company's reciprocal management segment is made up of Administrators For The
Professions, Inc. ("AFP"), the Company's New York subsidiary, and its two wholly
owned subsidiaries, Intermediaries and Group Data Corporation ("Group Data").
AFP acts as administrator and attorney-in-fact for PRI, the second largest
medical professional liability insurer for physicians in the state of New York.
Intermediaries acts as a reinsurance broker and intermediary in the placement of
reinsurance. Group Data acts as a broker in the placement of annuities for
structured settlements. The segment also includes the business of Professional
Medical Administrators, LLC ("PMA"), a 70% owned subsidiary of the Company. PMA
provides brokerage and administration services for professional liability
insurance programs.
24
Unaudited data for the Company's reciprocal management segment for the three
months and nine months ended September 30, 2002 and 2001 are summarized in the
table below. Dollar amounts are in thousands.
Three Months Ended Nine Months Ended
--------------------------------------- -------------------------------------
Sept 30, Percentage Sept 30, Sept 30, Percentage Sept 30,
2002 Change 2001 2002 Change 2001
--------------------------------------- -------------------------------------
Claims administration and management fees $ 6,571 0% $ 6,552 $ 16,314 8% $ 15,129
Net investment income 37 -64% 103 122 -57% 286
Commission income 1,321 27% 1,042 2,584 45% 1,782
Other income 21 -13% 24 62 -80% 314
Intersegment revenues 1,482 97% 754 2,770 14% 2,427
-------------- --------- --------------- ---------
Total revenues 9,432 11% 8,475 21,852 10% 19,938
-------------- --------- --------------- ---------
Claims administration and management expenses 4,511 -7% 4,833 13,171 3% 12,771
Interest expense 160 0% -- 160 0% --
Other expenses -- -100% 543 35 -98% 1,629
Intersegment expenses 399 259% 111 1,197 259% 333
-------------- --------- --------------- ---------
Total expenses 5,070 -8% 5,487 14,563 -1% 14,733
-------------- --------- --------------- ---------
Income from operations before taxes and
cumulative effect of accounting change 4,362 46% 2,988 7,289 40% 5,205
Less: Income taxes 1,727 25% 1,386 2,846 31% 2,174
Income before cumulative effect of accounting
change 2,635 64% 1,602 4,443 47% 3,031
-------------- --------- --------------- ---------
Less: Cumulative effect of accounting
change -- 0% -- 24,363 0% --
-------------- --------- --------------- ---------
Net income (loss) $ 2,635 64% $ 1,602 $ (19,920) -757% $ 3,031
============== ========= =============== =========
Three Months Ended Nine Months Ended
-------------------------------------- --------------------------------------
Sept 30, Percentage Sept 30, Sept 30, Percentage Sept 30,
2002 Change 2001 2002 Change 2001
-------------------------------------- --------------------------------------
Reciprocal premiums written under management $ 79,828 -9% $ 87,292 $ 155,043 1% $ 153,537
============== ========= =============== =========
As of As of
Sept 30, Percentage Sept 30,
2002 Change 2001
--------------------------------------
Reciprocal statutory assets under management $ 831,218 -2% $ 852,142
============== =========
Professional liability policyholders under
management 10,474 8% 9,722
============== =========
Claims administration and management fees for the three months ended September
30, 2002 were essentially level with those reported for the three months ended
September 30, 2001. For the nine months ended September 30, 2002 claims
administration and management fees increased 8% to $16.3 million from $15.1
million for the nine months ended September 30, 2001. The claims administration
and management fees earned by AFP are comprised entirely of management fees from
PRI and the increase is due to the growth in premiums written by PRI. In
accordance with the management agreement between AFP and PRI, AFP receives a
management fee equal to 13% of PRI's direct premiums written, with an adjustment
for expected return premiums. As such, the Company's revenues and results of
operations are financially sensitive to the revenues and financial condition of
PRI. PRI, as an MPL insurer, is subject to many of the same types of risks as
those of the Company's insurance subsidiaries and MPL companies generally.
