10-Q 1 c71094e10vq.txt FORM 10-Q FOR QUARTER ENDING JUNE 30, 2002 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, 2002. 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, 2002: Class B Common Stock, $1,000 par value - 1 share Class C Common Stock, no par value -- 10,762 shares 1 INDEX Midwest Medical Insurance Holding Company PART I. FINANCIAL INFORMATION Item 1. Financial Statements (Unaudited) Condensed consolidated balance sheets -- June 30, 2002 and December 31, 2001 Condensed consolidated statements of income - Three months ended June 30, 2002 and 2001; Six months ended June 30, 2002 and 2001 Condensed consolidated statements of cash flows - six months ended June 30, 2002 and 2001 Notes to condensed consolidated financial statements -- June 30, 2002 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 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 MIDWEST MEDICAL INSURANCE HOLDING COMPANY and SUBSIDIARIES Condensed Consolidated Statements of Income (Dollars in thousands) (Unaudited)

See notes to condensed consolidated financial statements. 4 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 MIDWEST MEDICAL INSURANCE HOLDING COMPANY and SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) June 30, 2002 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 2001 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, 2001 has been derived from the audited financial statements at that date but does not include all of the information and notes 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. In management's judgment, the following are the critical accounting policies of the Company: Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, as well as disclosure of contingent assets and liabilities at the date of the financial statements. Actual results could differ from those estimates. Investments The Company manages its investment portfolio to achieve its long-term investment objective of providing for the financial stability of the Company through preservation of assets and maximization of total portfolio return. Although management believes the Company has the ability to hold its fixed maturity investment portfolio to maturity, these investments are classified as "available for sale," as management may take advantage of opportunities to increase total return through sales of selected securities in response to changing market conditions. 6 NOTE A - BASIS OF PRESENTATION (continued) Consistent with management's classification of its investment in debt and equity securities as available for sale, such investments are carried at fair value, with unrealized holding gains and losses reflected as a component of other comprehensive income, net of applicable deferred taxes. Fair values are based on quoted market prices, where available. For fixed maturity investments not actively traded, fair values are estimated using values obtained from independent pricing services. Short-term investments are principally money market funds and commercial paper with maturities of less than one year. Short-term investments are recorded at cost, which approximates fair value. Other investments are less than 20% equity interests in a non-traded real estate investment trust and an international equity limited partnership. The real estate investment trust is recorded at appraised value and the international equity limited partnership is recorded at its net asset value. Realized gains and losses on sales of investments are reported on a pre-tax basis as a component of income and are determined on the specific identification basis. When evidence indicates a decline, which is other than temporary, in the underlying value or earning power of individual investments, such investments are written down to fair value by a charge to income. Losses and Loss Adjustment Expenses The liability for unpaid losses and loss adjustment expenses represents management's best estimate of the ultimate cost of all such amounts which are unpaid at the balance sheet dates. The liability is based on both case-by-case estimates and statistical analysis and projections using the historical loss experience of Midwest Medical and gives effect to estimates of trends in claim severity and frequency. These estimates are continually reviewed and, as adjustments become necessary, such adjustments are included in current operations. Midwest Medical believes that the estimate of the liability for losses and loss adjustment expenses is reasonable. Reinsurance Midwest Medical purchases reinsurance in order to reduce its liability on individual risks and to enable it to write business at limits it otherwise would be unable to accept. Reinsurance contracts are principally excess-of-loss contracts, which indemnify Midwest Medical for losses in excess of a stated retention limit up to the policy limits. Reinsurance costs are recorded as a reduction of premium, which is known in the insurance industry as ceded premium. NOTE B - INCOME TAXES The Company calculates its federal income tax provision for interim periods by estimating its annual federal effective tax rate and applying this rate to the income of the interim period. The estimated annual federal effective tax rate used for the three and six-month periods ended June 30, 2002 and 2001 was 34%. An estimate for state income taxes is also made for each entity. 