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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
(Mark One)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the Quarter Ended September 30, 2003
[ ] Transition report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the Period From _________ to __________.
Commission File Number: 001-14593
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THE MIIX GROUP, INCORPORATED
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(Exact name of Registrant as specified in its charter)
Delaware 22-3586492
- ------------------------------- ---------------------------------------
(State or other jurisdiction of (I.R.S. employer identification number)
incorporation or organization)
Two Princess Road, Lawrenceville, New Jersey 08648
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(Address of principal executive offices and zip code)
(609) 896-2404
----------------------------------------------------
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, par value $0.01 per share
---------------------------------------
Securities registered pursuant to Section 12(g) of the Act: None
----
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 as the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
YES [X] NO [ ]
Indicate by check mark whether the Registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act).
YES [ ] NO [X]
As of November 11, 2003, the number of outstanding shares of the
Registrant's Common Stock was 14,564,143.
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TABLE OF CONTENTS
- -----------------
PART I FINANCIAL INFORMATION............................................4
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS................................4
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.......................................13
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK......22
ITEM 4. CONTROLS AND PROCEDURES.........................................23
PART II OTHER INFORMATION...............................................23
ITEM 1. LEGAL PROCEEDINGS...............................................23
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K................................25
SIGNATURES ..................................................................26
2
FORWARD-LOOKING STATEMENTS
This Form 10-Q contains forward-looking statements that are based on the
Company's estimates and expectations concerning future events and anticipated
results and are subject to certain risks and uncertainties that could cause
actual results to differ materially from those reflected in the forward-looking
statements. These forward-looking statements are subject to uncertainties and
other factors that could cause actual results to differ materially from such
statements. In particular, the Company's ability to manage successfully the
solvent runoff of its business is subject to a number of contingencies and
uncertainties. These uncertainties and other factors are detailed from time to
time in the Company's filings with the appropriate securities commissions, and
include, without limitation, the Company having sufficient liquidity and working
capital, the performance of the Company's investment portfolio, the Company's
ability to manage claims, maintaining existing reinsurance agreements at
reasonable terms, the Company's ability to diversify its product lines, the
continued adequacy of the Company's loss and loss adjustment expense reserves,
the Company's avoidance of any material loss on collection of reinsurance
recoverables, adverse actions of applicable regulatory agencies, general
economic conditions, including changing interest rates, rates of inflation and
the performance of the financial markets, adverse judicial decisions and
rulings, changes in domestic and foreign laws, regulations and taxes, effects of
acquisitions and divestitures and various other factors. The words "believe,"
"expect," "anticipate," "project" and similar expressions identify
forward-looking statements. The Company's expectations regarding future
earnings, growth initiatives, underwriting, cost controls, adequacy of loss and
loss adjustment expense reserves, and enhancing shareholder value depend on a
variety of factors, including economic, competitive and market conditions which
may be beyond the Company's control and are thus difficult or impossible to
predict. In light of the significant uncertainties inherent in the
forward-looking information herein, the inclusion of such information should not
be regarded as representation by the Company or any other person that the
Company's objectives or plans will be realized. Readers are cautioned not to
place undue reliance on these forward-looking statements, which speak only as of
their dates. The Company undertakes no obligation to publicly update or revise
any forward-looking statements, whether as a result of new information, future
events or otherwise.
3
PART I FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
INDEPENDENT ACCOUNTANTS' REVIEW REPORT
Board of Directors
The MIIX Group, Incorporated
We have reviewed the accompanying consolidated balance sheet of The MIIX Group,
Incorporated as of September 30, 2003, the related consolidated statements of
income for the three and nine month periods ended September 30, 2003 and 2002,
the consolidated statement of equity for the nine month period ended September
30, 2003 and the consolidated statements of cash flows for the nine month
periods ended September 30, 2003 and 2002. These consolidated financial
statements are the responsibility of the Company's management.
We conducted our reviews in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data, and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted in
accordance with auditing standards generally accepted in the United States,
which will be performed for the full year with the objective of expressing an
opinion regarding the financial statements taken as a whole. Accordingly, we do
not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should
be made to the accompanying consolidated financial statements for them to be in
conformity with accounting principles generally accepted in the United States.
We have previously audited, in accordance with auditing standards generally
accepted in the United States, the consolidated balance sheets of The MIIX
Group, Incorporated as of December 31, 2002 and 2001, and the related
consolidated statements of income, stockholders' equity and cash flows for each
of the three years in the period ended December 31, 2002, not presented herein,
and in our report dated March 21, 2003, we expressed an unqualified opinion on
those consolidated financial statements; however, we referred in our report to
disclosures in the Notes to the December 31, 2002 consolidated financial
statements the potential consequences of which raised substantial doubt about
the Company's ability to continue as a going concern. In our opinion, the
information set forth in the accompanying consolidated balance sheet as of
December 31, 2002, is fairly stated, in all material respects, in relation to
the consolidated balance sheet as of December 31, 2002, from which it has been
derived.
ERNST & YOUNG LLP
Philadelphia, Pennsylvania
October 31, 2003
4
THE MIIX GROUP, INCORPORATED
CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
September 30, December 31,
----------- -----------
2003 2002
----------- -----------
ASSETS (Unaudited)
Securities available-for-sale:
Fixed-maturity investments, at fair value (amortized cost: 2003 - $722,134;
2002 - $771,414) $ 734,089 $ 788,580
Equity investments, at fair value (cost: 2003 - $2,781; 2002 - $4,804) 3,198 5,187
Short-term investments, at cost which approximates fair value .................. 105,059 262,537
----------- -----------
Total investments ........................................................ 842,346 1,056,304
Cash .............................................................................. 17,476 4,667
Accrued investment income ......................................................... 7,221 8,339
Premium receivable, net ........................................................... 739 7,602
Reinsurance recoverable on unpaid losses .......................................... 335,637 457,005
Prepaid reinsurance premiums ...................................................... 0 3,053
Reinsurance recoverable on paid losses, net ....................................... 36,495 31,822
Deferred policy acquisition costs ................................................. 0 1,016
Receivable for securities ......................................................... 28,626 0
Other assets ...................................................................... 44,832 47,055
----------- -----------
Total assets ............................................................. $ 1,313,372 $ 1,616,863
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Unpaid losses and loss adjustment expenses ........................................ $ 920,079 $ 1,151,635
Unearned premiums ................................................................. 425 25,262
Premium deposits .................................................................. 0 209
Funds held under reinsurance treaties ............................................. 243,908 332,741
Payable for securities ............................................................ 42,849 0
Other liabilities ................................................................. 50,290 65,750
----------- -----------
Total liabilities ........................................................ 1,257,551 1,575,597
----------- -----------
Commitments and Contingent Liabilities
Stockholders' Equity
Preferred stock, $0.01 par value, 50,000,000 shares authorized, no shares
issued and outstanding ......................................................... 0 0
Common stock, $0.01 par value, 100,000,000 shares authorized, 16,538,005 shares
issued (2003 - 14,564,143 shares outstanding; 2002 - 13,382,173 shares
outstanding) ................................................................... 166 166
Additional paid-in capital ........................................................ 40,270 53,909
Retained earnings ................................................................. 35,016 13,323
Treasury stock, at cost (2003 - 1,973,862 shares; 2002 - 3,155,832 shares) ........ (25,038) (40,199)
Stock purchase loans and unearned stock compensation .............................. (4,803) (3,662)
Accumulated other comprehensive income ............................................ 10,210 17,729
----------- -----------
Total stockholders' equity ............................................... 55,821 41,266
----------- -----------
Total liabilities and stockholders' equity ............................... $ 1,313,372 $ 1,616,863
=========== ===========
SEE ACCOMPANYING NOTES
5
THE MIIX GROUP, INCORPORATED
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts)
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------- ----------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
Revenues
Net premiums earned ................................. $ 1,989 $ 23,727 $ 29,126 $ 109,963
Net investment income ............................... 7,839 13,710 27,699 48,117
Realized investment gains (losses) .................. 2,595 (591) 4,950 (1,872)
Other revenue ....................................... 1,879 1,368 5,002 5,651
------------ ------------ ------------ ------------
Total revenues ................................. 14,302 38,214 66,777 161,859
------------ ------------ ------------ ------------
Expenses
Losses and loss adjustment expenses (recoveries) .... (3,844) 21,219 17,719 157,520
Underwriting expenses ............................... 4,287 5,987 14,706 27,351
Funds held charges .................................. 4,984 9,539 14,662 31,826
Other expenses ...................................... 162 584 631 2,254
Restructuring charge ................................ 0 0 0 2,552
------------ ------------ ------------ ------------
Total expenses ................................. 5,589 37,329 47,718 221,503
------------ ------------ ------------ ------------
Income (loss) before income taxes ................... 8,713 885 19,059 (59,644)
Income tax provision (benefit) ...................... 1,679 0 (2,634) (11,416)
------------ ------------ ------------ ------------
Net income (loss) before cumulative effect
of an accounting change ..................... 7,034 885 21,693 (48,228)
Cumulative effect of an accounting change,
net of tax .................................. 0 0 0 (2,373)
------------ ------------ ------------ ------------
Net income (loss) .............................. $ 7,034 $ 885 $ 21,693 $ (50,601)
============ ============ ============ ============
Basic and diluted earnings (loss) per share before
cumulative effect of an accounting change ......... $ 0.52 $ 0.07 $ 1.62 $ (3.60)
Cumulative effect of an accounting change ........... 0.00 0.00 0.00 (0.18)
------------ ------------ ------------ ------------
Basic and diluted earnings (loss) per share ......... $ 0.52 $ 0.07 $ 1.62 $ (3.78)
============ ============ ============ ============
Dividend per share of common stock .................. $ 0.00 $ 0.00 $ 0.00 $ 0.00
============ ============ ============ ============
SEE ACCOMPANYING NOTES
6
THE MIIX GROUP, INCORPORATED
CONSOLIDATED STATEMENT OF EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003
(In thousands, except share amounts)
(Unaudited)
Stock
Purchase
Loans and Accumulated
Number of Additional Unearned Other Total
Shares Common Paid-In Retained Treasury Stock Comprehensive Stockholders'
Outstanding Stock Capital Earnings Stock Compensation Income (Loss) Equity
----------- ----------- ----------- ----------- ----------- ----------- ----------- -------------
Balance at
January 1, 2003 ....... 13,382,173 $ 166 $ 53,909 $ 13,323 $ (40,199) $ (3,662) $ 17,729 $ 41,266
Net income .......... 21,693 21,693
Other comprehensive
income (loss),
net of tax: .......
