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United States
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q

(Mark One)

|X|

Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended March 31, 2004

or

|_|

Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transaction period from____________to ___________.

Commission file number 1-11983

FPIC Insurance Group, Inc.
(Exact Name of Registrant as Specified in its Charter)

Florida

 

59-3359111

(State or Other Jurisdiction of
Incorporation or Organization)

 

(IRS Employer
Identification No.)

225 Water Street, Suite 1400, Jacksonville, Florida   32202
(Address of Principal Executive Offices)         (Zip Code)

(904) 354-2482
(Registrant’s Telephone Number, Including Area Code)

www.fpic.com
(Registrant’s Internet Address)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes |X| No |_|

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934).  Yes |X| No |_|

As of May 6, 2004, there were 9,975,534 shares of the registrant’s common stock outstanding.

FPIC Insurance Group, Inc.
Index to Quarterly Report on Form 10-Q

Part I
Financial Information

 

Page

 

 

 

 
Item 1.

Condensed Consolidated Financial Statements of FPIC Insurance Group, Inc.
and Subsidiaries:

 

 

 

 

3

 

 

4

 

 

5

 

 

6

 

 

7

Management’s Discussion and Analysis of Financial Condition and
Results of Operations

 

16

 

32

 

32

 

 

 

 
Part II
Other Information

 

Page

 

 

 

 

 

32

 

32

 

32

 

32

 

32

 

33

 

 

 

 

 

33

FPIC INSURANCE GROUP, INC.

Condensed Consolidated Statements of Financial Position
As of March 31, 2004 and December 31, 2003
(in thousands, except common share data)

 

 

(unaudited)

 

 

 

 

 

Mar 31,
2004

 

Dec 31,
2003

 

 

 

 

 
Assets

 

 

 

 

 

 

 

 
Cash and cash equivalents

 

$

84,670

 

 

85,064

 

 
Bonds and U.S. Government securities, available for sale

 

 

538,993

 

 

528,647

 

 
Equity securities, available for sale

 

 

10

 

 

9

 

 
Other invested assets ((Includes related party amounts
of $788 and $788) Note 11)

 

 

4,732

 

 

4,774

 

 
Real estate, net

 

 

4,099

 

 

4,207

 

 

 

 

 

 
Total cash and investments

 

 

632,504

 

 

622,701

 

 

 

 

 

 

 

 

 

 
Premiums receivable, net ((Includes related party amounts
of $7,994 and $8,608) Note 11)

 

 

113,718

 

 

101,262

 

 
Accrued investment income

 

 

5,981

 

 

6,153

 

 
Reinsurance recoverable on paid losses (Note 11)

 

 

28,827

 

 

15,950

 

 
Due from reinsurers on unpaid losses and advance premiums
((Includes related party amounts of $90,153 and $82,474) Note 11)

 

 

294,362

 

 

275,766

 

 
Ceded unearned premiums ((Includes related party amounts
of $13,285 and $16,486) Note 11)

 

 

77,666

 

 

71,435

 

 
Property and equipment, net

 

 

5,058

 

 

5,248

 

 
Deferred policy acquisition costs ((Includes related party
amounts of $3,271 and $3,500) Note 11)

 

 

7,167

 

 

6,209

 

 
Deferred income taxes

 

 

33,089

 

 

34,819

 

 
Prepaid expenses

 

 

5,807

 

 

5,363

 

 
Goodwill

 

 

18,870

 

 

18,870

 

 
Intangible assets

 

 

727

 

 

782

 

 
Federal income tax receivable

 

 

—

 

 

2,179

 

 
Other assets (Note 11)

 

 

20,453

 

 

16,393

 

 

 

 

 

 
     Total assets

 

$

1,244,229

 

 

1,183,130

 

 

 

 

 

 

 

 

 

 

 

 

 
Liabilities and Shareholders’ Equity

 

 

 

 

 

 

 

 
Losses and loss adjustment expenses ((Includes related party
amounts of $21,500 and $20,555) Note 11)

 

$

588,933

 

 

574,529

 

 
Unearned premiums ((Includes related party amounts
of $45,492 and $47,240) Note 11)

 

 

192,258

 

 

177,435

 

 
Reinsurance payable ((Includes related party amounts
of $12,894 and $11,761) Note 11)

 

 

155,246

 

 

138,082

 

 
Paid in advance and unprocessed premiums

 

 

5,103

 

 

11,766

 

 
Long term debt

 

 

46,083

 

 

46,083

 

 
Deferred credit ((Related party) Note 11)

 

 

7,493

 

 

7,729

 

 
Deferred ceding commission

 

 

4,651

 

 

3,126

 

 
Federal income tax payable

 

 

1,284

 

 

—

 

 
Accrued expenses and other liabilities (Note 11)

 

 

45,090

 

 

37,723

 

 

 

 

 

 
Total liabilities

 

 

1,046,141

 

 

996,473

 

 

 

 

 

 

 

 

 

 

 

 

 

 
Commitments and contingencies (Note 7)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
Common stock, $0.10 par value, 50,000,000 shares authorized;
9,960,534 and 9,770,843 shares issued and outstanding at
March 31, 2004 and December 31, 2003, respectively

 

 

996

 

 

977

 

 
Additional paid-in capital

 

 

45,527

 

 

43,705

 

 
Accumulated other comprehensive income, net of deferred income taxes

 

 

6,856

 

 

4,276

 

 
Retained earnings

 

 

144,709

 

 

137,699

 

 

 

 

 

 
Total shareholders’ equity

 

 

198,088

 

 

186,657

 

 

 

 

 

 
Total liabilities and shareholders’ equity

 

$

1,244,229

 

 

1,183,130

 

 

 

 

 

See accompanying notes to the condensed consolidated financial statements.

3

FPIC INSURANCE GROUP, INC.

Condensed Consolidated Statements of Income and Comprehensive Income
For the Three Months Ended March 31, 2004 and 2003
(in thousands, except per common share data)

 

 

(unaudited)

 

 

 

Three Months Ended

 

 

 

 

 

 

Mar 31,
2004

 

Mar 31,
2003

 

 

 

 

 
Revenues

 

 

 

 

 

 

 

 
Net premiums earned (Note 11)

 

$

35,012

 

 

28,909

 

 
Claims administration and management fees (Note 11)

 

 

12,084

 

 

8,665

 

 
Net investment income

 

 

5,621

 

 

4,503

 

 
Commission income

 

 

1,843

 

 

1,584

 

 
Net realized investment gains (Note 2)

 

 

2,806

 

 

238

 

 
Finance charges and other income (Note 11)

 

 

197

 

 

231

 

 

 

 

 

 
Total revenues

 

 

57,563

 

 

44,130

 

 

 

 

 

 

 

 

 

 

 

 

 
Expenses

 

 

 

 

 

 

 

 
Net losses and loss adjustment expenses (Note 11)

 

 

29,374

 

 

26,634

 

 
Other underwriting expenses (Note 11)

 

 

3,503

 

 

2,504

 

 
Claims administration and management expenses

 

 

10,513

 

 

8,342

 

 
Interest expense on debt

 

 

590

 

 

1,163

 

 
Other expenses (Note 11)

 

 

1,841

 

 

1,311

 

 

 

 

 

 
Total expenses

 

 

45,821

 

 

39,954

 

 

 

 

 

 

 

 

 

 

 

 

 
Income from operations before income taxes

 

 

11,742

 

 

4,176

 

 

 

 

 

 

 

 

 

 
Less:  Income tax expense

 

 

4,732

 

 

1,416

 

 

 

 

 

 

 

 

 

 

 

 

 
Net income

 

$

7,010

 

 

2,760

 

 

 

 

 

 

 

 

 

 

 

 

 
Basic earnings per common share

 

$

0.71

 

 

0.29

 

 

 

 

 

 

 

 

 

 

 

 

 
Diluted earnings per common share

 

$

0.68

 

 

0.29

 

 

 

 

 

 

 

 

 

 

 

 

 
Basic weighted average common shares outstanding

 

 

9,878

 

 

9,409

 

 

 

 

 

 

 

 

 

 

 

 

 
Diluted weighted average common shares outstanding

 

 

10,331

 

 

9,416

 

 

 

 

 

 

 

 

 

 

 

 

 
Comprehensive Income

 

 

 

 

 

 

 

 
Net income

 

$

7,010

 

 

2,760

 

 

 

 

 

 
Other comprehensive income:

 

 

 

 

 

 

 

 
Unrealized holding gains (losses) on debt and equity securities

 

 

4,856

 

 

(344

)

 
Unrealized holding (losses) gains and amortization
on derivative financial instruments

 

 

(657

)

 

435

 

 
Income tax expense related to unrealized
gains and losses

 

 

(1,619

)

 

(12

)

 

 

 

 

 
Other comprehensive income

 

 

2,580

 

 

79

 

 

 

 

 

 
Comprehensive income

 

$

9,590

 

 

2,839

 

 

 

 

 

See accompanying notes to the condensed consolidated financial statements.

4

FPIC Insurance Group, Inc.

Condensed Consolidated Statements of Changes in Shareholders’ Equity
For the Three Months Ended March 31, 2004 and the Year Ended December 31, 2003

 

 

Common
Stock

 

Additional
Paid-in
Capital

 

Accumulated
Other
Comprehensive
Income

 

Retained
Earnings

 

Total

 

 

 

 

 

 

 

 
Balances at December 31, 2002

 

$

939

 

 

38,322

 

 

5,525

 

 

121,127

 

 

165,913

 

 
Net income

 

 

—

 

 

—

 

 

—

 

 

16,572

 

 

16,572

 

 
Minimum pension liability adjustment, net

 

 

—

 

 

—

 

 

(140

)

 

—

 

 

(140

)

 
Unrealized loss on debt and
equity securities, net

 

 

—

 

 

—

 

 

(2,835

)

 

—

 

 

(2,835

)

 
Unrealized gain on derivative
financial instruments, net

 

 

—

 

 

—

 

 

486

 

 

—

 

 

486

 

 
Settlement of  derivative financial instrument, net

 

 

—

 

 

—

 

 

1,532

 

 

—

 

 

1,532

 

 
Amortization of unrealized loss on
derivative financial instruments

 

 

—

 

 

—

 

 

(292

)

 

—

 

 

(292

)

 
Issuance of shares

 

 

38

 

 

4,385

 

 

—

 

 

—

 

 

4,423

 

 
Income tax reductions relating to exercise of
stock options

 

 

—

 

 

998

 

 

—

 

 

—

 

 

998

 

 

 

 

 

 

 

 
Balances at December 31, 2003

 

 

977

 

 

43,705

 

 

4,276

 

 

137,699

 

 

186,657

 

 
Net income

 

 

—

 

 

—

 

 

—

 

 

7,010

 

 

7,010

 

 
Unrealized gain on debt and
equity securities, net

 

 

—

 

 

—

 

 

2,983

 

 

—

 

 

2,983

 

 
Unrealized loss on derivative
financial instruments, net

 

 

—

 

 

—

 

 

(403

)

 

—

 

 

(403

)

 
Issuance of shares

 

 

19

 

 

1,822

 

 

—

 

 

—

 

 

1,841

 

 

 

 

 

 

 

 
Balances at March 31, 2004 (unaudited)

 

$

996

 

 

45,527

 

 

6,856

 

 

144,709

 

 

198,088

 

 

 

 

 

 

 

 

See accompanying notes to the condensed consolidated financial statements.