Growth at PRI is subject to surplus constraints, and as a reciprocal, PRI
operates at higher leverage ratios. PRI's rates, including rates charged for
policies in excess of $1.3 million, which have been reinsured to First
Professionals (see Note 11 - Related Party Transactions), are
25
mandated by the New York State Insurance Department ("NYSID"). Further, as
allowed under New York insurance laws, PRI has requested and received permission
from the NYSID to follow the permitted practice of discounting its loss and LAE
reserves.
Commission income increased 27% to $1.3 million for the three months ended
September 30, 2002 from $1.0 million for the three months ended September 30,
2001. Commission income increased 45% to $2.6 million for the nine months ended
September 30, 2002 from $1.8 million for the nine months ended September 30,
2001. The increase in commission income is due to an increase in brokerage
commissions earned by Intermediaries for the placement of reinsurance.
Other income for the three months ended September 30, 2002 was relatively flat
when compared to the three months ended September 30, 2001. Other income
decreased 80% to $0.06 million for the nine months ended September 30, 2002 from
$0.3 million for the nine months ended September 30, 2001. Effective January 1,
2002, AFP and PRI amended the management agreement eliminating the sharing by
AFP of 10% of PRI's statutory net income or loss. The amendment was approved by
the New York Department of Insurance.
Claims administration and management expenses decreased 7% to $4.5 million for
the three months ended September 30, 2002 from $4.8 million for the three months
ended September 30, 2001. Claims administration and management expenses
increased 3% to $13.2 million for the nine months ended September 30, 2002 from
$12.8 million for the nine months ended September 30, 2001. The decline in
claims administration and management expenses for the quarter ended September
30, 2002 is primarily attributable to the amendment of the management agreement
between AFP and PRI. In accordance with the amended agreement, PRI is to
reimburse AFP for 50% of risk management department expenses. The increase in
claims administration and management expenses for the nine months ended
September 30, 2002 is due to an increase in operating expenses incurred to
manage the growth in business at PRI, offset by a decline in risk management
department expenses reimbursed by PRI when compared to the nine months ended
September 30, 2001.
Interest expense increased to $0.2 million for the three months and nine months
ended September 30, 2002. The increase in interest expense is the result of
modifying the management agreement between AFP and PRI. In accordance with the
modified agreement, AFP has agreed to pay 6% annual interest on amounts already
earned and collected under the original agreement for 1999, 2000 and 2001, while
those years remain open for possible future re-determination and adjustment, if
any.
Other expenses decreased 100% for the three months ended September 30, 2002 from
$0.5 million for the three months ended September 30, 2001. Other expenses
decreased 98% to $0.04 for the nine months ended September 30, 2002 from $1.6
million for the nine months ended September 30, 2001. The decline in other
expenses is due to the effects of the Company's adoption of FAS 142. In
accordance with FAS 142, the Company ceased the amortization of goodwill and
indefinite lived intangible assets during the first quarter 2002.
In connection with its adoption of FAS 142, the reciprocal management segment
recorded a transitional impairment charge of $24.4 million, after-tax. In
management's opinion, the non-cash transitional impairment charge, which
represents the cumulative effect of the accounting change, primarily reflects
certain intangibles and synergies, which are opportunistic in nature, carry a
higher degree of uncertainty, and therefore were treated conservatively in the
valuation required by FAS 142.
26
Third Party Administration Segment
The Company's third party administration ("TPA") segment is made up of Employers
Mutual, Inc. ("EMI"). Unaudited data for the Company's TPA segment for the three
months and nine months ended September 30, 2002 and 2001 are summarized in the
table below. Dollar amounts are in thousands.