Net unrealized
appreciation
on securities
available-for-sale,
net of deferred
taxes ............. (7,519) (7,519)
Stock purchase and
loan agreement
activities ........ (8,922) (8) 99 91
Stock compensation
and treasury
stock activity .... 1,190,892 (13,639) 15,169 (1,240) 290
----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
Balance at
September 30, 2003 .... 14,564,143 $ 166 $ 40,270 $ 35,016 $ (25,038) $ (4,803) $ 10,210 $ 55,821
=========== =========== =========== =========== =========== =========== =========== ===========
SEE ACCOMPANYING NOTES
7
THE MIIX GROUP, INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Nine Months Ended
September 30,
------------------------
2003 2002
---------- ----------
Cash Flows from Operating Activities
Net income (loss) .............................................................. $ 21,693 $ (50,601)
Adjustments to reconcile net income (loss) to net cash provided by operating
activities:
Cumulative effect of an accounting change, net of tax .......................... 0 2,373
Realized (gains) losses ........................................................ (4,950) 1,872
Depreciation, accretion and amortization ....................................... 2,738 (1,442)
Changes in:
Unpaid losses and loss adjustment expenses ................................ (231,556) (67,179)
Unearned premiums ......................................................... (24,837) (39,762)
Premium deposits .......................................................... (209) (18,928)
Premium receivable, net ................................................... 6,863 (448)
Reinsurance balances, net ................................................. 30,915 2,504
Deferred policy acquisition costs ......................................... 1,016 2,541
Accrued investment income ................................................. 1,118 3,857
Net investment in direct financing leases ................................. 0 32,101
Other assets .............................................................. (119) 13,333
Other liabilities ......................................................... (15,078) (19,032)
---------- ----------
Net cash used in operating activities .......................................... (212,406) (138,811)
---------- ----------
Cash Flows from Investing Activities
Proceeds from fixed-maturity investment sales .................................. 442,099 742,679
Proceeds from fixed-maturity investments matured, called or prepaid ............ 164,855 109,880
Proceeds from equity investment sales .......................................... 2,023 387
Cost of investments acquired ................................................... (555,462) (615,258)
Change in short-term investments, net .......................................... 157,477 (77,321)
Net payable (receivable) for securities ........................................ 14,223 (11,438)
---------- ----------
Net cash provided by investing activities ...................................... 225,215 148,929
---------- ----------
Cash Flows from Financing Activities
Repayment of notes payable and other borrowings ................................ 0 (10,699)
---------- ----------
Net cash used in financing activities .......................................... 0 (10,699)
---------- ----------
Net change in cash ............................................................. 12,809 (581)
Cash, beginning of period ...................................................... 4,667 2,029
---------- ----------
Cash, end of period ............................................................ $ 17,476 $ 1,448
========== ==========
SEE ACCOMPANYING NOTES
8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. BASIS OF PRESENTATION
- --------------------------
The accompanying consolidated financial statements include the accounts and
operations of The MIIX Group, Incorporated (The "MIIX Group") and its
wholly-owned subsidiaries, MIIX Insurance Company ("MIIX"), Lawrenceville
Holdings, Inc. ("LHI"), Lawrenceville Property and Casualty Company ("LP&C"),
MIIX Insurance Company of New York ("MIIX New York") and New Jersey State
Medical Underwriters, Inc. and its wholly-owned subsidiaries ("Underwriters"),
collectively (the "Company"). The consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States for interim financial information, and in the opinion of
management, reflect all adjustments (recurring and non-recurring) considered
necessary for a fair presentation. Operating results for the interim period are
not necessarily indicative of the results to be expected for the full year.
These consolidated financial statements and notes should be read in conjunction
with the audited consolidated financial statements and notes of the Company for
the year ended December 31, 2002, which were filed with the Securities and
Exchange Commission on Form 10-K.
2. RECENT DEVELOPMENTS
- ------------------------
The Company has been subjected to a number of adverse developments as a result
of unexpected and unprecedented increases in loss and loss adjustment expense
("LAE") reserves during fiscal years 2002, 2001 and 2000 related to prior years'
experience. These increases have required the Company to increase loss reserves
in each of the last three years. For a more detailed discussion of these events,
see our Annual Report on Form 10-K for 2002.
As a result of the net losses reported in 2001, two of the Company's operating
subsidiaries triggered Risk Based Capital ("RBC") events requiring the filing of
a corrective action plan with each state of domicile. As a result, both
companies, MIIX and LP&C, entered solvent runoff. For a more detailed
description of these events, see our Annual Report on Form 10-K for 2002.
At December 31, 2002, MIIX's total adjusted capital was $18.7 million, which is
substantially below the Mandatory Control Level. MIIX requested approval from
the New Jersey Department of Banking and Insurance ("New Jersey Department") to
discount loss and LAE reserves and to merge LP&C into MIIX. Similarly, LP&C
requested approval from the Virginia Bureau of Insurance ("Virginia Bureau") to
merge LP&C into MIIX.
The request to discount MIIX's loss and LAE reserves on a statutory basis as of
December 31, 2002 was approved by the New Jersey Department. The permissible
discount rate was three (3) percent. MIIX's RBC level will not be impacted by
the ability to discount loss and LAE reserves, as the National Association of
Insurance Commissioners ("NAIC") standards do not permit discounting of loss and
LAE reserves to be taken into account in the calculation of RBC. The discounting
of MIIX's reserves resulted in an increase to MIIX's statutory surplus, bringing
total surplus to $72.3 million as of December 31, 2002.
While the requests to merge LP&C into MIIX remain pending with the regulators,
potential issues associated with the guaranty funds post-merger have been
addressed by most affected states. The Company continues in its efforts to merge
the two companies before year-end 2003.
On February 19, 2003, MIIX agreed to certain operating limitations with the New
Jersey Department. The limitations include a requirement for approval by the New
Jersey Department prior to MIIX incurring new debt, paying dividends or
investing in below investment grade assets.
On May 1, 2003, MIIX entered into an Order with the New Jersey Department that
sets forth the framework for the regulatory monitoring of MIIX. The Order is
consistent with the February 19, 2003 letter agreement of the parties, whereby
MIIX agreed to certain limitations on operations. The limitations, among other
things, require the approval of the New Jersey Department prior to payment of
dividends by the Company's insurance subsidiary, and for lending arrangements,
investments and inter-company arrangements outside of the normal course of
business, and requires
9
MIIX to periodically provide information relating to its operations and finances
to the New Jersey Department. See "Risks and Uncertainties."
The trading of The MIIX Group's common stock was suspended at the opening of
business on April 28, 2003. The New York Stock Exchange ("NYSE") had determined
that The MIIX Group's market capitalization and stockholders' equity were below
NYSE listing thresholds. The MIIX Group was considered "below criteria" as its
total capitalization was less than $50 million over a 30-day trading period and
stockholders' equity was less than $50 million. The MIIX Group's common stock
has commenced trading on the Over-The-Counter ("OTC") Bulletin Board under the
ticker symbol "MIIX." See "Risks and Uncertainties."
The Company continues to explore any strategic alternatives that may realize
value for its shareholders, including seeking purchasers for all or portions of
its remaining assets.
3. STOCK BASED COMPENSATION
- -----------------------------
The Company accounts for its stock-based compensation in accordance with
Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees ("APB 25") and related interpretations. Under APB 25, because the
exercise price of the Company's employee stock options equals the market price
of the underlying stock on the date of grant, no compensation expense is
recognized. During the nine months ended September 30, 2003, 38,671 options were
cancelled and 0 options were exercised. During the nine months ended September
30, 2003, a former officer tendered 8,922 shares of The MIIX Group common stock
and reduced his stock purchase and loan balance to $0. All transactions were
recorded at the fair value of The MIIX Group common stock on the effective dates
of the transactions.
