Back to GetFilings.com
1
==============================================================================
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
----------------
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 1-14094
MEADOWBROOK INSURANCE GROUP, INC.
(Exact name of registrant as specified in its charter)
MICHIGAN 38-2626206
(State of Incorporation) (IRS Employer Identification No.)
26600 TELEGRAPH ROAD, SOUTHFIELD, MICHIGAN 48034
(248) 358-1100
(Address, zip code and telephone of principal executive offices)
---------------
SECURITIES REGISTERED PURSUANT TO SECTION 12(d) OF THE ACT:
NAME OF EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
------------------- -------------------
Common Stock, $.01 per share New York Stock Exchange
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes x No _
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K.
The aggregate market value of the voting stock (common stock, $.01 par value)
held by non-affiliates of the registrant was $150,678,044 on March 20,1998,
based on the closing sales price of the Common Stock on such date.
The aggregate number of shares of the Registrant's Common Stock, $.01 par
value, outstanding on March 20,1998 was 8,660,164
DOCUMENTS INCORPORATED BY REFERENCE
Certain portions of the registrant's proxy statement for the annual meeting
scheduled for May 18, 1998 are incorporated by reference into Part III of this
report and certain portions of the 1997 Annual Report to Shareholders are
incorporated herein by reference into Part II of this report.
==============================================================================
2
PART I
ITEM 1. BUSINESS
THE COMPANY
Meadowbrook Insurance Group, Inc. (the "Company") is a Michigan corporation
which was originally incorporated in 1985 under the name Star Holding Company.
In November 1995, the Company changed its name and acquired Meadowbrook, Inc.
("Meadowbrook"). Meadowbrook was founded in 1955 as the Meadowbrook Insurance
Agency and was subsequently incorporated in 1965.
The Company serves as a holding company for not only Meadowbrook but also for
Star Insurance Company ("Star"), Savers Property and Casualty Insurance
Company ("Savers") and American Indemnity Insurance Company Ltd. ("American
Indemnity"). Star was formed in 1985 as a subsidiary of Star Holding Company.
Star then acquired Savers in 1990, and the Company acquired American Indemnity
in 1994.
The Company acquired Association Self Insurance Services, Inc. ("ASI") of
Montgomery, Alabama in November of 1996. The acquisition was not material to
the Company's results of operations. ASI is a full service risk-management
operation focused on pools and funds whose services include claims, loss
control, managed care, and policy issuance. ASI's operations were consolidated
with the Company's existing operations in Montgomery, Alabama.
In July of 1997, the Company acquired Crest Financial Services ("Crest"), a
California based holding company which holds 100% of Williamsburg National
Insurance Company ("Williamsburg"), an insurance carrier, and Crest Financial
Services, a risk management service company. Crest provides these services
primarily to the trucking industry within California. The acquisition was not
material to the Company's results of operation.
INDUSTRY SEGMENTS
Since 1976, the Company has been developing and managing alternative market
risk management programs for defined client groups and their members. The
alternative market, which developed as a result of historical volatility in
the cost and availability of traditional commercial insurance coverages,
includes a wide range of approaches to financing and managing risk exposures,
such as captives and rent-a-captives, risk retention and risk purchasing
groups, governmental pools and trusts and self-insurance plans. According to
an industry report made in 1994, the alternative market accounts for an
estimated $61 billion, or 33%, of the estimated $186 billion of United States
property and casualty premium written; and according to industry sources is
expected to reach an estimated $85 billion, or 38%, of the estimated $225
billion of United States property and casualty premium written in the year
2000. The Company believes that the alternative market has continued to expand
even during the current soft market as a result of the desire of many insureds
to exercise greater control over the risk management process and to obtain
customized risk management services.
GENERAL
The Company provides alternative risk management programs and services
primarily to industry, public entities, and trade/professional groups.
Revenues are generated from four principal sources: fees from program
management services, commissions earned on insurance placed by a subsidiary
with other carriers, earned insurance premiums, and investment income. The
subsidiaries of the Company that provide these services are Star, Savers,
Crest and its wholly owned insurer Williamsburg, American Indemnity, ASI, and
Meadowbrook, the risk management company.
1
3
Through these subsidiaries the Company develops programs, which are customized
packages of services or coverages marketed to the group's members. The programs
are categorized by the level of risk assumed by the Company either as managed
programs, risk-sharing programs, or fully-insured programs.
The Company's capabilities in the provision of both services and insurance
coverages provide flexibility for the consideration and implementation of a
variety of alternative market solutions. Services provided and insurance lines
of business include:
SERVICES LINES OF BUSINESS
- Risk Analysis and Identification - Workers' Compensation
- Feasibility Studies - Commercial Multi-Peril
- Program and Product Design - General Liability
- Sales, Marketing and Public Relations -- Errors and Omissions
- Consultation, Education and Training -- Automobile
- Captive Formation -- Owners, Landlord and
- Captive Management (Onshore and Offshore) Tenant
- Employment Practices
Liability
- Rent-a-Captive - Professional Liability
- Underwriting/Risk Selection -- Legal
- Policy Issuance -- Medical Malpractice
- Reinsurance Brokerage -- Real Estate Appraisers
- Claims Handling and Administration -- Accountants
- Litigation Management -- Pharmacists
- Accounting and Financial Statement Preparation - Inland Marine
- Regulatory Compliance -- Cargo
- Actuarial and Loss Reserve Analysis -- Watercraft
- Loss Prevention and Control - Product Liability
- Legal and Audit Support - Excess Reinsurance
- Information Technology and Processing - Commercial Property
DESCRIPTION OF SERVICES AND CAPABILITIES
PROGRAM DESIGN. Prior to implementing a new program, the Company reviews a
significant amount of data, including: financial projections for the
contemplated program; historical loss experience; actuarial studies of the
underlying risks; the creditworthiness of the potential client; and the
availability of reinsurance. A senior management team and associates
representing each of the risk-management disciplines within the Company work
together to design, market and implement new programs. While the Company does
not generate substantial fees for program design services, these services are an
integral part of the Company's program management services.
