Back to GetFilings.com

Table of Contents

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 November 10 , 2003 was 8,452,228.

Table of Contents

2

Table of Contents

AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES

ITEM 1. FINANCIAL STATEMENTS

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

3

Table of Contents

AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES

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

4

Table of Contents

AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES

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

5

Table of Contents

AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES

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

6

Table of Contents

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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 nine-month periods ended September 30, 2003 are not necessarily indicative of the results to be expected for the year ending December 31, 2003. The accompanying Unaudited 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 loss and loss adjustment expense reserves, investments, taxes, reinsurance, the reserve for extended reporting period claims. 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.

7

Table of Contents

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 loss and net loss per share would have been as follows for the three months and nine months ended September 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 September 30, 2003. During the nine months ended September 30, 2003, there were 5,000 options granted.

Derivative Financial Instruments

      During the second quarter of 2003, the Company purchased interest-only certificates that 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 entire interest-only certificates, based on quoted market prices, are recorded in current period earnings as investment income.

      At September 30, 2003 the Company had such certificates with a fair value of approximately $7.9 million. The fair value of these certificates increased approximately $65,000 and $465,000 during the three months and nine months ended September 30, 2003.

8

Table of Contents

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

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

2.     Effects of New Accounting Pronouncements

      In November 2002, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 45. “Guarantor’s Accounting and Disclosure Requirements for Guarantees of Indebtedness of Others” (“FIN No. 45”). This interpretation clarifies disclosures required to be made by a guarantor in its interim and annual financial statements and requires a guarantor to recognize, at the inception of the guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The provisions of FIN No. 45 pertaining to the recording of a liability are effective for all guarantees entered into, or modified, after December 31, 2002. The disclosure requirements of FIN No. 45 are effective for financial statements of interim or annual periods ending after December 31, 2002. APCapital has issued guarantees in connection with its establishment of trusts and issuance of debentures. The amounts due under the guarantees are also recorded as liabilities in the Company’s Unaudited Condensed Consolidated Financial Statements in accordance with the structure of the transaction. See Note 7 of the Notes to the Unaudited Condensed Consolidated Financial Statements for further details on the nature of the guarantees and the transactions that gave rise to the guarantees.

      In January 2003, the FASB issued FASB Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN No. 46”). This interpretation addresses consolidation by business enterprises of variable interest entities and is effective immediately for all variable interest entities created after January 31, 2003 and for the fiscal year or interim period beginning after June 15, 2003 for all variable interest entities in which the Company holds a variable interest that it acquired before February 1, 2003. The Company has evaluated certain investments, as required by FIN No. 46, and has determined that its investments in statutory trusts used to issue mandatorily redeemable trust preferred securities should not be consolidated. Accordingly, the Company has not consolidated the trusts in the accompanying Unaudited Condensed Consolidated Financial Statements.

3.     Loss Per Share

      Net loss per common share is computed by dividing net 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 nine months ended September 30, 2003 were 8,533,929 and 8,575,742, respectively, and 9,061,300 and 9,597,521, respectively, for the three months and nine months ended September 30, 2002. As the Company was in a net loss position for the three months and nine months ended September 30, 2003 and 2002, no effect of options or other stock awards was calculated as the impact would have been anti-dilutive.

9

Table of Contents

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      The following table sets forth the computation of basic and diluted loss before cumulative effect of a change in accounting principle per common share:

4.     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 Unaudited Condensed Consolidated 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 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.

10

Table of Contents

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      In September 2003, management formally adopted a plan to exit the health insurance line of business. The day to day aspects of the Company’s health insurance business are administered by a third party administrator (“TPA”). The contract between the TPA and the Company requires the Company to provide a 180 day notice to the TPA of its intent to terminate the agreement. The Company plans to give notice of this termination effective December 31, 2003. The Company will continue to renew policies during this 180-day period, after which, the Company will not issue any additional health insurance policies.

      Subsequent to the end of the third quarter the Company has entered into a non-binding letter of intent for the sale of its workers’ compensation policy renewals. The sale would provide the Company with a 2.5% fee for all premiums renewed over the next three years. The Company would continue to write business in Michigan and Minnesota under a 100% reinsurance arrangement with the purchaser. This fronting arrangement would continue for approximately one year, or until the purchaser is licensed in those states. The Company would be paid a fronting fee of 5.0% under this arrangement.