The following table illustrates the effect on net income and earnings per share
if the Company had applied the fair value recognition provisions of Statement of
Financial Accounting Standard ("SFAS") No. 123, "Accounting for Stock-Based
Compensation to Stock-Based Employee Compensation" for the nine months ended
September 30:
2003 2002
---------- ----------
(In thousands, except per share amounts)
----------------------------------------
Net income (loss), as reported $ 21,693 $ (50,601)
Total stock-based employee compensation expense
determined under fair value based method for all
awards, net of related tax effects 33 (225)
---------- ----------
Pro forma net gain (loss) $ 21,726 $ (50,826)
========== ==========
Basic earnings (loss) per share:
As reported $ 1.62 $ (3.78)
Pro forma 1.62 (3.80)
Diluted earnings (loss) per share:
As reported $ 1.62 $ (3.78)
Pro forma 1.62 (3.80)
Estimated weighted average of the fair value
of options granted $ 0.00 $ 0.62
The per share weighted-average fair value of stock options was estimated at each
date of grant using a Black-Scholes option pricing model using the following
assumptions: risk-free interest rates ranging from 1.7% to 6.8%; dividend yields
ranging from 0% to 2.7%; volatility factors of the expected market price of The
MIIX Group's common stock ranging from 34.5% to 38.1%; and a three-year weighted
average expected life of the options.
10
4. EARNINGS PER SHARE
- -----------------------
Basic earnings (loss) per share are computed using the weighted-average number
of common shares outstanding of 13,451,600 and 13,469,760 for the three months
ended September 30, 2003 and 2002, respectively, and 13,395,018 and 13,389,488
for the nine months ended September 30, 2003 and 2002, respectively.
Diluted earnings (loss) per share are computed using the weighted-average number
of common shares outstanding of 13,451,600 and 13,479,760 for the three months
ended September 30, 2003 and 2002, respectively, and 13,395,018 and 13,478,387
for the nine months ended September 30, 2003 and 2002, respectively.
The following table sets forth the computation of basic and diluted earnings per
share:
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- -----------------------
2003 2002 2003 2002
---------- ---------- ---------- ----------
(in thousands) (in thousands)
Numerator for basic and diluted earnings (loss) per
share of common stock:
Net income (loss) before cumulative effect of
an accounting change ......................... $ 7,034 $ 885 $ 21,693 $ (48,228)
Cumulative effect of an accounting change,
net of tax ................................... 0 0 0 (2,373)
---------- ---------- ---------- ----------
Net income (loss) ............................... $ 7,034 $ 885 $ 21,693 $ (50,601)
========== ========== ========== ==========
Denominator:
Denominator for basic earnings (loss) per share
of common stock - weighted-average shares
outstanding .................................. 13,452 13,470 13,395 13,389
Effect of dilutive securities:
Stock options and nonvested restricted stock .... 0 10 0 89
---------- ---------- ---------- ----------
Denominator for diluted earnings (loss) per share
of common stock - adjusted weighted-average
shares outstanding ........................... 13,452 13,480 13,395 13,478
========== ========== ========== ==========
Basic and diluted earnings (loss) per share of
common stock before cumulative effect of an
accounting change .................................. $ 0.52 $ 0.07 $ 1.62 $ (3.60)
Cumulative effect of an accounting change ............ 0.00 0.00 0.00 (0.18)
---------- ---------- ---------- ----------
Basic and diluted earnings (loss) per share of
common stock ....................................... $ 0.52 $ 0.07 $ 1.62 $ (3.78)
========== ========== ========== ==========
5. COMPREHENSIVE INCOME
- -------------------------
The Company has classified its entire investment portfolio as
available-for-sale. Unrealized gains (losses) at September 30, 2003 and December
31, 2002, except those determined to be other-than-temporary, are reflected as
accumulated other comprehensive income in the consolidated statement of equity
and consolidated balance sheets.
11
The components of comprehensive income (loss), net of related tax, for the
periods ended September 30, 2003 and 2002 are as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ ------------------------
2003 2002 2003 2002
---------- ---------- ---------- ----------
(in thousands) (in thousands)
Net income (loss) ....................................... $ 7,034 $ 885 $ 21,693 $ (50,601)
Other comprehensive income (loss):
Unrealized holding appreciation (depreciation) arising
during period (net of tax) ......................... (4,643) 15,079 (2,569) 17,412
Reclassification adjustment for (gains) losses realized
in net income (loss) (net of tax) .................. (2,595) 591 (4,950) 1,872
---------- ---------- ---------- ----------
Net unrealized appreciation (depreciation) arising during
the period ended September 30 (net of tax) ......... (7,238) 15,670 (7,519) 19,284
---------- ---------- ---------- ----------
Comprehensive income (loss) ............................. $ (204) $ 16,555 $ 14,174 $ (31,317)
========== ========== ========== ==========
6. DEFERRED POLICY ACQUISITION COSTS
- --------------------------------------
The following represents the components of deferred policy acquisition costs and
the amounts that were charged to expense for the nine months ended September 30,
2003 and 2002.
Nine Months Ended
September 30,
-------------------------
2003 2002
---------- ----------
(in thousands)
Balance at beginning of period ................... $ 1,016 $ 4,416
Cost deferred during the period .................. 453 4,862
Amortization expense ............................. (1,469) (7,403)
---------- ----------
Balance at end of period ......................... $ 0 $ 1,875
========== ==========
7. RESTRUCTURING CHARGE
- -------------------------
The first quarter of 2002 included a charge of approximately $2.6 million
composed primarily of severance and the write-off of remaining lease commitments
associated with the closure of the Company's offices in Dallas and Indianapolis,
and the decision to put MIIX and LP&C into runoff. As of September 30, 2003, the
remaining accrual for restructuring charges was $0.2 million. No similar event
occurred during the nine months ended September 30, 2003.
12
8. INCOME TAXES
- -----------------
A reconciliation of income taxes computed based on the expected annual effective
federal statutory tax rate to total income tax expense (benefit) before the
cumulative effect of an accounting change for the periods ended September 30,
2003 and 2002 are as follows:
Nine Months Ended September 30,
-------------------------------------------------------------
2003 2002
---------------------------- ----------------------------
% of Income % of Income
Before Before
Income Taxes Income Taxes Income Taxes Income Taxes
------------ ------------ ------------ ------------
(in thousands) (in thousands)
Expected annual effective federal
income tax expense (benefit)
at 35% ........................ $ 6,671 35.0 % $ (20,875) (35.0)%
Increase (decrease) in taxes
resulting from:
Valuation allowance ........... (9,502) (49.8)% 8,757 14.7 %
Tax-exempt interest ........... 0 0.0 % (444) (0.7)%
Other ......................... 197 1.0 % 1,146 1.9 %
------------ ------------ ------------ ------------
Total income tax benefit .......... $ (2,634) (13.8)% $ (11,416) (19.1)%
============ ============ ============ ============
The income tax benefit of $2.6 million for the nine months ended September 30,
2003 primarily reflects the change in the deferred tax valuation allowance
resulting from changes in deferred taxes on unrealized portfolio gains, as well
as the utilization of the Company's net operating loss carryforward.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the financial
statements and the related notes thereto appearing elsewhere in this Form 10-Q.
CRITICAL ACCOUNTING POLICIES
The Company's discussion and analysis of its financial condition and results of
operations are based upon the Company's consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States. The preparation of these financial statements requires
management to make estimates and judgments that affect the reporting amounts of
assets, liabilities, revenues and expenses and related disclosures of contingent
assets and liabilities. On an on-going basis, management evaluates its
estimates, including those related to income taxes, loss and LAE reserves,
contingencies and litigation. The Company bases its estimates on historical
experience and on various other assumptions that are believed to be reasonable
under the circumstances, the results of which form the basis for making
judgments about the carrying values of assets and liabilities that are not
readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions.
The Company believes the following critical accounting policies affect its more
significant judgments and estimates used in the preparation of its consolidated
financial statements:
REINSURANCE. Reinsurance recoverables include the balances due from reinsurance
companies for paid and unpaid losses and LAE that will be recovered from
reinsurers, based on contracts in force. Amounts recoverable from reinsurers are
estimated in a manner consistent with the claim liability associated with the
reinsured policy. Reinsurance contracts do not relieve the Company from its
primary obligations to policyholders. Failure of reinsurers to honor their
obligations could result in losses to the Company. The Company evaluates the
financial condition of its reinsurers and monitors concentrations of credit risk
with respect to the individual reinsurers, which participate in
13
its ceded programs to minimize its exposure to significant losses from reinsurer
insolvencies. The Company holds collateral in the form of letters of credit or
trust accounts for amounts recoverable from reinsurers that are not designated
as authorized reinsurers by the domiciliary Departments of Insurance.