Three Months Ended Nine Months Ended
----------------------------------------- ------------------------------------
Sept 30, Percentage Sept 30, Sept 30, Percentage Sept 30,
2002 Change 2001 2002 Change 2001
----------------------------------------- ------------------------------------
Claims administration and management fees $ 3,069 -2% $ 3,138 $ 9,247 -2% $ 9,455
Net investment income 19 -39% 31 38 -73% 140
Commission income 1,069 -8% 1,161 1,835 -7% 1,965
Other income -- -100% 6 8 -64% 22
Intersegment revenues -- -100% 104 80 -87% 638
------------ ------------ ----------- ----------
Total revenues 4,157 -6% 4,440 11,208 -8% 12,220
------------ ------------ ----------- ----------
Claims administration and management expenses 3,416 -8% 3,726 10,013 -9% 10,999
Other expenses -- -100% 189 -- -100% 532
Intersegment expenses 294 143% 121 859 135% 366
------------ ------------ ----------- ----------
Total expenses 3,710 -8% 4,036 10,872 -9% 11,897
------------ ------------ ----------- ----------
Income from operations before taxes and cumulative
effect of accounting change 447 11% 404 336 4% 323
Less: Income tax expense (benefit) 40 0% -- 70 404% (23)
------------ ------------ ----------- ----------
Income before cumulative effect of accounting change 407 1% 404 266 -23% 346
------------ ------------ ----------- ----------
Less: Cumulative effect of accounting change -- 0% -- 5,215 0% --
------------ ------------ ----------- ----------
Net income (loss) $ 407 1% $ 404 $ (4,949) -1530% $ 346
============ ============ =========== ==========
As of As of
Sept 30, Percentage Sept 30,
2002 Change 2001
---------------------------------------
Covered lives under employee benefit programs 106,411 1% 105,558
============ ============
Covered lives under workers compensation programs 38,100 1% 37,700
============ ============
Claims administration and management fees for the three months ended September
30, 2002 were essentially level when compared with the three months ended
September 30, 2001. Claims administration and management fees decreased 2% to
$9.2 million for the nine months ended September 30, 2002 from $9.5 million for
the nine months ended September 30, 2001. The Company's results of operations
for the period ended September 30, 2001 include the Company's Albuquerque TPA
division, which was disposed of in December 2001. Excluding the effect of the
Albuquerque TPA division, claims administration and management fees increased
$0.6 million and $1.7 million for the three months and nine months ended
September 30, 2002, respectively, when compared with the three months and nine
months ended September 30, 2001. The increase in claims administration and
management fees reflects growth in new business.
Commission income decreased 8% to $1.1 million for the three months ended
September 30, 2002 from $1.2 million for the three months ended September 30,
2001. Commission income decreased 7% to $1.8 million for the nine months ended
September 30, 2002 from $2.0 million for the nine months ended September 30,
2001. The decline in commission income is related to a decline in the number of
clients utilizing EMI for the placement of reinsurance.
27
Claims administration and management expenses decreased 8% to $3.4 million for
the three months ended September 30, 2002 from $3.7 million for the three months
ended September 30, 2001. Claims administration and management expenses
decreased 9% to $10.0 million for the nine months ended September 30, 2002 from
$11.0 million for the nine months ended September 30, 2001. The decline in
claims administration and management expenses is due to the disposition of the
Company's Albuquerque division. Excluding the effect of the Albuquerque TPA
division, claims administration and management expenses increased $0.5 million
and $1.4 million for the three months and nine months ended September 30, 2002,
respectively, when compared with the three months and nine months ended
September 30, 2001. The increase in claims administration and management
expenses is due to additional expenses incurred as the result of new business.
Other expenses decreased 100% for the three months and nine months ended
September 30, 2002 from $0.2 million and $0.5 million for the three and nine
months ended September 30, 2001, respectively. The decline in other expenses is
due to the Company's adoption of FAS 142. In accordance with FAS 142, the
Company, including the TPA segment, ceased the amortization of goodwill and
indefinite lived intangible assets during the first quarter 2002.
In connection with the adoption of FAS 142, the TPA segment recorded a
transitional impairment charge of $5.2 million, after-tax. In management's
opinion, the non-cash transitional impairment charge, which represents the
cumulative effect of the accounting change, primarily reflects changes in market
conditions and an increase in competition in recent years in the markets served
by the TPA segment.
Statement of Financial Position: September 30, 2002 Compared to December 31,
2001
Cash and invested assets increased $59.3 million to $501.3 million as of
September 30, 2002 from $442.0 million as of December 31, 2001. The increase in
cash and invested assets is due primarily to the growth in premiums, which
increased the amounts available for investment.