7 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, 2002 represents six months of unearned premium for every active policy renewed or newly written on January 1, 2002 with an expiration date of December 31, 2002. At December 31, 2001, most active 2001 policies expired and therefore had no unearned premium. Of the total unearned premium balance of $15,489,000 at December 31, 2001, $5,800,000 is reserved to recognize Midwest Medical's obligation to provide reporting endorsement coverage without additional premium upon the death, disability or retirement of policyholders. This amount represents an actuarial estimate of the present value of future benefits to be provided less the present value of future revenues to be received. The unearned premium balance at June 30, 2002 includes a $6,300,000 estimate for this obligation. The increase of $15,130,000 in premiums receivable from December 31, 2001 to June 30, 2002 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 $13,966,000 at December 31, 2001, $6,878,000 is for premium payments received from policyholders in advance of their January 1, 2002 policy renewal. No advance premium payments were recorded at June 30, 2002. NOTE D - POLICYHOLDER DIVIDENDS Midwest Medical's policyholder dividend program has been in place since 1999 replacing the previous retrospective premium credit program for physicians. Participating policies represented approximately 96% of total premiums in force and premium income at June 30, 2002 and December 31, 2001, respectively. The first two quarterly installments of the $4,050,000 policyholder dividend declared in the third quarter of 2001 by Midwest Medical's Board of Directors were paid in February and May, respectively. The remaining two quarterly installments will be paid to physician and clinic policyholders in August and November. The dividend is awarded proportionately based on annual premiums for physician and clinic policyholders that were insured by Midwest Medical in 1997 and remain insured throughout 2002. NOTE E - DISCONTINUED OPERATIONS Effective July 31, 2001, the Company sold all of the capital stock of MedPower Information Resources, Inc. to ClaimLynx, Inc. Proceeds from the sale were $150,000. The Company recorded a $240,000 loss on the sale net of an income tax benefit of $124,000. No significant assets or liabilities remain from MedPower. The Company's condensed consolidated financial statements and notes report its former electronic medical claims processor as discontinued operations. Prior periods have been restated accordingly. 8 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 $(5,290,000) and $(9,102,000)for the three and six-months ended June 30, 2002 and $(342,000) and $(5,964,000)for the three and six-months ended June 30, 2001. NOTE G - SEGMENT INFORMATION The Company's continuing operations are organized into five legal entity business segments. MMIC Business Office Solutions, Inc. (Office Solutions) began operations in February 2002 to provide physicians with business office outsourcing services. The main outsourcing service is the billing and collection of patient accounts. The other four segments are described under the "Background" section in Item 1 of the 2001 Annual Report on Form 10-K. The legal entity name of MMIHC Insurance Services, Inc. (Services) was changed to MMIC Benefits, Inc. (Benefits) in April 2002. 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, 2002 and 2001 (in thousands). 9 NOTE G - 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. 13 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 Insurance Company, MMIC Benefits, Inc., Midwest Medical Solutions, Inc., and MMIC Business Office Solutions, Inc. should be read in conjunction with the condensed consolidated financial statements and notes 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, 80% at June 30, 2002 and 86% at December 31, 2001, are invested in investment-grade bonds, equities, a real estate investment trust fund, an international equity limited partnership, and short-term investments. Other investments consist of equity interests in a non-traded real estate investment trust (REIT) and an international equity limited partnership. These investments are classified as available for sale and are therefore recorded at fair value. The fair value for the REIT is determined by the most recent independent appraisal and the fair value for the international equity limited partnership is determined by the period ending net asset value as reported by the limited partnership's custodian. In the second quarter of 2002, the Company completed a like-kind exchange that transferred its managed international equities account to the investment manager's international equity limited partnership. The transfer retains the Company's diversification in international equities while simplifying the administration and reducing the related investment expense. Operations generated $10,820,000 of positive cash flow during the first six months of 2002 compared to $(7,969,000) of negative cash flow for the same period of 2001. Growth in new business volume of approximately $12,600,000 and premium rate increases of approximately 18% on average per renewed account caused greater cash receipts in the first six months of 2002. Lower policyholder dividend payments also contributed to the positive cash flow. Increased reinsurance costs due to volume growth and reinsurance rate increases partially offset the above positive cash flows. Reinsurance, policyholder dividend, claim, and federal tax payments drove the negative operating cash flow in the first six months of 2001. The Company believes that its cash, internally generated funds and investments will be sufficient to meet normal operating requirements. The principal operating requirement is the payment of insurance claims. Loss and operating expense payments have been met from policyholder premium receipts during the first six months of 2002. Policyholder premium receipts are anticipated to cover loss and operating expense payments for the remainder of 2002 due to growth in new business volume and premium rate increases. Shareholders' equity decreased $(9,102,000) during the first six months of 2002. The decrease consisted of a net loss from operations of $(2,378,000) and net unrealized losses in the fair value of investments, net of deferred taxes, of $(6,724,000). 