FORMATION AND MANAGEMENT OF RISK-BEARING ENTITIES. The Company generates fees by
forming and managing risk-bearing entities for clients and agents. The Company
currently manages over twenty-nine captives and holds a minority interest in ten
of these captives. The offshore captives are managed by the Company's
subsidiaries in Bermuda and Barbados.
RISK SELECTION. The Company performs underwriting services for its clients, its
clients' captives and certain individual accounts. Compensation for underwriting
services generally is included in the Company's management fees. The Company's
underwriting personnel help develop the proper criteria for selecting risks,
while actuarial and reinsurance personnel evaluate and recommend the appropriate
levels of risk retention. The program is then tailored according to the
requirements of each client.
2
4
REINSURANCE BROKERAGE. The Company earns fees by placing excess reinsurance
for its programs. The Company's two reinsurance brokerage subsidiaries,
Meadowbrook Intermediaries, Inc. and Meadowbrook International, Ltd., place
reinsurance (as well as insurance coverage with high deductibles) for
insurance companies, captives and self-insured programs managed by the
Company. Reinsurance is also placed for clients that do not have other
business relationships with the Company.
LOSS CONTROL AND PREVENTION. The Company earns fees for loss control services
which are designed to help clients prevent or limit certain loss events.
Through an evaluation of the client's workplace environment, the Company's
loss control specialists assist the client in planning and implementing a loss
prevention program and, in certain cases, provide educational and training
programs for the client.
CLAIMS HANDLING AND ADMINISTRATION. The Company is experienced in handling and
managing claims for workers' compensation and most other casualty lines,
property and general liability. It handles all claims functions for most of
the programs managed by the Company. The Company's involvement in claims
handling and administration provides feedback to program managers in assessing
the client's risk environment and the overall structure of the program.
SALES AND MARKETING. The Company markets its programs and services to
associations, groups, local, regional and national insurance agents and
insurance consultants. Once a program has been developed for a particular
association or group, the Company generally then markets the program to
members of the association or group. Sales and marketing efforts include
personal contact, direct mail, telemarketing, advertising, internet based
marketing (www.meadowbrookinsgrp.com), and attendance at seminars and trade
and industry conventions.
CUSTOMERS, MARKETING AND DISTRIBUTION
FEE BASED OPERATIONS:
AGENCY. The Company earns commissions through the operation of a retail
property and casualty insurance agency. Formed in 1955 as Meadowbrook's
original business, the insurance agency places principally commercial
insurance, as well as personal property, casualty, life and accident and
health insurance, with more than 25 insurance carriers. The agency has grown
to be one of the largest agencies in Michigan. In addition, with the 1997
acquisition of Crest, the Company added two California based subsidiaries: a
licensed insurance agent, and a licensed general agent and excess and surplus
lines broker.
In total, the Company's agency operations generated commissions of $7.6
million, $4.8 million and $4.8 million for the years ended December 31, 1997,
1996 and 1995, respectively. In addition to its independent retail agency
activities, the Company's insurance agency also earns revenue by serving as
agent for several of the Company's programs, including two of its ten largest
programs.
MANAGED PROGRAMS. In a managed program, the Company, through Meadowbrook,
earns commission and fee revenue by providing management and other services to
a client's risk-bearing entity, but generally does not share in the operating
results of such programs. The Company believes that its managed programs
provide a stable source of revenue as well as opportunities for revenue growth
without a proportionate increase in expenses. Revenue growth may occur through
the sale of existing managed program products to additional members of the
sponsoring client group, the expansion of coverages and services provided to
existing programs and the creation of programs for new client groups (such as
additional municipal associations) with needs that are similar to existing
client groups.
Meadowbrook specializes in providing managed programs to public entity
associations, and currently manages public entity pools and other captive
insurance entities, which provide insurance coverage for over 2500
participants, including city, county, township and village
3
5
governments in five states. Over the years, Meadowbrook has been able to expand
the services offered under existing programs as well as to increase the number
of participants in these managed programs.
Managed program services for which Meadowbrook receives commissions and fees
include: program design and development; underwriting; reinsurance brokerage;
policy administration; loss prevention and control services (including the
provision of specialized law enforcement training); claims and litigation
management; information processing and accounting functions; and general
management oversight of the program on behalf of the sponsoring client group.
Fees and commissions received by the Company under its managed programs are
generally either in a fixed amount or based on a percentage of premium serviced.
In addition to municipal associations, Meadowbrook also manages mutual insurance
companies, offshore captives and other insurance entities including the
Company's insurance subsidiaries Star, Savers and Williamsburg.
In total, Meadowbrook employs 585 associates.
INSURANCE OPERATIONS:
The Company's major insurance subsidiaries, Star, Savers and Williamsburg,
collectively the "Insurance operations", issue insurance policies for both
risk-sharing and fully-insured programs. These companies are complemented by
American Indemnity, which offers clients a rent-a-captive vehicle for
risk-sharing programs. The insurance operations are managed by Meadowbrook and
have no employees.