5

FPIC Insurance Group, Inc.

Condensed Consolidated Statements of Cash Flows
For the Three Months Ended March 31, 2004 and 2003
(in thousands)

 

 

(unaudited)

 

 

 

Three Months Ended

 

 

 

 

 

 

Mar 31,
2004

 

Mar 31,
2003

 

 

 

 

 
Cash flows from operating activities:

 

 

 

 

 

 

 

 
Net income

 

$

7,010

 

 

2,760

 

 
Adjustments to reconcile net income to cash provided by operating activities:

 

 

 

 

 

 

 

 
Depreciation, amortization and accretion

 

 

2,557

 

 

(1,910

)

 
Realized gains on investments

 

 

(2,806

)

 

(238

)

 
Net losses from other invested assets

 

 

118

 

 

60

 

 
Bad debt expense

 

 

—

 

 

3

 

 
Deferred income tax expense

 

 

111

 

 

532

 

 
Other changes in assets and liabilities:

 

 

 

 

 

 

 

 
Premiums receivable, net

 

 

(12,456

)

 

(6,349

)

 
Accrued investment income

 

 

172

 

 

253

 

 
Reinsurance recoverable on paid losses

 

 

(12,877

)

 

809

 

 
Due from reinsurers on unpaid losses

 

 

(18,596

)

 

(29,408

)

 
Ceded unearned premiums

 

 

(6,231

)

 

(8,623

)

 
Deferred policy acquisition costs

 

 

(2,350

)

 

852

 

 
Prepaid expenses

 

 

(444

)

 

152

 

 
Federal income taxes

 

 

3,464

 

 

(2,226

)

 
Other assets

 

 

(3,353

)

 

137

 

 
Losses and loss adjustment expenses

 

 

14,404

 

 

33,038

 

 
Unearned premiums

 

 

14,823

 

 

18,705

 

 
Reinsurance payable

 

 

17,164

 

 

10,901

 

 
Paid in advance and unprocessed premiums

 

 

(6,663

)

 

(7,994

)

 
Deferred ceding commission

 

 

2,271

 

 

3,099

 

 
Accrued expenses and other liabilities

 

 

974

 

 

8,734

 

 

 

 

 

 
Net cash (used in) provided by operating activities

 

 

(2,708

)

 

23,287

 

 

 

 

 
Cash flows from investing activities:

 

 

 

 

 

 

 

 
Proceeds from sale or maturity of bonds and U.S. Government securities

 

 

199,098

 

 

136,110

 

 
Purchase of bonds and U.S. Government securities

 

 

(198,313

)

 

(156,001

)

 
Proceeds from sale of other invested assets

 

 

62

 

 

306

 

 
Proceeds from sale of real estate investments

 

 

42

 

 

—

 

 
Purchase of real estate investments

 

 

(4

)

 

—

 

 
Purchase of property and equipment

 

 

(412

)

 

(1,580

)

 

 

 

 

 
Net cash provided by (used in) investing activities

 

 

473

 

 

(21,165

)

 

 

 

 
Cash flows from financing activities:

 

 

 

 

 

 

 

 
Payment of term loan

 

 

—

 

 

(1,458

)

 
Issuance of common stock

 

 

1,841

 

 

145

 

 

 

 

 

 
Net cash provided by (used in) financing activities

 

 

1,841

 

 

(1,313

)

 

 

 

 
Net (decrease) increase in cash and cash equivalents

 

 

(394

)

 

809

 
Cash and cash equivalents at beginning of period

 

 

85,064

 

 

86,589

 

 

 

 

 
Cash and cash equivalents at end of period

 

$

84,670

 

 

87,398

 

 

 

 

 
Supplemental disclosure of cash flow information:

 

 

 

 

 

 

 

 
Interest paid on long term debt

 

$

617

 

 

1,106

 

 

 

 

 

 
Federal income taxes paid

 

$

500

 

 

3,300

 

 

 

 

 

 
Federal income tax refunds received

 

$

—

 

 

346

 

 

 

 

 
Supplemental disclosure of noncash investing activities:

 

 

 

 

 

 

 

 
Due (to) from broker on unsettled investment trades, net

 

$

(5,039

)

 

12,976

 

 

 

 

 

See accompanying notes to the condensed consolidated financial statements.

6

FPIC Insurance Group, Inc. and Subsidiaries
Notes to the Condensed Consolidated Financial Statements
(In Thousands, Except as Noted)

1.
Organization and Basis of Presentation

 

 

 

The accompanying condensed consolidated financial statements represent the consolidation of FPIC Insurance Group, Inc. (“FPIC”) and all majority owned and controlled subsidiaries.  The statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”).  All significant transactions between the parent and consolidated subsidiaries have been eliminated. Reference is made to our most recently filed Form 10-K, which includes information necessary for understanding our businesses and financial statement presentations.  In particular, our significant accounting policies are presented in Note 2 to the consolidated financial statements included in that report.

 

 

 

The condensed consolidated quarterly financial statements are unaudited.  These statements include all adjustments, consisting only of normal recurring accruals, that are, in the opinion of management, necessary for the fair presentation of results for interim periods.  Certain prior period data has been reclassified to conform to the current period presentation. The results reported in these condensed consolidated quarterly financial statements should not be regarded as necessarily indicative of results that may be expected for the entire year.  For example, the timing and magnitude of claim losses incurred by our insurance subsidiaries due to the estimation process inherent in determining the liability for losses and loss adjustment expenses (“LAE”) can be relatively more significant to results of interim periods than to results for a full year.  Also, variations in the amount and timing of realized investment gains and losses could cause significant variations in periodic net income.

 

 

 

Certain prior period amounts presented in the condensed consolidated financial statements for the three months ended March 31, 2003 have been reclassified to conform with the current presentation.

 

 

 

Stock-Based Compensation

 

 

 

FPIC has elected to adopt Financial Accounting Standard No. (“FAS”) 123, “Accounting for Stock-Based Compensation” on a disclosure basis only and measure stock-based compensation in accordance with Accounting Principles Board No. 25, “Accounting for Stock Issued to Employees,” using intrinsic values with appropriate disclosures under the fair value based method as required by FAS 123 and FAS 148, “Accounting for Stock-Based Compensation, Transition and Disclosure.”  Generally, the exercise price for stock options granted to an employee equals the fair market value of FPIC common stock at the date of grant, thereby resulting in no recognition of compensation expense.

7

FPIC Insurance Group, Inc. and Subsidiaries
Notes to the Condensed Consolidated Financial Statements
(In Thousands, Except as Noted)

 

Had compensation cost for FPIC’s stock option plans been determined based on the fair value method set forth in FAS 123, FPIC’s net income and basic and diluted earnings per common share would have been impacted as follows:


 

 

 

Three Months Ended

 

 

 

 

 

 

 

 

Mar 31,
2004

 

Mar 31,
2003

 

 

 

 

 

 

 
Pro forma net income:

 

 

 

 

 

 

 

 
Net income, as reported

 

$

7,010

 

 

2,760

 

 
Stock-based compensation expense determined under
fair value based method, net of income taxes

 

 

(299

)

 

(470

)

 

 

 

 

 

 
Pro forma net income

 

$

6,711

 

 

2,290

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
Basic earnings per common share:

 

 

 

 

 

 

 

 
Net income, as reported

 

$

0.71

 

 

0.29

 

 
Stock-based compensation expense determined under
fair value based method, net of income taxes

 

 

(0.03

)

 

(0.05

)

 

 

 

 

 

 
Pro forma net income

 

$

0.68

 

 

0.24

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
Diluted earnings per common share:

 

 

 

 

 

 

 

 
Net income, as reported

 

$

0.68

 

 

0.29

 

 
Stock-based compensation expense determined under
fair value based method, net of income taxes

 

 

(0.03

)

 

(0.05

)

 

 

 

 

 

 
Pro forma net income

 

$

0.65

 

 

0.24

 

 

 

 

 

 

2.
Investments

 

 

 

Realized investment gains and losses are determined on the basis of specific identification.  Declines in the fair value of securities considered to be other than temporary, if any, are recorded as realized losses in the condensed consolidated statements of income.

 

 

 

Data with respect to bonds and U.S. Government and equity securities, available for sale, are presented in the table below.

 
Three Months Ended

 

Proceeds
from sales
and
maturities

 

Gross
realized
gains on
sales

 

Gross
realized
losses
on sales

 

 

 

Amortized cost of
investments in
bonds and U.S.
Government and
equity securities

 

 

 

 

 

 

 

 

 

 
March 31, 2004

 

$

199,098

 

 

3,398

 

 

(596)   

 

As of March 31, 2004

 

 

$

527,788

 

 

 
March 31, 2003

 

$

136,110

 

 

1,056

 

 

(1,019)   

 

As of Dec 31, 2003

 

 

$

522,159

 

 

 

Net realized investment gains on all investments for the three months ended March 31, 2004 and 2003 totaled $2,806 and $238, respectively.  Included in net realized investment gains for the three months ended March 31, 2004 and 2003 are gains of $4 and $201, respectively on the sale of real estate.

8

FPIC Insurance Group, Inc. and Subsidiaries
Notes to the Condensed Consolidated Financial Statements
(In Thousands, Except as Noted)

3.
Goodwill

 

 

 

As required by FAS 142 “Goodwill and Other Intangible Assets,” we completed annual impairment testing of our remaining goodwill as of December 31, 2003 and 2002 during the first quarters of 2004 and 2003, respectively, including obtaining updated reports from independent valuation consultants.  Based on the results of such testing, we determined that the fair value of our goodwill exceeded its carrying value and, accordingly, no impairment was recognized.

 

 

 

Reference is made to Notes 2 and 9 to the consolidated financial statements included in our most recently filed Form 10-K, which includes additional information about our accounting for goodwill.

 

 
4.
Reinsurance

 

 

 

The effects of ceded reinsurance on premiums written and earned for the three months ended March 31, 2004 and 2003 are presented in the table below.

 

 

 

Three Months Ended

 

 

 

 

 

 

 

 

Mar 31,
2004

 

Mar 31,
2003

 

 

 

 

 

 

 

 

 

Written

 

Earned

 

Written

 

Earned

 

 

 

 

 

 

 

 

 
Direct and assumed premiums

 

$

98,603

 

 

83,780

 

 

104,535

 

 

85,825

 

 
Ceded premiums

 

 

(54,999

)

 

(48,768

)

 

(65,539

)

 

(56,916

)

 

 

 

 

 

 

 

 
Net premiums

 

$

43,604

 

 

35,012

 

 

38,996

 

 

28,909

 

 

 

 

 

 

 

 

 

The effects of ceded reinsurance on losses and LAE incurred for the three months ended March 31, 2004 and 2003 are presented in the table below.

 

 

 

Three Months Ended

 

 

 

 

 

 

 

 

Mar 31,
2004

 

Mar 31,
2003

 

 

 

 

 

 

 
Losses and LAE incurred

 

$

70,630

 

 

69,586

 

 
Reinsurance recoverable

 

 

(41,256

)

 

(42,952

)

 

 

 

 

 

 
Net losses and LAE incurred

 

$

29,374

 

 

26,634

 

 

 

 

 

 

 

We have renewed our excess of loss reinsurance program, effective January 1, 2004.  The structure and coverage of such agreements are generally similar to those of our 2003 excess of loss reinsurance program as reported in our most recently filed Form 10-K.  Based on analysis of our exposure to extra-contractual obligations and claims in excess of policy limits (“ECO/XPL”), we have elected not to renew the supplemental awards made ECO/XPL reinsurance that we have carried in addition to the ECO/XPL coverage already included as part of our primary excess of loss reinsurance program.  Therefore, this additional layer of excess reinsurance will no longer be in effect after April 1, 2004 and we will self insure this excess risk in the future.

 

 

 

Reference is made to Note 22 to the consolidated financial statements included in our most recently filed Form 10-K, which includes additional information regarding reinsurance involving related parties. 

9

FPIC Insurance Group, Inc. and Subsidiaries
Notes to the Condensed Consolidated Financial Statements
(In Thousands, Except as Noted)

5.
Long Term Debt

 

 

 

FPIC’s long term debt includes junior subordinated debentures and senior notes, which are uncollateralized and bear floating interest rates equal to the three-month LIBOR plus spreads ranging from 3.85% to 4.2% (the interest rates ranged from 4.97% to 5.32% as of March 31, 2004).  The floating interest rates are adjustable quarterly with changes in the three-month LIBOR, and in the case of the first two offerings, the maximum rate that may be charged under the securities within the first five years is 12.5%.  We have also purchased hedging instruments designed to maintain the ultimate floating rate interest cost on all of these securities within a stated range for five years from closing.  For additional information on FPIC’s hedging instruments and interest costs, see the discussion below under Note 6, Derivative Financial Instruments.

 

 

 

Indenture agreements relating to FPIC’s junior subordinated debentures and trust preferred securities contain limitations, under certain circumstances, as to (i) the declaration or payment of dividends, or distributions thereon, or the redemption, purchase, acquisition or liquidation with respect to any capital stock of FPIC or its affiliates; (ii) the payment, in certain circumstances, of principal of, premium or interest on, or the repayment, repurchase or redemption of debt securities of FPIC or its affiliates that rank in equal standing with or are junior in interest to the debentures; or (iii) the payment, in certain circumstances, under any guarantees of FPIC or its affiliates that rank equal in standing with, or junior in interest to capital securities guarantees relating to the issuance of the debentures. Circumstances that would result in such limitations include a continuing event of default, as defined by the indenture agreements, a default with respect to payment of any obligations under capital securities guarantees, or a continuing interest deferral election by FPIC.

 

 

 

Reference is made to Note 13, Long Term Debt, Revolving Credit Facility and Term Loan, to the consolidated financial statements included in our most recently filed Form 10-K, which includes additional information regarding our long term debt.

 

 
6.
Derivative Financial Instruments

 

 

 

As of March 31, 2004, FPIC had four interest rate collars. The collars are designed to maintain FPIC’s ultimate floating rate interest costs on its junior subordinated debentures and senior notes to within specified interest ranges for five years from the closing date of those liabilities. The initial costs of the hedging instruments acquired for this purpose of $1,134, in aggregate, have been capitalized and will be amortized over their respective five year maturity periods.  Reference is made to Note 14, Derivative Financial Instruments, to the consolidated financial statements included in our most recently filed Form 10-K, which includes additional information regarding our interest risk management strategy and the effect of this strategy on FPIC’s consolidated financial statements.

 

 

 

The interest rate collars and terms as of March 31, 2004 are presented below with their corresponding effects on the floating rate interest costs associated with the junior subordinated debentures and senior notes.

 

Notional
Amount

 

Maturity Date

 

LIBOR
Floor (1)

 

LIBOR
Cap (1)

 

Floor Rate

 

Cap Rate

 

 

 

 

 

 

 

 

 
$

15,000

 

 

5/15/2008

 

 

1.20

%

 

 

4.40

%

 

 

5.30

%

 

 

8.50

%

 

 
$

5,000

 

 

5/23/2008

 

 

1.20

%

 

 

4.40

%

 

 

5.40

%

 

 

8.60

%

 

 
$

10,000

 

 

5/23/2008

 

 

1.20

%

 

 

4.40

%

 

 

5.40

%

 

 

8.60

%

 

 
$

15,000

 

 

10/29/2008

 

 

1.00

%

 

 

4.65

%

 

 

4.85

%

 

 

8.50

%

 

 


(1) Based on three-month LIBOR

 

 

 

 

 

 

 

 

 

 

10

FPIC Insurance Group, Inc. and Subsidiaries
Notes to the Condensed Consolidated Financial Statements
(In Thousands, Except as Noted)

7.
Commitments and Contingencies

 

 

 

FPIC’s insurance subsidiaries from time to time become subject to claims for extra-contractual obligations or risks in excess of policy limits in connection with their insurance claims.  These claims are sometimes referred to as “bad faith” actions as it is alleged that the insurance company acted in bad faith in the administration of a claim against an insured.  Bad faith actions are infrequent and generally occur in instances where a jury verdict exceeds the insured’s policy limits. Under such circumstances, it is routinely alleged that the insurance company failed to negotiate a settlement of a claim in good faith within the insured’s policy limit.  FPIC has evaluated such exposures as of March 31, 2004, and believes its positions and defenses are meritorious.  However, there can be no absolute assurance as to the outcome of such exposures.  FPIC currently maintains insurance for such occurrences in the form of a component of its ceded reinsurance, which serves to mitigate exposure to such claims.  Such coverage would not apply to future bad faith actions, if any, arising from medical professional liability claims reported prior to 2000.  In one current bad faith action arising in 1993, no such coverage is available and an estimate of possible loss above the amount currently reserved cannot be made.  In addition, multiple claims for extra contractual obligations or one or more large claims in a single year could result in potential exposure materially in excess of insurance coverage or in increased costs of such insurance coverage.

 

 

 

FPIC may also become involved in legal actions not involving claims under its insurance policies from time to time. FPIC has evaluated such exposures as of March 31, 2004, and in all cases believes its positions and defenses are meritorious.  However, there can be no absolute assurance as to the outcome of such exposures.

 

 

 

FPIC’s insurance subsidiaries are subject to assessment by the financial guaranty associations in the states in which they conduct business for the provision of funds necessary for the settlement of covered claims under certain policies of insolvent insurers.  Generally, these associations can assess member insurers on the basis of written premiums in their particular states.

While management has evaluated the incidents and circumstances surrounding the above-mentioned asserted or unasserted legal claims and assessments of which it is aware and believes that these will not have materially adverse effects on FPIC beyond amounts already recognized and accrued, there can be no absolute assurance as to their ultimate outcomes.

 

 

 

Management Agreement Between Administrators for the Professions (“AFP”) and Physicians’ Reciprocal Insurers (“PRI”)

 

 

 

The management agreement between our subsidiary AFP and PRI, the New York insurance reciprocal managed by AFP, was amended to remove the sharing by AFP of 10% of PRI’s statutory net income or loss, effective January 1, 2002.   With regard to profit sharing amounts already earned and collected, AFP has agreed to hold the years 1999, 2000 and 2001 open for re-determination and possible adjustment for a period of five years each (expiring 2004, 2005 and 2006, respectively.)  Such adjustments would be based primarily on development of and related adjustments, if any, to loss and LAE reserves for those years.  AFP has earned and collected profit sharing amounts under the original agreement totaling $3,584 for the three years ended December 31, 2001.  As of March 31, 2004, and based on PRI’s operating results, no amounts were payable under this provision of the amended management agreement.  Reference is made to Note 22, Related Party Transactions, to the consolidated financial statements included in our most recently filed Form 10-K for additional information regarding the management agreement with PRI.  Also, FPIC has issued an irrevocable letter of credit in the amount of $500,000 as collateral under the operating lease for the building occupied by AFP and PRI in Manhasset, New York.

11

FPIC Insurance Group, Inc. and Subsidiaries
Notes to the Condensed Consolidated Financial Statements
(In Thousands, Except as Noted)

8.
Reconciliation of Basic and Diluted Earnings Per Common Share

 

 

 
Data with respect to FPIC’s basic and diluted earnings per common share are shown below.

 

 

 

Three Months Ended

 

 

 

 

 

 

 

 

Mar 31,
2004

 

Mar 31,
2003

 

 

 

 

 

 

 
Net income

 

$

7,010

 

 

2,760

 

 

 

 

 

 

 
Basic earnings  per common share

 

$

0.71

 

 

0.29

 

 

 

 

 

 

 
Diluted earnings  per common share

 

$

0.68

 

 

0.29

 

 

 

 

 

 

 
Basic weighted average shares outstanding

 

 

9,878

 

 

9,409

 

 
Common stock equivalents

 

 

453

 

 

7

 

 

 

 

 

 

 
Diluted weighted average shares outstanding

 

 

10,331

 

 

9,416

 

 

 

 

 

 

9.
Employee Benefit Plans

 

 

 

The components of the actuarially computed net periodic pension cost for our two defined benefit plans and supplemental executive retirement plan for the three months ended March 31, 2004 and 2003 are summarized in the table below.

 

 

 

Three Months Ended

 

 

 

 

 

 

 

 

Mar 31,
2004

 

Mar 31,
2003

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
Service cost of benefits earned during the period

 

$

541

 

 

367

 

 
Interest cost on projected benefit obligation

 

 

356

 

 

259

 

 
Expected return on plan assets

 

 

(232

)

 

(166

)

 
Recognized net actuarial loss

 

 

19

 

 

12

 

 
Net amortization and deferral

 

 

254

 

 

169

 

 

 

 

 

 

 

 

Net periodic pension cost

 

$

938

 

 

641

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

FPIC and its subsidiaries have made contributions totaling $1,728 to its employee post-retirement plans as of March 31, 2004.  We currently anticipate contributing an additional $2,303 to our employee post-retirement plans during the remainder of 2004 for total contributions during 2004 of $4,031.

 

 

 

Reference is made to Note 19, Employee Benefit Plans, to the consolidated financial statements included in our most recently filed Form 10-K, which includes additional information regarding our employee benefit plans.

12

FPIC Insurance Group, Inc. and Subsidiaries
Notes to the Condensed Consolidated Financial Statements
(In Thousands, Except as Noted)

10.

Segment Information

 

 

 

The accounting policies of FPIC’s segments are the same as those described in the summary of significant accounting policies found in Note 2, Significant Accounting Policies, to the consolidated financial statements included in our most recently filed Form 10-K.  We evaluate a segment’s performance based on net income or loss and account for intersegment sales and transfers, which are eliminated in the condensed consolidated financial statements, as if the sales or transfers were to a third party.  Holding company operations are included within the insurance segment due to its size and prominence and the substantial attention devoted to the segment.  Management believes that intersegment revenues associated with transactions between the segments would be reasonably approximate with similar products or services that may have been obtained from or provided to unrelated third parties.  All segments are managed separately because each respective business is distinct in terms of markets served, products and services, technology, and required business resources and strategies.

 

 

 

Selected financial information by segment is summarized in the tables below.

 

 

 

As of
Mar 31, 2004

 

As of
Dec 31, 2003

 

 

 

 

 

 

 
Identifiable Assets:

 

 

 

 

 

 

 

Insurance

 

$

1,201,764

 

 

1,139,653

 

 

 

Reciprocal management

 

 

39,604

 

 

39,634

 

 

 

Third party administration

 

 

5,812

 

 

5,995

 

 

 

Intersegment eliminations

 

 

(2,951

)

 

(2,152

)

 

 

 

 

 

 

 

Total assets

 

$

1,244,229

 

 

1,183,130

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

 

 

 

 

 

 

Mar 31,
2004

 

Mar 31,
2003

 

 

 

 

 

 

 
Total Revenues:

 

 

 

 

 

 

 

 

 

Insurance

 

$

44,285

 

 

34,240

 

 

 

Reciprocal management

 

 

11,019

 

 

7,132

 

 

 

Third party administration

 

 

3,980

 

 

4,008

 

 

 

Intersegment eliminations

 

 

(1,721

)

 

(1,250

)

 

 

 

 

 

 

 

Total revenues

 

$

57,563

 

 

44,130

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
Net Income:

 

 

 

 

 

 

 

 

 

Insurance

 

$

4,551

 

 

1,291

 

 

 

Reciprocal management

 

 

2,443

 

 

1,338

 

 

 

Third party administration

 

 

16

 

 

131

 

 

 

 

 

 

 

 

Net  income

 

$

7,010

 

 

2,760

 

 

 

 

 

 

13

FPIC Insurance Group, Inc. and Subsidiaries
Notes to the Condensed Consolidated Financial Statements
(In Thousands, Except as Noted)

11.
Related Party Transactions

 

 

 

Following is a summary of the related party transactions of FPIC and its consolidated subsidiaries included in the condensed consolidated statements of financial position as of March 31, 2004 and December 31, 2003, and the condensed consolidated statements of income and comprehensive income for the three months ended March 31, 2004 and 2003.  Credit balances are presented parenthetically.  Reference is made to Note 22, Related Party Transactions, to the consolidated financial statements included in our most recently filed Form 10-K, which includes additional information regarding our related party transactions.

 
Statements of Financial Position:

 

As of
Mar 31,
2004

 

As of
Dec 31,
2003

 

 

 

 

 

 

 

 

Other invested assets

 

$

788

 

 

788

 

 

 

Premiums receivable

 

$

7,994

 

 

8,608

 

 

 

Reinsurance recoverable on paid losses

 

$

3,678

 

 

2,738

 

 

 

Reinsurance recoverable on unpaid losses and advance premiums

 

$

12,557

 

 

12,012

 

 

 
Reinsurance recoverable on unpaid losses and advance premiums,
fronting arrangements (1)

 

$

77,596

 

 

70,462

 

 

 

Ceded unearned premiums

 

$

1,679

 

 

3,638

 

 

 

Ceded unearned premiums, fronting arrangements (2)

 

$

11,606

 

 

12,848

 

 

 

Deferred policy acquisition costs

 

$

3,448

 

 

4,035

 

 

 

Deferred policy acquisition costs, fronting arrangements

 

$

(177

)

 

(535

)

 

 

Other assets

 

$

2,699

 

 

4,171

 

 

 

Liability for losses and LAE

 

$

(21,500

)

 

(20,555

)

 

 

Unearned premiums

 

$

(45,492

)

 

(47,240

)

 

 

Reinsurance payable

 

$

920

 

 

(23

)

 

 

Reinsurance payable, fronting arrangements

 

$

(13,814

)

 

(11,738

)

 

 

Deferred credit

 

$

(7,493

)

 

(7,729

)

 

 

Accrued expenses and other liabilities

 

$

(920

)

 

(1,030

)

 
(1)

Corresponding direct liability for losses and LAE to unrelated parties under fronting arrangements were ($78,801) and ($71,620) as of March 31, 2004 and December 31, 2003, respectively.

 

 

 

 
(2)

Corresponding direct unearned premiums from unrelated parties under fronting arrangements were ($11,606) and ($12,848) as of March 31, 2004 and December 31, 2003, respectively.

14

FPIC Insurance Group, Inc. and Subsidiaries
Notes to the Condensed Consolidated Financial Statements
(In Thousands, Except as Noted)

 

 

 

Three Months Ended

 

 

 

 

 

 

 

 

Mar 31,
2004

 

Mar 31,
2003

 

 

 

 

 

 

 
Statements of Income and Comphrehensive Income:

 

 

 

 

 

 

 

 

 

Net premiums earned

 

$

(583

)

 

(542

)

 

 

Net premiums earned, fronting arrangements (1)

 

$

10,504

 

 

12,256

 

 

 

Claims administration and management fees

 

$

(8,465

)

 

(4,988

)

 

 

Finance charge and other income

 

$

—

 

 

(13

)

 

 

Net losses and LAE

 

$

(540

)

 

(249

)

 

 

Net losses and LAE, fronting arrangements (2)

 

$ 

(11,745

)

 

(9,272

)

 

 

Other underwriting expenses

 

$

82

 

 

1,032

 

 

 

Other underwriting expenses, fronting arrangements

 

$

(1,665

)

 

(1,661

)

 

 

Other expenses

 

$

53

 

 

53

 

 
(1)

Corresponding direct premiums earned from unrelated parties under fronting arrangements were ($10,500) and ($12,253) for the three months ended March 31, 2004 and 2003, respectively.

 

 

 

 
(2)

Corresponding direct losses and LAE incurred to unrelated parties under fronting arrangements were $11,865 and $9,272 for the three months ended March 31, 2004 and 2003, respectively.

 

 

 

As of December 31, 2003, the management agreement with APA Management, Inc. and the Consulting Group of APA, Inc. consulting agreement had expired.  Included in our 2003 results are expenses incurred with regard to these agreements that did not occur during the three months ended March 31, 2004.

 

 

 

During October 2003 we sold our 20% investment in APS Insurance Services, Inc. (“APS”) to the majority shareholder.  APS serves as the exclusive management company for American Physicians Insurance Exchange (“APIE”), a Texas medical professional liability insurance exchange, with which we had also engaged in a fronting program.  The fronting program with APIE expired December 31, 2002, at which time we ceased writing business for APIE on our policy forms and placed the existing business in run-off.

 

 
12.
New Accounting Pronouncements

 

 

 

FAS 132 (revised 2003), “Employers’ Disclosures about Pensions and Other Postretirement Benefits an amendment of FASB Statements No. 87, 88, and 106” revises employers’ disclosures about pension plans and other postretirement benefit plans.  The statement does not change the measurement or recognition of those plans required by FAS 87, “Employers’ Accounting for Pensions,” FAS 88, “Employers’ Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits,” and FAS 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions.”  FAS 132 (revised 2003) retains the disclosure requirements contained in FAS 132, “Employers’ Disclosures about Pensions and Other Postretirement Benefits,” which it replaces.  It requires additional disclosures to those in the original FAS 132 about the assets, obligations, cash flows, and net periodic benefit cost of defined benefit pension plans and other defined benefit postretirement plans.  The required information should be provided separately for pension plans and for other postretirement benefit plans.  The interim-period disclosures required by FAS 132 (revised 2003) are effective for interim periods beginning after December 15, 2003.

15

Item 2.  Management’s Discussion and Analysis (“MD&A”) of Financial Condition and Results of Operations

For purposes of this management discussion and analysis, the term “FPIC” refers to FPIC Insurance Group, Inc. and subsidiaries.  The following discussion and analysis of financial condition, results of operations, liquidity and capital resources and other matters should be read in conjunction with the accompanying condensed consolidated financial statements for the three months ended March 31, 2004, included in Part I, Item 1, as well as the audited, consolidated financial statements and notes included in FPIC’s Form 10-K for the year ended December 31, 2003, which was filed with the Securities and Exchange Commission (“SEC”) on March 15, 2004. 

Safe Harbor Disclosure

The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking statements. Any written or oral statements made by or on behalf of FPIC may include forward-looking statements, which reflect our current views with respect to future events and financial performance. These forward-looking statements are subject to certain uncertainties and other factors that could cause actual results to differ materially from such statements. These uncertainties and other factors include, but are not limited to:

i)

Risks factors, including the effect on reserves and underwriting results, associated with changing market conditions that result from fluctuating cyclical patterns of property and casualty insurance business;

 

 

ii)

The uncertainties of the loss reserving process;

 

 

iii)

The occurrence of insured or reinsured events with a frequency or severity exceeding our estimates;

 

 

iv)

The impact of surplus constraints on growth;

 

 

v)

The competitive environment in which FPIC operates, including reliance on independent agents to place insurance, physicians electing to practice without insurance coverage, related trends and associated pricing pressures and developments;

 

 

vi)

The actual amount of new and renewal business;

 

 

vii)

Business risks that result from FPIC’s size and geographic concentration;

 

 

viii)

Developments in reinsurance markets that could affect our reinsurance programs;

 

 

ix)

The ability to collect reinsurance recoverables;

 

 

x)

The dependence of our reciprocal management segment upon a single major customer, Physicians’ Reciprocal Insurers (“PRI”), for the preponderance of its revenue and consequently, the effect of rates and claims experience on PRI’s ability to maintain or grow its premium base;

 

 

xi)

Developments in global financial markets that could affect our investment portfolio and financing plans;

 

 

xii)

Risk factors associated with the impact of rising interest rates on the market value of FPIC’s investments;

 

 

xiii)

Risks factors associated with the impact of rising interest rates on FPIC’s interest costs associated with its long term debt;

 

 

xiv)

Adverse changes in securities markets;

 

 

xv)

Rates, including rates on excess policies, being subject to or mandated by legal requirements and regulatory approval, which could affect our business or reinsurance arrangements;

 

 

xvi)

Uncertainties relating to government and regulatory policies (such as subjecting FPIC to insurance regulation or taxation in additional jurisdictions or amending, revoking or enacting any laws, regulations or treaties affecting our current operations);

 

 

xvii)

Legal developments, including claims for extra-contractual obligations or in excess of policy limits in connection with the administration of insurance claims;

16


xviii)

Business and financial risks associated with the unpredictability of court decisions;

 

 

xix)

The loss of the services of any of our executive officers;

 

 

xx)

Risks of impairment of assets, generally, including the risk of impairment or inability to continue to recognize deferred acquisition costs, deferred tax assets, goodwill and other deferred or intangible assets;

 

 

xxi)

General economic conditions, either nationally or in our market areas, that are worse than expected;

 

 

xxii)

Changes in our financial ratings resulting from one or more of these uncertainties or other factors and the potential impact on our agents’ ability to place insurance business on behalf of FPIC; and

 

 

 

other risk factors discussed elsewhere in FPIC’s Form 10-K for the year ended December 31, 2003, filed with the SEC on March 15, 2004.

The words “believe,” “anticipate,” “foresee,” “estimate,” “project,” “plan,” “expect,” “intend,” “hope,” “should,” “will,” “will likely result” or “will continue” and variations thereof or similar expressions identify forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of their dates. FPIC undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.

Critical Accounting Policies

Our discussion and analysis of financial condition and results of operations are based upon the condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”).  The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures of contingent assets and liabilities.  On an on-going basis, we evaluate our estimates, including those related to income taxes, loss and loss adjustment expense (“LAE”) reserves and related reinsurance assets, contingencies and litigation, and the carrying amount of certain assets for which estimates of their values are required.  We generally base our estimates on historical experience or other appropriate assumptions that we believe are reasonable and relevant under the circumstances.  Of necessity, such evaluations may be less in scope for purposes of preparing interim financial statements; for example, we do not perform a complete reserve study every quarter, and instead, rely on other analytical procedures.  The results of these estimation processes 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. 

We believe the following critical accounting policies, which are described more fully below and in the corresponding MD&A section and Note 2, Significant Accounting Policies, to the consolidated financial statements included in our most recently filed annual report on Form 10-K, affect our more significant judgments and estimates used in the preparation of the condensed consolidated financial statements.  In addition to these critical accounting policies that may affect our estimates, the following matters regarding our management and other agreements with PRI and its status as a major client of ours are also pertinent risk considerations when reviewing these interim condensed consolidated financial statements.

17

Liability for Losses and LAE

Our liability for losses and LAE (also referred to as our loss and LAE reserves) is the largest liability of FPIC and the most sensitive financial statement item to estimation and judgment. Medical professional liability (“MPL”) insurance, including business written directly and reinsurance assumed, is our primary line of business and accounted for $562.7 million and $549.8 million, or 96%, of our total consolidated liability for losses and LAE as of March 31, 2004 and December 31, 2003, respectively. The remainder of our reserves represent other smaller lines and products.

The primary factors affecting our estimates of how much we will pay and therefore reserve for insurance claims, defense costs and other related costs are:

 
•

Frequency and severity trends (numbers of claims and how much we will pay for each claim on average for one or more periods);

 

 

 

 
•

Frequency of claims closed with indemnity payments (the percentage of claims received that ultimately result in a loss payment versus those that are settled and closed without a loss payment);

 

 

 

 
•

The timing or pattern of future payments;

 

 

 

 
•

The amount of defense cost we will pay for each claim or group of claims; and

 

 

 

 
•

Inflationary trends that are expected to bear on future loss and LAE payments.

These factors, in turn, can be affected by the judicial environment and tort-related trends over time. It is also important to note that one or more of the actuarial methods used by us do not rely on specific assumptions for these factors; rather, these assumptions are developed as a by-product of the application of the methods, which may then be monitored and factored into the final judgmental considerations of the selection of the point estimate and range of reasonable values around the point estimate from among the methods. All of the above-mentioned factors individually can and will generally vary from one period to the next over time but are estimated to approximate their ultimate values in setting reserve estimates.

In addition, due to the relatively small number of claims and the average cost per claim, any change in the trends assumed in the ultimate values for these factors may be expected to result in a significant change in the reserve estimates. Because our aggregate loss and LAE reserves are so large, this also means that virtually any change in the level of our carried reserves will be material to results of operations and may be material to our financial position. As an example, a 1% increase or decrease in carried reserves, net of reinsurance, as of March 31, 2004, would result in an after-tax addition or reduction in reported net income of $1.8 million, or 26% of our consolidated net income for the three months ended March 31, 2004. A typical range of reasonable values for MPL reserve estimates is considered to be as wide as 15%; thus, our results of operations and financial position are very sensitive to our reserve estimates and judgments, in addition to the performance of the business itself.

Reinsurance

Reinsurance does not relieve us from our primary obligations to policyholders. Therefore, the failure of reinsurers to honor their obligations could result in losses to us. The amounts recoverable from reinsurers on our unpaid losses and LAE are calculated by applying the terms of the respective ceded reinsurance contracts to our estimates of the underlying loss and LAE reserves that are subject to reinsurance. Thus, to the extent that our reinsured reserves change or are adjusted, so will the related reinsurance recoverable amounts and our exposure.

18

We evaluate the financial condition of our reinsurers and monitor concentrations of credit risk with respect to the individual reinsurers that participate in our ceded programs to minimize our exposure to significant losses from reinsurer insolvencies. We hold 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 applicable departments of insurance of the states that have jurisdiction over the underlying business.

Income Taxes

Deferred tax assets and liabilities are estimated and 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 carry forwards.

A valuation allowance against deferred tax assets is estimated and 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. We estimate and believe it is more likely than not that our deferred tax assets will be fully realized. In the event that actual results differ from our estimates, or those estimates are adjusted in future periods, we may need to establish a valuation allowance, which would impact our financial position and results of operations.

Goodwill and Intangible Assets

Effective January 1, 2002, we adopted Financial Accounting Standard No. (“FAS”) 142, “Goodwill and Other Intangible Assets.” Under FAS 142, goodwill and indefinite-lived intangible assets are no longer amortized through charges to income, but continue to be subject to annual (or under certain circumstances more frequent) impairment testing based on estimated fair values.

We have obtained independent appraisals annually since the adoption of FAS 142, the most recent of which was performed as of December 31, 2003, which indicates that our goodwill and other intangible assets are fully recoverable. Our remaining goodwill and intangible assets of $19.6 million will continue to be subject to impairment testing through independent appraisal or otherwise at least annually, and potentially more often should a triggering event occur. A triggering event under FAS 142 might include such things as a significant adverse change in legal factors or business climate, an adverse action or assessment by a regulator, unanticipated competition, or a loss of key personnel.

Investments

Our invested assets comprise our largest single asset class and consist mostly of investment securities in the form of fixed income investments in bonds and notes. Our fixed income investment securities are carried at their market values and accounted for $539.0 million and $528.6 million or 85% of our total cash and invested assets, and 43% and 45% of our total assets, respectively as of March 31, 2004 and December 31, 2003, respectively.  Unrealized gains or losses in their market values are recorded directly in shareholders’ equity, net of tax effects, as a component of accumulated other comprehensive income.

There is an exception to the treatment noted above if and when an investment security considered to be available for sale is deemed to be other-than-temporarily impaired. An other than temporary impairment may occur when the market value of a security falls below its cost by a material amount for an extended period of time (generally one year but can be less under certain circumstances) or when other creditworthiness issues arise with regard to an issuer. If and when a security is deemed to be other than temporarily impaired it is written down to its estimated market value with a corresponding realized investment loss recognized in net income.

19

Commitments and Contingencies

Liabilities for loss contingencies arising from claims, assessments, litigation, fines and penalties and other sources are recorded when it is probable that a liability has been incurred and the amount of the assessment and/or remediation can be reasonably estimated.

Our insurance subsidiaries are also subject to assessment by the financial guaranty associations in the states in which they conduct business for the provision of funds necessary for the settlement of covered claims under certain policies of insolvent insurers.  Generally, these associations can assess member insurers on the basis of written premiums in their particular states. In addition to standard assessments, the Florida and Missouri legislatures may also levy special assessments to settle claims caused by certain catastrophic losses, such as a hurricane. We would be assessed on the basis of premiums written.  No special assessments have been made in 2004 or 2003.

Revenue Recognition

Premium income, which is our main source of revenue, is generally recognized pro-rata over the respective period of each policy. Premium receivables are recorded net of an estimated allowance for uncollectible amounts.

See the following MD&A section for additional considerations regarding our reciprocal management segment and business with PRI.

Business with PRI

Reciprocal Management Agreement

Administrators for the Professions, Inc. (“AFP”) has a 10-year management agreement with PRI, under which it receives a management fee annually equal to 13% of PRI’s direct premiums written. The current term of the management agreement runs through December 31, 2008. Under the terms of the management agreement, AFP receives this fee in exchange for performing services necessary to conduct and manage the entire operation of PRI. Such services include all or substantially all marketing, underwriting, policy issuance, policy administration, investment management, claims handling and general and administrative functions, including human resources, accounting, financial reporting, and others, on an on-going basis over the life of the agreement. AFP is also reimbursed by PRI for certain expenses paid on PRI’s behalf. The expenses reimbursed by PRI are principally salaries and related payroll expenses, and overhead costs associated with claims, legal and risk management course personnel employed by AFP who work on PRI business.

The management fees are estimated, billed and collected on a monthly basis. Our entitlement to such fees is ultimately based upon the provision of all of the services necessary to manage PRI over the term of the contract.  Revenues are estimated and recognized as earned ratably over the year, which generally corresponds with when they are billed as this accounting treatment reasonably approximates and accomplishes a recognition pattern that corresponds with the provision of the required services during the quarters and the year. The fees estimated and billed, which are recognized in income, are reduced by an estimated provision for return premiums.

See the MD&A section, Contractual Obligations, Commitments and Off-Balance Sheet Arrangements included in our most recently filed annual report on Form 10-K for the year ended December 31, 2003 for a discussion and analysis of an additional commitment and related contingent liability assumed by AFP as a result of an amendment to its management agreement with PRI, effective January 1, 2002.

20

AFP also has two subsidiaries, FPIC Intermediaries, Inc. (“FPIC Intermediaries”) and Group Data Corporation (“Group Data”). FPIC Intermediaries acts as a reinsurance co-broker and intermediary for PRI and our insurance subsidiaries. Group Data acts as a co-agent and co-broker for our internal insurance needs and for the purchase of structured settlements from time to time for settled MPL claims for PRI.  The reciprocal management segment also includes FPIC’s 80% owned subsidiary Professional Medical Administrators, LLC (“PMA”), which acts as co-broker, intermediary and manager of reinsurance programs for PRI’s program business in Pennsylvania, whereby PRI assumes the premiums and risks insured.  PRI also owns 10% of PMA and until August 2003, our subsidiary, First Professionals Insurance Company, Inc. (“First Professionals”) acted as the fronting carrier for PRI for the program business managed on its behalf by PMA.  Since then, PRI has used an outside carrier to act as its fronting carrier.

The financial results for these business arrangements make up our reciprocal management segment and are presented and discussed in the following applicable section of this MD&A. Additional financial information and disclosures about our reciprocal management segment and business can be found in Note 1, Organization and Nature of Operations, Note 16, Commitments and Contingencies, Note 20, Segment Information, and Note 22, Related Party Transactions, to our consolidated financial statements included in our most recently filed annual report on Form 10-K for the year ended December 31, 2003.

Reinsurance with PRI

Our insurance subsidiary, First Professionals, assumes reinsurance from PRI. As discussed above, program business assumed by PRI in Pennsylvania was written on First Professionals’ policy forms, as fronting carrier, through July 31, 2003. Effective August 1, 2003, PRI engaged an unrelated fronting carrier for this business and, with the exception of tail coverage, no new or renewal business is being written on First Professionals’ policy forms.

The assumed reinsurance and fronting fees on PRI business of First Professionals are included in the Insurance Segment and are also discussed further in the applicable sections of the MD&A and in Note 22, Related Party Transactions, to our consolidated financial statements included in our most recently filed annual report on Form 10-K for the year ended December 31, 2003.

PRI is a Major Client of Ours

In addition to their contributions to our results of operations, our agreements and business arrangements with PRI as a major client of ours also means that our revenues and results of operations are financially sensitive to its revenues and financial condition. We do not own PRI, or have a controlling financial interest in PRI, nor is PRI considered a variable interest entity under FASB Interpretation No. 46R, Consolidation of Variable Interest Entities (as Revised), and so PRI’s financial statements are not consolidated or included in ours. Instead, PRI is similar to a mutual insurer and the risks and rewards of ownership vest with the policyholders of PRI.

PRI and our subsidiary, AFP, are regulated by the New York State Insurance Department (the “NYSID”). PRI files its annual and quarterly statements with the NYSID containing its statutory-basis financial statements and other data. AFP and PRI are required to file audits of their financial statements annually with the NYSID obtained from the same qualified independent auditing firm.

21

PRI, as an MPL insurer, is subject to many of the same types of risks as those of our insurance subsidiaries and MPL companies generally. These risks include, but are not limited to, rate adequacy, adverse loss experience, and the effects of changes in market interest rates that it can earn on invested assets. PRI files information with regard to its rates annually with the NYSID. PRI implemented an 8.5% rate increase effective July 1, 2003 following several years of level rates. Growth at PRI is also subject to surplus constraints; however, as a reciprocal, PRI is able to operate with lower surplus and at higher leverage ratios than non-reciprocals such as our insurance subsidiaries. PRI’s policyholders’ surplus exceeds the minimum amount required under New York insurance laws and regulations. New York insurance laws and regulations do not impose risk-adjusted capital requirements on PRI.  Further, as allowed under New York insurance laws, PRI has requested and received permission from the NYSID to follow the permitted practice of discounting its loss and LAE reserves.

The NYSID mandates the insurance rates PRI and other New York MPL carriers are allowed to charge their policyholders. These include the rates charged for policies in excess of $1.3 million and for covered extended reporting endorsements for death, disability and retirement, which have been reinsured to First Professionals. Under New York insurance statutes, the NYSID is also authorized to surcharge PRI’s policyholders in the event it is determined that PRI’s rates were deficient in one or more prior years as a result of adverse loss development. The amount of the surcharge may be up to 8% of PRI’s policyholders’ premiums annually until such deficiency is recovered.

Despite the unique aspects of the business and regulatory environments in which PRI operates, as an MPL insurer, it is still subject to many of the same types of risks as those of other MPL and property-casualty insurers, including similar risks to many of those described under “Safe Harbor Disclosure.”

Management’s Discussion and Analysis of Results of Operations:  Three Months Ended March 31, 2004 Compared to Three Months Ended March 31, 2003

Overview

Net income for the three months ended March 31, 2004 was $7.0 million, or $0.68 per diluted share, an increase of 154% and 134%, respectively, when compared with net income of $2.8 million, or $0.29 per diluted share, for the three months ended March 31, 2003.  Our insurance and reciprocal management segments both reported higher net income when compared with the same period in the prior year.

Total revenues for the three months ended March 31, 2004 increased $13.5 million to $57.6 million from $44.1 million for the three months ended March 31, 2003.   The increase in total revenues is the result of higher premiums earned and higher claims administration and management fees.  Net investment income increased as our fixed income securities portfolio has grown significantly in 2003 and in recent years with the growth in our insurance business.  Net realized investment gains also increased.

Total expenses for the three months ended March 31, 2004 increased $5.8 million to $45.8 million from $40.0 million for the three months ended March 31, 2003.  However, increases in expenses were lower than increases in revenues primarily resulting from improved underwriting and operating results in the insurance segment.  Our GAAP underwriting (combined) ratio improved from 101% for the three months ended March 31, 2003 to 94% for the three months ended March 31, 2004.  Claims administration and management expenses at our reciprocal management segment increased as a result of growth in business at that segment.  Interest expense declined due to lower total borrowing costs (interest plus the costs of related hedging instruments) on our long term debt.  Income tax expense was higher due to higher taxable income and, to a smaller extent, a provision made in the first quarter of 2004 for possible income tax contingencies.

22

Insurance Segment

The insurance segment is made up of our four insurance subsidiaries, First Professionals, Anesthesiologists Professional Assurance Company (“APAC”) and The Tenere Group, Inc. companies of Intermed Insurance Company (“Intermed”) and Interlex Insurance Company (“Interlex”).  Holding company operations are also included in the insurance segment due to its size and prominence and the substantial attention devoted to the segment. Unaudited financial and selected other data for our insurance segment for the three months ended March 31, 2004 and 2003 is summarized in the table below.  Dollar amounts are in thousands.

Insurance Segment Results and Selected Other Information

 

 

Three Months Ended

 

 

 

 

 

 

Mar 31,
2004

 

Percentage
Change

 

Mar 31,
2003

 

 

 

 
Direct and assumed premiums written

 

$ 

98,603

 

-6

%

 

$ 

104,535

 

 

 

 

 

 

 

 
Net premiums written

 

$

43,604

 

12

%

 

$

38,996

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
Net premiums earned

 

$

35,012

 

21

%

 

$

28,909

 
Net investment income

 

 

5,586

 

25

%

 

 

4,466

 
Net realized investment gains

 

 

2,806

 

1079

%

 

 

238

 
Finance charges and other income

 

 

170

 

-19

%

 

 

209

 
Intersegment revenues

 

 

711

 

70

%

 

 

418

 

 

 

 

 

 

 

 

 
Total revenues

 

 

44,285

 

29

%

 

 

34,240

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
Net losses and LAE

 

 

29,374

 

10

%

 

 

26,634

 
Other underwriting expense

 

 

3,503

 

40

%

 

 

2,504

 
Interest expense

 

 

590

 

-49

%

 

 

1,163

 
Other expenses

 

 

1,787

 

42

%

 

 

1,258

 
Intersegment expenses

 

 

998

 

22

%

 

 

820

 

 

 

 

 

 

 

 

 
Total expenses

 

 

36,252

 

12

%

 

 

32,379

 

 

 

 

 

 

 

 
Income from operations before income taxes

 

 

8,033

 

332

%

 

 

1,861

 

 
Less: Income tax expense

 

 

3,482

 

511

%

 

 

570

 

 

 

 

 

 

 

 

 
Net income

 

$

4,551

 

253

%

 

$

1,291

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
Selected Direct Professional Liability Claims Information

 

 

 

 

 

 

 

 

 

 
Net paid losses and LAE on professional liability claims

 

$

31,939

 

35

%

 

$

23,611

 

 

 

 

 

 

 

 
Average net paid loss per professional liability claim with indemnity payment

 

$

217

 

34

%

 

$

162

 

 

 

 

 

 

 

 
Total professional liability claims and incidents reported during the period

 

 

543

 

-34

%

 

 

827

 

 

 

 

 

 

 

 
Total professional liability claims with indemnity payment

 

 

101

 

46

%

 

 

69

 

 

 

 

 

 

 

 
Total professional liability claims and incidents closed without indemnity
payment

 

 

492

 

43

%

 

 

343

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
Selected Policyholder Counts

 

 

 

 

 

 

 

 

 

 

Professional liability policyholders (Excludes policyholders under professional liability fronting arrangements of 847 and 3,887, respectively)

 

 

13,742

 

-14

%

 

 

15,969

 

 

 

 

 

 

 

 

Insurance segment net income increased significantly during the quarter ended March 31, 2004, primarily due to an increase in net premiums earned and net investment income and lower interest expense on long term debt.  Net realized investment gains were also higher in the quarter ended March 31, 2004.

23

Our insurance segment results include the effects of our net account quota share agreement with the Hannover Re companies.  As a result of this agreement, net premiums earned, net losses and LAE incurred and other underwriting expenses were reduced by amounts ceded under the agreement of $21.4 million, $16.8 million and $5.9 million, respectively, for the quarter ended March 31, 2004.  For the quarter ended March 31, 2003, net premiums earned, net losses and LAE incurred and other underwriting expenses were reduced by $24.6 million, $19.9 million and $6.5 million, respectively, as a result of the agreement.  Before the amounts ceded under the Hannover Re agreement, net premiums earned, net losses and LAE incurred and other underwriting expenses were $56.4 million, $46.2 million and $9.4 million, respectively, for the quarter ended March 31, 2004 and $53.5 million, $46.5 million and $9.0 million, respectively, for the quarter ended March 31, 2003.

As a result of the Hannover Re agreement, our net underwriting margin (defined as net premiums earned less net losses and LAE and other underwriting expenses) improved by $1.3 million and $1.8 million for the quarters ended March 31, 2004 and 2003, respectively.  Insurance segment net income as a result of the Hannover Re agreement decreased by $0.2 million for the quarter ended March 31, 2004 and increased by $0.6 million for the quarter ended March 31, 2003.  The effects of the Hannover Re agreement to the insurance segment’s net income included finance charges associated with funds withheld under the agreement of $1.6 million and $0.8 million for the quarters ended March 31, 2004 and 2003, respectively.  These finance charges are included in other expenses.

Net premiums earned before the Hannover Re agreement increased $2.9 million for the quarter ended March 31, 2004 when compared with the same period in 2003.  The increase is primarily the result of pricing improvements.  First Professionals, APAC and Intermed have implemented significant rate increases during each of the previous three years.  The increases resulting from pricing improvements were offset to some degree by decreases in the number of policyholders in non-core states and in Missouri as insurance capacity is freed up for First Professionals’ core MPL business in Florida.  The policyholder reduction in Missouri was expected as a result of a very large rate increase implemented in 2003.

Our investment revenues, net investment income and net realized investment gains, all increased for the quarter ended March 31, 2004.  Net investment income increased primarily as a result of the increase in our fixed income investment portfolio, which continues to grow with the corresponding increases in our insurance business.  Net realized investment gains increased as we took advantage of market and economic conditions and liquidated securities with investment gains with a view toward re-positioning our portfolio in accordance with our overall investment objectives and strategy.  Unrealized investment gains and losses were $12,797 and $1,582, respectively, as of March 31, 2004.

Net losses and LAE incurred before the Hannover Re agreement decreased $0.3 million for the quarter ended March 31, 2004 when compared with the same period in 2003.  Our net loss ratio (defined as the ratio of net losses and LAE incurred to net premiums earned) before the Hannover Re agreement for the quarters ended March 31, 2004 and 2003 were 82% and 87%, respectively.  The decrease in our net losses and LAE and corresponding loss ratio reflects the pricing improvements in our insurance business, taking into consideration the inherent lag between the time premiums are written and when they are subsequently earned and the related losses are incurred, and including appropriately conservative assumptions for expected loss trends.

24

The increases in net paid losses and LAE, average net paid losses and LAE, and professional liability claims closed with indemnity payments are all generally consistent and expected as a result of recent growth in our insurance business, considering the inherent time lag until the related claims are settled and closed.  The average net paid loss amount for the three months ended March 31, 2004 was significantly higher than the comparable average for the three months ended March 31, 2003; however the average net paid loss amount for the first quarter of 2003 was also relatively low in comparison with other recent quarters.   The average net paid loss amount for the first quarter of 2004 was lower than the amount reported for the fourth quarter of 2003.  Newly reported claims and incidents were down significantly in the first quarter of 2004 when compared with the first quarter of 2003.  This was expected following a speed up in claims reporting as plaintiffs’ attorneys accelerated case filings to precede the effective date of tort reform legislation passed in Florida last fall.  In addition, we have reduced our total policy counts as a result of confining our growth in policyholders to Florida while reducing our exposure in or exiting certain other states.  Overall, our claims experience in the first quarter of 2004 was consistent and in line with the assumptions currently reflected in our loss and LAE reserve estimates.

25

Reciprocal Management Segment

Our reciprocal management segment is made up of AFP, our New York subsidiary, and its two wholly owned subsidiaries, FPIC Intermediaries and Group Data.  AFP acts as administrator and attorney-in-fact for PRI, the second largest medical professional liability insurer for physicians in the state of New York.  FPIC Intermediaries acts as a reinsurance broker and intermediary in the placement of reinsurance for PRI and FPIC.  Group Data acts as a broker in the placement of annuities for structured settlements.  The segment also includes the business of PMA, an 80% owned subsidiary.  PMA provides brokerage and administration services to PRI for professional liability insurance programs.  Unaudited financial and selected other data for the reciprocal management segment for the three months ended March 31, 2004 and 2003 is summarized in the table below.  Dollar amounts are in thousands.

Reciprocal Management Segment Results and Selected Other Information

 

 

Three Months Ended

 

 

 

 

 

 

Mar 31,
2004

 

Percentage
Change

 

Mar 31,
2003

 

 

 

 
Claims administration and management fees

 

$ 

8,465

 

70

%

 

$ 

4,988

 
Net investment income

 

 

28

 

-15

%

 

 

33

 
Commission income

 

 

1,489

 

18

%

 

 

1,267

 
Other income

 

 

27

 

29

%

 

 

21

 
Intersegment revenues

 

 

1,010

 

23

%

 

 

823

 

 

 

 

 

 

 

 

 
Total revenues

 

 

11,019

 

55

%

 

 

7,132

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
Claims administration and management expenses

 

 

6,716

 

45

%

 

 

4,625

 
Other expenses

 

 

54

 

2

%

 

 

53

 
Intersegment expenses

 

 

571

 

62

%

 

 

352

 

 

 

 

 

 

 

 

 
Total expenses

 

 

7,341

 

46

%

 

 

5,030

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
Income from operations before income taxes

 

 

3,678

 

75

%

 

 

2,102

 

 

 

 

 

 

 

 

 

 

 

 

 
Less: Income taxes

 

 

1,235

 

62

%

 

 

764

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
Net income

 

$

2,443

 

83

%

 

$

1,338

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
Selected Information Regarding Management of PRI

 

 

 

 

 

 

 

 

 

 
Reciprocal premiums written under management

 

$

83,599

 

173

%

 

$

30,646

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of

 

 

 

 

 

 

Mar 31,
2004

 

Percentage
Change

 

Mar 31,
2003

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
Reciprocal statutory assets under management

 

$

921,338

 

13

%

 

$

815,404

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
Professional liability policyholders under management

 

 

11,237

 

6

%

 

 

10,642

 

 

 

 

 

 

 

 

Reciprocal management net income increased during the quarter ended March 31, 2004, primarily due to higher management fees and commission income.  The growth in these revenues was the result of growth in premiums written at PRI due to a newly acquired institutional client and higher insurance premiums placed by PMA under a PRI professional liability insurance program.

26

Claims administration and management fees earned by AFP are comprised entirely of management fees from PRI.  In accordance with the management agreement between AFP and PRI, AFP receives a management fee equal to 13% of PRI’s direct premiums written, with an adjustment for expected return premiums.  As such, increases in the direct premiums written by PRI result in a corresponding increase in management fees earned by AFP.  The addition of a new institutional client is expected to add approximately $49.5 million to PRI ‘s 2004 annual written premiums resulting in an increase in the management fees earned for the first quarter and also increasing the fees that will be earned in subsequent quarters of 2004 as services are provided. 

Commission income earned by the reciprocal management segment increased for the quarter ended March 31, 2004 primarily as a result of an increase in insurance premiums placed by PMA under a PRI professional liability insurance program, where commissions are received based on the amount of insurance premium placed.  This increase in commission income was slightly offset by lower brokerage commissions earned by Intermediaries from third party reinsurers as a result of the decrease in the placement of reinsurance premiums for our insurance.

The increase in claims administration and management expenses for the quarter ended March 31, 2004 when compared with the same quarter in 2003 is due to the combination of an increase in operating expenses at AFP and commission expenses at PMA.  The increase in operating expenses at AFP is the result of corresponding growth of PRI.  The increase in commission expenses at PMA was associated with an increase in premiums written and placed under a PRI professional liability insurance program.

27

Third Party Administration (“TPA”) Segment

Our TPA segment represents the business of our subsidiary, Employers Mutual, Inc. (“EMI”).  Unaudited financial and selected other data for our TPA segment for the three months ended March 31, 2004 and 2003 is summarized in the table below.  Dollar amounts are in thousands.

TPA Segment Results and Selected Other Information

 

 

Three Months Ended

 

 

 

 

 

 

Mar 31,
2004

 

Percentage
Change

 

Mar 31,
2003

 

 

 

 

 

 

 

 

 

 

 

 
Claims administration and management fees

 

$

3,619

 

-2

%

 

$

3,677

 
Net investment income

 

 

7

 

75

%

 

 

4

 
Commission income

 

 

354

 

12

%

 

 

317

 
Other income

 

 

—

 

-100

%

 

 

1

 
Intersegment revenues

 

 

—

 

-100

%

 

 

9

 

 

 

 

 

 

 

 

 
Total revenues

 

 

3,980

 

-1

%

 

 

4,008

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
Claims administration and management expenses

 

 

3,797

 

2

%

 

 

3,717

 
Intersegment expenses

 

 

152

 

95

%

 

 

78

 

 

 

 

 

 

 

 

 
Total expenses

 

 

3,949

 

4

%

 

 

3,795

 

 

 

 

 

 

 

 
Income from operations before income taxes

 

 

31

 

-85

%

 

 

213

 

 

 

 

 

 

 

 

 

 

 

 

 
Less: Income tax expense

 

 

15

 

-82

%

 

 

82

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
Net income

 

$

16

 

-88

%

 

$

131

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of

 

 

 

 

 

 

Mar 31,
2004

 

Percentage
Change

 

Mar 31,
2003

 

 

 

 
Selected TPA Segment Customer Data

 

 

 

 

 

 

 

 

 

 
Covered lives under employee benefit programs

 

 

99,665

 

-10

%

 

 

111,301

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
Covered lives under workers compensation programs

 

 

42,400

 

11

%

 

 

38,100

 

 

 

 

 

 

 

 

TPA net income decreased during the quarter ended March 31, 2004 primarily due to small decreases in claims administration and management fee revenue, related margins and higher intersegment expenses when compared with the same period in 2003.  Operating margins decreased somewhat during the first three months of 2004, when compared with the first three months of 2003, as a result of higher operating expenses associated with a strategic growth initiative.  The net decline in revenues for the three months ended March 31, 2004 as compared to the first quarter of 2003 was due to a reduction in covered lives associated with employee benefit programs under management.

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Management’s Discussion and Analysis of Financial Position:  March 31, 2004 Compared to December 31, 2003

Cash and invested assets increased $9.8 million to $632.5 million as of March 31, 2004 from $622.7 million as of December 31, 2003.  The increase in cash and invested assets is primarily due to an increase in the aggregate market value of our fixed income investments, growth in premiums at our insurance segment and growth in claims administration and management fees and commission income at our reciprocal management segment.  Also contributing to the increase was cash received from the exercise of stock options and resulting issuance of our common stock.  Offsetting these increases were higher paid claims in the quarter, including some for which corresponding reinsurance recoveries have not yet been received as of March 31, 2004.

Insurance assets, including premiums receivable and reinsurance recoverables and related assets, all increased as of March 31, 2004 primarily as the result of growth experienced in our insurance premiums.  Recoverables on paid losses increased due to an increase in paid losses for which the corresponding recoveries were not yet received as of March 31, 2004.  Approximately $12.8 million of the increase due from reinsurers on unpaid losses is attributable to loss and LAE reserves ceded under the Hannover Re agreement during the first three months of 2004. 

The increases in our insurance liabilities as of March 31, 2004, including the liability for losses and LAE, unearned premiums and reinsurance payable, are attributable to recent growth in our core MPL insurance business.  Reinsurance payable increased $18.2 million as a result of business ceded under the Hannover Re agreement, which was partially offset by the payment of premiums due under FPIC’s primary reinsurance agreement.

As more fully discussed in the preceding MD&A section on Critical Accounting Policies, Liability for Losses and LAE, multiple methods and assumptions are made in the actuarial testing of loss and LAE reserves.  FPIC’s only significant line of business is medical professional liability insurance, which insures physicians, dentists and other health care providers against professional liability claims associated with the practice of medicine.  The number of claims are relatively few in number and the number that actually result in an indemnity (loss) payment are fewer and tend to be significant in amount (as opposed to a large number of small claims, relatively speaking), as they comprise compensation and damages to injured patients. 

The primary factors affecting FPIC’s MPL loss and LAE reserves can be summarized in terms of frequency and severity trends, including the frequency of indemnity payments (the percentage of claims received that ultimately result in a loss payment versus those that are settled and closed without a loss payment), the timing or pattern of future payments, the average cost of indemnity (loss cost) per claim, and defense cost trends.  These factors, in turn, can be affected by the future judicial environment and tort-related trends.  It is also important to note that all the actuarial methods used do not rely on specific assumptions for these factors; rather, these assumptions are developed as a by-product of the application of the methods, which may then be monitored and factored into the final judgmental considerations of the selection of the point estimate and range of reasonable values around the point estimate from among the methods. 

All of these factors individually can and will vary from one period to the next over time but are estimated to approximate their ultimate assumed or average per claim values in setting reserve estimates.  In addition, due to the relatively small number of claims and the average cost per claim, any change in trend determined with regard to any of the ultimate values assumed for these factors may be expected to result in a significant change in the reserve estimates.  Also, given the size of our loss and LAE reserves, virtually any change in the level of carried reserves will be material to results of operations and may be material to our financial position.  For example, a 1% increase or decrease in carried reserves, net of reinsurance, as of March 31, 2004, would result in an after-tax addition or reduction in reported income of approximately $1.8 million ($2.9 million before income taxes), which would comprise 26% of FPIC’s consolidated net income for the quarter ended March 31, 2004.

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The decrease in premiums paid in advance and unprocessed premiums reflects the number of policy renewals that fall on January 1.  As a result of this renewal period, paid in advance premiums are typically higher as of December 31 of each year.

The significant increases in other assets and accrued expenses and other liabilities of approximately $4.1 million and $7.4 million, respectively as of March 31, 2004, are primarily attributable to purchase and sale transactions involving investment securities, which were entered into prior to March 31, 2004, but for which settlements occurred in April 2004.

Stock Repurchase Plans

Under our stock repurchase program, we may repurchase shares at such times, and in such amounts, as management deems appropriate.  We did not repurchase any shares during the first quarter of 2004 and a total of 365,500 shares remain available to be repurchased under the program.  Under certain circumstances, limitations may be placed on FPIC’s ability to purchase its capital stock by the terms of agreements relating to its junior subordinated debentures.  For information regarding these limitations, refer to Note 5, Long Term Debt to the accompanying condensed consolidated financial statements, or Note 13, Long Term Debt, Revolving Credit Facility and Term Loan, to the consolidated financial statements in our most recently filed Form 10-K.  For additional information, see also the discussion of Liquidity and Capital Resources, below.

Liquidity and Capital Resources

The payment of losses and LAE, insurance operating expenses (including reinsurance costs), claims administration and management expenses, non-insurance operating expenses, interest expense and income taxes in the ordinary course of business are the principal needs for our liquid funds. The principal sources of cash from our operations to meet our on-going liquidity requirements are the premiums collected for the insurance sold by our insurance subsidiaries, income on the investment of those funds, and claims administration and management fees and reinsurance brokerage and other commission income earned by our non-insurance subsidiaries.  

Net Cash (Used In) Provided By Operating Activities

As reported in the condensed consolidated statement of cash flows, net cash used in operating activities was $2.7 million for three months ended March 31, 2004 compared with net cash provided by operating activities of  $23.3 million for the three months ended March 31, 2003.  The net use of cash for operating activities for the three months ended March 31, 2004 can be attributed to an increase in paid losses and LAE for the quarter relative to amounts paid in the first quarter of 2003.  Paid losses and LAE in the first quarter of 2004 were proportionately higher relative to premiums written and collected primarily as the result of significant growth in the business during 2001 and 2002, and taking into account the inherent time lag between that growth and subsequent development and settlements of the related claims.  Also adding to higher paid losses and LAE were several reinsured claims that were settled in the first quarter of 2004, but for which the related reinsurance recoveries had not yet been received as of March 31, 2004.  At March 31, 2004, we had cash and invested assets of $632.5 million and held fixed maturity debt securities with a fair value of approximately $8.2 million with scheduled maturities during the next twelve months.  We believe that our cash and invested assets as of March 31, 2004, combined with expected cash flows from operating activities for the remainder of the year and the scheduled maturities of investments in 2004, will be sufficient to meet our cash needs for operating purposes for at least the next twelve months.

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A number of factors could cause unexpected changes in liquidity and capital resources available, including but not limited to the following:

1.

Unexpected changes in premium revenue due to higher or lower than expected new business or retention of insurance policies in force;

 

 

2.

Unexpected changes in the amounts needed to defend and settle claims;

 

 

3.

Unexpected changes in operating costs, including new or increased taxes;

 

 

4.

Failure of one or more of our reinsurers leading to uncollectible reinsurance recoverables;

 

 

5.

Possible impairments of our long term investments; and

 

 

6.

Unexpected changes in liquidity provided by our reciprocal management and TPA segments.

Furthermore, liquidity and capital risks can come about as the result of the broader business and financial risks facing us including the uncertainties and factors disclosed in the Safe Harbor Disclosure.  Many, if not most of these types of uncertainties, could have a corresponding and materially negative effect on our liquidity and capital resources, as well as our financial condition and results of operations.  In order to compensate for such risk, we:

1.

Maintain what management considers to be adequate capital and reinsurance;

 

 

2.

Monitor our reserves and regularly perform actuarial reviews of loss and LAE reserves; and

 

 

3.

Attempt to maintain adequate asset diversification and liquidity (by managing our cash flow from operations coupled with the maturities from our fixed income portfolio investments).

Long Term Debt

Our junior subordinated debentures and senior notes are uncollateralized and mature in 2033 unless we exercise our option to call them earlier, which is generally 5 years from the date of issue.  No principal payments are due in the interim.  These securities bear floating interest rates equal to the three-month LIBOR plus spreads ranging from 3.85% to 4.2% (the interest rates ranged from 4.97% to 5.32% as of March 31, 2004).  The floating interest rates are adjustable quarterly with changes in the three-month LIBOR, and in the case of the first two offerings, the maximum rate that may be charged under the securities within the first five years is 12.5%.  We have also purchased hedging instruments, as described below, designed to maintain the ultimate floating rate interest cost on all of these securities within a stated range for five years from closing.

Indenture agreements relating to FPIC’s junior subordinated debentures and trust preferred securities contain limitations, under certain circumstances, as to (i) the declaration or payment of dividends, or distributions thereon, or the redemption, purchase, acquisition or liquidation with respect to any capital stock of FPIC or its affiliates; (ii) the payment, in certain circumstances, of principal of, premium or interest on, or the repayment, repurchase or redemption of, debt securities of FPIC or its affiliates that rank in equal standing with or are junior in interest to the debentures; or (iii) the payment, in certain circumstances, under any guarantees of FPIC or its affiliates that rank equal in standing with or junior in interest to capital securities guarantees relating to the issuance of the debentures. Circumstances that would result in such limitations include a continuing event of default, as defined by the indenture agreements, a default with respect to payment of any obligations under capital securities guarantees, or a continuing interest deferral election by FPIC.

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Issuance costs for all three offerings in the aggregate amount of approximately $1.4 million were capitalized and will be amortized over their respective stated maturity periods of thirty years.  In addition, hedge agreements were purchased that effectively place floors and caps on the three-month LIBOR floating interest of approximately 1.0% to 1.20% and 4.40% to 4.65%, respectively, on notional principal corresponding with the principal amounts of each offering, for 5 years from issuance.  These instruments will effectively serve to hedge our total floating interest rate borrowing costs under the securities to within a range of 4.85% to 8.60% for five years and until such time that we have the right to call the securities.  The initial costs of the hedge instruments acquired for this purpose of $1.1 million, in aggregate, have been capitalized and will be amortized over their respective five year maturity periods.

Contractual Obligations, Commitments and Off-Balance Sheet Arrangements

There have been no material changes in contractual obligations, commitments and off-balance sheet arrangements described in the applicable section of the MD&A included in our most recently filed annual report on Form 10-K for the year ended December 31, 2003.

Item 3.  Quantitative and Qualitative Disclosures About Market Risk

There have been no material changes in the reported market risks, as described in our 2003 annual report on Form 10-K, since the end of the most recent fiscal year.  

Item 4.  Controls and Procedures

(a)

An evaluation of FPIC’s controls and procedures (as defined by Rule 13a-15(e) of the Securities Exchange Act of 1934 (the “Act”)), was completed as of March 31, 2004 by FPIC’s Chief Executive Officer and Chief Financial Officer.  Based on such evaluation, FPIC’s disclosure controls and procedures were found to be effective in ensuring that material information, relating to FPIC and its consolidated subsidiaries, as required to be disclosed by FPIC in its periodic reports filed with the Securities and Exchange Commission, is accumulated and made known to the Chief Executive Officer and Chief Financial Officer, and other management, as appropriate, to allow for timely decisions regarding required disclosure.

 

 

(b)

There have been no significant changes in FPIC’s internal controls over financial reporting identified in connection with the evaluation referred to in paragraph (a) above that occurred during the last quarter and that have materially affected, or are reasonably likely to materially affect, FPIC’s internal controls over financial reporting.

Part II – Other Information

Item 1.  Legal Proceedings – None

Item 2.  Changes in Securities and Use of Proceeds –

For information on our issuer repurchase program, see the MD&A section, Stock Repurchase Plans on page 30.

Item 3.  Defaults Upon Senior Securities – None

Item 4.  Submission of Matters to a Vote of Security Holders – None

Item 5.  Other Information –

In accordance with the requirements of the Federal Securities Laws, FPIC recognizes blackout periods during which directors, officers and certain employees with an awareness of material, nonpublic information are prohibited from transacting in FPIC’s stock.  FPIC will maintain a blackout period for such persons until 48 hours after the filing of this Form 10-Q with the Securities and Exchange Commission.

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Item 6.  Exhibits and Reports on Form 8-K

Exhibits:

31.1

Certification of John R. Byers, President and Chief Executive Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

 

31.2

Certification of Kim D. Thorpe, Executive Vice President and Chief Financial Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

 

 

32

Certification of John R. Byers, President and Chief Executive Officer, and Kim D. Thorpe, Executive Vice President and Chief Financial Officer, pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

Reports on Form 8-K:

On February 25, 2004, FPIC furnished a Form 8-K notifying the SEC that FPIC issued an earnings press release announcing selected financial data concerning fourth quarter 2003 unaudited consolidated results of operations and financial condition presented in accordance with accounting principles generally accepted in the United States of America.

Signature

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.

May 10, 2004

FPIC Insurance Group, Inc.

 

/s/  Kim D. Thorpe

 

 

 

Kim D. Thorpe, Executive Vice
President and Chief Financial Officer
(Principal Financial Officer)
(Principal Accounting Officer)

33