Premiums receivable increased $33.7 million to $107.1 million as of September
30, 2002 from $73.4 million as of December 31, 2001. Approximately $26.9 million
of the increase in premiums receivable is associated with growth in premiums
written as a result of price improvements on the Company's core MPL insurance
business and growth in the number of MPL policyholders. In addition,
approximately $6.7 million of the increase in premiums receivable is associated
with growth in premiums written under fronting arrangements for workers'
compensation business whereby the Company cedes substantially all of the
business to other insurance carriers.
Due from reinsurers on unpaid losses and advance premiums increased $62.9
million to $143.3 million as of September 30, 2002 from $80.4 million as of
December 31, 2001. Ceded unearned premiums increased $54.3 million to $95.1
million as of September 30, 2002 from $40.8 million as of December 31, 2001. The
increases in these assets are the result of the increase in the underlying
reserves and unearned premiums ceded to other insurance carriers under
reinsurance arrangements associated with growth in premiums written and earned
on the Company's core MPL insurance business. Effective July 1, 2002, First
Professionals entered into a finite quota share reinsurance agreement with
Hannover Re. Approximately $18.2 million of the growth in due from reinsurers on
unpaid losses and advance premiums and $45.1 million of growth in ceded unearned
premiums relates to the new reinsurance agreement. The Hannover Re agreement
supplements the Company's existing reinsurance programs.
Deferred policy acquisition costs decreased $4.2 million to $4.8 million as of
September 30, 2002 from $9.0 million as of December 31, 2001. The decline in
deferred policy acquisition costs is related to the finite quota share agreement
between First Professionals and Hannover Re, whereby First Professionals has
deferred the portion of its ceding commissions associated with unearned premiums
ceded under the agreement as of September 30, 2002.
28
Deferred income taxes increased $17.1 million to $37.0 million as of September
30, 2002 from $19.9 million as of December 31, 2001. The increase in deferred
income taxes is primarily due to the Company's adoption of FAS 142. As a result
of the transitional impairment tests required by FAS 142, the Company recognized
a one-time, non-cash after-tax charge of $29.6 million and recorded deferred tax
assets for tax-deductible goodwill, in the amount of $18.8 million.
Goodwill decreased $48.3 million to $18.9 million as of September 30, 2002 from
$67.2 million as of December 31, 2001. The decrease in goodwill is due to the
adoption of FAS 142. As a result of the transitional impairment tests required
by FAS 142, the Company reduced the carrying value of goodwill at its reciprocal
management and TPA segments. In management's opinion, the transitional
impairment charge at the reciprocal management segment primarily reflects
certain intangibles and synergies, which are opportunistic in nature, carry a
relatively higher degree of uncertainty, and therefore was treated
conservatively in the valuation required by FAS 142. The transitional impairment
charge at the TPA segment primarily reflects changes in market conditions and an
increase in competition in recent years in the markets served by the Company's
TPA segment.
Federal income tax receivable decreased $4.5 million to $0.8 million as of
September 30, 2002 from $5.3 million as of December 31, 2001. The decline in the
federal income tax receivable is primarily attributable to the recognition of
tax expense related to current year earnings offset by a federal tax refund
related to the overpayment of estimated taxes in 2001. In addition, the Company
is nearing completion of the examination of its 1998 and 1999 federal income tax
returns by the Internal Revenue Service and in connection therewith, established
a $1.0 million reserve in the second quarter of 2002 for potential tax
contingencies. Management believes that its positions are meritorious on these
and other potential issues raised in the examination and that the accrual made
is appropriate; however, there can be no assurance that the Company will
ultimately prevail on such matters.
Other assets increased $5.6 million to $18.8 million as of September 30, 2002
from $13.2 million as of December 31, 2001. Approximately $4.3 million of the
increase in other assets is due to the sale of investments for which the
proceeds from the sale had not been received at September 30, 2002 and a
receivable from the broker was recorded. The increase in other assets is also
attributable to receivables recorded during the third quarter for amounts due
under the Company's fronting programs and an increase in amounts due AFP related
to a change in the Company's management agreement between AFP and PRI. The
increase in other assets was partially offset by the receipt of a state tax
refund due to the overpayment of estimated taxes in 2001.