The Insurance operations are authorized to write business, on either an admitted
or surplus lines basis, in fifty states. Through both risk-sharing and fully
insured programs, the Insurance operations primarily offer workers'
compensation, commercial multiple peril, inland marine and other liability. The
Insurance operations also provide policy issuance services for surety bonds and
transfer the risk to Connecticut Surety (see Surety Bonds below). For the year
ended December 31, 1997, workers' compensation line of business accounted for
44.8% and 48.1% of gross written premiums and net earned premiums, respectively.
Star, Savers, and Williamsburg are domiciled in Michigan, Missouri, and
California, respectively.
During 1997, A.M.Best affirmed an A-, A-, and B++ for Star, Savers, and
Williamsburg, respectively. A.M. Best ratings are based upon factors of concern
to policyholders and are not directed toward the protection of investors. No
assurances can be given that in the future A.M. Best will not reduce or withdraw
the ratings of the Company's insurance subsidiaries.
CLIENT RISK-SHARING. In a client risk-sharing program, the Company participates
in the operating results of the program, and the client group also shares in
such results through a captive, a rent-a-captive or a retrospectively-rated
program. In many instances, a captive owned by a client reinsures a portion of
the risk on a quota-share basis. In addition to premium revenue and investment
income from its participation in the operating results of the program, the
Company may also be compensated through the receipt of ceding commissions and
other fees for policy issuance services and acquisition costs, captive
management services, reinsurance brokerage, loss prevention services and claims
handling and administration services. For financial reporting purposes, ceding
commissions are treated as a reduction in underwriting expenses.
The Company's experience has been that the number of claims and the cost of
losses tend to be lower in risk-sharing programs than with traditional forms of
insurance. The Company believes that client risk-sharing motivates insureds to
focus on loss prevention and control measures and to establish and adhere to
stricter underwriting guidelines. As a result of its experience with
risk-
4
6
sharing programs, the Insurance operations have sustained a ten year average
combined ratio of 95.3% and have outperformed the industry by an average of 12
points.
The Company assists the sponsoring group in forming a captive, which is
capitalized by contributions from members of the sponsoring group in exchange
for shares of the captive. The captive is generally managed for a fee by an
offshore subsidiary of the Company. The Company works with the client to
determine the amount of risk exposure that will be assumed by the captive, which
varies depending on the captive's capitalization, the line of business, the
amount to be retained by the Company and the amount to be reinsured by excess
reinsurers. The Company then issues an insurance policy and receives premium
from the insured. Pursuant to the quota-share reinsurance agreement with the
captive, the Company generally transfers (cedes) a portion of the retained risk
to the captive and pays to the captive its share of the net premium (after
deducting ceding commissions, policy issuance fees, the cost of excess
reinsurance, taxes and other fees and expenses). The Company generally seeks to
cede approximately 50% of its loss exposures, but in some cases cedes as little
as 20% or as much as 80% of its loss exposures. The Company secures obligations
due from captives through the use of funds withheld trusts and letters of
credit. Through its reinsurance intermediary subsidiaries, the Company obtains
excess-of-loss reinsurance, subject to agreed upon limits and retention levels.
The Company generally administers all claims handling functions, and the captive
provides funds to the Company for the payment of the captive's proportionate
share of paid claims and claims expenses. The captive realizes investment income
from its capital, unearned premium and loss reserves, and shares in the
underwriting results.
The Company also offers its clients "rent-a-captive" risk-sharing programs.
These programs allow a client to retain a significant portion of its own loss
exposure without the administrative costs and capital commitment required to
establish and operate its own captive.
In another variation on client risk-sharing, the Company establishes
retrospectively-rated programs for individual accounts. In such a program, the
Company works with the client to develop the appropriate self-insured retention
and loss fund amount and then helps arrange for excess of loss reinsurance. The
client reimburses the Company for all claims payments within the client's
retention. The Company generally earns a management fee (which includes claims
and loss control fees). In most of these programs, the Company also participates
in the operating results of the reinsurance coverage and earns a ceding
commission.
AGENT RISK-SHARING. The Company also writes program business on a risk-sharing
basis with agents or brokers. The Company believes that agent risk-sharing has
grown as a result of market volatility and lack of coverage availability in the
traditional market. Risk-sharing is achieved either through an agent-owned
captive, rent-a-captive or through a contingent commission structure tied to
operating results. The Company believes that certain agents and brokers view
risk-sharing as a means to recapture lost profit margins on commissions that
have been reduced due to premium reductions in the soft market and to establish
a long-term relationship with an insurer.
The agent may own a captive or purchase an interest in a rent-a-captive which
acts as a reinsurer on business produced. In some cases, the captive's
shareholders may include key producers, subproducers and insureds. In other
circumstances, the agent accepts a lower up-front commission in exchange for a
multi-year contingent commission based on operating results. The Company
believes that multi-year commission structures motivate the agent to produce
business with better risk characteristics and higher profit potential.
FULLY-INSURED PROGRAMS. In a fully-insured program, the Company earns premium
revenue by providing insurance coverage without a risk-sharing mechanism. The
Company may provide fully-insured programs when it perceives opportunities for
the development of risk-sharing programs in the future.
5
7
SURETY BONDS. The Company formed a surety bond business unit in late 1993 and
began issuing surety bonds for contractors and licensees in 1994. The Company
earned premium revenue on surety bonds issued through general agents
throughout the United States, including a wholly-owned subsidiary of the
Company. General agents were paid commissions and, in some cases, profit
sharing bonuses based upon loss ratios. The general agents had limited
underwriting authority. In marketing payment and performance surety bonds to
clients, the Company generally considered the net worth and working capital
ratios and the client's experience, expertise, financial statements and
historical track record. In certain instances, the Company required collateral
before issuing a surety bond. The form of collateral varied depending upon an
assessment of the risk factors associated with the surety bond. Generally,
collateral consisted of escrowed cash, letters of credit or investment
securities, all of which was held through the term of the bond.
