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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 (Fee Required)

For the fiscal year ended December 31, 2002

o Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 (No Fee Required)

Commission file number 0-21230

Midwest Medical Insurance Holding Company

Registrant’s telephone number, including area code: (952) 838-6700

Securities registered pursuant to Section 12(b) of the Act:   NONE

Securities registered pursuant to Section 12(g) of the Act:

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 periods 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) 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. o

The aggregate market value of the common stock held by non-affiliates of the registrant as of June 28, 2002, the last business day of the registrant's most recently completed second fiscal quarter, was $-0-.

The number of shares outstanding of the issuer’s classes of common stock, as of March 21, 2003:

   Class B Common Stock, $1,000 par value – 1 share
   Class C Common Stock, no par value – 10,847 shares

DOCUMENTS INCORPORATED BY REFERENCE

None.

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PART I

Item 1. BUSINESS

Background

Midwest Medical Insurance Holding Company (Midwest Holding) is a holding company organized under the laws of the State of Minnesota. Midwest Medical Insurance Company (Midwest Medical), Midwest Medical Solutions, Inc. (Medical Solutions), MMIC Benefits, Inc. (Benefits) and MMIC Business Office Solutions, Inc. (Office Solutions) are wholly owned subsidiaries of Midwest Holding. Midwest Holding and its subsidiaries are referred to collectively as the Company unless the reference pertains to a specific entity.

The Company’s principal business operation is Midwest Medical. Midwest Medical’s primary business is selling and issuing policies of medical professional liability insurance to: (1) individual physicians, (2) partnerships or professional corporations composed of physicians, (3) clinics, (4) hospitals and (5) health plans.

Midwest Medical was originally organized in 1980 under the auspices of the Minnesota Medical Association to provide professional liability (malpractice) insurance to Minnesota physicians who were members of the Minnesota Medical Association. The business was reorganized on November 30, 1988 into a stock insurance company, Midwest Medical, which was wholly owned by a holding company, Midwest Holding. The new organization allowed Midwest Holding to more readily pursue other business opportunities on behalf of its physician owners. Another purpose of the reorganization was to give physicians a limited equity interest in their malpractice insurer while preserving its capital and surplus. On July 1, 1993, the Iowa physician-owned malpractice insurer, Iowa Physicians Mutual Insurance Trust, merged with Midwest Medical. On June 5, 1996, the Nebraska physician-owned malpractice insurer, Medical Liability Mutual Insurance Company of Nebraska, merged with Midwest Medical. Midwest Medical now provides malpractice insurance to physicians and physician groups in Minnesota, Iowa, North Dakota, South Dakota, Nebraska, Illinois and Wisconsin on a claims-made basis. Midwest Medical has had the sponsorship of the Minnesota Medical Association since inception and also has the sponsorship of the Iowa Medical Society, the North Dakota Medical Association and the South Dakota Medical Association. Professional liability, general liability and umbrella excess liability insurance is also available to hospitals and other healthcare facilities throughout Midwest Medical’s territory.

During 1997, Midwest Holding formed Medical Solutions as a business development company to strengthen and promote the independence and interdependencies of physicians, clinics and hospitals that Midwest Medical serves. Business development opportunities being pursued include practice enhancement, strategic consulting, and technology services and support.

In January 1998, Medical Solutions purchased the assets of MedPower Information Services, Inc. and then contributed those assets to its newly formed, wholly owned subsidiary, MedPower Information Resources, Inc. (MedPower). MedPower processed and electronically submitted

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Item 1. BUSINESS (continued)

medical claims for more than 100 healthcare providers in the Upper Midwest. MedPower was sold effective July 31, 2001. Further information regarding the sale of MedPower can be found in Item 7 under discontinued operations and in Note 2 of the audited consolidated financial statements in Item 8 of this Annual Report on Form 10-K.

Benefits was incorporated in 1995 and began active operations in January 1999 with the acquisition of a block of business from Johnson-McCann Benefits, Inc. Benefits is an insurance agency specializing in providing Upper Midwest employers with group insurance products such as health, dental, life, disability and workers’ compensation.

Office Solutions began operations in February 2002 to provide physicians with business office outsourcing services. The main outsourcing service is the billing and collection of patient accounts.

Midwest Holding provides management and administrative services to Midwest Medical and Medical Solutions for a fee generally equal to the cost of services provided. Benefits and Office Solutions operate independently and do not have management agreements with Midwest Holding.

Policyholder Eligibility Requirements

An individual physician must meet the following criteria in order to be eligible to obtain insurance coverage from Midwest Medical:

	1.		An applicant must be licensed to practice medicine, surgery or osteopathy in Minnesota, Iowa, North Dakota, South Dakota, Nebraska, Illinois or Wisconsin; and
	2.		An applicant must conduct a majority of his or her practice in Minnesota, Iowa, North Dakota, South Dakota, Nebraska, Illinois or Wisconsin.

Midwest Medical also provides professional liability insurance to entities, including partnerships, professional corporations and other associations through which qualifying physicians practice medicine, surgery or osteopathy. A medical group must meet the following criteria in order to be eligible to be insured by Midwest Medical:

	1.		The entity must have its principal place of business in Minnesota, Iowa, North Dakota, South Dakota, Nebraska, Illinois or Wisconsin; and
	2.		The group must demonstrate that a majority of the individual physicians practicing medicine, surgery or osteopathy on a full-time basis through such clinics are, or intend to be, insured by Midwest Medical.

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Item 1. BUSINESS (continued)

Midwest Medical also provides professional liability, general liability and umbrella excess liability to hospitals and other healthcare facilities. A business must meet the following criteria in order to be eligible to be insured by Midwest Medical:

	1.		The entity must have its principal place of business in Minnesota, Iowa, North Dakota, South Dakota, Nebraska, Illinois or Wisconsin; and
	2.		The facility must be a licensed hospital or other healthcare facility.

Policy Forms

Midwest Medical offers a “claims-made” medical malpractice liability insurance policy. Under a claims-made policy, coverage is provided for claims asserted and reported to Midwest Medical while the policy is in effect relating to occurrences which took place during the period in which the policyholder had coverage with Midwest Medical. For purposes of policy coverage, a claim includes any lawsuit, allegation of liability or other notice of patient dissatisfaction with services performed that is communicated to Midwest Medical as required by the policy. The policy also covers prior acts (i.e., claims first made during the policy period with respect to occurrences which took place prior to the date the insured initially secured coverage from Midwest Medical) for physicians previously insured under a claims-made policy with another professional liability insurer. Prior-acts coverage is not available from Midwest Medical for physicians who have not been continuously insured prior to obtaining coverage from Midwest Medical.

Midwest Medical also offers reporting endorsements (tails) which provide coverage of subsequent claims (i.e., claims first made subsequent to the date the insured terminates basic insurance coverage with Midwest Medical, but with respect to occurrences which took place while the insurance coverage was in effect prior to such termination date) made against its former insureds who have voluntarily terminated insurance coverage with Midwest Medical. In the event of death, permanent disability or retirement at age 55 or older after five years of continuous coverage with Midwest Medical, the reporting endorsement is provided at no additional premium.

Midwest Medical offers basic limits of coverage from $1,000,000 for each claim, subject to $3,000,000 annual aggregate, up to $12,000,000 for each claim, subject to $14,000,000 annual aggregate. Excess coverage above the basic limits is available from Midwest Medical’s reinsurers on a facultative basis.

