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UNITED STATES

Form 10-Q

American Physicians Capital, Inc.

1301 North Hagadorn Road, East Lansing, Michigan 48823

Registrant’s telephone number, including area code: (517) 351-1150

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  o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act)

YES  x       NO  o

The number of shares outstanding of the registrant’s common stock, no par value per share, as of August 11, 2003 was 8,705,588.

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AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES

ITEM 1. FINANCIAL STATEMENTS

The accompanying notes are an integral part of the condensed consolidated financial statements.

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AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES

The accompanying notes are an integral part of the condensed consolidated financial statements.

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AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES

The accompanying notes are an integral part of the condensed consolidated financial statements.

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AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES

The accompanying notes are an integral part of the condensed consolidated financial statements.

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AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES

1.     Basis of Presentation

      The accompanying unaudited condensed consolidated financial statements include the accounts of American Physicians Capital, Inc. (“APCapital”) and its wholly owned subsidiaries, together referred to in this report as the “Company.” All significant intercompany accounts and transactions are eliminated in consolidation.

      The Company is principally engaged in the business of providing medical professional liability and workers’ compensation insurance throughout the United States with a concentration of writings in the Midwest.

      The accompanying unaudited condensed consolidated financial statements of the Company have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”) and with the instructions for Form 10-Q and Rule 10-01 of Regulation S-X as they apply to interim financial information. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements.

      In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. The operating results for the three-month and six-month periods ended June 30, 2003 are not necessarily indicative of the results to be expected for the year ending December 31, 2003. The accompanying condensed consolidated financial statements should be read with the annual consolidated financial statements and notes contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2002.

      The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

      The most significant estimates that are susceptible to significant change in the near-term relate to the determination of the losses and loss adjustment expense reserves, investments, taxes, reinsurance, the reserve for extended reporting period claims and derivative financial instruments. Although considerable variability is inherent in these estimates, management believes that the current estimates are reasonable in all material respects. The estimates are reviewed regularly and adjusted as necessary. Such adjustments are reflected in current operations.

      Certain 2002 amounts have been reclassified to conform with the 2003 presentation.

Stock-based Compensation

      The Company uses the intrinsic value-based method to account for all stock-based employee compensation plans and has adopted the disclosure alternative of Statement of Financial Accounting Standard (“SFAS”) No. 123 “Accounting for Stock-Based Compensation”, as amended by SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure.” In accordance with SFAS No. 123, as amended by SFAS No. 148, the Company is required to disclose the pro forma effects on operating results as if the Company had elected the fair value approach to account for its stock-based employee compensation plans.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      If compensation had been determined based on the fair value at the grant date, consistent with the provisions of SFAS No. 123, our net income (loss) and net income (loss) per share would have been as follows for the three months and six months ended June 30, 2003 and 2002:

      Such pro forma disclosures may not be representative of future compensation costs as options may vest over several years and additional grants may be made.

      There were no options granted during the three months ended June 30, 2003. During the six months ended June 30, 2003, there were 5,000 options granted.

Derivative Financial Instruments

      During the second quarter of 2003, the Company has purchased interest-only certificates, which may not allow for the recovery of substantially all of its investment. These certificates pay a variable rate of interest that is inversely related to the London Interbank Offered Rate (“LIBOR”). The Company has determined that these certificates contain an embedded derivative instrument as defined by SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.”

      All interest-only certificates with an inverse floating rate of interest are carried on the balance sheet at fair value as a fixed maturity security. These certificates are not linked to specific assets or liabilities on the balance sheet or to a forecasted transaction and, therefore, do not qualify for hedge accounting. In addition, the Company does not feel that it can reliably identify and separately measure the embedded derivative instrument. Any changes in the fair value of the certificates, based on quoted market prices, are recorded in current period earnings as investment income.

      At June 30, 2003 the Company had such certificates with a fair value of approximately $7.7 million. The fair value of these certificates increased approximately $400,000 during the three months and six months ended June 30, 2003.