INCOME TAXES. The Company accounts for income taxes in accordance with SFAS No.
109, "Accounting for Income Taxes." Deferred tax assets and liabilities are
recognized for the future tax consequences attributable to temporary differences
between the financial statement carrying amounts of existing assets and
liabilities and their respective tax bases and operating loss and tax credit
carryforwards. Deferred tax assets and liabilities are measured using enacted
tax rates expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled. The effect on
deferred tax assets and liabilities of a change in tax rates is recognized in
income in the period that includes the enactment date. A valuation allowance
against deferred tax assets is recorded if it is more likely than not, that all
or some portion of the benefits related to the deferred tax assets will not be
realized. Valuation allowances are based on estimates of taxable income and the
period over which deferred tax assets will be recoverable. In the event that
actual results differ from these estimates or these estimates are adjusted in
future periods, the Company may need to establish a valuation allowance, which
would impact its financial position and results of operations. A valuation
allowance has been established for the full value of the net deferred tax assets
at September 30, 2003 and December 31, 2002.
LOSS AND LOSS ADJUSTMENT EXPENSES. The Company estimates its liability for
losses and LAE using actuarial projections of ultimate losses and LAE and other
quantitative and qualitative analyses of conditions expected to affect the
future development of claims and related expenses. The estimated liability for
losses is based upon paid and case reserve estimates for losses reported,
adjusted through judgmental formulaic calculations to develop ultimate loss
expectations; related estimates of incurred but not reported losses and expected
cash reserve developments based on past experience and projected future trends;
deduction of amounts for reinsurance placed with reinsurers; and estimates
received related to assumed reinsurance. Amounts attributable to ceded
reinsurance derived in estimating the liability for loss and LAE are
reclassified as assets in the consolidated balance sheets as required by SFAS
No. 113. The liability for LAE is provided by estimating future expenses to be
incurred in settlement of claims provided for in the liability for losses and is
estimated using similar techniques.
The liabilities for losses and LAE and the related estimation methods are
continually reviewed and revised to reflect current conditions and trends. The
resulting adjustments are reflected in the operating results of the current
year. While management believes the liabilities for losses and LAE are adequate
to cover the ultimate liability, the actual ultimate loss costs may vary from
the amounts presently provided and such differences may be material.
INVESTMENTS. The Company has designated its entire investment portfolio as
available-for-sale. Temporary changes in fair values of available-for-sale
securities, after adjustment of deferred income taxes, are reported as
unrealized appreciation or depreciation directly in equity as a component of
other comprehensive income.
The Company regularly evaluates the carrying value of its investments based on
current economic conditions, past credit loss experience and other
circumstances. A decline in fair value that is other-than-temporary is
recognized by an adjustment to carrying value treated as a realized investment
loss and a reduction in the cost basis of the investment in the period when such
a determination is made.
RECENT DEVELOPMENTS
The Company has been subjected to a number of adverse developments as a result
of unexpected and unprecedented increases in loss and LAE reserves during fiscal
years 2002, 2001 and 2000 related to prior years' experience. These increases
have required the Company to increase loss reserves in each of the last three
years. For a more detailed discussion of these events, see our Annual Report on
Form 10-K for 2002.
As a result of the net losses reported in 2001, two of the Company's operating
subsidiaries triggered RBC events requiring the filing of a corrective action
plan with each state of domicile. As a result, both companies, MIIX and LP&C,
entered solvent runoff. For a more detailed description of these events, see our
Annual Report on Form 10-K for 2002.
14
At December 31, 2002, MIIX's total adjusted capital was $18.7 million, which is
substantially below the Mandatory Control Level. MIIX requested approval from
the New Jersey Department to discount loss and LAE reserves and to merge LP&C
into MIIX. Similarly, LP&C requested approval from the Virginia Bureau to merge
LP&C into MIIX.
The request to discount MIIX's loss and LAE reserves on a statutory basis as of
December 31, 2002 was approved by the New Jersey Department. The permissible
discount rate was three (3) percent. MIIX's RBC level will not be impacted by
the ability to discount loss and LAE reserves, as the NAIC standards do not
permit discounting of loss and LAE reserves to be taken into account in the
calculation of RBC. The discounting of MIIX's reserves resulted in an increase
to MIIX's statutory surplus, bringing total surplus to $72.3 million as of
December 31, 2002.
While the requests to merge LP&C into MIIX remain pending with the regulators,
potential issues associated with the guaranty funds post-merger have been
addressed by most affected states. The Company continues in its efforts to merge
the two companies before year-end 2003.
On February 19, 2003, MIIX agreed to certain operating limitations with the New
Jersey Department. The limitations include a requirement for approval by the New
Jersey Department prior to MIIX incurring new debt, paying dividends or
investing in below investment grade assets.
On May 1, 2003, MIIX entered into an Order with the New Jersey Department that
sets forth the framework for the regulatory monitoring of MIIX. The Order is
consistent with the February 19, 2003 letter agreement of the parties, whereby
MIIX agreed to certain limitations on operations. The limitations, among other
things, require the approval of the New Jersey Department prior to payment of
dividends by the Company's insurance subsidiary, and for lending arrangements,
investments and inter-company arrangements outside of the normal course of
business, and requires MIIX to periodically provide information relating to its
operations and finances to the New Jersey Department. See "Risks and
Uncertainties."
The trading of The MIIX Group's common stock was suspended at the opening of
business on April 28, 2003. The NYSE had determined that The MIIX Group's market
capitalization and stockholders' equity were below NYSE listing thresholds. The
MIIX Group was considered "below criteria" as its total capitalization was less
than $50 million over a 30-day trading period and stockholders' equity was less
than $50 million. The MIIX Group's common stock has commenced trading on the OTC
Bulletin Board under the ticker symbol "MIIX." See "Risks and Uncertainties."
The Company continues to explore any strategic alternatives that may realize
value for its shareholders, including seeking purchasers for all or portions of
its remaining assets.
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED TO THE THREE MONTHS ENDED
SEPTEMBER 30, 2002
NET PREMIUMS EARNED. Net premiums earned were $2.0 million for the three months
ended September 30, 2003, a decrease of approximately $21.7 million, or 91.6%,
from $23.7 million for the three months ended September 30, 2002. This net
decrease consists of a decrease in direct premiums earned of $30.9 million,
partially offset by a decrease in ceded premiums earned of $9.2 million. The
decrease in direct premiums earned reflects the Company's cessation of writing
or renewing policies during 2002. The reduction in ceded premiums earned
resulted from reduced direct earned premiums during the period as well as
additional ceded earned premiums of $13.1 million in the first quarter of 2002
associated with changes in estimates made to ceded loss and LAE reserves at that
time.
Total premiums written were $0.3 million for the three months ended September
30, 2003, an increase of $2.6 million, or 111.1%, from total premiums written of
negative $2.3 million for the three months ended September 30, 2002. The
increase in total premiums written primarily reflects the Company's cessation of
writing or renewing policies during the second quarter of 2002, which resulted
in extensive cancellation activity in the third quarter of 2002. Activity in the
third quarter of 2003 consisted primarily of tail coverage premiums.
NET INVESTMENT INCOME. Net investment income decreased approximately $5.9
million, or 42.8%, to $7.8 million for the three months ended September 30, 2003
from $13.7 million for the same period in 2002. Average invested assets
15
at amortized cost decreased to approximately $854.8 million for the three months
ended September 30, 2003, compared to approximately $1.14 billion for the same
period last year. The decrease in net investment income reflects the impact of
declining market yields coupled with a decline in the invested asset base, as
well as an increase in average short-duration investments held during the third
quarter of 2003.
The average annualized pre-tax yield on the investment portfolio decreased to
3.67% for the three months ended September 30, 2003 from 4.83% for the same
period in 2002. The decrease is primarily due to the reasons set forth above.
REALIZED INVESTMENT GAINS (LOSSES). Net realized investment gains increased
approximately $3.2 million, or 539.1%, to $2.6 million for the three months
ended September 30, 2003, compared to a net realized loss of $0.6 million for
the same period in 2002. During the quarter ended September 30, 2003, the
Company recorded realized gains of approximately $5.2 million primarily due to
sales of fixed-maturity investments as a result of modifications to the
investment portfolio. During the same period, the Company recognized
approximately $2.6 million of realized losses. The realized losses included $1.7
million related to other-than-temporary declines in investment values, primarily
as a result of continued poor performance in collateralized bond and loan
obligations. In the third quarter of 2002, realized gains of approximately $5.1
million were recognized due to sales of fixed-maturity investments and realized
losses included $5.7 million of other-than-temporary declines in investment
values, of which $2.5 million was attributable to collateralized bond
obligations and $2.6 million was associated with United Airlines corporate
bonds.
OTHER REVENUE. Other revenue was $1.9 million and $1.4 million for the three
months ended September 30, 2003 and 2002, respectively. The increase of $0.5
million, or 35.7%, was due to an increase of $0.9 million associated with
management services and related contracts with MIIX Advantage and an increase of
$0.7 million in renewal rights revenue, partially offset by decreases of $0.6
million and $0.3 million in finance charge revenue and commissions through
Medical Brokers, Inc. ("MBI"), respectively.