In December 1996, the Company entered into a five-year joint underwriting
agreement with Connecticut Surety Corporation. The agreement provides for the
transfer of the underwriting risk on the majority of the Company's existing
surety bond business. In addition, Star will continue to write new surety
business, utilizing its capital and licenses, and Connecticut Surety will
manage the operations and assume the risk. This arrangement substantially
reduces the Company's underwriting risk exposure while creating a five-year
fee arrangement. This enables the Company to refocus its efforts on its core
business, alternative risk management.
DEPENDENCE ON KEY PROGRAMS
The Company provides alternative risk management programs and services to
certain large client groups and associations and then markets them to their
individual members. In 1997, 1996, and 1995 the Company's top four programs,
excluding the surety bond business, accounted for 46%, 37% and 34%,
respectively, of the Company's total net earned premiums on an actual basis.
The loss or cancellation of any of the Company's significant programs by the
relevant client groups, or the general availability of commercial market
coverage to members of such groups on more favorable terms than provided under
the Company's programs, could have an adverse effect on the Company's results
of operations.
RESERVES
The information required by this item is incorporated by reference to pages
23, 36, 37, and 41 of the Company's 1997 Annual Report to Shareholders.
Reserves are computed by the Company based on actuarial principles and
procedures applicable to the lines of business written by the Company. These
reserve calculations are reviewed regularly by management and the Company
engages independent actuaries on an annual basis to express an opinion as to
the adequacy of statutory reserves established by management. These opinions
are filed with the various jurisdictions in which the Company is licensed.
Provisions for inflation are implicitly considered in the reserving process.
For GAAP and statutory purposes, the Company's reserves are carried at the
total estimate for ultimate expected loss without any discount to reflect the
time value of money.
Significant periods of time often elapse between the occurrence of an insured
loss, the reporting of the loss to the Company, and the Company's payment of
that loss. To recognize liabilities for unpaid losses, the Company establishes
reserves as balance sheet liabilities representing estimates of amounts needed
to pay reported and unreported losses and loss adjustment expenses ("LAE").
The following table shows the development of reserves for unpaid losses and
LAE from 1988 through 1997 for the Company's current insurance subsidiaries.
6
8
Due to the Company's adoption of SFAS 113, the bottom portion of the table shows
the impact of reinsurance for the years 1992 through 1997, reconciling the net
reserves shown in the upper portion of the table to gross reserves.
ANALYSIS OF LOSS AND LOSS ADJUSTMENT EXPENSE DEVELOPMENT
YEARS ENDED DECEMBER 31,
(Dollars in thousands)
- -----------------------------------------------------------------------------------------------------------------
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997
-------- ------- -------- -------- -------- -------- ------- -------- -------- ---------
- -----------------------------------------------------------------------------------------------------------------
Reserves for losses
and LAE at end
of period.......... $6,311 $6,262 $9,293 $13,964 $23,545 $35,744 $47,149 $64,668 $65,775 $60,786
Cumulative paid as of:
1 year later....... 2,512 1,737 2,877 4,326 5,420 11,172 15,792 25,659 31,626
2 years later...... 3,484 3,284 4,796 6,309 10,052 19,298 26,227 42,969
3 years later...... 4,178 4,508 5,117 7,652 13,554 23,571 33,227
4 years later...... 5,103 4,195 5,971 8,954 15,598 26,700
5 years later...... 4,625 4,594 6,568 9,564 16,574
6 years later...... 4,822 4.970 6,786 10,360
7 years later...... 5,126 5,154 7,123
8 years later...... 5,257 5,425
9 years later...... 5,378
Reserves re-estimated
as of end of year:
1 year later....... 5,466 8,204 9,939 14,693 22,609 35,354 46,738 65,058 67,010
2 years later...... 7,228 7,488 9,800 14,361 21,661 33,524 45,578 65,312
3 years later...... 6,010 7,296 9,396 12,853 20,909 33,308 45,255
4 years later...... 6,374 6,683 8,758 12,649 20,623 33,685
5 years later...... 5,961 6,299 8,600 12,525 19,639
6 years later...... 5,825 6,293 8,371 12,186
7 years later...... 5,850 6,128 7,970
8 years later...... 5,798 5,866
9 years later...... 5,623
Cumulative redundancy
(deficiency):
Dollars.......... $ 688 $ 396 $1,323 $ 1,778 $ 3,906 $ 2,059 $ 1,894 $ (694) $(1,235)
Percentage....... 10.90% 6.32% 14.24% 12.73% 16.59% 5.76% 4.02% -1.00% -1.88%
Net reserves......... $23,545 $35,744 $47,149 $64,668 $65,746 $60,786
Ceded reserves....... 20,399 14,707 17,844 22,318 26,644 38,193
Gross reserves....... 43,944 50,451 64,993 86,986 92,390 98,979
------ ------ ------ ------ ------ ------
Net re-estimated..... 19,639 33,685 45,255 65,312 67,010 --
Ceded re-estimated... 22,442 16,004 21,478 28,560 28,795 --
Gross re-estimated... 42,081 49,689 66,733 93,618 95,805 --
------ -------- -------- ------ --------------
Gross cumulative
redundancy
(deficiency) ..... $ 1,863 $ 962 $(1,740) $(6,632) $(3,415) --
- -----------------------------------------------------------------------------------------------------------------
Loss and LAE reserves have historically developed redundancies on a net basis
apart from the most recent two years. The cumulative deficiencies of $644,000
and $1,235,000 in 1995 and 1996, respectively, reflect adverse development on
the surety bond program, partially offset by favorable development in the
residual market pools. The residual market pools in many states have declined
resulting in reductions in pool premiums and losses. Gross deficiencies of
$6,632,000 and $3,415,000 in 1995 and 1996, respectively, also reflect adverse
development on the surety bond program. Payments on both a gross and net basis
have typically been about one third of respective prior year-end reserves.