The liability for loss and LAE increased $84.6 million to $403.1 million as of
September 30, 2002 from $318.5 million as of December 31, 2001. Excluding the
effect of the return of loss and LAE reserves of approximately $9.3 million, on
business previously assumed under one of the First Professionals' reinsurance
contracts with PRI, which was commuted in the first quarter of 2002, the
increase in the Company's liability for loss and LAE for the first nine months
of 2002 was approximately $93.9 million. The increase in the liability for loss
and LAE is primarily attributable to increases in premiums earned on the
Company's core MPL business and the establishment of reserves for this book of
business, taking into consideration expected loss trends and other pertinent
considerations.
The liability for losses and LAE represents management's best estimate of the
ultimate cost of all losses incurred but unpaid and considers historical loss
experience, expected loss trends, the Company's loss retention levels and trends
in the frequency and severity of claims. The process of establishing reserves
for property and casualty claims is a complex process, requiring significant
reliance upon estimates. The Company's estimates are revised as additional
experience and other data become available and are reviewed periodically or as
other significant events occur that may affect reserves. Any such revisions
could result in future changes in the estimates of losses or reinsurance
recoverables and would be reflected in the Company's results of operations when
the change occurs.
29
For the purposes of setting aside reserves on risks insured during the current
period, for which very little experience is present, a forecasted loss ratio is
determined that is applied to earned premiums during the period. This forecasted
loss ratio is judgmentally determined taking into account the results of the
most recent actuarial study performed, current pricing and underwriting, and
expected loss and LAE trends and other pertinent considerations. In addition,
management monitors and analyzes key loss and LAE indicators and trends
throughout the year, including but not limited to paid losses, newly reported
claims and incidents, closed claim activity, and other metrics in order to
assess the reasonableness of its loss reserve estimates and the forecasted loss
and LAE ratio being applied during the current period.
Unearned premiums increased $43.9 million to $190.7 million as of September 30,
2002 from $146.8 million as of December 31, 2001. The increase in unearned
premiums is the result of the growth in premiums written at the Company's
insurance subsidiaries.
Reinsurance payable increased $50.9 million to $77.6 million as of September 30,
2002 from $26.7 million as of December 31, 2001. Approximately $60.3 of the
increase in reinsurance payable is related to the finite quota share agreement
between First Professionals and Hannover Re and to premiums written under a
fronting arrangement for workers' compensation business. The increase in
reinsurance premiums payable was partially offset by the payment of premiums due
under the Company's primary reinsurance agreement.
Premiums paid in advance and unprocessed premiums decreased $4.9 million to $5.0
million as of September 30, 2002 from $9.9 million as of December 31, 2001. The
decrease in paid in advance and unprocessed premiums reflects the policy renewal
cycle whereby policies are generally renewed with an effective date of December
1, January 1, or July 1 of each year, with a majority of the policies being
renewed on January 1.
Deferred ceding commissions increased to $5.6 million as of September 30, 2002.
The increase in deferred ceding commissions is related to the finite quota share
reinsurance agreement between First Professionals and Hannover Re and represents
the unearned portion of acquisition and underwriting costs reimbursed by
Hannover Re related to the reinsured portion of the Company's policies ceded in
accordance with the agreement.
Accrued expenses and other liabilities increased $17.5 million to $48.8 million
as of September 30, 2002 from $31.3 million as of December 31, 2001.
Approximately $11.7 million of the increase in accrued expenses and other
liabilities is related to the purchase of investments for which the proceeds
from the sale had not been paid at September 30, 2002 and a payable to broker
was recorded. Approximately $4.8 million of the increase in accrued expenses and
other liabilities is related to commissions payable associated with an increase
in insurance business.
Stock Repurchase Plans
Under the Company's stock repurchase programs, shares may be repurchased at such
times, and in such amounts, as management deems appropriate, and subject to the
requirements of its credit facility under which the Company may repurchase
shares up to an amount not to exceed 50% of net income of the immediately
preceding year provided no default or event of default exists under the credit
facility. A decision whether or not to make additional repurchases is based upon
an analysis of the best use of the Company's capital. The Company did not
repurchase any shares during the quarter ended September 30, 2002. Since the
commencement of these repurchase programs, the Company has repurchased 875,000
of its shares at a cost of approximately $16.2 million. A total of 365,500
shares remain available to be repurchased under the programs.