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Item 1. BUSINESS (continued)

Marketing and Distribution

Salaried marketing representatives of Midwest Holding have generally handled most of the marketing and sales of Midwest Medical policies. With the recent growth in premium volume, marketing representatives have increasingly worked with agents in the production of business. Agents are often used by larger policyholders in securing insurance coverage on their behalf. Insurance companies will also often work with agents in developing new types of insurance coverage. Midwest Medical approves all policies that are sold through agents before they become effective. No commissions are earned by agents until such approval has been granted.

Distribution of policies is handled through a processing system that was updated in 1998. Since the majority of its policies are on a calendar-year basis, Midwest Medical’s policy processing operations must be highly efficient. This efficiency has allowed Midwest Medical to consistently process and deliver policies on a timely basis to policyholders.

Reinsurance

Midwest Medical purchases reinsurance in order to reduce its liability on individual risks. A reinsurance transaction takes place when an insurance company transfers or “cedes” to another insurer a portion of its exposure on insurance it writes. The reinsurer assumes the exposure in return for a portion of the premium. The reinsurer’s liability is limited to losses it assumes that are in excess of the portion retained by Midwest Medical. However, in the event the reinsurer is unable or otherwise fails to pay, Midwest Medical remains primarily liable for the loss.

Historically, entering into reinsurance agreements permitted Midwest Medical to issue policies having greater liability limits than otherwise would have been allowed under Minnesota insurance law, which prohibits an insurer from retaining a risk on any one claim that is greater than 10% of its surplus. As Midwest Medical’s surplus has grown, Midwest Medical now utilizes reinsurance primarily to limit its risk on any single claim. Such limits of risk assumed by Midwest Medical for physician coverage have increased from $150,000 in the first year of operations to $1,000,000 currently. The reinsurer will pay losses in excess of the amount of risk retained by Midwest Medical, not to exceed the limits of liability of the policies issued by Midwest Medical.

Midwest Medical’s reinsurance contract in effect during 2002 was structured in two components: “basic” and “excess.” The basic component provided a primary layer of coverage of $1,000,000 in excess of $1,000,000 of retention per insured. The premium ceded for this coverage was 9.75% of net written premium with a profit-sharing provision that will be determined after three years. The excess component covered limits of liability of $2,000,000 for each claim and $4,000,000 in the aggregate up to $12,000,000 for each claim and $14,000,000 in the aggregate.

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Item 1. BUSINESS (continued)

Under the excess coverage component, Midwest Medical ceded all premium and exposure to the reinsurers and collected a ceding commission of 25%. The reinsurers, their participation percentages and their current A.M. Best ratings are listed below:

	•		Hannover Reinsurance Company, (40%), A+
	•		Transatlantic Reinsurance Company, (30%), A+
	•		Gerling Global Reinsurance Corporation of America, (20%), B++
	•		Lloyds syndicates, (10%), A–

Midwest Medical renewed its reinsurance agreement effective January 1, 2003. The premium ceded for the basic component (or primary layer) on the renewed reinsurance agreement increased to 10% of net written premium. The reinsurers on the 2003 agreement, their participation percentages and their current A.M. Best ratings are listed below:

	•		Hannover Reinsurance Company, (40%), A+
	•		XL Reinsurance America, (20%), A+
	•		Axis Reinsurance Company, (15%), A
	•		Lloyds syndicates, (25%), A–

From 1992 through 2000, Midwest Medical utilized “swing-rated” treaty reinsurance contracts. Premium ceded is based upon the losses paid under the contract limited to a minimum and a maximum percentage of the underlying Midwest Medical subject premium. These treaties do not include a commutation clause, but rather develop over time as claims are settled. The paid losses on the 1998–2000 reinsurance contract have already triggered the maximum premium ceded limit and the 1992–1994 and 1995–1997 reinsurance contracts together have fewer than 20 outstanding claims. Consequently, management believes that the potential for further significant premium ceded on these contract years is small. All reinsurance contracts have been commuted and no claims are outstanding for years prior to 1992.

Investments

The Company’s investment portfolio is under the direction of the Board of Directors acting through the Investment Committee. The Investment Committee establishes the Company’s investment policy, which provides guidelines to help maintain the Company’s financial stability through preserving assets and maximizing pretax investment income. Adequate liquidity is maintained to ensure that the Company has the ability to meet its operational requirements, particularly the payment of insurance claims. The Company employs outside investment managers who manage the portfolio on a discretionary basis consistent with the policies set by the Investment Committee. In addition, the Investment Committee utilizes the services of an outside consultant who calculates performance measures and provides an independent opinion on the overall results being obtained by the investment managers.

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Item 1. BUSINESS (continued)

The table below shows how the Company’s portfolio was invested at December 31, 2002 and 2001, respectively. Additional investment information can be found in Note 4 of the audited consolidated financial statements in Item 8 of this Annual Report on Form 10-K.

The majority of the Company’s fixed maturity portfolio is invested in investment-grade fixed income bonds issued primarily by the United States Government, governmental agencies and corporations. The table below contains additional information concerning the investment ratings of the Company’s fixed maturity investments at December 31, 2002 and 2001, respectively:

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Item 1. BUSINESS (continued)

The decrease in the proportion of equity securities from 25.8% at December 31, 2001 to 12.6% at December 31, 2002 was primarily due to a decrease in equity market values and a like-kind exchange completed in the second quarter of 2002 that transferred the Company’s managed international equity securities account to the investment manager’s international equity limited partnership. The international equity limited partnership is considered one investment, similar to a mutual fund, while the managed international equities account consisted of 40 to 50 separately valued international equity securities. The like-kind exchange simplified the Company’s administration and reduced the related investment expense while retaining the Company’s diversification in international equity markets. The limited partnership is classified as an other investment on the consolidated balance sheets. As a result, the proportion of other investments, which also includes the real estate investment trust, grew to 15.0% of total invested assets at December 31, 2002 from 8.7% at December 31, 2001.

The remainder of the Company’s investment portfolio, 16.0% and 8.7% at December 31, 2002 and 2001, respectively, was invested in short-term investments. Short-term investments consist primarily of money market funds and high-quality commercial paper with maturities of less than one year. Due to the growth in insurance operations and the volatility of the fixed maturity and equity markets, the Company and its investment managers elected to keep more funds in highly liquid short-term investments at the end of 2002.

Rating

A.M. Best & Company, Inc., publisher of Best’s Insurance Reports, Property-Casualty, 2001 Edition, has assigned Midwest Medical an “A”, or excellent, rating in 2002. Midwest Medical has held a Best’s “A” rating since 1991. This is the highest rating currently assigned to any company that specializes in medical malpractice insurance. Best’s ratings are based on an analysis of the financial condition and operation of an insurance company as compared with the industry in general. Midwest Medical believes that a favorable rating has a positive effect because customers and their advisors often review Best’s ratings when selecting an insurer and are more apt to purchase insurance from a company with a positive rating because of the greater security and stability associated with it. A positive rating relates primarily to the ability of an insurer to meet its insurance obligations and does not directly relate to the value of the insurer’s securities.

Government Regulation

Midwest Medical is subject to governmental regulation in the states in which it conducts its business. Such regulation is conducted by state agencies having broad administrative power dealing with all aspects of Midwest Medical’s business, including policy terms, rates, dividends to policyholders and dividends to the parent corporation, Midwest Holding. Midwest Medical is required to file periodic information with state regulatory authorities and is subject to periodic financial and business conduct examinations by state regulatory authorities.