However, in 1997, net payments were 48% of 1996 reserves due to two novations
conducted in 1997 as well as the run-off of the surety bond business. In
addition, gross payments in 1993 were 46.1% of 1992 year-end gross reserves,
due to the settlement of the large claim on an agent risk-sharing program
covering a type of risk that is no longer insured by the Company. Net payments
in 1993 were only 23.0% of 1992 year-end net reserves, due to the commutation
of a reinsurance treaty with a captive in which the recapture of $4.5 million
in loss and loss adjustment reserves was recorded as a reduction in net paid
losses. Excluding the effects of these two items, 1993 payments would have
represented 33.8% and 37.1% of 1992 year-end reserves on a gross and net basis,
respectively.
INVESTMENTS
The information required by this item is incorporated by reference to pages 22,
35, and 38-41 of the Company's 1997 Annual Report to Shareholders.
7
9
COMPETITION AND PRICING
The Company competes both with other providers of alternative risk management
programs and services and with traditional providers of commercial insurance
coverages. Both the alternative risk management and the traditional property and
casualty insurance markets are highly competitive. The Company's alternative
risk management programs and services compete with products and services offered
by insurance companies, other providers of alternative risk management services
(including certain domestic and foreign insurers and reinsurers and insurance
brokers) as well as with self-insurance plans, captives managed by others, and a
variety of other risk-financing vehicles and mechanisms. These competitive
products are offered by other companies that may have greater financial
resources than the Company.
The market for alternative risk management products and services is
significantly influenced by market conditions affecting the traditional property
and casualty insurance industry. Insurance market conditions historically have
been subject to significant variability due to premium rate competition, natural
disasters and other catastrophic events, judicial trends, changes in the
investment and interest rate environment, regulation and general economic
conditions. Pricing is a primary means of competition in the commercial
insurance market. Competition is also based on the availability and quality of
products, quality and speed of service (including claims service), financial
strength, ratings, distribution systems and technical expertise. The primary
basis for competition among alternative risk management providers varies with
the financial and insurance needs and resources of each potential insured.
Principal factors that are considered by insureds include: an analysis of the
net present-value (after tax) of the cost of financing the insured's expected
level of losses, the amount of excess coverage provided in the event losses
exceed expected levels, cash flow and tax planning considerations and the
expected quality and consistency of the services to be provided. The Company
believes that it is able to compete based on its experience, the quality of its
products and services and its program-oriented approach. However, its ability to
successfully compete is dependent upon a number of factors, many of which,
including market and competitive conditions, are outside of the Company's
control.
8
10
REGULATION
REGULATION IN GENERAL
The Company's insurance subsidiaries are subject to regulation by government
agencies in the states in which they do business. The nature and extent of such
regulation vary from jurisdiction to jurisdiction, but typically involve prior
approval of the acquisition of control of an insurance company or of any company
controlling an insurance company, regulation of certain transactions entered
into by an insurance company with any of its affiliates, approval of premium
rates, forms and policies used for many lines of insurance, standards of
solvency and minimum amounts of capital and surplus which must be maintained,
establishment of reserves required to be maintained for unearned premium, losses
and loss expense or for other purposes, limitations on types and amounts of
investments, restrictions on the size of risks which may be insured by a single
company, licensing of insurers and agents, deposits of securities for the
benefit of policyholders, and the filing of periodic reports with respect to
financial condition and other matters. In addition, state regulatory examiners
perform periodic examinations of insurance companies. Such regulation is
generally intended for the protection of policyholders rather than security
holders.
In addition to the regulatory oversight of the Company's insurance subsidiaries,
the Company is also subject to regulation under the Michigan, Missouri and
California Insurance Holding Company System Regulatory Acts (the "Holding
Company Acts"). The Holding Company Acts contain certain reporting requirements
including those requiring the Company, as the ultimate parent company, to file
information relating to its capital structure, ownership, and financial
condition and general business operations of its insurance subsidiaries. The
Holding Company Acts contain special reporting and prior approval requirements
with respect to transactions among affiliates.
Insurance companies are also affected by a variety of state and federal
legislative and regulatory measures and judicial decisions that define and
extend the risks and benefits for which insurance is sought and provided. These
include redefinitions of risk exposure in areas such as product liability,
environmental damage and workers' compensation. In addition, individual state
insurance departments may prevent premium rates for some classes of insureds
from reflecting the level of risk assumed by the insurer for those classes. Such
developments may adversely affect the profitability of various lines of
insurance. In some cases, these adverse effects on profitability can be
minimized through re-pricing, if permitted by applicable regulations, of
coverages or limitations or cessation of the affected business.
The Company's reinsurance intermediaries are subject to regulation as
reinsurance intermediaries. Under applicable regulations, the intermediary is
responsible as a fiduciary for funds received for the account of the parties to
the reinsurance transaction and is required to hold such funds in appropriate
bank accounts subject to restrictions on withdrawals and prohibitions on
commingling.