      The Company uses these certificates as a part of its overall interest rate risk-management strategy related to its investment portfolio.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

2.     Income (Loss) Per Share

      Net income (loss) per common share is computed by dividing net income (loss) by the weighted average number of shares of common stock and common stock equivalents (e.g., stock options and stock awards) outstanding, calculated on a daily basis. Basic weighted average shares outstanding for the three months and six months ended June 30, 2003 were 8,599,392 and 8,596,995, respectively, and 9,712,499 and 9,870,303, respectively, for the three months and six months ended June 30, 2002. Diluted weighted average shares outstanding were 8,972,313 and 8,909,701, respectively, for the three months and six months ended June 30, 2003. As the Company was in a net loss position for the three months and six months ended June 30, 2002, no effect of options or other stock awards was calculated as the impact would have been anti-dilutive.

      The following table sets forth the computation of basic and diluted income (loss) per common share:

3.     Segment Information

      The Company is organized and operates principally in the property and casualty insurance industry and has five reportable segments — medical professional liability, workers’ compensation, health, personal and commercial, and corporate and other. The accounting policies of the segments are described in the notes to the financial statements included in the Company’s most recent Annual Report on Form 10-K.

      Expense allocations are based primarily on loss and loss adjustment expenses by line of business and certain other estimates for underwriting expenses. Investment income, investment expense, amortization expense and interest expense are allocated to the segments based on that segment’s “ownership” percentage of

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

the assets or liabilities underlying the income or expense. General and administrative expenses are all attributed to the holding company and are included in corporate and other.

4.     Goodwill

      Effective January 1, 2002, the Company adopted Statement of Financial Accounting Standard (“SFAS”) No. 142, “Goodwill and Other Intangible Assets.” At that date, the only goodwill or other intangible asset recorded by the Company was the $13.9 million associated with the purchase of Stratton-Cheeseman Management Company in 1999. Based on the results of the impairment testing, the recorded net goodwill of $13.9 million was written off as the fair value of the Company’s reporting units did not support the carrying value of previously recorded goodwill. For purposes of the impairment testing, fair value was estimated using various methods, including multiples of projected net income and market capitalization. The goodwill impairment was recorded as a cumulative effect of a change in accounting principle, net of a deferred income tax benefit of $4.9 million. In accordance with the transition guidance given in SFAS No. 142, the goodwill impairment charge, net of tax, that was determined in the fourth quarter of 2002 was recorded in the first quarter of 2002.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

5.     Mandatorily Redeemable Trust Preferred Securities

      In May 2003, subsidiary trusts of the Company issued, in two separate issues of $15 million each, mandatorily redeemable trust preferred securities (“TPS”) to, in each case, a trust formed by an institutional investor. The Company’s trusts received a total of $29.1 million in net proceeds, after the deduction of a total of approximately $906,000 of commissions paid to the placement agents in the transactions. These costs have been capitalized and are included in other assets on the balance sheet. Issuance costs will be amortized over five years as a component of amortization expense. The Company estimates that the fair value of the TPS issued approximates the gross proceeds of cash received at the time of issuance. The TPS have financial terms similar to those of the floating rate junior subordinated deferrable interest debentures (the “Debentures”) discussed below.

      The Company formed American Physicians Capital Statutory Trust I and APCapital Trust II (the “Trusts”) for the purpose of issuing the TPS. The gross proceeds from issuance were used to purchase the Debentures issued by APCapital. The Debentures are the sole assets of the Trusts. The Debentures mature in 30 years and bear interest at an annual rate equal to the three-month LIBOR plus 4.10% for the first issuance, and plus 4.20% for the second issuance, payable quarterly beginning in August 2003. The interest rate is adjusted on a quarterly basis provided that prior to May 2008, the interest rate shall not exceed 12.50%. The initial interest rates of 5.41% (Trust I issuance) and 5.48% (Trust II issuance) resulted in interest expense of approximately $188,000 for the three months and six months ended June 30, 2003. At June 30, 2003, accrued interest payable was approximately $188,000. The Debentures are callable by APCapital at par beginning in May 2008.

      The Debentures are unsecured obligations of the Company and are junior in the right of payment to all future senior indebtedness of the Company. APCapital has guaranteed that the payments made to the Trusts will be distributed by the Trusts to the holders of the TPS. The Debentures, and related investment in the Trusts, have been eliminated in consolidation.