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Item 1. BUSINESS (continued)

Midwest Holding is also subject to statutes governing insurance holding company systems in Minnesota, which relate primarily to the acquisition or control of insurance companies directly or through a holding company. These statutes require Midwest Holding to also file periodic information with state regulatory authorities, which could be subject to follow-up examination.

Competition

Two major competitors exited the medical malpractice insurance market over the past two years. The St. Paul Companies made a business decision to stop writing medical malpractice insurance and PHICO became financially insolvent and was liquidated by the Pennsylvania Department of Insurance. As a result, Midwest Medical received an unprecedented level of new business opportunities in its five core states of Minnesota, Iowa, South Dakota, North Dakota and Nebraska and became the largest provider of medical malpractice insurance in each of these states based on the amount of premium written. The table below shows the amount of premium written on a direct basis by Midwest Medical for its five core states over the last three years:

The primary national company that remains active in Midwest Medical’s market area is Medical Protective Insurance Company. Three physician-owned specialty carriers, COPIC Insurance Company, The Doctors’ Company and PIC-Wisconsin, are also active in Midwest Medical’s core states but have yet to develop a significant market presence. Midwest Medical is the only carrier endorsed by local medical societies in Minnesota, Iowa, North Dakota and South Dakota and owned by its physician-insureds, which management believes provides Midwest Medical a competitive advantage in marketing to physicians and healthcare administrators.

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Item 1. BUSINESS (continued)

Noninsurance Products and Services

The Company is also developing additional business relationships with Midwest Medical policyholders through the products and services offered by its noninsurance businesses. Management believes that delivering high-quality noninsurance products and services needed and sought by its policyholders will boost customer retention and combat the price-driven, commodity nature of the medical malpractice insurance market.

Several years of surveying policyholders along with researching and developing possible business opportunities have led to the active marketing of the following noninsurance products and services:

	•		technology consulting services, including network installation, web site development and other information technology support
	•		sales, implementation and support of electronic practice management and electronic medical records software
	•		outsourced billing, collections and other medical practice office services
	•		sales and support of group insurance products to employers

The competition in these business lines is fragmented, and the Company believes that its established brand and solid reputation in the medical malpractice insurance industry provides it a competitive advantage in marketing to physicians and healthcare administrators. Account executives dedicated to Medical Solutions and Benefits are in charge of the marketing and sales of noninsurance products and services. The account executives are compensated on a combined salary and commission basis. The marketing representatives and employees of Midwest Holding are also encouraged through incentives to cross-sell noninsurance products and services to policyholders. Currently, the noninsurance products and services generate less than 5% of total Company revenues. Based on its business plans, management believes that it can exceed 10% of total Company revenues in two years.

Employees

As of December 31, 2002, Midwest Holding had 105 employees, of whom 10 were executives, 66 were supervisory employees or specialists and 29 were clerical employees. As of December 31, 2002, Benefits had 14 employees, of whom 1 was an executive, 9 were supervisory employees or specialists and 4 were clerical employees. No employees of Midwest Holding and Benefits are covered by a collective bargaining agreement, no work stoppages have occurred and management believes that relations with employees are good.

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Item 1. BUSINESS (continued)

Risk Factors

Cautionary note regarding forward-looking statements.

This Annual Report on Form 10-K contains “forward-looking statements” made by the Company’s management within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Act of 1934, as amended. These forward-looking statements are not historical facts, but rather are based on management’s current expectations, estimates, projections, beliefs and assumptions about the Company’s industry and businesses. These statements are not guarantees of future performance and are subject to risks, uncertainties and other factors, some of which are beyond management’s control and are difficult to predict.

These factors could cause actual results to differ materially from those expressed in the forward-looking statements. Management attempts to identify and describe the significant risks and uncertainties in the following risk factors and elsewhere in this Annual Report on Form 10-K. The reader is cautioned not to place undue reliance on these forward-looking statements, which reflect management’s view only as of the date of this Annual Report on Form 10-K. The significant factors that could affect forward-looking statements can change and the Company is not obligated to update any forward-looking statement or publicly release the result of any revisions to them to reflect events or circumstances after the date of this Annual Report on Form 10-K or to reflect the occurrence of unanticipated events. By this cautionary note, the Company intends to avail itself of the safe harbor from liability with respect to forward-looking statements provided by Section 27A and Section 21E referred to previously.

Company’s revenues are concentrated in one business and geographic region.

More than 80% of the Company’s revenues come from premiums earned. Substantially all of the Company’s premiums are generated from medical malpractice insurance policies issued to physicians, physician groups, clinics, hospitals and health plans. As a result, negative developments in the economic, competitive or regulatory conditions in the medical malpractice insurance industry could have a material adverse effect on the Company’s results of operations.

Nearly all of the Company’s premiums are generated from the five Upper Midwest states of Minnesota, Iowa, South Dakota, North Dakota and Nebraska. The revenues and profitability of the Company are therefore subject to the prevailing regulatory, legal, economic and other conditions in these states.

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Item 1. BUSINESS (continued)

Competition may focus on Company’s dominant regional market presence.

Competitors may view the Company’s Upper Midwest markets as attractive and step up efforts to persuade policyholders to do business with them. Some of these competitors have greater financial resources than the Company and could offer attractive pricing and coverage terms. Additional competitive factors include policyholder dividends, financial stability, breadth and flexibility of coverage and the level and quality of services provided. Although the Company believes it has a strong competitive position in its Upper Midwest markets, greater competition could adversely affect the Company’s ability to retain and expand its medical malpractice insurance business.

Industry factors beyond the Company’s control can impact financial results.

Many factors influence the financial results of the medical malpractice insurance industry. Often these factors are beyond the control of the Company, such as changes in severity and frequency of claims, changes in applicable law and regulatory reform, changes in judicial attitudes toward medical malpractice claims and changes in inflation, interest rates and general economic conditions.

The availability of medical malpractice insurance, also known as the industry’s underwriting capacity, is determined principally by the industry’s level of capitalization, historical underwriting results, investment returns and perceived premium rate adequacy. Historically, the financial performance of the medical malpractice insurance industry has tended to fluctuate between a “soft” insurance market and a “hard” insurance market. A soft insurance market is characterized by a surplus of underwriting capacity chasing market share creating a highly competitive marketplace that could result in premium rates and underwriting terms and conditions that are below profitable levels. A hard insurance market is characterized by a withdrawal of underwriting capacity creating less product availability and less competition that, in turn, allows remaining insurers to set premium rates and underwriting terms and conditions at more profitable levels.

Although the medical malpractice insurance industry is currently facing a hard market, the soft market of prior years continues to adversely affect industry financial results. No assurances can be given as to whether or when the current hard insurance market will improve industry financial results or the extent that any industry improvement may improve the Company’s financial condition and results of operations.

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Item 1. BUSINESS (continued)

Changes in the healthcare environment can adversely impact policyholders and the Company.

Significant attention has recently been focused on reforming the healthcare system at both the federal and state levels. A broad range of healthcare reform and patients’ rights measures have been suggested, and public discussion of such measures will likely continue in the future. Proposals have included, among others, spending limits, price controls, limits on increases in insurance premiums, limits on the liability of doctors and hospitals for tort claims, increased tort liabilities for managed care organizations and changes in the healthcare insurance system. The Company cannot predict which, if any, reform proposals will be adopted, when they may be adopted or what impact they may have on the Company. While some of these proposals could be beneficial to the Company, the adoption of others could have a material adverse effect on the Company’s financial condition or results of operations.