Liquidity and Capital Resources
The payment of losses, LAE and operating expenses in the ordinary course of
business is the principal need for the Company's liquid funds. Cash provided by
operating activities has been used to pay these
30
items and was sufficient during the third quarter and first nine months of 2002
to meet these needs. As reported in the consolidated statement of cash flows,
the Company generated positive net cash from operating activities of $52.0
million for the nine months ended September 30, 2002. In addition, at September
30, 2002, the Company held investments with a fair value of approximately $43.9
million scheduled to mature during the next twelve months. Management believes
cash flows from operating activities, combined with scheduled maturities of
investments, will be sufficient to meet the Company's cash needs for operating
purposes for at least the next twelve months. However, a number of factors could
cause unexpected changes in liquidity and capital resources available to the
Company. For example, inflation, changes in medical procedures, increased use of
managed care, and adverse legislative changes, among others, could cause
increases in the dollar amounts paid for losses and LAE. Other potential risks
to liquidity and capital resources include, but are not limited to, the same
types of uncertainties and factors disclosed by the Company in its Safe Harbor
Disclosure. Many, if not most of these types of uncertainties, could have a
corresponding and materially negative affect on the Company's liquidity and
capital resources, as well as its financial condition and results of operations.
In order to compensate for such risk, the Company: (i) maintains what management
considers to be adequate reinsurance; (ii) monitors its reserve positions and
regularly performs actuarial reviews of loss and LAE reserves; and (iii)
maintains adequate asset liquidity (by managing its cash flow from operations
coupled with the maturities from its fixed income portfolio investments).
As of September 30, 2002, the Company had an outstanding principle amount of
$48.7 million under a credit facility with five banks. The credit facility is
comprised of (i) a $37.5 million revolving credit facility (with a $15 million
letter of credit sub-facility), which matures on August 31, 2004, and (ii) a
$11.7 million term loan facility, repayable in quarterly installments of
approximately $1.5 million. Amounts outstanding under the credit facility bear
interest at a variable rate, primarily based upon LIBOR plus an initial margin
of 2.50 percentage points, which may be reduced to a minimum of 2.00 percentage
points as the Company reduces its outstanding indebtedness. In connection with
the Company's credit facility, the Company also entered into two-interest rate
swap agreements (the "swap agreements"). The Company uses the swap agreements to
minimize fluctuations in cash flows caused by interest rate volatility and to
effectively convert all of its floating-rate debt to fixed-rate debt.
The Company is not required to maintain compensating balances in connection with
its credit facility but is charged a fee on the unused portion, which ranges
from 30 to 40 basis points. Under the terms of the credit facility, the Company
is required to meet certain financial covenants. Significant covenants are as
follows: a) total debt to cash flow available for debt service may not exceed
3.50:1; b) combined net premiums written to combined statutory capital and
surplus may not exceed 2.00:1; c) the fixed charge coverage ratio may not be
less than 2.00:1 at the end of each quarter through December 31, 2002, and
thereafter the fixed charge coverage ratio may not be less than 2.25:1; and d)
funded debt to total capital plus funded debt may not exceed 0.27:1. The credit
facility also contains minimum equity and risk-based capital requirements and
requires the Company's insurance subsidiaries to maintain at least an A-
(Excellent) group rating from Best.
On October 23, 2002, Best announced its decision to change the Company's group
rating from A- (Excellent) with a negative outlook to B++ (Very Good) with a
stable outlook. As a result of the rating change, the Company is in
non-compliance with the credit facility. As a result of such non-compliance, the
Company requested and received from its lenders an agreement of forbearance
dated October 24, 2002 (the "Forbearance"), under which the lenders have agreed
not to take any action with regard to this covenant violation for a 30-day
period, until November 23, 2002, to allow adequate time for the Company and its
lenders to agree and finalize appropriate revisions to the credit facility.
As of the date of this filing, the Company and its lenders have not completed
negotiations on revisions to the credit facility to cure the potential event of
default. In the event the Company and its lenders are unable to complete
revisions to the credit facility within the 30-day forbearance period, which
ends on or before November 23, 2002, (and assuming the Company is unable to
secure additional forbearance), the
31
lenders would be entitled under the terms of the credit facility to declare an
event of default and demand immediate repayment of the outstanding loans under
the credit facility.