LOSS AND LOSS ADJUSTMENT EXPENSE (LAE). The provision for losses and LAE
decreased $25.1 million, or 118.1%, to negative $3.8 million for the three
months ended September 30, 2003 from $21.2 million for the three months ended
September 30, 2002. The provision for losses and LAE is net of ceded losses and
LAE of $5.0 million and $17.7 million for the three months ended September 30,
2003 and 2002, respectively. The decrease in net loss and LAE for the three
months ended September 30, 2003 was composed of decreases in direct, assumed and
ceded losses and LAE incurred of $36.9 million, $0.9 million and $12.7 million,
respectively. The net decrease largely resulted from the reduction in net earned
premium in the third quarter of 2003 compared to 2002.
UNDERWRITING EXPENSES. Underwriting expenses decreased $1.7 million, or 28.4%,
to $4.3 million for the three months ended September 30, 2003 from $6.0 million
for the three months ended September 30, 2002. The net decrease for the quarter
ended September 30, 2003 primarily results from the effects of discontinued
insurance operations, with reduced commissions, premium taxes and reductions in
compensation and benefit costs related to the restructuring and downsizing
actions which began in the first quarter of 2002. The ratio of underwriting
expenses to net premiums earned was 215.5% for the three months ended September
30, 2003, compared to 25.2% for the same period in 2002. The increase in 2003
reflects decreased earned premium in 2003 due to the Company's cessation of
writing or renewing policies during 2002.
FUNDS HELD CHARGES. Funds held charges related to the Company's aggregate
reinsurance contracts decreased $4.5 million, or 47.8%, to $5.0 million for the
three months ended September 30, 2003 from $9.5 million for the three months
ended September 30, 2002. The decrease in funds held charges was due to a
decrease of $87.5 million in the funds held liability from September 30, 2002.
The funds held liability decrease was due to the commutation of the 1993 and
1994 aggregate reinsurance treaties and ceded paid losses applied to the other
treaty years. In addition, funds held charges for the three months ended
September 30, 2002 contained $3.9 million in retroactive charges associated with
an increase in prior years' ceded loss and LAE reserves.
Funds held charges are calculated based upon the beginning of quarter funds held
balances and are adjusted based upon changes to ceded premiums associated with
changes in ceded losses.
16
OTHER EXPENSES. Other expenses decreased $0.4 million, or 72.3%, to $0.2 million
for the three months ended September 30, 2003 from $0.6 million for the three
months ended September 30, 2002. This net decrease results primarily from the
sale of substantially all of the net assets of the Company's leasing operations,
effective April 30, 2002.
INCOME TAX PROVISION (BENEFIT). Income taxes increased approximately $1.7
million to a tax provision of $1.7 million for the three months ended September
30, 2003, resulting in a 19.3% effective tax rate, compared to an income tax
expense of $0 and an effective tax rate of 0% for the same period in 2002. The
income tax provision of $1.7 million in the third quarter of 2003 primarily
reflects the change in the deferred tax valuation allowance resulting from
changes in deferred taxes on unrealized portfolio gains, as well as the
utilization of the Company's net operating loss carryforward.
NET INCOME (LOSS). Net income was $7.0 million for the three months ended
September 30, 2003, an increase of $6.1 million, or 694.8%, from $0.9 million
for the three months ended September 30, 2002 for the reasons discussed above.
NINE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED TO THE NINE MONTHS ENDED SEPTEMBER
30, 2002
NET PREMIUMS EARNED. Net premiums earned were $29.1 million for the nine months
ended September 30, 2003, a decrease of approximately $80.9 million, or 73.5%,
from $110.0 million for the nine months ended September 30, 2002. This net
decrease consists of a decrease in direct premiums earned of $115.3 million,
offset by a decrease in ceded premiums earned of $34.4 million. The decrease in
direct premiums earned reflects the Company's cessation of writing or renewing
policies during 2002. The reduction in ceded premiums earned resulted from
reduced direct earned premiums during the period as well as additional ceded
earned premiums of $13.1 million in the first quarter of 2002 associated with
adjustments made to ceded loss and LAE reserves at that time.
Total premiums written were negative $0.7 million for the nine months ended
September 30, 2003, a decrease of $100.4 million, or 100.7%, from total premiums
written of $99.7 million for the nine months ended September 30, 2002. The
decrease in total premiums written primarily reflects the Company's cessation of
writing or renewing policies during the second quarter of 2002. Activity for the
nine months ended September 30, 2003 included New Jersey policy cancellations of
$4.9 million, somewhat offset by tail coverage premiums written in other states
of $3.9 million and other net premiums written of $0.3 million.
NET INVESTMENT INCOME. Net investment income decreased approximately $20.4
million, or 42.4%, to $27.7 million for the nine months ended September 30,
2003, from $48.1 million for the same period in 2002. Average invested assets at
amortized cost decreased to approximately $934.4 million for the nine months
ended September 30, 2003, compared to approximately $1.17 billion for the same
period in 2002. The decrease in net investment income reflects the combined
effects of a decline in market yields, a decline in the total invested asset
base and an increase in average short-duration investments held during the first
nine months of 2003 compared to the same period in 2002.
The average annualized pre-tax yield on the investment portfolio decreased to
3.97% for the nine months ended September 30, 2003, from 5.47% for the same
period in 2002. The decrease is primarily due to the reasons set forth above.
REALIZED INVESTMENT GAINS (LOSSES). Net realized investment gains (losses)
increased approximately $6.8 million, or 364.4%, to a gain of $4.9 million for
the nine months ended September 30, 2003, compared to a net realized investment
loss of $1.9 million for the same period in 2002. During the nine months ended
September 30, 2003, the Company recorded realized gains of approximately $17.3
million, primarily due to sales of fixed-maturity investments as a result of
modifications to the investment portfolio. During the same period, the Company
recognized approximately $12.4 million of realized losses. The realized losses
included $10.4 million related to other-than-temporary declines in investment
values, of which $8.1 million was associated with Conseco/Green Tree Financial
corporate bonds and $2.1 million was attributable to collateralized bond
obligations. For the nine months ended September 30, 2002, realized gains of
$10.0 million were recognized primarily due to sales of fixed-maturity
investments, offset by $11.9 million of realized losses related to
other-than-temporary declines in investment values,
17
of which $8.6 million was attributable to collateralized bond obligations and
$2.6 million was associated with United Airline's corporate bonds.
OTHER REVENUE. Other revenue decreased approximately $0.7 million, or 11.5%, to
$5.0 million for the nine months ended September 30, 2003, from $5.7 million for
the same period last year. This net decrease is primarily composed of a decrease
of approximately $1.4 million due to the sale of substantially all of the assets
of the Company's leasing subsidiary, Hamilton National Leasing Corporation
("Hamilton"), effective April 30, 2002, a decrease in finance charge income of
approximately $2.6 million resulting from the Company's premium financing
program and a decrease of $0.4 million in commissions through MBI, partially
offset by increases of $2.2 million associated with management services and
related contracts with MIIX Advantage and $2.1 million in renewal rights
revenue.
LOSS AND LOSS ADJUSTMENT EXPENSES (LAE). The provision for losses and LAE
decreased $139.8 million, or 88.8%, to $17.7 million for the nine months ended
September 30, 2003, from $157.5 million for the nine months ended September 30,
2002. The provision for losses and LAE is net of ceded losses and LAE of $(6.4)
million and $50.5 million for the nine months ended September 30, 2003 and 2002,
respectively. The decrease in net loss and LAE for the nine months ended
September 30, 2003 was composed of decreases in direct, assumed and ceded losses
and LAE incurred of $191.2 million, $5.5 million and $56.9 million,
respectively, compared to the same period of 2002. The ratio of net losses and
LAE to net premiums earned decreased to 60.8% for the nine months ended
September 30, 2003 from 143.2% for the same period in 2002.
UNDERWRITING EXPENSES. Underwriting expenses decreased $12.7 million, or 46.2%,
to $14.7 million for the nine months ended September 30, 2003, from $27.4
million for the nine months ended September 30, 2002. The net decrease for the
first nine months of 2003 primarily resulted from the effects of discontinued
insurance operations, with reduced commissions, premium taxes and reductions in
compensation and benefit costs related to the restructuring and downsizing
actions which began in the first quarter of 2002. The ratio of underwriting
expenses to net premiums earned was 50.5% and 24.9% for the nine months ended
September 30, 2003 and 2002, respectively. The increased expense ratio in 2003
reflects the Company's cessation of writing or renewing policies during 2002.
FUNDS HELD CHARGES. Funds held charges decreased $17.1 million, or 53.9%, to
$14.7 million for the nine months ended September 30, 2003, from $31.8 million
for the nine months ended September 30, 2002. The decrease primarily relates to
adjustments to ceded loss and LAE reserves recorded in the first and third
quarters of 2002 that resulted in additional ceded premiums earned and produced
$12.2 million of additional funds held charges in those quarters. In addition,
the funds held liability decreased by $87.5 million from September 30, 2002, due
to the commutation of the 1993 and 1994 aggregate reinsurance treaties, along
with ceded paid loss amounts applied to the other treaty years.