14 Results of Operations Net premiums earned increased $11,786,000 for the first six months of 2002 compared to the same period of 2001. New business generated approximately $5,434,000 of additional earned premium. Base rate increases and fewer premium discounts resulted in an average written premium increase of approximately 18% on policies that renewed in the first six months of 2002. This was partially offset by greater reinsurance costs. The greater premium volume coupled with an increase in 2002 reinsurance rates caused current year reinsurance costs to increase from $4,120,000 in 2001 to $6,629,000 in 2002. Although the exit of major competitors from the medical malpractice marketplace has created many opportunities to write new business, Midwest Medical remains selective in assuming new risks. The following provides further detail on premiums written and earned for the six months ended June 30, 2002 and 2001:

Net capital gains of $782,000 were realized during the first six months of 2002, a decrease of $(5,344,000) over the same period in 2001. The realized capital gains in the first six months of 2002 resulted primarily from bond sales initiated by the investment manager who manages the portfolio on a pre-tax total return basis. In the first six months of 2001, equities selected by the outside, domestic equity manager were sold to fund the additional REIT purchase of $10,000,000 and policyholder dividend payments. 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 $2,341,000 for the first six months of 2002, an increase of $805,000 from the same period of 2001. Most of this increase is due to Medical Solutions' revenue growth primarily from the practice solutions division. Practice solutions is a value added reseller of the NextGen electronic practice management (EPM) and electronic medical records (EMR) systems. Practice solutions generated $783,000 in new revenues from the sale, installation and support of NextGen systems in the first six months of 2002. Losses and loss adjustment expenses increased $12,718,000 for the first six months of 2002 versus 2001. 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 2002 incurred losses was in line with management's expectations due to Midwest Medical's growth in business and the corresponding 15 exposure as well as a recent upward trend in claims severity. Nothing came to management's attention during this period that would materially alter loss expectations for the remainder of the year. Underwriting, acquisition and insurance expenses increased $677,000 for the first six months of 2002 compared to the same period in 2001. Additional commissions and premium taxes resulting from the greater premium volume drove the increase. Other operating expenses increased $824,000 for the first six months of 2002 compared to the same period in 2001. The increase was primarily due to the practice solutions division of Medical Solutions becoming fully operational towards the end of 2001 and the launch of Office Solutions in the first quarter of 2002. The first six months of 2002 incurred an income tax benefit of $1,240,000 compared to an income tax expense of $1,312,000 for the same period in 2001. The effective tax rates were 34% and 36%, respectively. State income tax estimates caused the difference from the estimated annual federal effective tax rate of 34% in 2001. As a result of the factors discussed above, the Company recorded a net loss of $2,378,000 for the six months ended June 30, 2002 compared to net income of $2,177,000 for the same period of 2001. 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. 16 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 investments in equity securities and the international equity limited partnership, and foreign currency exchange rate risk on its investment in the international equity limited partnership. 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 and the international equity limited partnership by approximately $7,000,000 at June 30, 2002 compared to $7,800,000 at December 31, 2001. No material change occurred in the interest rate risk or the foreign currency exchange rate risk since the year ended December 31, 2001. 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 99.1 Chief Executive Officer Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 99.2 Chief Financial Officer Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (b) Reports on Form 8-K None 17 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 12, 2002 /s/ David P. Bounk --------------- ------------------------------------- David P. Bounk President and Chief Executive Officer Date August 12, 2002 /s/ Niles Cole --------------- ------------------------------------- Niles Cole Vice President and Principal Financial Officer and Principal Accounting Officer 18

MIDWEST MEDICAL INSURANCE HOLDING CO 10-Q