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Item 2.     Management’s Discussion and Analysis of Financial Condition and Results of Operations

      The following discussion and analysis should be read in conjunction with the condensed consolidated financial statements and the notes thereto included elsewhere in this report and the Company’s Annual Report on Form 10-K for the year ended December 31, 2002. The following discussion of our financial condition and results of operations contains certain forward-looking statements related to our anticipated future financial condition and operating results and our current business plans. When we use words such as “believes,” “expects,” “anticipates,” “estimates” or similar expressions, we are making forward-looking statements. These forward-looking statements represent our outlook only as of the date of this report. While we believe that any forward-looking statements we have made are reasonable, actual results could differ materially since these statements are based on our current expectations and are subject to risks and uncertainties. These risks and uncertainties are detailed from time to time in reports filed by the Company with the Securities and Exchange Commission. See, for example, the disclosures in “Item 1 — Business — Uncertainties Relating to Forward-Looking Statements” of the Company’s Annual Report on Form 10-K for the year ended December 31, 2002, and in other reports filed by the Company with the Securities and Exchange Commission (“SEC”).

      In addition to those factors previously detailed and stated elsewhere in this report, the Company has identified the following risks and uncertainties that could cause our future actual results to differ materially from our current expectations.

	•	The continued adverse development related to the run-off of our personal and commercial business could result in additional unanticipated losses.
	•	We may be unable to collect the full amount of reinsurance recoverable, which could result in a future charge to income, from Gerling Global, a significant reinsurer, if their cash flow or surplus levels are inadequate to make claim payments.
	•	If the Company is unable to generate sufficient taxable income in the future, we may not be able to realize some or all of our deferred tax assets.

      Other factors not currently anticipated by management may also materially and adversely affect the Company’s financial position and results of operations. The Company does not undertake, and expressly disclaims any obligation, to update or alter its forward-looking statements, whether as a result of new information, future events or otherwise, except as required by applicable law.

      We operate primarily in three insurance product segments: medical professional liability, workers’ compensation, and health. Effective December 31, 2001, the Company exited the personal and commercial lines of business. The personal and commercial insurance operating segment will continue to generate income (loss) due to the development of unpaid loss and loss adjustment expenses associated with this segment. See Note 3 of the Notes to Condensed Consolidated Financial Statements, contained elsewhere in this report, for further information regarding the operating results of our business segments.

Non GAAP and Other Financial Measures

      In the analysis of our operating results that follows, we refer to various financial ratios and other measures that management uses to analyze and compare the underwriting results of our insurance operations. These ratios are calculated on a GAAP basis and include:

	•	Loss ratio — This ratio compares our losses and loss adjustment expenses incurred, net of reinsurance, to our net premiums earned, and indicates how much we expect to pay policyholders for claims and related settlement expenses compared to the amount of premiums we earn. The lower the percentage, the more profitable our insurance business is, all other things being equal.
	•	Underwriting expense ratio — This ratio compares our expenses to obtain new business and renew existing business, plus normal operating expenses, to our net premiums earned. The ratio is used to measure how efficient we are at obtaining business and operating the insurance segments. The lower the percentage, the more efficient we are, all else being equal. Sometimes, however, a higher

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		underwriting expense ratio can result in better business and improve our loss ratio, and overall profitability.
	•	Combined ratio — This ratio equals the sum of our loss ratio and underwriting expense ratio. The lower the percentage, the more profitable our insurance business is. This ratio excludes the effects of investment income.
	•	Underwriting gain (loss) — This measure equals the net premiums earned less loss and loss adjustment expenses as well as underwriting expenses. It is another measure of the underwriting performance of our various insurance segments.

      In addition to our reported GAAP loss ratios, we also report accident year loss ratios. The accident year loss ratio is computed by taking total incurred loss and loss adjustment expenses, less any development on prior year loss reserves, divided by net premiums earned. We believe this ratio is useful in evaluating our current underwriting performance, as it focuses on the relationships between current premiums earned and current losses. Considerable variability is inherent in the establishment of loss reserves related to the current accident year. While management believes that its estimate is reasonable, there can be no assurance that these loss reserves will develop as expected. Our method of calculating accident year loss ratios may differ from those used by other companies and, therefore, comparability may be limited.

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Results of Operations — Three Months and Six Months Ended June 30, 2003, Compared to Three Months and Six Months Ended June 30, 2002

          Medical Professional Liability Insurance Operations

      The following table sets forth the operating results of our medical professional liability insurance operations for the three-month and six-month periods ended June 30, 2003 and 2002.