In the event repayment of its loans is accelerated, the Company would not have
sufficient liquidity solely from immediate available operating funds and would
be required to secure replacement financing, raise additional capital,
restructure its operations and sell assets, or a combination of these in order
to raise the funds necessary to repay its loans. Any such circumstances would
likely have a material detrimental impact on the Company's results of operations
and financial condition. While there can be no absolute assurance of the
successful completion of such revisions, based upon the status of the
negotiations between the parties to date, the Company believes that suitable
revisions will be completed within the 30-day forbearance period, on or before
November 23, 2002, and that declaration by the lenders of an event of default is
unlikely. The Company does expect certain changes to the terms of its loan
agreement. Upon completion of its negotiations, management will publish the new
terms.
In accordance with the terms of the Forbearance, the Company has pledged cash
collateral of $2 million to the lenders and has agreed to set aside an
additional $1 million in cash collateral to be pledged to the lenders no later
than January 31, 2003. The Company has paid forbearance fees to the lenders in
the aggregate amount of $0.2 million.
Dividends payable by the Company's insurance subsidiaries are subject to certain
limitations imposed by Florida and Missouri laws. In 2002, these subsidiaries
are permitted, within insurance regulatory guidelines, to pay dividends of
approximately $10.7 million without prior regulatory approval.
Accounting Pronouncements
In June 2002, the Financial Accounting Standards Board ("FASB") issued FAS 146,
"Accounting for Costs Associated with Exit or Disposal Activities." FAS 146
addresses financial accounting and reporting for costs associated with exit or
disposal activities and nullifies Emerging Issues Task Force Issue No. 94-3,
"Liability Recognition for Certain Employee Termination Benefits and Other Costs
to Exit an Activity (including Certain Costs Incurred in a Restructuring)." FAS
146 is effective for exit or disposal activities initiated on or after December
31, 2002. The Company believes the adoption of FAS 146 will not have a
significant impact on its consolidated financial statements.
In October 2002, the FASB issued FAS 147, "Acquisitions of Certain Financial
Institutions - an amendment of FASB Statements No. 72 and 144 and FASB
Interpretation No. 9." FAS 147 requires acquisitions of financial institutions,
except for transactions between two or more mutual enterprises, be accounted for
in accordance with FAS 141, "Business Combinations," and FAS 142, "Goodwill and
Other Intangible Assets." FAS 147 also amends FAS 144 to include in its scope
long-term customer-relationship intangible assets of financial institutions such
as depositor and borrower relationship intangible assets and credit cardholder
intangible assets. FAS 147 is effective on October 1, 2002. The Company believes
the adoption of FAS 147 will not have a significant impact on its consolidated
financial statements.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
There have been no material changes in the reported market risks, as described
in the Company's 2001 annual report on Form 10K, since the end of the most
recent fiscal year.
Item 4. Disclosure Controls and Procedures
An evaluation of the Company's disclosure controls and procedures (as defined by
Rule 13a-14(c) of the Securities Exchange Act of 1934 (the "Act") was completed
as of November 7, 2002, the "Evaluation Date" (as defined by Rule
13a-14(b)(4)(ii) of the Act), by the Company's Chief Executive Officer and Chief
Financial Officer, as "Certifying Officers" (as defined by Rule 13a-14(a) of the
Act. Based on such evaluation, the Company's disclosure controls and procedures
were found to be effective in ensuring that material information, relating to
the Company and its consolidated subsidiaries, as required to be disclosed by
the Company in its periodic reports filed with the Securities and Exchange
32
Commission, is accumulated and made known to the Certifying Officers, and other
management, as appropriate, to allow for timely decisions regarding required
disclosure. There have been no significant changes in the Company's internal
controls or in other factors that could significantly affect such controls
subsequent to the Evaluation Date and up to and including the date of this
report, and no corrective actions with regard to significant deficiencies or
material weaknesses were required to be performed.