In addition to regulatory and legislative efforts, there have been significant market-driven changes in the healthcare environment. In recent years, a number of factors related to the emergence of “managed care” have negatively impacted or threatened to impact the medical practice and economic independence of physicians. Physicians have found it more difficult to conduct a traditional fee-for-service practice and many have been driven to join or contractually affiliate with managed care organizations, healthcare delivery systems or practice management organizations. This consolidation could result in reducing significantly the role of the physician and the medical group from the medical malpractice insurance purchasing decision. In addition, the consolidation could reduce primary medical malpractice insurance premiums paid by healthcare systems, as larger healthcare systems generally retain more risk by accepting higher deductibles and self-insured retentions or form their own captive insurance companies.

Liability for unpaid losses and loss adjustment expenses could prove to be inadequate.

The liability for unpaid losses and loss adjustment expenses (loss reserves) established by the Company’s management consists of estimates of the amounts needed to pay reported and unreported claims and the related loss adjustment expenses. The estimates are based on assumptions related to the ultimate cost of settling such claims based on facts and interpretation of circumstances then known, predictions of future events, future trends in claims frequency and severity and judicial theories of liability, legislative activity and other factors. Given the many estimates and assumptions being made, the establishment of an appropriate level of loss reserves is an inherently uncertain process, and there can be no assurance that currently established loss reserves will prove adequate in light of subsequent actual experience. Further uncertainty arises from the time that elapses from when a claim is reported to when a definite determination of ultimate liability is made, particularly where the judicial, political and regulatory climates are changing. The time that elapses for medical malpractice claims handled by the Company generally averages around two years, but can range from one to ten years depending on the circumstances. As a result, trends in losses may be slow to appear, and accordingly, the

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Item 1. BUSINESS (continued)

Company’s reaction in terms of modifying underwriting practices and changing premium rates may lag underlying loss trends. While the Company believes that its loss reserves are adequate, there can be no assurances that the Company’s ultimate losses and loss adjustment expenses will not deviate from the estimates in the Company’s consolidated financial statements. If loss reserves prove to be inadequate, the Company will need to increase them, which could have a material adverse effect on the Company’s consolidated financial position or results of operations.

Reinsurance availability and cost can significantly impact the Company’s ability to meet policyholders’ coverage needs.

The amount and cost of reinsurance available to companies specializing in medical malpractice insurance are subject to prevailing market conditions that are largely beyond the control of the Company. Large losses from the September 11 terrorist attacks, asbestos and environmental claims and directors’ and officers’ claims have reduced capacity and increased rates in the reinsurance market in general. The Company’s ability to provide medical malpractice insurance at competitive premium rates and coverage limits on a continuing basis will depend in large part on its ability to secure adequate reinsurance in amounts and at rates that are commercially reasonable. Although the Company anticipates that it will continue to be able to obtain such reinsurance on reasonable terms, no assurances can be given.

Volatile investment markets and investment performance can adversely affect the Company’s financial condition and operating results.

Continuing geopolitical concerns, corporate governance issues and other developments have recently created unprecedented volatility in financial markets across the globe. In addition, the sluggish national economy has led to a series of interest rate reductions over the past two years by the Federal Reserve. These factors, which are beyond the control of the Company, affect the performance of the Company’s investments. Market values of the Company’s invested assets have declined substantially the past two to three years, particularly in equity investments. Investment income yields from fixed maturity and short-term investments have declined the past two years due to the reduction in interest rates. The Company is also required to closely monitor investments whose declines in market values might be considered other-than-temporary. The Company recorded a $1,613,000 charge to income in 2002 for declines in market value that were deemed other-than-temporary. Although the Company believes that its investment strategy is prudent for a medical malpractice specialty insurer, no assurances can be given as to when investment market conditions will improve or to the extent any such improvement will improve the Company’s financial condition and results of operations.

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Item 1. BUSINESS (continued)

Regulatory, legislative and related developments could adversely affect the Company’s business.

Insurance companies are subject to supervision and regulation by the state insurance authority in each state in which they transact business. Such supervision and regulation relate to numerous aspects of an insurance company’s business and financial condition, including limitations on lines of business, underwriting limitations, the setting of premium rates, the establishment of standards of solvency, statutory surplus requirements, the licensing of insurers and agents, concentration of investments, levels of reserves, the payment of dividends, transactions with affiliates, changes of control and the approval of policy forms. Such regulation is concerned primarily with the protection of policyholders’ interests rather than stockholders’ interests.

State regulatory oversight and various proposals at the federal level may in the future adversely affect the Company’s results of operations. In recent years, the state insurance regulatory framework has come under increased federal scrutiny, and certain state legislators have considered or enacted laws that alter and, in many cases, increase state authority to regulate insurance companies and insurance holding companies’ systems. Further, the National Association of Insurance Commissioners (NAIC) and state insurance regulators are reexamining existing laws and regulations, which in many states has resulted in the adoption of certain laws that specifically focus on insurance company investments, issues relating to the solvency of insurance companies, capital guidelines, interpretations of existing laws, the development of new laws and definition of extraordinary dividends.

A.M. Best could downgrade the Company’s rating if financial performance deteriorates.

A.M. Best is the most recognized insurance industry rating organization. Buyers of insurance often use A.M. Best insurance company ratings to gauge an insurance company’s financial strength, operating performance and ability to meet its obligations, particularly the payment of claims. If the Company’s financial condition or results of operations were to be adversely affected by any factors, including the risk factors discussed above, A.M. Best could downgrade the Company’s rating from its current “A”, or excellent, level. A downgrade could adversely impact the Company’s ability to compete and, therefore, to retain and expand its medical malpractice insurance business. This, in turn, could also adversely impact the Company’s strategy with respect to cross-selling noninsurance products and services to policyholders.

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Item 2. PROPERTIES

The Company owns the following fixed assets, all of which are used in the conduct of its business:

Midwest Holding and its subsidiaries own no real estate. Midwest Holding leases office space in Edina, Minnesota with total square feet of 26,069 and a lease term of six years and two months that expires on November 30, 2005. Midwest Holding also leases 5,018 square feet of office space in West Des Moines, Iowa under a three-year lease that expires on August 31, 2003. Midwest Holding leases an additional 4,610 square feet of office space in Omaha, Nebraska under a five-year lease that expires January 31, 2007. Medical Solutions leases 8,031 square feet of office space in Plymouth, Minnesota under a five-year lease that expires November 30, 2006. Benefits leases a separate 5,437-square-foot facility located in Shoreview, Minnesota. This lease expires March 31, 2006. Annual rent expense was approximately $1,215,000 in 2002 and $1,020,000 in 2001.

Item 3. LEGAL PROCEEDINGS

The Company is party to certain claims arising in the ordinary course of conducting its business. Management believes the outcome of such claims will not materially affect the Company’s current or future financial position or results of operations.

Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

There were no matters submitted to a vote of security holders.

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PART II

Item 5. MARKET FOR REGISTRANT’S COMMON STOCK AND RELATED STOCKHOLDER MATTERS

(a)		There is no market for Midwest Holding’s Class B or Class C Common Stock. Class C, no par value, shares are issued only to insured individual physicians or individual physicians jointly with the legal entities in which they practice. The shares are restricted and cannot be sold to anyone other than Midwest Holding and are subject to mandatory redemption for no consideration at the time that the physician terminates insurance coverage with Midwest Medical for any reason.
(b)		As of March 21, 2003, the Minnesota Medical Association held the one share of Class B Common Stock and 10,847 physicians held one share each of Class C Common Stock.
(c)		Midwest Holding has never paid a shareholder dividend, nor does it intend to within the foreseeable future. Without prior approval from the Minnesota Commissioner of Commerce, annual dividends to Midwest Holding from Midwest Medical cannot exceed 10% of policyholder surplus of Midwest Medical or the prior year’s net income from operations of Midwest Medical, excluding realized capital gains, whichever is greater.