INSURANCE REGULATION CONCERNING CHANGE OR ACQUISITION OF CONTROL
Star, Savers and Williamsburg are domestic property and casualty insurance
companies organized, respectively, under the insurance laws (the "Insurance
Codes") of Michigan, Missouri and California. The Insurance Codes provide that
the acquisition or change of "control" of a domestic insurer or of any person
that controls a domestic insurer cannot be consummated without the prior
approval of the relevant insurance regulatory authority. A person seeking to
acquire control, directly or indirectly, of a domestic insurance company or of
any person controlling a domestic insurance company must generally file with the
relevant insurance regulatory authority an application for change of control
containing certain information required by statute and published regulations and
provide a copy of such to the domestic insurer. In all three states, control is
generally presumed to exist if any person, directly or indirectly, owns,
controls, holds
9
11
with the power to vote or holds proxies representing 10% or more of the voting
securities of any other person.
In addition, many state insurance regulatory laws contain provisions that
require pre-notification to state agencies of a change in control of a
non-domestic admitted insurance company in that state. While such
pre-notification statutes do not authorize the state agency to disapprove the
change of control, such statutes do authorize issuance of a cease and desist
order with respect to the non-domestic admitted insurer if certain conditions
exist such as undue market concentration.
Any future transactions that would constitute a change in control of the
Company would also generally require prior approval by the Insurance
Departments of Michigan, Missouri and California and would require
pre-acquisition notification in those states which have adopted
pre-acquisition notification provisions and in which the insurers are
admitted. Such requirements may deter, delay or prevent certain transactions
that could be advantageous to the stockholders of the Company.
RESTRICTIONS ON DIVIDENDS AND RISK-BASED CAPITAL
The information required by this item is incorporated by reference to pages
25-27 and 44 of the Company's 1997 Annual Report to Shareholders.
EFFECT OF FEDERAL LEGISLATION
Although the federal government does not directly regulate the business of
insurance, federal initiatives often affect the insurance business in a
variety of ways. Current and proposed federal measures which may significantly
affect the insurance business include federal government participation in
asbestos and other product liability claims, pension regulation (ERISA),
examination of the taxation of insurers and reinsurers minimum levels of
liability insurance and automobile safety regulations.
NAIC-IRIS RATIOS
The NAIC's Insurance Regulatory Information System ("IRIS") was developed by a
committee of state insurance regulators and is primarily intended to assist
state insurance departments in executing their statutory mandates to oversee
the financial condition of insurance companies operating in their respective
states. IRIS identifies 11 industry ratios and specifies "usual values" for
each ratio. Departure from the usual values on four or more ratios generally
leads to inquiries from individual state insurance commissioners.
In 1997, Star had one ratio which varied from the "usual value" range as
follows:
For Star:
RATIO USUAL RANGE STAR VALUE
----------------------- ----------- ----------
Agents' balances / under 40 43
Surplus................
Star's "agents' balance to surplus ratio" was affected by increased gross
premium writings in the fourth quarter. In particular, two portfolio
transfers (novations) occurred in late 1997 and will be collected and
remitted to reinsurers in early 1998. Eliminating the effect of these
portfolio transfers, the agents' balance would have been 30, which puts Star
within the usual range.
10
12
ITEM 2. PROPERTIES
The Company currently leases its corporate offices in Southfield, Michigan from
26600 Development Associates Limited Partnership. In 1996, the Company paid rent
in the amount of approximately $1,060,000. The term of the lease for the offices
in Southfield expires on September 30, 2004. The Company, through its
subsidiaries, is also a party to various leases for locations in which such
subsidiaries have offices. The Company does not consider any of these leases to
be material.
ITEM 3. LEGAL PROCEEDINGS
On June 26, 1995, two shareholders of a former agent of Star initiated legal
proceedings against, among others, Star and Meadowbrook. The plaintiffs have
requested injunctive relief, compensatory damages, punitive and exemplary
damages, and attorney's fees in an unspecified amount. The Nevada Insurance
Department revoked the license of the first plaintiff and denied further
licensing of the second plaintiff. The Company is vigorously defending itself
and has filed counterclaims against the plaintiffs. While the Company believes
that it has meritorious defenses and counterclaims in this lawsuit, there can be
no assurance that the Company's results of operations and financial condition
will not be materially adversely affected by this lawsuit. The ultimate outcome
of the lawsuit cannot be determined at this time, and the Company is unable to
estimate the range of possible loss, if any.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
The information required by this item is incorporated by reference to page 51 of
the Company's 1997 Annual Report to Shareholders.
ITEM 6. SELECTED FINANCIAL DATA
The information required by this item is incorporated by reference to page 28 of
the Company's 1997 Annual Report to Shareholders.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The information required by this item is incorporated by reference to pages
19-27 of the Company's 1997 Annual Report to Shareholders.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this item is incorporated by reference to pages
30-34 of the Company's 1997 Annual Report to Shareholders.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
11
13
Not Applicable
PART III
Certain information required by Part III is omitted from this Report in that the
Registrant has filed a definitive proxy statement pursuant to Regulation 14A
(the "Proxy Statement") not later than 120 days after the end of the fiscal year
covered by this report and certain information included therein is incorporated
herein by reference. Only those sections of the Proxy Statement that
specifically address the items set forth herein are incorporated by reference.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item is included under the caption "Directors
and Executive Officers" of the Company's Proxy Statement relating to the Annual
Meeting of Shareholders to be held on May 18, 1998, which is hereby incorporated
by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is included under the captions "Executive
Compensation", "Report of Compensation Committee on Executive Compensation" and
"Stock Performance Graph" of the Company's Proxy Statement relating to the
Annual Meeting of Shareholders to be held on May 18, 1998, which are hereby
incorporated by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
The information required by this item is included under the caption "Security
Ownership of Certain Beneficial Owners and Management" of the Company's Proxy
Statement relating to the Annual Meeting of Shareholders to be held on May 18,
1998, which is hereby incorporated by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Not applicable.
12
14
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS
ON FORM 8-K
(A) The following documents are filed as part of this Report:
1. Financial Statements: The following Consolidated Financial Statements of
Meadowbrook Insurance Group, Inc., the accompanying Notes to Consolidated
Financial Statements and Report of Coopers & Lybrand L.L.P., Independent
Accountants, have been incorporated herein by reference in their entirety, from
pages 29-49 of the 1997 Annual Report to Shareholders:
Report of Coopers & Lybrand L.L.P., Independent Accountants
Consolidated Balance Sheet - December 31, 1997 and 1996
Consolidated Statement of Income - Fiscal Years Ended December 31, 1997, 1996
and 1995
Consolidated Statement of Shareholders' Equity - Fiscal Years Ended December 31,
1997, 1996 and 1995
Consolidated Statement of Cash Flows - Fiscal Years Ended December 31, 1997,
1996 and 1995
Notes to Consolidated Financial Statements
2. Report of Independent Accountants on Financial Statement
Schedule Listed Under 14(a)3 of this Form 10-K (attached on pg. 17)
3. Financial Statement Schedule
Schedule II Condensed Financial Information of Registrant (attached on
pg. 18-20)
Schedules not listed above have been omitted because they are not applicable or
are not required or the information required to be set forth therein is included
in the Consolidated Financial Statements and Notes thereto.
4. Exhibits The Exhibits listed on the accompanying Index to Exhibits
immediately following the financial statement schedule are filed as part of, or
incorporated by reference into, this Form 10-K.
13
15
INDEX TO EXHIBITS
Exhibit
No. Description Filing Basis
- ------- ----------- ------------
3.1 Articles of Incorporation of the Company, including
Certificate of Amendment to the Articles of
Incorporation. *
3.2 Bylaws of the Company. *
10.1 Employment Agreement between the Company and
James R. Parry, Sr. ("Parry") dated January 1, 1993. *
Exhibit
No. Description Filing Basis
- ------- ----------- ------------
10.2 Management Services Agreement among the Company,
Star, Savers and Meadowbrook dated January 1, 1993. *
10.3 Meadowbrook Insurance Group, Inc. 1995 Stock Option Plan. *
10.4 Lease between Meadowbrook and 26600 Development
Associates Limited Partnership, with fourth amendment to
lease dated March 21, 1995. *
10.5 Fifth and sixth Amendments to Lease between Meadowbrook
and 26600 Development Associates Limited Partnership
dated August 7, 1995 and May 13, 1996. *
10.6 Meadowbrook, Inc. 401(k) Profit Sharing Plan Trust,
amended and restated December 31, 1994. *
10.7 Employment Agreement, Covenant Not to Compete and
Restricted Stock Agreement dated as of August 1, 1995
between Meadowbrook and Robert A. Engle. *
10.8 Employment Agreement, Covenant Not to Compete and
Restricted Stock Agreement dated as of August 1, 1995
between Meadowbrook and Robert A. Engle, Amendment. *
10.9 Stock Purchase Agreement dated August 1, 1995 among the
Company , Robert A. Engle, Trustee of the Robert A. Engle
Revocable Trust dated November 24, 1993, Merton J. Segal
and certain other employees of the Company. *
10.10 Stock Purchase Agreement dated August 1, 1995 among the
Company , Robert A. Engle, Trustee of the Robert A. Engle
Revocable Trust dated November 24, 1993, Merton J. Segal
and certain other employees of the Company, Amendment. *
11 Statement re computation of per share earnings. Pg. 21
13 1997 Annual Report to Shareholders. Pg. 22-75
21 List of Subsidiaries. Pg. 76
14
16
23 Consent of Independent Accountants Pg. 77
24 Power of attorney. Pg. 78
27 Financial Data Schedule. Pg. 79
28.1 Star Insurance Company's 1997 Schedule P. Pg. 80 - 131 **
28.2 Savers Property & Casualty Insurance Company's 1997
Schedule P. Pg. 132 - 187**
28.3 Williamsburg National Insurance Company's 1997
Schedule P. Pg. 188 - 244**
(*) Incorporated by reference to Form S-1 Registration
Statement (No. 33-2626206) of Meadowbrook
Insurance Group, Inc. declared effective November 20, 1995.
(**) Submitted in paper format under separate cover; see Form SE filing.
(B) REPORTS ON FORM 8-K
No reports on Form 8-K were filed by the Registrant during the year ended
December 31, 1997.
15
17
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities and
Exchange Act of 1934, the Registrant has duly caused this Report to be signed
on its behalf by the undersigned, thereunto duly authorized, in Southfield,
Michigan, on March 26, 1998.
MEADOWBROOK INSURANCE GROUP, INC.
By: **
------------------------------------
Merton J. Segal
Chairman and Chief Executive Officer
(Principal Executive Officer)
By:/s/ Daniel G. Gibson
------------------------------------------
Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)
Dated: March 26, 1998
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacity and on the dates indicated.
Signature Title Date
- --------- ----- ----
** Chairman, Chief Executive Officer and March 26, 1998
- ---------------------- Director (Principal Executive Officer)
Merton J. Segal
** Vice Chairman and Director March 26, 1998
- ----------------------
Warren D. Gardner
/s/ Robert S. Cubbin Office of the President, Secretary March 26, 1998
- ---------------------- and Director
Robert S. Cubbin
** Office of the President, Treasurer March 26, 1998
- ---------------------- and Director
Joseph C. Henry
** Office of the President, March 26, 1998
- ---------------------- Chief Marketing Officer and Director
James R. Parry, Sr.
** Director March 26, 1998
- ----------------------
Bruce E. Thal
** Director March 26, 1998
- ----------------------
Hugh W. Greenberg
** By: /s/ Robert S. Cubbin
----------------------
Robert S. Cubbin, Attorney-in-fact
16
18
[LETTERHEAD OF COOPERS & LYBRAND]
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders
Meadowbrook Insurance Group, Inc.
We have audited the consolidated financial statements of Meadowbrook Insurance
Group, Inc. and subsidiaries as of December 31, 1997 and 1996, and for each of
the three years in the period ended December 31, 1997, which financial
statements are included on pages 30 through 49 of the 1997 Annual Report to
Shareholders of Meadowbrook Insurance Group, Inc. and Incorporated by reference
herein. We have also audited the financial statement schedule listed under
Item 14(A)3 of this Form 10-K. These financial statements and financial
statement schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Meadowbrook
Insurance Group, Inc. and Subsidiaries as of December 31, 1997 and 1996, and the
consolidated results of their operations and their cash flows for each of
the three years in the period ended December 31, 1997, in conformity with
generally accepted accounting principles. In addition, in our opinion, the
financial statement schedule referred to above, when considered in relation to
the basic financial statements taken as a whole, presents fairly, in all
material respects, the information required to be included therein.
COOPERS & LYBRAND LLP
Detroit, Michigan
March 19, 1998
17
19
SCHEDULE II
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
MEADOWBROOK INSURANCE GROUP, INC.
PARENT COMPANY ONLY
INCOME STATEMENT
For the years ended December 31,
-------
1997 1996 1995
----------- ----------- -----------
Revenue: $ 23,970 $ 275,740 $ 129,376
Operating expenses:
Interest expense 370,875 -- 316,175
Other expenses 488,274 350,849 109,770
----------- ----------- -----------
Total Operating Expenses 859,149 350,849 425,945
----------- ----------- -----------
Loss before federal income taxes (835,179) (75,109) (296,569)
Federal income tax benefit (293,955) (41,940) (100,834)
----------- ----------- -----------
Net loss before subsidiary equity (541,224) (33,169) (195,735)
earnings ----------- ----------- -----------
Subsidiary equity earnings 13,583,680 8,739,193 7,415,605
----------- ----------- -----------
Net Income $13,042,456 $ 8,706,024 $ 7,219,870
=========== =========== ===========
18
20
SCHEDULE II
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
MEADOWBROOK INSURANCE GROUP, INC.
PARENT COMPANY ONLY
BALANCE SHEET
As of December 31, 1997 and 1996
-------
1997 1996
------------- -------------
ASSETS
Cash and cash equivalents $ 64,996 $ 1,056,424
Investment in subsidiaries 114,837,287 91,772,990
Receivables from subsidiaries 6,894,567 6,975,678
Intangible assets 3,073,693
Other assets 521,303 639,376
------------- -------------
Total Assets $ 125,391,846 $ 100,444,468
============= =============
LIABILITIES
Other liabilities $ 305,933 $ 243,634
Line of credit 9,639,507 --
------------- -------------
Total Liabilities 9,945,440 243,634
SHAREHOLDERS' EQUITY
Common Stock 86,602 86,493
Additional paid in capital 72,650,671 72,873,396
Retained earnings 39,730,884 27,381,111
Unrealized appreciation (depreciation) on
available for sale securities 2,978,249 (140,166)
------------- -------------
Total Shareholders' Equity 115,446,406 100,200,834
------------- -------------
Total Liabilities and Shareholders' Equity $ 125,391,846 $ 100,444,468
============= =============
19
21
SCHEDULE II
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
MEADOWBROOK INSURANCE GROUP, INC.
PARENT COMPANY ONLY
STATEMENT OF CASH FLOWS
For the years ended December 31,
-------
1997 1996 1995
------------ ------------ ------------
Net cash provided by (used in)
operating activities: $ 445,015 $ (6,145,849) $ (718,847)
------------ ------------ ------------
Cash Flow from Investing Activities:
Investment in subsidiaries (9,513,711) -- (32,504,672)
------------ ------------ ------------
Net cash used in
investing activities: (9,513,711) -- (32,504,672)
------------ ------------ ------------
Cash Flows from Financing Activities:
Proceeds from borrowings 11,139,507 -- --
Principal payments on borrowings (2,146,940) -- (3,500,000)
Additional expenses from IPO -- (221,018) --
Dividends paid on common stock (692,683) (517,797) --
Retirement of common stock (222,616) (470,370) (27,655)
Issuance of common stock -- 318,739 44,242,503
------------ ------------ ------------
Net cash (used in) provided by
financing activities: 8,077,268 (890,446) 40,714,848
------------ ------------ ------------
Increase/(decrease) in cash and
cash equivalents (991,428) (7,036,295) 7,491,329
Cash and cash equivalents,
beginning of year 1,056,424 8,092,719 601,390
------------ ------------ ------------
Cash and cash equivalents
end of year $ 64,996 $ 1,056,424 $ 8,092,719
============ ============ ============
20