Part II - Other Information
Item 1. Legal Proceedings - None
Item 2. Changes in Securities and Use of Proceeds - None
Item 3. Defaults Upon Senior Securities - None
Item 4. Submission of Matters to a Vote of Security Holders - None
Item 5. Other Information
o On October 23, 2002, Best announced its decision to change the Company's
group rating from A- (Excellent) with a negative outlook to B++ (Very Good)
with a stable outlook. As a result of the rating change, the Company is in
non-compliance with the credit facility. As a result of such non-
compliance, the Company requested and received from its lenders an
agreement of forbearance dated October 24, 2002 (the "Forbearance"), under
which the lenders have agreed not to take any action with regard to this
covenant violation for a 30-day period, until November 23, 2002, to allow
adequate time for the Company and its lenders to agree and finalize
appropriate revisions to the credit facility.
o In accordance with the requirements of the Federal Securities Laws, the
Company recognizes blackout periods during which directors, officers and
certain employees with an awareness of material, nonpublic information are
prohibited from transacting in the Company's stock. The Company will
maintain a blackout period for such persons until 48 hours after the
resolution of the covenant default under the Company's credit facility
resulting from the change in the Company's Best rating.
o Item 6. Exhibits and Reports on Form 8-K
o Exhibit 10(PP)-- Amendment of the Management Agreement between AFP and
PRI.
o Exhibit 10(QQ)-- Collateral Assignment of Certificate of Deposit.
o Exhibit 99.1-- Certification of John R. Byers pursuant to 18 U.S.C.
Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
o Exhibit 99.2-- Certification of Kim D. Thorpe pursuant to 18 U.S.C.
Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
o On August 7, 2002, the Company filed a Form 8-K notifying the Securities
and Exchange Commission (the "SEC") that the Company had entered into a
finite reinsurance agreement with Hannover Reinsurance (Ireland) Limited
and E+S Reinsurance (Ireland) Ltd., two Hannover Re group companies,
whereby the Company's largest insurance subsidiary, First Professionals,
will cede approximately $48.5 million of its 2002 unearned premiums as of
June 30, 2002, effective July 1, 2002, and fifty percent of its direct
written premiums, net of other reinsurance, during the last six months of
2002 and the first six months of 2003.
o On October 14, 2002, the Company filed a Form 8-K with the SEC announcing
that the Company had entered into a consulting agreement with David L.
Rader, whereby Mr. Rader will provide consulting services to the Company,
effective November 1, 2002. Mr. Rader retired from his position as
President and Chief Executive Office of First Professionals effective
October 31, 2002. Mr. Robert E. White, Jr., who served as Executive Vice
President and Chief Operating Officer of First Professionals, became
President of First Professionals effective November 1, 2002.
o On October 29, 2002, the Company filed a Form 8-K notifying the SEC that
Best had announced its decision to change the Company's group rating from
A- (Excellent) with a negative outlook to B++ (Very Good) with a stable
outlook. As a result of the rating change, the Company was in non-
compliance with its loan agreement. As a result of such non-compliance,
the Company requested and received from its Lenders a forbearance dated
October 24, 2002 (the "Forbearance") under which the Lenders have agreed
not to take any action with regard to this covenant violation for a 30-day
period, until November 23, 2002, to allow adequate time for the Company and
its Lenders to agree and finalize appropriate revisions to the Loan
Agreement.
33
Signatures
Pursuant to the requirements 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.
November 13, 2002 FPIC Insurance Group, Inc.
/s/ Kim D. Thorpe
-----------------------------------------
Kim D. Thorpe, Executive Vice President
and Chief Financial Officer (Principal
Financial Officer)
34
Certification Pursuant Section 302 of
The Sarbanes-Oxley Act of 2002.
I, John R. Byers, certify that:
1. I have reviewed this quarterly report on Form 10-Q of FPIC Insurance Group,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report
is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
November 13, 2002
/s/ John R. Byers
----------------------------------------
President and Chief Executive Officer
35
Certification Pursuant Section 302 of
The Sarbanes-Oxley Act of 2002.
I, Kim D. Thorpe, certify that:
1. I have reviewed this quarterly report on Form 10-Q of FPIC Insurance Group,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report
is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
November 13, 2002
/s/ Kim D. Thorpe
-----------------------------------------
Executive Vice President and Chief
Financial Officer
36