OTHER EXPENSES. Other expenses decreased $1.7 million, or 72.0%, to $0.6 million
for the nine months ended September 30, 2003, from $2.3 million for the same
period in 2002. The net decrease is primarily due to the sale of substantially
all of the assets of Hamilton, the Company's leasing subsidiary, effective April
30, 2002.
RESTRUCTURING CHARGE. The Company announced, in March, 2002, its intention to
place all operations of LP&C into runoff and recorded a restructuring charge of
$2.6 million during the first quarter of 2002 relating to the reduction of
regional and home office staff and the closing of regional offices in Dallas and
Indianapolis. No similar event occurred in the nine months ended September 30,
2003.
INCOME TAX PROVISION (BENEFIT). Income taxes increased approximately $8.8
million to a tax benefit of $2.6 million for the nine months ended September 30,
2003, resulting in an effective tax rate of (13.8)%, compared to a tax benefit
of $11.4 million, and an effective tax rate of (19.1)% for the same period in
2002. The income tax benefit of $2.6 million for the first nine months of 2003
primarily reflects the change in the deferred tax valuation allowance resulting
from changes in deferred taxes on unrealized portfolio gains, as well as the
utilization of the Company's net operating loss carryforward.
CUMULATIVE EFFECT OF AN ACCOUNTING CHANGE, NET OF TAX. On January 1, 2002, the
Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets," which
requires that goodwill no longer be amortized as an expense, but
18
instead reviewed and tested for impairment under a fair value approach. The
cumulative effect of adopting SFAS No. 142 was a charge of $2.4 million on
January 1, 2002.
NET INCOME (LOSS). Net income was $21.7 million for the nine months ended
September 30, 2003, an increase of $72.3 million from a net loss of $50.6
million for the nine months ended September 30, 2002 for the reasons discussed
above.
FINANCIAL CONDITION
CASH AND INVESTED ASSETS. Aggregate invested assets at fair value, including
cash and short-term investments, were $859.8 million at September 30, 2003 and
$1,061.0 million at December 31, 2002. The net decrease of $201.2 million
largely resulted from the sale of fixed-maturity investments to meet
accelerating claims settlements.
Fixed-maturity investments available for sale at fair value, including
short-term investments, were $839.1 million, or 99.6% of the investment
portfolio of the Company as of September 30, 2003. At that date, the average
credit quality of the fixed income portfolio was "AA," as defined by independent
rating agencies, while the portfolio effective duration was 3.4 years.
UNPAID LOSSES AND LAE, REINSURANCE RECOVERABLE ON UNPAID LOSSES AND LAE AND
FUNDS HELD UNDER REINSURANCE TREATIES. Gross unpaid losses and LAE were $920.1
million at September 30, 2003 and $1,151.6 million at December 31, 2002. The net
decrease in unpaid losses and LAE reserves was primarily attributable to claims
paid activity. Reinsurance recoverable on unpaid losses and LAE was $335.6
million at September 30, 2003 and $457.0 million at December 31, 2002. The net
decrease in reinsurance recoverable is primarily attributable to increases in
ceded loss and LAE collection from reinsurers and a decrease in ceded loss and
LAE reserves. Substantially all of the reinsurance recoverables at September 30,
2003 are collateralized by the funds held under reinsurance treaties and letters
of credit.
STOCKHOLDERS' EQUITY. Total stockholders' equity was $55.8 million at September
30, 2003 and $41.3 million at December 31, 2002. The net increase of $14.5
million consisted of net income of $21.7 million, a change in unrealized net
depreciation of investments of $7.5 million and $0.3 million resulting from
treasury stock activity associated with net stock purchase and loan and unearned
stock compensation.
LIQUIDITY AND CAPITAL RESOURCES
The MIIX Group is a holding company whose assets primarily consist of all of the
capital stock of its subsidiaries. Its principal sources of funds are dividends
and other permissible payments from its subsidiaries and revenues from
non-insurance operations. MIIX is restricted by state regulation as to any
dividends it can declare without the consent of the New Jersey Department in
accordance with the letter agreement of February 19, 2003 and the Order of May
1, 2003. The Company's other insurance subsidiaries are subject to similar
provisions and restrictions. Both The MIIX Group and the Company's non-insurance
subsidiary are also restricted from paying dividends until all amounts owed to
the insurance subsidiary are paid. No significant amounts are currently
available for payment of dividends by the Company's other insurance subsidiaries
without prior approval of the applicable insurance department. During the first
quarter of 2002, the New Jersey Department approved a $2.1 million dividend
payment from MIIX to The MIIX Group. However, The MIIX Group does not expect
that MIIX will have the ability to declare and pay dividends to The MIIX Group
to meet its operating needs, except to the extent that the New Jersey Department
specifically approves dividend payments in the future. However, the agreement of
February 19, 2003 and the Order of May 1, 2003 do permit the subsidiaries to
remit funds to the holding company to facilitate payment of the holding
company's routine operating expenses. See "Risks and Uncertainties."
On May 3, 2002 and on May 10, 2002, the Company's business plan, which provides
for MIIX and LP&C to be placed in solvent runoff, was approved by the New Jersey
Department and the Virginia Bureau, respectively. MIIX and LP&C ceased writing
business in all states in accordance with each state's specific withdrawal
requirements. As a result, the Company expects that cash flow from operations in
the future will continue to be negative, as payments of outstanding claims and
expenses exceed revenues, primarily that are attributable to investment income.
The Company also withdrew MIIX and LP&C from the interactive rating process with
A.M. Best. At the time of the
19
withdrawal, the companies were rated C+. The Company received approval from the
New Jersey Department for the formation and capitalization of a 100%
physician-owned insurance company, MIIX Advantage, that focuses on insuring New
Jersey physicians. MIIX Advantage began writing insurance policies on September
1, 2002. The Company entered into a management contract and other financial
arrangements with the new company. The revenues from these agreements and
investment income will be the Company's only source of revenues in the
foreseeable future as it seeks to grow its related consulting business by
providing similar services to self-funded entities and other health care
provider owned insurers.
The primary sources of the Company's liquidity are net investment income,
proceeds from the maturity or sale of invested assets, recoveries from
reinsurance and revenues from non-insurance operations. Funds are used to pay
losses and LAE, operating expenses, reinsurance premiums and taxes. The
Company's net cash flow used by operating activities were approximately $212.4
million and $138.8 million for the nine months ended September 30, 2003 and
2002, respectively, and $180.6 million for the year ended 2002. The decrease in
cash flow during this period was primarily the result of increased loss
payments, reflecting both the maturation of the Company's expansion book of
business, acceleration of claims settlements in New Jersey and Pennsylvania, the
settlement of a few higher severity cases, lower investment income and a
decrease in premium collection reflecting the decrease in written premium.
Because of the inherent unpredictability related to the timing of the payment of
claims, it is not unusual for cash flow from operations for a medical
malpractice insurance company to vary, perhaps substantially, from year to year.
Because the Company ceased writing insurance policies, cash flow is expected to
decrease substantially. See "Risks and Uncertainties." As noted elsewhere in
this Report, the sufficiency of the Company's cash flows to sustain its
operations is dependent on a number of uncertain factors; investment income and
claims experience are among the most important of these factors.
The Company's investments consist primarily of fixed-maturity securities. The
Company's current investment strategy seeks to maximize after-tax income through
a high quality, diversified, duration-sensitive, taxable bond portfolio, while
maintaining an adequate level of liquidity. The Company plans to continue this
strategy. At September 30, 2003, the portfolio has an average credit quality of
"AA," an average duration of 3.4 years and an annualized yield of 4.1%.
The Company held collateral of $243.9 million and $332.7 million at September
30, 2003 and December 31, 2002, respectively, in the form of funds held and
$159.5 million at September 30, 2003 and December 31, 2002 in the form of
letters of credit, for recoverable amounts on ceded unpaid losses and LAE under
certain reinsurance contracts. Under the contracts, and as a result of the
downgrade of the Company's A.M. Best rating to below B+ during the first quarter
of 2002, reinsurers requested that assets supporting the funds withheld account
be placed in trust. The Company has established the required trust accounts in
accordance with contract provisions. Each of the aggregate excess reinsurance
contracts also contains a provision allowing reinsurers to offer additional
reinsurance coverage that the Company is obligated to accept. For contract years
beginning November 1, 2000 and forward, the contracts require that the funds
withheld balance on a particular contract year be below $500,000 before
reinsurers may offer the additional coverage. For contract years prior to
November 1, 2000, the contracts provide no funds withheld threshold amount,
although the reinsurance intermediary has confirmed in writing that the
intention of the parties was that the additional coverage would be offered only
if and when the funds withheld balance was in a loss position. As of September
30, 2003, no funds withheld balances were below $500,000 or in a loss position.
Under the terms of the reinsurance contracts, the funds held are credited with
interest at contractual rates ranging from 6.0% to 8.6%, which is recorded as an
expense in the period incurred.
During 2002, The MIIX Group Board of Directors suspended the payments of
dividends to shareholders. Future payments and amounts of cash dividends will
depend upon, among other factors, the Company's operating results, overall
financial condition, capital requirements, ability to receive dividends from its
insurance company subsidiaries, which are subject to regulatory approval and
general business conditions. Payment of dividends is also subject to approval by
the Board of Directors. The Company does not expect to pay dividends for the
foreseeable future.
During the nine month period ended September 30, 2003, 1,190,982 restricted
shares of The MIIX Group common stock were granted, having a per share market
value of $1.29. During the nine months ended September 30, 2003, 38,671 options
were cancelled and 0 options were exercised. During the nine months ended
September 30, 2003, a
20
former officer tendered 8,922 shares of The MIIX Group common stock and reduced
the stock purchase and loan balance to $0. All transactions were recorded at the
fair value of The MIIX Group common stock on the effective dates of the
transactions.
RISKS AND UNCERTAINTIES
As a result of the events described above under the caption "Recent
Developments," the Company is subject to a number of risks and uncertainties.
Some of the most obvious are the following:
RISK OF INCREASED SUPERVISION. The Company recorded an adjustment of $20.5
million to net loss and LAE reserves at December 31, 2002. While the Company's
reserves were not adjusted in the first three quarters of 2003, the effect of
the December 31, 2002 reserve adjustment was to further erode MIIX's total
adjusted capital to $18.7 million, which is substantially below the Mandatory
Control Level specified in the New Jersey statutes. At the Mandatory Control
Level, the Insurance Commissioner of the New Jersey Department is authorized to
place MIIX in supervision, rehabilitation or liquidation, which could cause the
Commissioner to require payment of any monies owed to MIIX by its affiliates
and, depending on the circumstances of the affiliate at the time, could possibly
result in the insolvency of an affiliate. The New Jersey Department has already
established limitations on the operations of MIIX in a letter agreement of
February 19, 2003, as well as in an Order of May 1, 2003. If the Company is
required at year-end 2003 to record significant additional net loss and LAE
reserve adjustments, the New Jersey Department may take additional regulatory
action by placing the Company under more stringent supervision, which could
result in the inability of MIIX to continue to operate. Notwithstanding our
current arrangements with the New Jersey Department, the New Jersey Department
has the power to revisit these arrangements at any time and, should it exercise
its power and increase its level of supervision, the Company could be materially
adversely affected.
RISKS IN CLAIMS EXPERIENCE. The Company currently anticipates that its assets
will be sufficient to discharge its liabilities. While this anticipation is
based upon actuarial projections, loss and LAE reserves are estimates of future
events whose outcomes are unknown at the current time. The inherent uncertainty
associated with estimating loss and LAE reserves may lead to actual results that
differ, perhaps materially, from our projections. Should the Company experience
worse than anticipated losses, it is highly likely that MIIX would be subjected
to additional regulatory action, including possibly rehabilitation or
liquidation. The Company continues to see some acceleration of claims in
connection with the runoff of MIIX. Should this acceleration become substantial,
even favorable settlements could result in short-term negative adjustments to
the Company's loss and LAE reserves, which would further increase the risk of
additional regulatory action. The Company has also seen significant recent
increases in the severity of claims, particularly in its New Jersey book of
business. Even a single, sizeable adverse judgment could materially and
adversely affect the Company.
LIMITED INCOME FROM OPERATIONS. MIIX ceased writing insurance on September 1,
2002, except where required by law. Because of the resultant decrease in premium
income, the Company's revenues will be limited. While the Company intends to
seek management contracts with other insurance entities and/or to establish
itself as a third-party administrator of professional liability contracts, no
assurances can be given that it will be able to do so. In consequence, the
Company's revenues will be largely limited to investment income and income from
various contractual arrangements with MIIX Advantage. No assurances can be given
that these revenues will be adequate to support the Company's operations or to
permit it to avoid additional regulatory action.
INVESTMENT RISK. A significant portion of the Company's assets are invested in
fixed-maturity investments. The Company manages its portfolio through three
independent investment advisors and has a relationship with an investment
consulting firm. The Company is exposed to all of the risks of the capital
markets, which have been substantial in recent periods because of the general
deterioration of those markets as well as increasing volatility in particular
sectors. In response to these developments, the Company has modified its
investment portfolio to reduce the level of risk to which it is exposed. In the
process of this modification, the Company may liquidate securities, sometimes at
a loss. Additionally, in past quarters the Company has had to record investment
write-downs on certain corporate and structured investments. While the Company
continues to monitor these investments, there is a risk additional losses may be
incurred. Furthermore, the movement of the Company's investments from
instruments believed to be more risky to those believed to be less risky may
result in a reduction of the Company's return on investments, and because of the
acceleration of claims and increasing claims severity, the Company is retaining
an
21
increasing percentage of its investment portfolio in short-duration securities,
which are generally yielding less than longer maturities. Even if the Company is
able to manage its claims portfolio successfully, deterioration in the Company's
investment portfolio or losses incurred in liquidating the portfolio not offset
by gains, could result in the Company being subjected to additional regulatory
action.
LACK OF MARKET LIQUIDITY. Following delisting from the NYSE, The MIIX Group
stock began to trade on the OTC Bulletin Board and in the "pink sheets"
maintained by the National Quotation Bureau, Inc. These markets are generally
considered to be less efficient and not as liquid as the NYSE. Trading in these
markets will likely decrease the liquidity of The MIIX Group's common stock,
which could reduce the trading price and increase the transaction costs of
trading shares of The MIIX Group's common stock.
LACK OF CASH FLOW AND LIQUIDITY. The Company's cash flow has declined
significantly over the past two years as a result of increased losses and loss
of premium revenue. The Company expects that its cash flow will continue to
decline substantially. In addition, given that MIIX's RBC is substantially below
the Mandatory Control Level, the New Jersey Insurance Commissioner could take
further regulatory action that would have the effect of reducing the Company's
cash flow. The Company currently does not have any sources of liquidity other
than the revenues from MIIX Advantage, net investment income, proceeds from the
sales of securities and reinsurance recoverables. It does not maintain any
credit facilities and it is unlikely that it could access the capital markets in
the foreseeable future. Any further significant reduction in the Company's cash
flow would have a material adverse effect on the Company's financial condition,
and could result in bankruptcy or insolvency of the Company.
SIGNIFICANT LITIGATION. The Company is subject to litigation that could have a
material adverse effect on its financial condition.
POTENTIAL IMPACT OF REINSURANCE. The Company has entered into a number of
aggregate reinsurance contracts. The contracts in effect provide reinsurance for
policies written during 1995 through September 1, 2002 and contain certain
provisions related to funds held balances or surplus level that obligate the
Company to accept additional reinsurance coverage if the stipulated levels are
not maintained. Continued operating losses could result in the Company falling
below the stipulated levels and require the Company to accept additional
reinsurance coverage. Additional loss and loss reserve adjustments could exceed
maximum losses that can be ceded under the terms of the contract in a particular
calendar year. The Company would be liable for the full amount of losses and LAE
above the maximum covered by the aggregate reinsurance contracts.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk represents the potential for loss due to adverse changes in the fair
value of financial instruments. The market risk associated with the financial
instruments of the Company relates to the investment portfolio, which exposes
the Company to risks related to unforeseen changes in interest rates, credit
quality, prepayments and valuations. Analytical tools and monitoring systems are
in place to continually assess and react to each of these elements of market
risk.
Interest rate risk is considered by management to be the most significant market
risk element currently facing the Company. Interest rate risk is the price
sensitivity of a fixed-maturity security to changes in interest rates. The
Company views these potential changes in price within the overall context of
asset and liability management. To reduce the Company's interest rate risk,
duration targets are set for the fixed income portfolio after consideration of
the duration of associated liabilities, primarily losses and LAE reserves, and
other factors.
The Company's investment portfolio at September 30, 2003 is primarily composed
of fixed-maturity securities, consisting of 87.2% of total investments at market
value. U.S. government bonds represent 20.3%, corporate bonds represent 31.7%
and mortgage-backed and asset-backed securities represent 35.2% of
fixed-maturity investments. Short-term investments represent 12.5% of total
investments at market value and equity investments, primarily common stock,
accounts for the remaining 0.3%.
At September 30, 2003, the Company had net unrealized gains on its
fixed-maturity investment portfolio of $12.0 million. The net unrealized gains
of $12.0 million on the fixed-maturity portfolio represented 27.5% of total
22
stockholders' equity gross of net unrealized gains on investments. At December
31, 2002, the Company had net unrealized gains on its fixed-maturity investment
portfolio of $17.3 million.
Asset and liability matching is an important part of the Company's portfolio
management process. The Company utilizes financial modeling and scenario
analysis to closely monitor the effective modified duration of both assets and
liabilities in order to minimize any mismatching. The goal of effective asset
liability management is to allow payment of claims and operating expenses from
operating funds without disrupting the Company's long-term investment strategy.
In addition to interest rate risk, fixed-maturity securities like those
comprising the Company's investment portfolio involve other risks such as
default or credit risk. The Company manages this risk by limiting the amount of
higher risk obligations (determined by credit rating assigned by private rating
agencies) in which it invests.
Mortgage-backed and asset-backed securities involve similar risks associated
with fixed-maturity investments: interest rate risk, reinvestment rate risk and
default or credit risk. In addition, mortgage-backed and asset-backed securities
also possess prepayment risk, which is the risk that a security's originally
scheduled interest and principal payments will differ considerably due to
changes in the level of interest rates. The Company has directed its investment
advisors to purchase mortgage-backed and asset-backed securities structured to
enhance credit quality and/or provide prepayment stability.
Short-term investments are composed of highly rated money market instruments,
which are subject to an element of interest rate risk, although to a lesser
extent than those instruments discussed above due to a shorter maturity.
The Company also holds a number of equity investments. The value of the common
stock investments is dependent upon general conditions in the securities markets
and the business and financial performance of the individual companies in the
equity portfolio.
There have been no material changes to the Company's financial market risks
since December 31, 2002.
ITEM 4. CONTROLS AND PROCEDURES
As of the end of the period covered by this report, management, including The
MIIX Group's Chief Executive Officer and Chief Financial Officer, carried out an
evaluation of the effectiveness of The MIIX Group's disclosure controls and
procedures. Based upon that evaluation, the Chief Executive Officer and Chief
Financial Officer have concluded that The MIIX Group's disclosure controls and
procedures are effective. There have been no significant changes in The MIIX
Group's internal control over financial reporting during the period ended
September 30, 2003 that have materially affected, or that are reasonably likely
to materially affect, The MIIX Group's internal control over financial
reporting.
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
DEATH BENEFIT PLAN. In October 1999, a former Underwriters Board member filed an
action in the Superior Court of New Jersey against the Medical Inter-Insurance
Exchange of New Jersey (the "Exchange"), Underwriters, The MIIX Group and Daniel
Goldberg, former CEO of the Company, seeking damages arising out of the
unanimous decision of the Exchange and Underwriters Boards in July 1998 to
terminate a Death Benefit Plan that was adopted in December 1991 to provide
members of the Boards and their committees with a $1 million death benefit. In
October 2001, the court determined that judgment should be entered in favor of
plaintiff in the amount of $490,585, representing the cash balance of the life
insurance policy insuring plaintiff's life, which was held by the Exchange to
secure the payment of benefits under the Death Benefit Plan. The judgment
provides that this sum is payable in ten equal annual installments following
plaintiff's death, in accordance with the Plan's terms. The Company appealed
this decision. By Order dated March 18, 2003, the Superior Court of New Jersey,
Appellate Division, ruled on the Slobodien v. Medical Inter-Insurance Exchange
case. The court overturned the Law Division ruling and held that, under the
terms of the agreement, the Death Benefit Plan could be terminated by the Board
of Directors at any time, and that plaintiff
23
had no right to the cash value of the insurance policy. The court, therefore,
reversed and remanded the matter to the lower court for entry of judgment in
favor of the defendants. Plaintiff has filed a petition for certification to the
Supreme Court of New Jersey to review the Appellate Division decision. On July
1, 2003, the Supreme Court denied the Petition for Certification.
Two subsequent actions by other Plan participants, one styled as a class action
on behalf of all Plan participants, were filed in the Superior Court of New
Jersey against the Company on November 7, 2000 and December 11, 2001. These
actions were stayed pending the outcome of the appeal in the first action.
Pursuant to the terms of those orders, upon the Supreme Court's denial of the
Petition for Certification in the Slobodien Action, those cases were dismissed
with prejudice.
GLASSER V. THE MIIX GROUP, INC., ET AL. On February 5, 2003, a shareholder of
the Company instituted a putative class action in the United States District
Court for the District of New Jersey against the Company, present and former
directors and officers of the Company, Medical Society of New Jersey ("MSNJ")
and Fox-Pitt Kelton, Inc., which acted as financial advisor to the Company. The
complaint alleges that the Company and its directors and officers engaged in
securities fraud, breaches of fiduciary duty and violations of New Jersey
antitrust laws in connection with the MIIX Advantage contracts and alleged
misrepresentations and omissions of material fact in various SEC filings by the
Company. On May 13, 2003, another shareholder of the Company instituted a
separate putative class action in the United States District Court for the
District of New Jersey (Wasserstrum v. The MIIX Group, Inc., et al.) against the
Company and certain of its officers alleging securities fraud. The law firms
representing plaintiffs in the two actions agreed to consolidate the plaintiffs'
claims against the Company. On August 12, 2003, a Consolidated Amended Complaint
("Complaint") was filed by the plaintiffs against the Company, present and
former directors and officers of the Company and MSNJ alleging securities fraud
based on alleged misrepresentations and omissions of material fact in various
SEC filings by the Company concerning the Company's financial condition, its
statement of reserves, the pricing of its policies, the MIIX Advantage contracts
and other matters. The Complaint seeks certification of a plaintiff class of the
Company's shareholders from July 30, 1999 to September 12, 2002 and unspecified
damages, pre- and post-judgment interest, attorneys' fees and costs. On October
21, 2003, the Company filed a motion to dismiss the Complaint which is currently
pending. The Company intends to vigorously defend the consolidated action.
The outcome of the consolidated action could have a material adverse effect on
the Company's financial condition and results of operations.
FOX-PITT KELTON V. THE MIIX GROUP, INC. On February 10, 2003, Fox-Pitt Kelton
("FPK"), which had been engaged as financial advisor to the Company, instituted
suit against the Company in the Supreme Court of New York to recover fees
allegedly due from the Company as a result of the investment banking services it
rendered in connection with the Company's efforts to dispose of assets or obtain
capital and the agreements entered into between the Company and MIIX Advantage.
FPK has filed a motion for summary judgment in its favor which is now pending
decision before the court.
The Company and external counsel believe the Company has valid defenses to FPK's
claims. The Company intends to vigorously defend the action.
WEISFELD V. THE MIIX GROUP, INC., ET AL. On November 20, 2002, a former
executive of the Medical Society of New Jersey ("MSNJ") filed suit in the
Superior Court of New Jersey against MSNJ and certain of its officers, including
MSNJ officers who were also MIIX Group board members, alleging wrongful
discharge and defamation. On March 19, 2003, plaintiff filed pleadings amending
the Complaint to include MIIX Group as a defendant, alleging that MIIX Group
tortiously interfered with his employment relationship and that its alleged
influence over MSNJ was a causative factor in his discharge. Motions to dismiss
plaintiffs' Amended Complaint were filed by all defendants. By order dated
August 19, 2003, the Court granted the defendants' motions to dismiss and the
entire Complaint was dismissed with prejudice. On October 2, 2003, plaintiffs
filed a notice of appeal of the dismissal of the Complaint with the Superior
Court of New Jersey, Appellate Division.
The Company may be a party to litigation from time to time in the ordinary
course of business.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. Exhibits
Exhibit Exhibit
Number Description
3.1 Restated Certificate of Incorporation
(incorporated by reference to Exhibit 3.1
filed with the Company's registration
statement on Form S-1 filed on October 28,
1998.)
3.2 Bylaws of The MIIX Group as amended and
restated (incorporated by reference to
Exhibit 3.2 filed with the Company's Annual
Report on Form 10-K for the year ended
December 31, 2002, filed on April 1, 2003.)
15* Acknowledgement of Independent Auditors.
31.1* Certification of Chief Executive Officer
under Section 302 of the Sarbanes-Oxley Act
of 2002.
31.2* Certification of Chief Financial Officer
under Section 302 of the Sarbanes-Oxley Act
of 2002.
32.1* Certification of Chief Executive Officer
under Section 906 of the Sarbanes-Oxley Act
of 2002.
32.2* Certification of Chief Financial Officer
under Section 906 of the Sarbanes-Oxley Act
of 2002.
* Filed herewith.
In accordance with SEC Release No. 33-8238, Exhibits 32.1 and 32.2
are to be treated as "accompanying" this report rather than
"filed" as part of the report.
b. Reports on Form 8-K
1. The Company filed a Current Report under Item 9 on Form
8-K on August 18, 2003, furnishing supplemental
financial information, including management's pro forma
calculation of the runoff value of the Company.
2. The Company filed a Current Report under Item 5 on Form
8-K on September 8, 2003, furnishing a press release
that announced the appointment of Scott L. Barbee to the
Board of Directors of The MIIX Group, Inc.
3. The Company filed a Current Report under Items 7 and 9
on Form 8-K on October 30, 2003, furnishing a press
release that announced its financial results for the
three and nine months ended September 30, 2003.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
THE MIIX GROUP, INCORPORATED
By: /s/ PATRICIA A. COSTANTE
--------------------------------------------
Chairman and Chief Executive Officer
(principal executive officer)
By: /s/ ALLEN G. SUGERMAN
--------------------------------------------
Chief Financial Officer and Treasurer
(principal financial and accounting officer)
Dated: November 14, 2003
26