Item 6. SELECTED FINANCIAL DATA

Following is the selected financial data of the Company for the five years ended December 31, 2002. This data should be read in conjunction with the audited consolidated financial statements and notes thereto appearing under Item 8 of this Form 10-K.

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Item 6. SELECTED FINANCIAL DATA (continued)

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Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Manner of Presentation

The financial statements of Midwest Holding and its subsidiaries are presented on a consolidated basis. In future references in this analysis, which should be read together with the 2002 audited consolidated financial statements and notes thereto appearing under Item 8 of this Annual Report on Form 10-K, Midwest Holding and its subsidiaries are referred to collectively as the Company unless the reference pertains to a specific entity.

Liquidity and Capital Resources

The majority of the Company’s assets are invested in investment-grade bonds, common stocks, an international equity limited partnership, a real estate investment trust and short-term investments. These investments totaled $255,702,000 and $247,293,000 at December 31, 2002 and 2001, respectively, which represented 84% and 86% of total assets. The Investment Committee of the Board of Directors establishes the Company’s investment policy. The main objectives of the current investment policy are the preservation of assets, maximizing pretax total portfolio return and assuring adequate liquidity to meet operational requirements, particularly the payment of insurance claims. Additional information regarding the Company’s investments can be found under the Investments section in Item 1 and Note 4 of the audited consolidated financial statements in Item 8 of this Annual Report on Form 10-K.

The Company’s cash flow from operations was $24,677,000 in 2002 versus $(8,829,000) in 2001 and $1,544,000 in 2000. Growth in new business volume of approximately $18,759,000 and premium rate increases of approximately 18% on average per renewed account caused greater cash receipts in 2002. Lower policyholder dividend payments also contributed to the positive cash flow. Increased reinsurance costs due to volume growth and reinsurance rate increases partially offset the above positive cash flows. The 2001 cash flow from operations was unfavorably impacted by an increase in claim payments, policyholder dividend payments and premium adjustments paid to reinsurers on reinsurance contracts for prior years. These negative cash flows were partially offset by an increase in premium volume. The 2000 cash flow from operations was favorably impacted by premium adjustments received from reinsurers on reinsurance contracts for prior years and federal tax refunds received from the Internal Revenue Service for the 1992 to 1996 tax years. These positive cash flows in 2000 were partially offset by the payment of policyholder dividends.

New business and premium rate increases continued in 2002, driving greater cash receipts from policyholders. The exit of two main competitors, The St. Paul Companies and PHICO, from Midwest Medical’s core markets has created many new opportunities to write business. Other competitors are generally raising rates aggressively or exiting certain segments of the medical malpractice market, which has also created additional opportunities for Midwest Medical to write business. Due to these market conditions, an estimated $50,000,000 of medical malpractice insurance premium became available in Midwest Medical’s five core states during 2002.

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Of that amount, Midwest Medical analyzed approximately $35,000,000, of which approximately $18,000,000 was actually written and bound. Midwest Medical is selective in the new business it writes to ensure premiums reasonably compensate it for the risks assumed. Increasing reinsurance costs and claims severity has caused, and will likely continue to cause, Midwest Medical to raise premium rates in the near term. Midwest Medical, however, has generally not had to raise rates to the same degree as other insurers in many parts of the United States medical malpractice insurance market.

More than $65,000,000 of premium has been returned to policyholders since 1993 through policyholder dividends or retrospective premium credits. The policyholder dividend program replaced the retrospective premium credit program beginning in 1999. Policyholder dividends are generally paid in four equal quarterly installments in the year following their declaration by the Board of Directors. In 2002, Midwest Medical paid the $4,050,000 of policyholder dividends declared in 2001 by its Board of Directors. In 2001, Midwest Medical paid the $8,108,000 of policyholder dividends declared in 2000 by its Board of Directors.

As discussed under the Reinsurance section of Item 1 of this Form 10-K, the renewal of Midwest Medical’s reinsurance agreement resulted in a rate change effective January 1, 2003. The flat, ceded premium rate for the basic reinsurance component increased to 10% from 9.75%. Rates in the reinsurance market in general continue to rise in response to large losses from the September 11 terrorist attacks, asbestos and environmental claims, directors’ and officers’ claims, growing property and casualty claims severity and declining investment income. Midwest Medical’s reinsurance rate increase was considerably lower than other medical malpractice insurance companies due primarily to more favorable loss experience. The rate change, however, coupled with growing premium volume, will result in greater reinsurance costs in 2003.

Loss and operating expense payments have generally been met from policyholder premium receipts with any excess cash invested. In 2001, operating cash needs primarily from claim payments exceeded premium receipts requiring approximately $8,800,000 of cash from the investment portfolio. Due primarily to the increase in premium volume and rates, operating cash receipts exceeded loss and operating expenses by approximately $24,700,000 in 2002. Based on increasing premium volume and rate trends, management expects positive operating cash flow in 2003. Management regularly analyzes loss liabilities to project the cash flow required in future years. Because the overall investment portfolio is highly liquid, exact matching of bond maturities and loss liabilities is not a goal. Bond maturities are primarily selected to maximize total return.

During 2002, Medical Solutions negotiated a $1,930,000 installment loan to finance the purchase of an unlimited license agreement to resell electronic practice management and electronic medical records software. The loan calls for 36 monthly payments of $58,634 with an effective interest rate of 5.9%. Cash from the loan is provided as the four installment payments on the

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Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)

unlimited license agreement are made. During 2002, Medical Solutions paid two installments on the unlimited license agreement totaling $1,315,000 and, therefore, received two loan installments for the same amount. The remaining two installment payments totaling $615,000 were made in the first quarter of 2003. Servicing of the debt will be principally from internally generated operating funds.

The Company believes that its cash and investments, combined with cash generated from operations, will be sufficient to meet its present and reasonably foreseeable operating, capital and debt service requirements. Additional external debt financing is not anticipated. The Company does maintain a $5,000,000 secured line of credit with its bank in the event of an urgent cash need. The Company had no material capital expenditure commitments as of December 31, 2002 other than the two remaining installment payments totaling $615,000 on Medical Solutions’ unlimited license agreement

During 2000, Midwest Holding completed a stock restructure that exchanged and redeemed all outstanding Class A Common Shares. Under the terms of the stock restructure, Class A shareholders received $66 for each Class A share owned, plus one Class C share. The stock restructure paid approximately $9,541,000 to Class A shareholders for the redemption of their Class A shares. An $8,500,000 loan from Midwest Medical to Midwest Holding largely funded these payments. Midwest Medical primarily used proceeds from sales of domestic equity securities to provide the loan. The loan was a noninterest-bearing note and was retired in May 2001 by Midwest Holding through a dividend received from Midwest Medical. More details about the stock restructure, Class A and Class C Common Stock are found in Note 3 to the audited consolidated financial statements under Item 8 of this Annual Report on Form 10-K.

The Board of Directors of Midwest Medical will periodically declare and pay dividends to Midwest Holding to provide capital for holding company and noninsurance business operations including new business ventures. In 2001, a dividend from Midwest Medical was also used by Midwest Holding to retire an $8,500,000 loan used to fund stock restructure payments in 2000. In 2002, Midwest Medical did not pay any dividends to Midwest Holding. Midwest Medical declared and paid dividends of $11,400,000 and $3,000,000 to Midwest Holding in 2001 and 2000, respectively.