      The Company has also begun the process of negotiating a loss portfolio transfer for its existing workers compensation reserves for unpaid loss and loss adjustment expenses. As of September 30, 2003, workers’ compensation reserves for unpaid losses and loss adjustment expenses totaled $68.3 million, $62.4 million net of reinsurance.

      During the fourth quarter of 2003, the Company will finalize the terms of this transaction.

5.     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

11

Table of Contents

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

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.

6.     Unpaid Losses and Loss Adjustment Expenses

      Activity in unpaid loss and loss adjustment expenses for the nine months ended September 30, 2003 and 2002 was as follows:

      During the nine months ended September 30, 2003 and 2002, management made adjustments to prior year’s reserves for unpaid loss and loss adjustment expenses, specifically, accident years 1999 through 2002. The unfavorable development totaled $43.3 million in 2003 and $2.6 million in 2002. As a percentage of net reserves as of the beginning of the year, these adjustments represented 7.9% and 0.5% in 2003 and 2002, respectively.

      Unfavorable development of $43 million was recorded in the third quarter of 2003 on the Company’s medical professional liability segment. This development was the result of increased severities in paid claims in the third quarter of 2003, which indicated a much higher trend in claims severity. As a result, actuarial projections calculated higher ultimate severities of loss on currently existing claims related to the 1999 to 2002 accident years. Due to the higher ultimate estimated severity and corresponding higher ultimate loss, management increased its estimate of incurred but not reported claims related to the 1999 through 2002 accident years.

      The unfavorable development in the third quarter of 2003 was primarily related to the Company’s Florida ($16 million), Ohio ($16.4 million) and Kentucky ($15 million) markets, partially offset by positive

12

Table of Contents

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

development in the Michigan market. The Company announced its exit of the Florida market in 2002 and discontinued writing occurrence policies in Ohio in early 2002. Primarily due to the elimination of poor risks in Kentucky, the Company’s insured physician count in that state has decreased approximately 10% from December 31, 2002.

      Management believes that the estimate of the ultimate liability for losses and loss adjustment expenses at September 30, 2003 is reasonable and reflective of anticipated ultimate experience. However, it is possible that the Company’s actual incurred loss and loss adjustment expenses will not conform to the assumptions inherent in the determination of the liability. Accordingly, it is reasonably possible that the ultimate settlement of losses and the related loss adjustment expenses may vary significantly from the estimated amounts included in the accompanying Unaudited Condensed Consolidated Financial Statements.

7.     Long Term Debt

      In May 2003, the Company formed American Physicians Capital Statutory Trust I and APCapital Trust II (the “Trusts”) by contributing equity of $464,000 to each trust. The trusts were formed for the purpose of issuing mandatorily redeemable trust preferred securities (“TPS”). Each trust issued $15 million of TPS to another trust formed by an institutional investor. The 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 commissions were ultimately paid by APCapital, and have been capitalized and are included in other assets on the accompanying Unaudited Condensed Consolidated Balance Sheet. Issuance costs will be amortized over five years as a component of amortization expense. The TPS issued by the trusts have financial terms similar to the floating rate junior subordinated deferrable interest debentures (the “Debentures”) issued by APCapital.

      The gross proceeds from the trust issuances, and the cash from the equity contribution, were used by the trusts to purchase Debentures issued by APCapital. In accordance with FIN No. 46, these trusts are not consolidated in the Company’s Unaudited Condensed Consolidated Financial Statements. See Note 2 for further discussion regarding the impact of FIN No. 46.

      The Debentures issued by APCapital mature in 30 years and bear interest at an annual rate equal to the three-month LIBOR plus 4.10% for the first trust issuance, and plus 4.20% for the second trust 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 weighted average interest rates of 5.32% (Trust I issuance) and 5.42% (Trust II issuance) resulted in interest expense of approximately $414,000 and $602,000 for the three months and nine months ended September 30, 2003. At September 30, 2003, accrued interest payable to the trusts was approximately $182,000. The Debentures are callable by APCapital at par beginning in May 2008. APCapital has guaranteed that the payments made to the Trusts will be distributed by the Trusts to the holders of the TPS.

      The Debentures are unsecured obligations of the Company and are junior in the right of payment to all future senior indebtedness of the Company. The Company estimates that the fair value of the debentures approximates the gross proceeds of cash received at the time of issuance.

13

Table of Contents

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

8.     Income Taxes

      The provision for income taxes for the three months and nine months ended September 30, 2003 and 2002 consists of:

      Income taxes incurred do not bear the usual relationship to income before income taxes for the three-month and nine-month periods ended September 30, 2003 and 2002 due to the following: