10-Q 1 c64157e10-q.txt QUARTERLY REPORT 1 ================================================================================ 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 Period Ended June 30, 2001. or [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Transition Period From ________________to____________ Commission file number 0-21230 ------- Midwest Medical Insurance Holding Company ------------------------------------------------------ (Exact name of registrant as specified in its charter) Minnesota 41-1625287 ------------------------------- ------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 7650 Edinborough Way, Suite 400 Minneapolis, Minnesota 55435-5978 ---------------------------------------- ---------- (Address of principal executive offices) (Zip Code) 952-838-6700 ---------------------------------------------------- (Registrant's telephone number, including area code) Not applicable --------------------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] The number of shares outstanding of the issuer's classes of common stock as of June 30, 2001: Class B Common Stock, $1,000 par value - 1 share Class C Common Stock, no par value - 8,468 shares ================================================================================ 2 INDEX Midwest Medical Insurance Holding Company PART I. FINANCIAL INFORMATION Item 1. Financial Statements (Unaudited) Condensed consolidated balance sheets - June 30, 2001 and December 31, 2000 Condensed consolidated statements of income - Three months ended June 30, 2001 and 2000; Six months ended June 30, 2001 and 2000 Condensed consolidated statements of cash flows - six months ended June 30, 2001 and 2000 Notes to condensed consolidated financial statements - June 30, 2001 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Item 3. Quantitative and Qualitative Disclosures About Market Risk PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K SIGNATURES 2 3 Part I. Financial Information Item 1. - Financial Statements MIDWEST MEDICAL INSURANCE HOLDING COMPANY and SUBSIDIARIES Condensed Consolidated Balance Sheets (Dollars in thousands)

See notes to condensed consolidated financial statements. 3 4 MIDWEST MEDICAL INSURANCE HOLDING COMPANY and SUBSIDIARIES Condensed Consolidated Statements of Income (Dollars in thousands) (Unaudited)

See notes to condensed consolidated financial statements. 4 5 MIDWEST MEDICAL INSURANCE HOLDING COMPANY and SUBSIDIARIES Condensed Consolidated Statements of Cash Flows (Dollars in thousands) (Unaudited)

See notes to condensed consolidated financial statements. 5 6 MIDWEST MEDICAL INSURANCE HOLDING COMPANY and SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) June 30, 2001 NOTE A - BASIS OF PRESENTATION The accompanying unaudited interim condensed consolidated financial statements of Midwest Medical Insurance Holding Company and its subsidiaries have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for any interim period are not necessarily indicative of the results that may occur for the full year. These interim financial statements should be read in conjunction with the 2000 consolidated financial statements and notes thereto included in Midwest Holding's Annual Report on Form 10-K as filed with the Securities and Exchange Commission. The balance sheet at December 31, 2000 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. Certain amounts applicable to prior periods have been reclassified to conform to the classifications followed in the current year. All intercompany amounts have been eliminated. NOTE B - INCOME TAXES The Company calculates its income tax provision for interim periods by estimating its annual effective tax rate and applying this rate to the income of the interim period. The estimated annual effective tax rate used for the three and six-month periods ended June 30, 2001 was approximately 36% compared to 35% for the same periods of 2000. During the second quarter of 2000, Midwest Medical Insurance Company received $4,418,000 in federal tax refunds and interest that resulted from the IRS examinations for the 1992 to 1996 tax years. The $2,715,000 of tax refunds was recorded as an income tax benefit while the $1,703,000 of interest was recorded to other revenues. NOTE C - UNEARNED PREMIUMS, PREMIUMS RECEIVABLE and OTHER LIABILITIES The majority of Midwest Medical's insurance policies expire at December 31 and renew on January 1 of each year. As a result, the majority of the unearned premium amount at June 30, 2001 represents six months of unearned premium for every active policy renewed or newly written on January 1, 2001 with an expiration date of December 31, 2001. At December 31, 2000, most active 2000 policies expired and therefore had no unearned premium. 6 7 NOTE C - UNEARNED PREMIUMS, PREMIUMS RECEIVABLE and OTHER LIABILITIES (continued) Of the total unearned premium balance of $12,050,000 at December 31, 2000, $6,200,000 is reserved to recognize Midwest Medical's obligation to provide reporting endorsement coverage without additional premium upon the death, disability or retirement of policyholders. That same amount is also included in the unearned premium balance at June 30, 2001 and represents the actuarially determined present value of future benefits to be provided less the present value of future revenues to be received. The increase of $14,497,000 in premiums receivable from December 31, 2000 to June 30, 2001 is primarily due to the renewal of most active policies on January 1. The full year's premium is recorded as written and collectible at January 1. Premiums may be paid annually or quarterly and each year's premium is nearly all collected during the year. The receivable balance remaining at the end of the year primarily relates to the small number of policies underwritten by Midwest Medical that have other than December 31 expiration dates. Of the total other liabilities balance of $10,624,000 at December 31, 2000, $5,237,000 is for premium payments received from policyholders in advance of their January 1, 2001 policy renewal. No advance premium payments were recorded at June 30, 2001. NOTE D - POLICYHOLDER DIVIDENDS In 1999, Midwest Medical replaced the retrospective premium credit program for physicians with a policyholder dividend program. To implement the policyholder dividend program, Midwest Medical issued participating policy endorsements to all active physician, clinic and hospital accounts during 1999 and 2000. Participating policies represented approximately 97% and 96% of total premiums in force and premium income at June 30, 2001 and December 31, 2000, respectively. The $8,000,000 of physician and clinic policyholder dividends declared in 2000 is awarded proportionately based on annual premiums for physician and clinic policyholders that were insured by Midwest Medical in 1996 and remain insured throughout 2001. The dividend will be paid in four equal installments in February, May, August and November 2001. The $108,000 of hospital policyholder dividends declared in 2000 is awarded based on the number of years insured with Midwest Medical and will be paid within two months after the hospital policy renews in 2001. NOTE E - SEGMENT INFORMATION The Company is organized into five legal entity business segments. The segments are described under the "Background" section in Item 1 of the 2000 Annual Report on Form 10-K. The following financial information summarizes the results of operations and total assets reported by the Company's five business segments for the three and six-month periods ended June 30, 2001 and 2000 (in thousands). 7 8 NOTE E - SEGMENT INFORMATION (continued)

------------- (1) Intersegment eliminations for revenues and expenses are primarily for management and administrative services provided by Midwest Holding. Eliminations for assets consist primarily of investments in wholly-owned subsidiaries, intersegment receivables and payables for management fees and reclassifications between assets and liabilities primarily for taxes. (2) Other revenues consist primarily of net realized capital gains. 8 9 NOTE E - SEGMENT INFORMATION (continued)

------------- (1) Intersegment eliminations for revenues and expenses are primarily for management, administrative and investment services provided by Midwest Holding. Eliminations for assets consist primarily of investments in wholly-owned subsidiaries, intersegment receivables for management fees and reclassifications between assets and liabilities primarily for taxes. (2) Other revenues consist primarily of net realized capital gains and interest received on federal income tax refunds. 11 12 NOTE F - COMPREHENSIVE INCOME The components of Midwest Holding's comprehensive income are net income and changes in net unrealized appreciation of investments. Total comprehensive income was $(342,000) and $(5,964,000) for the three and six-months ended June 30, 2001 and $969,000 and $5,464,000 for the three and six-months ended June 30, 2000. Item 2. - Management's Discussion and Analysis of Financial Condition and Results of Operations General The following analysis of the financial condition and results of operations of Midwest Holding and its wholly-owned subsidiaries, Midwest Medical, MMIHC Insurance Services, Inc., Midwest Medical Solutions, Inc., and MedPower Information Resources, Inc. should be read in conjunction with the condensed consolidated financial statements and notes thereto included in this report. Midwest Holding and its subsidiaries are collectively referred to as the Company unless the reference pertains to a specific entity. Capital Resources and Liquidity The majority of the Company's assets, 83% at June 30, 2001 and 87% at December 31, 2000, are invested in investment-grade bonds, equities and short-term instruments. The Company's investments in debt and equity securities are classified as available for sale and are therefore carried at fair value. Other investments consist of equity interests in non-traded real estate investment trusts (REIT) that are also classified as available for sale and are recorded at the fair value determined by the most recent independent appraisal. The Company purchased an additional $10,000,000 of the REIT in the first quarter of 2001 bringing its ownership interest in the REIT to approximately 7% of the total shares outstanding. The purchase used proceeds from sales of equity securities and was made to capture the current attractive yield on the REIT, approximately 8.5%, and to reduce the Company's portfolio allocation to equities to a level more consistent with the rest of the medical malpractice insurance industry. The Company believes that this will also help to reduce the volatility in the market value of the total investment portfolio. Operations generated $(7,969,000) of negative cash flow during the first six months of 2001 compared to $2,359,000 of positive cash flow for the same period of 2000. During the first six months of 2001, dividend payments of $4,045,000 were made to policyholders and payments of $1,877,000 were made to reinsurers. Unfavorable experience adjustments on the 1992-1994 and 1995-1997 reinsurance contracts triggered the payments to the reinsurers. An increase in claim payments also contributed to the negative cash flow in the first six months of 2001. The positive cash flow in the first six months of 2000 was primarily due to payments of $5,208,000 received from reinsurers for favorable experience adjustments on the 1992-1994 and 1995-1997 reinsurance contracts. Federal tax refunds including interest of $4,418,000 also contributed to the positive operating cash flow. This was partially offset by $5,073,000 of policyholder dividend payments. The Company believes that its cash, internally generated funds and investments will be sufficient to meet normal operating requirements. 12 13 Capital Resources and Liquidity (continued) Shareholders' equity decreased by $(5,964,000) during the first six months of 2001. Net income of $2,177,000 was offset by net unrealized losses in the fair value of investments, net of deferred taxes, of $(8,141,000). Results of Operations Net premiums earned decreased $351,000 for the first six months of 2001 compared to the same period of 2000. An unfavorable experience adjustment of $2,329,000 was recorded in the second quarter on the 1995-1997 reinsurance contract due primarily to a large claim paid on the 1996 report year. This was partially offset by new business resulting in approximately $1,868,000 of additional premiums earned, a 5% premium rate increase for Iowa policyholders and fewer premium discounts. Fewer premium discounts were awarded as competitive pressures are easing in most of Midwest Medical's markets. Competitors are generally raising rates aggressively or exiting certain medical malpractice market segments altogether. These insurance marketplace conditions, rising rates and more limited availability, are often referred to as a "hard market". Net capital gains of $6,126,000 were realized during the first six months of 2001, a decrease of $204,000 over the same period in 2000. Equities selected by the outside, domestic equity manager were sold in the first half of 2001 to fund the additional REIT purchase of $10,000,000 as well as policyholder dividend payments. Appreciated technology common stocks were sold in the first quarter of 2000 to maintain appropriate equity portfolio diversification. Future levels of realized capital gains or losses are difficult to predict as investment managers purchase and sell securities in response to changing market conditions and investment policy guidelines. Other revenues were $1,690,000 for the first six months of 2001, a decrease of $1,584,000 from the same period of 2000. Most of this decrease is due to the $1,703,000 of interest on federal tax refunds recorded in the second quarter of 2000. Also contributing to the decrease is the elimination of finance charges on 2001 premium billings to Midwest Medical policyholders. Finance charges of $484,000 were included in other revenues for the first half of 2000. Offsetting these decreases were a $402,000 increase in Solutions' revenues primarily from the information technology consulting division and a $258,000 increase in Services' revenues primarily from commission income earned on new accounts. Losses and loss adjustment expenses increased $2,647,000 for the first six months of 2001 versus 2000. The increase in 2001 was primarily due to the growth in Midwest Medical business and the corresponding exposure. The increase in Midwest Medical's retention on a single claim from $750,000 to $1,000,000 beginning 2001 also contributed to the increase in incurred losses. Since the effects of interim claim frequency and severity statistics are not actuarially analyzed, incurred losses are estimated during the interim using historical company data, known trends and management's judgment. The increase in incurred losses for the first six months of 2001 was, for the most part, anticipated by management due to Midwest Medical's increased exposure and the recent growth in claims severity. Due to these same reasons, management expects a continuation in the upward trend in losses for the remainder of the year. 13 14 Results of Operations (continued) Underwriting, acquisition and insurance expenses increased $108,000 for the first six months of 2001 compared to the same period in 2000. An increase in gross premium written drove additional commission expense in the first six months of 2001. Other operating expenses increased $333,000 for the first six months of 2001 compared to the same period in 2000. Additional staff for Solutions and Services and greater commissions paid to Services' producers accounted for most of the increase. These increases were partially offset by lower development costs in Solutions and lower consulting expenses in MedPower. Income tax expense increased to $1,251,000 for the six months ending June 30, 2001 from $208,000 for the same period in 2000. The increase was primarily due to the $2,715,000 income tax benefit recorded in the second quarter of 2000 for federal tax refunds received on the 1992 to 1996 tax years. As a result of the factors discussed above, the Company recorded net income of $2,177,000 for the six months ended June 30, 2001 compared to net income of $8,228,000 for the same period of 2000. Cautionary Note Regarding Forward-Looking Statements Statements other than historical information contained in this report are considered to be "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Act of 1934, as amended. All forward-looking statements address matters that involve risks and uncertainties. Accordingly, in addition to the factors discussed in this report, there are or will be other significant factors that could cause actual results to differ materially from those indicated. These factors include but are not limited to: 1. the impact of changing market conditions on the Company's business strategy; 2. the effects of increased competition on pricing, coverage terms, retention of customers and ability to attract new customers; 3. greater severity or frequency of the types of losses that the Company insures; 4. faster or more adverse loss development experience than what the Company had based its underwriting, reserving, and investment practices; 5. developments in global financial markets which could adversely affect the performance of the Company's investment portfolio; 6. litigation, regulatory or tax developments which could adversely affect the Company's business; 7. risks associated with the introduction of new products and services; 8. dependence on key personnel; and 9. the impact of mergers and acquisitions. The above factors should be considered when reviewing any forward-looking statement contained in this report. The significant factors that could affect forward-looking statements are subject to change, and the Company does not intend to update any forward-looking statement or the above list of significant factors. 14 15 Cautionary Note Regarding Forward-Looking Statements (continued) By this cautionary note, the Company intends to rely upon the safe harbor from liability with respect to forward-looking statements provided by Section 27A and Section 21E referred to previously. Item 3. - Quantitative and Qualitative Disclosures About Market Risk Market risk is the risk of loss that may occur when fluctuations in interest and foreign currency exchange rates and equity and commodity prices change the value of a financial instrument. Both derivative and nonderivative financial instruments have market risk. The Company is primarily exposed to interest rate risk on its investment in fixed maturities, equity price risk on its investment in equity securities, and foreign currency exchange rate risk on its investment in international equity securities. Based on the effective duration of the fixed maturity investment portfolio, an abrupt 100 basis point increase in interest rates along the entire interest rate yield curve would adversely affect the fair value of fixed maturity investments by approximately $6,200,000 at June 30, 2001 compared to $6,500,000 at December 31, 2000. Based primarily on past annual performance relative to the Standard & Poors 500 Market Index (S&P 500), an abrupt ten percent decrease in the S&P 500 would adversely affect the fair value of equity securities by approximately $8,100,000 at June 30, 2001 compared to $10,400,000 at December 31, 2000. No material change occurred in the foreign currency exchange rate risk on the investment in international equity securities at June 30, 2001 compared to December 31, 2000. The Company believes that there would be no material effect on its net income and cash flows in any of the above scenarios. This effect on net income and cash flows does not consider the possible effects a change in economic activity could have in such an environment. Investors, customers, regulators and legislators could respond to these fluctuations in ways the Company cannot foresee. Because the Company cannot be certain what specific actions would be taken and their effects, the above sensitivity analyses assume no significant changes in the Company's financial structure. Part II. Other Information Item 6. - Exhibits and Reports on Form 8-K (a) Exhibits None (b) Reports on Form 8-K None 15 16 Signatures Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Midwest Medical Insurance Holding Company ----------------------------------------- (Registrant) Date August 6, 2001 /s/ David P. Bounk ------------------- ----------------------------------------- David P. Bounk President and Chief Executive Officer Date August 6, 2001 /s/ Niles Cole ------------------- ----------------------------------------- Niles Cole Vice President and Principal Financial Officer and Principal Accounting Officer 16

MIDWEST MEDICAL INSURANCE HOLDING CO 10-Q