Shareholders’ equity decreased $15,872,000 during 2002. The decrease consisted of a net loss from operations of $(3,556,000) and net unrealized losses in the fair value of investments, net of deferred taxes, of $(12,316,000). The decline in equity market values caused $(8,600,000) of net unrealized losses in the common stock portfolio and an additional $(2,042,000) of net unrealized loss in the international equity limited partnership. The increases and decreases in shareholders’ equity are further described in the consolidated statements of changes in shareholders’ equity found in the accompanying audited consolidated financial statements found under Item 8 of this Annual Report on Form 10-K.

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Results of Operations

Net premiums earned increased $20,375,000 in 2002 from 2001. The increase was the result of the following significant factors:

	•		New 2002 business increased earned premium by approximately $14,777,000.
	•		Rate increases and granting fewer premium discounts increased earned premium by approximately $8,412,000 in 2002.
	•		Premiums from reporting endorsements that provide policyholder tail coverage increased earned premium by approximately $761,000 in 2002.
	•		The estimated reinsurance premium applicable to the two reinsurance agreements covering the years 1992–1994 and 1995–1997, which is based in part on reinsured claims experience, increased $316,000 in 2002 compared to an increase of $3,125,000 in 2001. This resulted in a net increase in premiums earned between years of $2,809,000.
	•		Due to the increase in reinsurance rates and premiums written, particularly for excess component reinsurance layers, current year reinsurance costs were $6,398,000 greater in 2002 compared to 2001. This decreased 2002 net premiums earned.

Net premiums earned increased $8,753,000 in 2001 from 2000. The increase was the result of the following significant factors:

	•		New 2001 business increased earned premium by approximately $7,785,000.
	•		Rate increases and granting fewer premium discounts increased earned premium by approximately $3,400,000 in 2001.
	•		Premiums from reporting endorsements that provide policyholder tail coverage increased earned premium by approximately $1,686,000 in 2001.
	•		The estimated reinsurance premium applicable to the two reinsurance agreements covering the years 1992–1994 and 1995–1997, which is based in part on reinsured claims experience, increased $3,125,000 in 2001 compared to an increase of $634,000 in 2000. This resulted in a net decrease in premiums earned between years of $2,491,000.
	•		Due primarily to the increase in premiums written, current year reinsurance costs were $1,685,000 greater in 2001 compared to 2000. This decreased 2001 net premiums earned.

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Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)

Net investment income decreased $937,000 in 2002 from 2001 and increased $101,000 in 2001 from 2000. Lower yields on fixed maturity and short-term investments due to the declining interest rate environment principally caused the decrease in net investment income in 2002. The increase in yield from the additional purchase of the real estate investment trust and lower investment expenses due to the decline in market values of equity securities caused the increase in net investment income in 2001. This was partially offset by lower yields on fixed maturity and short-term investments due to the decline in interest rates during 2001.

Realized capital gains decreased $5,213,000 to $1,358,000 in 2002 and decreased $3,931,000 to $6,571,000 in 2001. Net capital gains of approximately $3,668,000 were realized on sales of fixed maturity investments in 2002. This was partially offset by $1,613,000 for losses realized on the declines in market values of fixed maturity investments that were deemed other-than-temporary and by $690,000 for net capital losses realized on sales of equity securities. The sales of fixed maturity and equity securities were primarily initiated by the investment managers who manage the portfolios to maximize pretax total return while adhering to the guidelines provided by the Company’s investment policy. During 2001, sales of equity securities realized $6,752,000 of net capital gains while sales of fixed maturity investments realized $(181,000) of net capital losses. Approximately $3,000,000 of the net realized capital gains on equity securities resulted from the sale of common stocks in the first quarter to fund the additional real estate investment trust purchase of $10,000,000. All other 2001 realized capital gains and losses resulted from the management of the portfolio on a pretax total return basis.

The Company employs four outside professional advisors to manage its investment portfolio: one each to manage fixed income securities, large-cap domestic equity securities, the international equity limited partnership and the real estate investment trust. The managers operate within the Company’s adopted investment policy as approved by the Investment Committee of the Board of Directors. The Investment Committee meets with outside investment managers, along with the Company’s outside investment consultant quarterly. Future levels of realized capital gains or losses are difficult to predict as investment managers purchase and sell securities in response to changing market conditions and investment policy guidelines.

Other revenues increased $1,145,000 from $2,637,000 in 2001 to $3,782,000 in 2002. Medical Solutions’ revenue growth, primarily from the value-added reselling of electronic practice management (EPM) and electronic medical records (EMR) systems, drove most of the increase. The sale, installation and support of EPM and EMR systems generated $895,000 of new revenues in 2002. Medical Solutions’ generated an additional $70,000 of revenue growth from technology consulting services and Benefits’ added $177,000 of revenue growth primarily from commission income earned on new employer accounts.

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Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)

Other revenues decreased $1,386,000 from $4,023,000 in 2000 to $2,637,000 in 2001. Most of this decrease is due to the $1,716,000 recorded by Midwest Medical in 2000 for interest on federal tax refunds. Also contributing to the decrease is the elimination of finance charges on 2001 premium billings to Midwest Medical policyholders. Finance charges of $556,000 were included in other revenues for 2000. Offsetting these decreases were a $691,000 increase in Medical Solutions’ revenues primarily from technology consulting services and a $479,000 increase in Benefits’ revenues primarily from commission income earned on new accounts.

Losses and loss adjustment expenses are the costs associated with the settlement of insurance claims and are the Company’s principal expense. Losses and loss adjustment expenses were $74,819,000 in 2002 compared to $58,299,000 in 2001 and $39,587,000 in 2000. As a percentage of premiums earned, losses and loss adjustment expenses were 106.2%, 116.4% and 95.8% in 2002, 2001 and 2000, respectively. As shown in Note 6 to the audited consolidated financial statements, the current year’s provision for losses and loss adjustment expense, which is based upon policyholder exposure, expected frequency of losses and severity of losses, increased by $13,792,000 in 2002 compared to $10,664,000 in 2001. The increases were primarily driven by additional policyholder exposure from the increase in premium volume and the increase in Midwest Medical’s retention from $750,000 to $1,000,000 per insured for the basic component (or primary layer) of coverage beginning 2001. Also, since a significant portion of the increase in premium volume came from new business, the Company took a conservative loss position due to the lack of experience with these new policyholders. Losses and loss adjustment expenses also include adjustments of prior years’ estimates. These adjustments to the liability for unpaid losses and loss adjustment expenses are evaluated by management and supported by an outside actuarial analysis performed at the conclusion of the year. As shown in Note 6 of the audited consolidated financial statements, these evaluations resulted in an increase of $2,900,000 in 2002 to the estimated liability applicable to prior years versus an increase of $172,000 in 2001. The unfavorable development on prior years resulted primarily from an increase in claims severity and a Minnesota legislative action that extended the statute of limitations from two to four years.

The following schedule summarizes the development of the liability for unpaid losses and loss adjustment expenses from 1992 through 2002. This schedule is presented net of reinsurance, which the Company believes best explains the development as it affects operating results. Midwest Medical has had a conservative loss reserving policy that, when coupled with a decline in claim frequency during the early to mid-1990s, resulted in redundancies in the liability for unpaid losses and loss adjustment expenses. The redundancies in the loss liability, which develop as actual results become known, have significantly decreased since 1992 to where deficiencies developed the last two years. Downward competitive pressure on premium rates during the latter portion of the 1990s, coupled with increasing claims severity, have primarily driven this unfavorable development.

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Development of Liability for Loss and Loss Adjustment Expense
(In Thousands)

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Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)

The Company does not discount the liability for unpaid losses and loss adjustment expenses in its consolidated financial statements. While the Company believes that its liability for unpaid losses and loss adjustment expenses is adequate, there can be no assurances that the Company’s ultimate losses and loss adjustment expenses will not deviate from the estimates in the Company’s consolidated financial statements. If the liability proves to be inadequate, the Company will need to increase it, which could have a material adverse effect on the Company’s consolidated financial position or results of operations.

Policyholder dividends are generated from unanticipated profits on prior coverage years. No policyholder dividends were declared by the Board of Directors of Midwest Medical in 2002. The decision was based on the 1998 coverage year, which did not develop unanticipated profits that could be returned to policyholders. Policyholder dividends of $4,050,000 and $8,108,000 were declared in 2001 and 2000, respectively, and were paid to policyholders the following year. The decrease in policyholder dividends from 2000 to 2001 is primarily due to less favorable loss experience on the 1997 coverage year on which the 2001 policyholder dividend was based.

Underwriting, acquisition and insurance expenses increased $1,359,000 from $8,844,000 in 2001 to $10,203,000 in 2002. Greater premium volume drove a $2,107,000 increase in commission payments and a $586,000 increase in premium taxes. The expense for state guaranty fund assessments increased $239,000 principally from the insolvency of PHICO. These increases were partially offset by greater ceding commissions earned by Midwest Medical of approximately $1,670,000 resulting from the increase in premiums ceded to the excess component of the treaty reinsurance contract for the current year.

Underwriting, acquisition and insurance expenses increased $1,274,000 from $7,570,000 in 2000 to $8,844,000 in 2001. Greater premium volume drove a $1,179,000 increase in commission payments and a $399,000 increase in premium taxes. These increases were partially offset by greater ceding commissions earned by Midwest Medical of approximately $243,000 resulting from the increase in premiums ceded to the excess component of the treaty reinsurance contract for the current year.

Other operating expenses increased $1,213,000 from $6,901,000 in 2001 to $8,114,000 in 2002. Medical Solutions drove $976,000 of the increase from supplier and staff costs primarily to sell, install and support electronic practice management and electronic medical records software. Medical Solutions also incurred an additional $107,000 of rent expense from leasing separate office space beginning December 2001. Launching Office Solutions in 2002 increased other operating expenses by another $149,000.

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Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)

Other operating expenses increased $79,000 from $6,822,000 in 2000 to $6,901,000 in 2001. Additional staff for Medical Solutions’ technology consulting services and practice management software initiatives and greater commissions paid to Benefits’ producers for new business primarily drove the increase. This was partially offset by the decrease in stock restructure expenses, which were all incurred in 2000 by Midwest Holding.

Loss from continuing operations before income taxes was $(6,120,000) in 2002 compared to $(6,448,000) in 2001. Greater premiums earned and other revenues, along with no policyholder dividends being declared, helped to reduce the loss in 2002. This was partially offset by greater loss liabilities estimated for the current year, unfavorable development on prior years’ loss liabilities, lower realized capital gains and greater operating expenses incurred to support the growth in revenues.

Loss from continuing operations before income taxes was $(6,448,000) in 2001 compared to income of $6,022,000 in 2000. The decrease resulted primarily from greater loss liabilities estimated for the current year, less favorable development on prior years’ loss liabilities and lower realized capital gains. This was partially offset by an increase in net premiums earned and lower policyholder dividends. Income in 2000 also benefited from some nonrecurring items such as the realized capital gains recorded on sales of domestic equity securities to fund the stock restructure as well as interest on federal tax refunds.

Income taxes decreased $342,000 resulting in an income tax benefit of $(2,564,000) for 2002 compared to an income tax benefit of $(2,222,000) for 2001. The effective tax benefit rates for 2002 and 2001 were 41.9% and 34.5%, respectively. The increase in the income tax benefit is primarily due to Midwest Medical receiving a $443,000 tax refund in the third quarter of 2002. This refund resulted from amending the 1997 tax return to address issues carried over from the 1992–1996 Internal Revenue Service examination.

Income taxes decreased $2,659,000, resulting in an income tax benefit of $(2,222,000) for 2001 compared to an income tax expense of $437,000 for 2000. The effective tax rates for 2001 and 2000 were 34.5% and 7.3%, respectively. The principal factor in the increase in the effective tax rate was a recovery of prior year taxes recorded in 2000. The tax recovery in 2000 was primarily due to federal tax refunds received by Midwest Medical from the Internal Revenue Service for the 1992 to 1996 tax years.

Discontinued operations represent the impact of the sale of MedPower effective July 31, 2001. The Company decided to sell MedPower as continued strong competition in the electronic medical claims processing marketplace diminished the prospect of generating sufficient revenues for MedPower to earn a profit. The Company incurred a loss net of tax of $(135,000) on the 2001 operation of MedPower through July 31 and recorded a loss net of tax of $(240,000) on the sale. Further information regarding MedPower and its sale is found in Notes 1 and 2 to the audited consolidated financial statements.

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Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)

Net (loss) income recorded by the Company increased $1,045,000 to a net loss of $(3,556,000) in 2002 and decreased $(9,887,000) to a net loss of $(4,601,000) in 2001 due to the factors discussed above.

Critical Accounting Policies

The discussion and analysis of the Company’s consolidated financial position and results of operations are based upon the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires estimation and judgment that affect the reported amounts of assets, liabilities, revenues and expenses. Management bases its estimates on historical experience, outside actuarial analyses and on various other assumptions that are believed to be reasonable under the circumstances. The results form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Following are the Company’s most critical accounting policies that affect significant areas and involve judgment and estimates. If these estimates differ materially from actual results, the impact to the consolidated financial statements may be material.

Premium Revenue Recognition

Premiums written are primarily earned on a daily pro rata basis over the terms of the policies to which they apply. A portion of premiums written is deferred to recognize Midwest Medical’s obligation to provide reporting endorsement coverage without additional premium upon the death, disability or retirement of policyholders. This amount is recorded as an unearned premium reserve and represents an actuarial estimate of the present value of future benefits to be provided less the present value of future revenues to be received. The actuarial estimate involves making assumptions with respect to the Company’s physician population including mortality and future premium costs.

Unpaid Losses and Loss Adjustment Expenses

The liability for unpaid losses and loss adjustment expenses represents management’s best estimate of the ultimate cost of all such amounts that are unpaid at the balance sheet dates. The liability is based on both case-by-case estimates and statistical analysis and projections using the historical loss experience of Midwest Medical and gives effect to estimates of trends in claim severity and frequency. Midwest Medical utilizes an independent actuary in establishing its liability for unpaid losses and loss adjustment expenses. Establishing an appropriate liability is an inherently uncertain process as the ultimate liability may be greater or less than the amount provided. Any increase in the amount, including liabilities for insured events of prior years, could have a material adverse effect on the results of operations for the period in which any adjustment is made.

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Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)

Investments

Although management believes the Company has the ability to hold its fixed maturity investment portfolio to maturity, all investments, including fixed maturities, are classified as “available for sale,” as management may take advantage of opportunities to increase total return through sales of selected securities in response to changing market conditions. As a result, the Company’s investments are carried at fair value, with unrealized holding gains and losses reflected as a component of other comprehensive income, net of applicable deferred taxes. Fair values for fixed maturities and equity securities are based on quoted market prices or independent pricing services. The international equity limited partnership is recorded at its net asset value and the real estate investment trust is recorded at appraised value.

Realized gains and losses on sales of investments are reported on a pretax basis as a component of income and are determined on the specific identification basis. When evidence indicates a decline, judged to be other-than-temporary, in the underlying value or earning power of individual investments, such investments are written down to fair value by recording a realized investment loss. Factors that management may consider in determining whether an other-than-temporary impairment condition exists include:

	•		whether a market decline is attributable to specific adverse conditions for a particular investment
	•		whether a market decline is attributable to general market conditions that reflect prospects of the economy as a whole or prospects of a particular industry
	•		the length of time and the extent to which fair value has been less than amortized cost
	•		the financial condition of the issuer
	•		the intent and ability of management to retain the investment for a period of time sufficient to allow for prudent anticipation of a recovery in market value
	•		whether dividends have been reduced or eliminated or scheduled interest payments on debt securities have not been made

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Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)

Income Taxes

Income taxes are accounted in accordance with Statement of Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes. Accounting for income taxes involves estimating the Company’s current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in the consolidated balance sheets. Management must then assess the likelihood that the deferred tax assets will be recovered from future taxable income. To the extent that a recovery is believed to be not likely, management is required to establish a valuation allowance. To the extent a valuation allowance is established or changed in a period, an expense or benefit is recognized within the provision for income taxes in the consolidated statements of income.

Significant judgment is required in determining the provision for income taxes, deferred tax assets and liabilities and any valuation allowance recorded against the deferred tax assets. Based on estimates of future taxable income, management has judged that it is more likely than not that the Company will realize the benefit of the deferred tax assets and therefore has not established a valuation allowance. In the event that actual results differ from these estimates or these estimates are adjusted in future periods, a valuation allowance may need to be established, which could materially affect the Company’s financial position and results of operations.

Reinsurance

Midwest Medical purchases reinsurance in order to reduce its liability on individual risks and to enable it to write business at limits it otherwise would be unable to accept. Reinsurance contracts are principally excess-of-loss contracts, which indemnify Midwest Medical for losses in excess of a stated retention limit up to the policy limits. Reinsurance costs are recorded as a reduction of premium, which is referred to as ceded premium.

Midwest Medical, with the assistance of its reinsurance broker, analyzes the credit quality of its reinsurers. To date, Midwest Medical has not experienced any material difficulties in collecting reinsurance recoverables. No assurances can be given, however, regarding the future ability of any of Midwest Medical’s reinsurers to meet their obligations. To the extent any reinsurer is unable to meet their obligations, Midwest Medical would become liable for the reinsuring company’s losses under the reinsurance agreement. This possibility is mitigated by collateral that Midwest Medical holds in the form of letters of credit under the related reinsurance agreement. Midwest Medical can draw upon the letters of credit in the event the applicable reinsuring company is unable to pay its obligation.

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Other Matters

In accordance with Section 10A of the Securities Exchange Act of 1934, as amended by Section 202 of the Sarbanes-Oxley Act of 2002, non-audit services approved by the Audit Committee of the Board of Directors at its December 2002 and February 2003 meetings and to be performed by Ernst & Young LLP, the Company’s independent auditors, are (1) tax compliance and planning services and (2) business risk assessment services.

Inflation

Management considers inflation in pricing and estimating the liability for unpaid losses and loss adjustment expenses. Inflation can have an impact on medical malpractice claims where there is a long period of time from when the claim is reported to when it is settled. The actual effect of inflation on the Company’s results cannot be accurately known until claims are ultimately settled. The Company believes that its premium rate-making process and its evaluation of the liability for unpaid losses and loss adjustment expenses adequately address the effects of inflation.

Item 7a. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk is the risk of loss that may occur when fluctuations in interest and foreign currency exchange rates and equity and commodity prices change the value of a financial instrument. Both derivative and nonderivative financial instruments have market risk. The Company is primarily exposed to interest rate risk on its investment in fixed maturities, equity price risk on its investment in equity securities and the international equity limited partnership and foreign currency exchange rate risk on its investment in the international equity limited partnership.

Professional outside investment firms manage the Company’s investment portfolios according to the objectives and parameters set by the Company’s investment policy as approved by the Investment Committee of the Board of Directors. Under the current investment policy, the only derivative instrument the Company may use is covered call options. A call option gives the purchaser a right to buy a stock at a specified price within a specified time. The Company’s domestic equity investment manager may write call options on equity securities the Company owns (a “covered” call option) to manage exposure to equity price risk and enhance investment returns. No covered call options were written or outstanding in 2002 or 2001.

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Item 7a. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK (continued)

Based on the effective duration of the fixed maturity investment portfolio, an abrupt 100-basis-point increase in interest rates along the entire interest rate yield curve would adversely affect the fair value of fixed maturity investments by approximately $5,100,000 at December 31, 2002, compared to $5,800,000 at December 31, 2001.

Based on past annual performance relative to the Standard & Poor’s 500 Market Index (S&P 500), an abrupt 10% decrease in the S&P 500 would adversely affect the fair value of the Company’s investment in domestic equity securities by approximately $4,300,000 at December 31, 2002, compared to $6,000,000 at December 31, 2001.

Based on past annual performance relative to the Morgan Stanley Capital International Europe, Australasian, Far East Market Index (MSCI EAFE), an abrupt 10% decrease in the MSCI EAFE would adversely affect the fair value of the Company’s investment in the international equity limited partnership by approximately $500,000 at December 31, 2002, compared to $400,000 for the Company’s investment in international equity securities at December 31, 2001.

A hypothetical 10% weakening of all foreign currencies relative to the United States dollar would adversely affect the fair value of the Company’s investment in the international equity limited partnership by approximately $1,700,000 at December 31, 2002, compared to $1,800,000 for the Company’s investment in international equity securities at December 31, 2001.

The Company believes that none of the above scenarios would have a material effect on its net income and cash flows. This belief does not consider the possible impact of changes in economic activity that could result under each of the above scenarios. Investors, customers, regulators and legislators could respond to these fluctuations in ways the Company cannot foresee. Because the Company cannot be certain what specific actions would be taken and their effects, the above sensitivity analyses assume no significant changes in the Company’s financial structure.

Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The audited consolidated financial statements of Midwest Medical Insurance Holding Company and Subsidiaries are presented on the following pages 33 through 60 of this Annual Report on Form 10-K.

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Midwest Medical Insurance Holding Company and Subsidiaries

Consolidated Financial Statements

Years Ended December 31, 2002, 2001 and 2000

Contents

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Report of Independent Auditors

The Board of Directors
Midwest Medical Insurance Holding Company
      and Subsidiaries

We have audited the accompanying consolidated balance sheets of Midwest Medical Insurance Holding Company and Subsidiaries (the Company) as of December 31, 2002 and 2001 and the related consolidated statements of income, changes in shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2002. Our audits also included the financial statement schedules listed in the index at Item 15(a). These financial statements and schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States. 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 Midwest Medical Insurance Holding Company and Subsidiaries at December 31, 2002 and 2001 and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.

/s/ Ernst & Young LLP

Minneapolis, Minnesota
February 4, 2003

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Table of Contents

Midwest Medical Insurance Holding Company and Subsidiaries

Consolidated Balance Sheets

(In Thousands, Except for Share Amounts)